Fiscal policy instruments and the political economy of designing programs to reach the poorest

1. Fiscal policy instruments and the political economy of designing programs to reach the poorest Ehtisham Ahmad October 2007 The views in this paper are personal and do not necessarily represent those of the IMF.

2. The issues • Information needed to identify the poorest • Generally those unable to participate in the labor market • Marginal groups without family support • Often excluded from formal programs: pensions or unemployment insurance • Information available to localities, but not easily to the center/donors

3. The issues (continued) • Local officials: may not have the appropriate incentives to implement “central programs” • “Capture by elites” • Absence of information on “outcomes” • In addition, overlapping responsibilities: • typically allow the local governments to “pass the buck” to the center

4. Policy instruments: taxation • Trend to centralize broad based taxes (VAT, CIT); e.g., China and Mexico • Need for some own-source revenues at margin for accountability • Poorer areas may lack resources to meet poverty spending

5. Policy instruments: transfers • Equalization transfers used in many advanced countries (Australia, China) • But may not ensure that needs of the poorest are met in all cases • Scope for targeted interventions? • Central government operations • Could be costly and administratively demanding • Central financing and local operations • Likely model: but possibility of leakages • Political economy considerations and policy design

6. The policy agenda: examples from Mexico and China • Can one use insights from developments in method to design programs to support the poorest? • Use of competition—both across regions as well as over time • Importance of defining program objectives; monitoring mechanisms/ • Contracts—enforceability? • Moves towards performance budgeting? • Sequencing of measures to move in this direction

7. Some experiences

8. Local provision: China • Wu bao (five guarantees)—minimum basic guarantee for those without family support (largely rural) • Reasonably well targeted • Based on community identification and support • Variance based on community/local government resources • Together with anti-poverty program, covered 6 percent of the rural population in early 1990s. • Variance in level of local support increases after market based reforms • Increasing difficulties in getting local governments to implement central programs • Grain silos (federal programs, financed by center, administered by local governments)

9. Central provision:Mexican insights • Mexican Progresa/Opportunidades regarded as successful central anti-poverty program • Together with Seguro Popular to top up health care for uninsured • Direct Federal administration • Coverage: 70 percent of rural population; 25 percent of total population • Disincentives to participate in the formal sector

10. Replication of Communidades • Red Solidaridad (El Salvador); Tekoporã (Paraguay) • Also direct central provision • Attempts to involve local governments not successful • Kudos to center; what’s in it for local politicians? • Clear example of “overlapping responsibilities” • What could be done by the center to better utilize local information and implementation? • Cost effectiveness is important

11. Hybrid: central finance, local provision • Di bao; largely urban program in China, since 1999 • local selection of recipients • Variable eligibility criteria • Central funding—0 in rich areas, 100 percent in Tibet • Protects center from open ended program, but possible exclusion of the poorest • Possibility of tighter central determination of criteria, without risk of open-ended costs? • Minimize incentives for local governments to misrepresent needs and divert resources

12. Method • Draws on “competition” models • Used horizontally in the external aid literature • Failure of conditionality in foreign aid Svensson J. (1999) and (2003) • Multi-tiered nested decision-making (Ahmad et al, 2002) • Intertemporal developments (simple 3-period model—Ahmad and Martinez, 2004) • Specific/conditional transfers to local governments • Appropriate feedback mechanisms or penalties • Inherent in multi-year budgets where future funds depend on intermediate performance targets.

13. Main result • Competition between recipient units and freedom of allocation over time (multi-year budgeting) reduce diversion of transfers towards local goals • Requires: • Clear definition of “outcomes” that can be monitored • Rather than just tracking of funds • Multi-year budgets

14. The model • Each year the central government distributes: • a transfer,2T, to regions A and B • A and B can, and prefer to, divert a share, maximum of F, of the transfer to their own goals • Center cannot monitor easily the use of funds/extent of diversion • But can tell if there are no “grain silos” being built • Number of wu bao individuals/families housed

16. Conclusion: Options • Direct central provision of the programs • Possible, but could be costly and demanding on administrative resources • Local provision, with own-financing, • leads to accountability, but • Variability of resources—poor regions worse off • Central financing of earmarked transfers, with local administration • Likelihood of diversion of resources, but....

17. ...there is an alternative • Introduction of competition plays a role in effective transfer design, • Even in the presence of overlapping competencies • Horizontal competition (using foreign aid literature seen insufficient to remove incentives to divert) • Multi-period budgets with future funds dependent on demonstrable outcomes the most effective instruments • Can credible contracts be designed? (i.e., will funds be cut-off for non-performance?)

18. Conclusions • Contracts should specify “outcomes”, introducing relative performance criteria • Can be developed over time, in moves towards performance budgeting • Preconditions: better monitoring of both non-financial and “costing” elements • More flexibility in cases where clarifying responsibilities may be a lengthy process (e.g., both Mexico and China)