The Economics of “Fiscal Space”

1. The Economics of “Fiscal Space” Shanta Devarajan World Bank

2. Two tautologies • Increasing the fiscal deficit to spend on productive expenditures may lower the debt-to-GDP ratio

3. Two tautologies (cont’d)

4. Two questions • Which components of K1,K2,K3,G1,G2 are “productive”? • Empirically estimate (Barro, Easterly and Rebelo, Devarajan-Swaroop-Zou) • A priori classification (infrastructure, health, education are productive, defense is not) • Problem: Public spending on some components (such as health, education) are not necessarily aimed at growth

5. Bigger problem: Public spending does not even achieve health and education * Percent deviation from rate predicted by GDP per capita Source: Spending and GDP from World Development Indicators database. School completion from Bruns, Mingat and Rakatomalala 2003

6. Bigger problem: Public spending does not even achieve health and education * Percent deviation from rate predicted by GDP per capita Source: Spending and GDP from World Development Indicators database. Under-5 mortality from Unicef 2002

7. Determinants of infant mortality in Malaysia

8. In 1995, survey of 250 primary schools in 19 of 39 districts; Grants for Primary Education in Uganda Primary Education in Uganda (PETS) US$ per Student 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1995 1994 1993 1999 1990 1991 Intended Grant Amount Received by School (mean)

9. All India Teacher Absence Map (Public Schools) Source: Kremer, Muralidharan, Chaudhury, Hammer, and Rogers. 2004. “Teacher Absence in India.”

10. India 2003: Doctor absence from primary health clinics by state and reason

11. Two questions (cont’d) • Is an appropriate rule-of-thumb? (Agenor, IMF) Rules v. Discretion

12. Implications for modeling exercise • Analytical models • Incorporate government failure (time-inconsistency) • Empirical estimates of public sector inefficiency • What to do about it?