Public Expenditure in Latin America: Trends and Key Policy Issues

Public Expenditure in Latin America: Trends and Key Policy Issues Benedict Clements Western Hemisphere Department International Monetary Fund* ECLAC Fiscal Policy Seminar Santiago de Chile January 29, 2007 * The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

Outline • Latin American Public Spending: A Discontinuous March Upward • Key Expenditure Issues for the Region • The Reform Agenda: Making Government Expenditure More Efficient and Equitable

Trends in Public Spending Fiscal balances have improved in the region in recent years

Trends in PublicSpending Primary spending, however, has resumed its upward drift

Trends in PublicSpending Real spending has followed a procyclical pattern

Trends in PublicSpending Current spending has driven the rise in outlays...

Trends in PublicSpending …while capital spending has fallen as a share of outlays

Outline • Latin American Public Spending: A Discontinuous March Upward • Key Expenditure Issues for the Region • Cyclicality of spending • Public investment • Public employment • Social spending • The Reform Agenda: Making Government Expenditure More Efficient and Equitable

Cyclicality of Spending Expenditure is procyclical in all spending categories • Capital outlays are the most procyclical • Compared to other developing countries, a higher share of LA countries have procyclical spending • LA countries also have somewhat higher coefficients Estimates of the Short-Run Response of Spending to Output Shocks Source: Akitoby and others (2006).

Cyclicality of Spending There is no evidence of asymmetry Response of Expenditure to Output Gaps Dependent Variable: Primary expenditure to GDP • Output gap has a statistically significant impact on spending • Positive and negative output gaps have different coefficients, but the difference is not statistically significant * Significant at 10%; ** significant at 5%; *** significant at 1%.

Public Investment Public investment is lower than in other developing regions Public Investment in Latin America and Other Regions, 1990 – 2006

Public Investment Not all countries in the region, however, suffer infrastructure “lags”

Public Investment Infrastructure lags may also reflect inefficiencies in public investment • Efficiency can be assessed by evaluating the link between public investment and improvements in infrastructure • First step is to evaluate relationship between total infrastructure spending (public and private) and improvements in infrastructure using a nonparametric technique

D Efficient C A b’ Less Efficient b B X(A) X(B) Public Investment Infrastructure Production Possibility Frontier Output (improvements in infrastructure indicators) Y(A) Y(B) Input (infrastructure spending to GDP) The most efficient countries are those on the “production frontier” (ACD)

Public Investment Efficiency varies by country Aggregated Public Efficiency Scores 1/ Efficiency in various sectors (transport, electricity, water, telecommunications) aggregated using the share of public investment in each applicable sector. 2/ Adjusted by the effect of private sector spending on the efficiency score in each sector.

Public Sector Employment Public wage expenditure and employment are not high by world standards… Government Wages and Employment in Latin America and Other Regions, 2004 or latest year

Public Sector Employment …but the quality of government services remains low

Public Sector Employment Wide variance in wage bills and quality of civil service • No relationship between wage bill and quality of civil service • Institutional weaknesses remain in many countries (IADB, 2005 and Echerbarría and Cortázar, 2005): • Patronage in hiring and promotions • Absence of performance evaluation • Internal inequities in remuneration

Social Spending Social spending absorbs a high share of government outlays • Health and education spending in line with other regions • Social protection spending lower than OECD but higher than emerging Asia • Inefficiencies in spending have retarded gains in social indicators • Poverty remains high despite substantial social spending General Government Social Spending in Latin America and Other Regions, 2004 1/ Total includes housing and community amenities.

Social Spending The distributive effects of social spending varies • Social spending in Latin America is regressive – poorest 20% receive less than a fifth of the benefits • Tertiary education and social security spending largely benefit high-income groups • Primary education and social assistance spending primarily benefit the poor Latin America: Distribution of Benefits from Social Spending to the Top and Bottom Quintiles Source: ECLAC

Social Spending The success of targeted social assistance programs • Conditional cash transfer programs have expanded in recent years • Benefits have been well-targeted to the poor and have helped reduce poverty rates • However, these programs remain modest in size (1 to 1 ½ % of GDP) and are a small share of social spending

Outline • Latin American Public Spending: A Discontinuous March Upward • Key Expenditure Issues for the Region • The Reform Agenda: Making Government Expenditure More Efficient and Equitable

Taming cyclicality • Reducing spending growth during current cyclical upswing a key challenge • Fiscal rules to reduce spending growth could be helpful -- but need to be backed by effective enforcement • Reducing spending volatility will help improve the efficiency of spending

Making government spending more efficient • Infrastructure lags reflect inefficiencies in public investment • Large efficiency gains possible by adopting best practices of most efficient countries • Quality of civil service varies widely • Reform efforts to tackle institutional weaknesses

Improving the equity of spending • Continued reform of social insurance schemes • Make education spending more pro-poor • Increase user fees in tertiary education, combined with scholarships for low-income households • Improve quality of secondary education to reduce repetition rates and broaden access to tertiary level • Expand targeted social assistance programs

Public Expenditure in Latin America: Trends and Key Policy Issues