Fiscal Implications of Scaling up aid to deal with the HIV/AIDS epidemic

1. Fiscal Implications of Scaling up aid to deal with the HIV/AIDS epidemic Bernard Walters School of Social Sciences University of Manchester Manchester Date: 20th – 21st November, 2006 Brasilia, Brazil

2. Questions: • What is the correct relationship between fiscal and monetary/exchange rate policy? • Will Aid-fuelled fiscal policy choices increase the chances of Dutch Disease? • Will Aid-fuelled fiscal policy choices have an impact on inflation? • Are there likely to be diminishing returns to aid and can these be ameliorated?

3. The purposes of aid Gupta et al. (2005) note 3 broad motives for aid • Humanitarian Relief • Aid which influences long term growth • Aid which influences short term growth Aid to relief suffering from HIV/AIDS falls under 1. Implications: • Spending decisions should be made according to characteristics of the epidemic • Reflects the notion that economic growth may be an inappropriate metric for judging aid effectiveness • The MDGs have no necessary connection with growth

4. So: • This implies the need to work back from disease characteristics, treatment technologies to spending priorities, to fiscal projections to aid needs. • But • Is a major undertaking in itself • It must incorporate assumptions about the relationship between • Commitments and disbursements • Volatility of aid • Predictability of aid • And likelihood of aid decreasing before the end of the programme • The trajectory of domestic revenue • In addition, there is an extremely large variability in the extent of the disease in different countries • Countries differ significantly in their other social and economic characteristics • So country specific analysis and policy design is necessary

5. Further observations • Aid for HIV/Aids is going to countries, for the most part, which are already very aid dependent • In terms of the ODA/GDP ratios • In terms of the ODA/Government Spending ratios • A general rise in aid to achieve the MDGs is proposed and is, to some extent, under way. • Context: • Spending on HIV/Aids is, in many circumstances a relatively small proportion of the general increase in aid. • In many cases in countries which are extremely aid dependent

6. Absorbing and Spending Aid • Aid is neither absorbed nor spent • Aid is absorbed but not spent • Aid is spent but not absorbed • Aid is absorbed and spent Clearly in the context of humanitarian relief aid must be both absorbed and spent The fiscal deficit must rise, financed by the domestic counterpart to the aid inflow. This requires fiscal and monetary policy co-ordination

7. The impact of aid on production possibilities • If all aid spent on imported goods then absorption and spending are identical; no effect on domestic production possibilities • If the aid requires complementary domestic inputs the aid allows imports to provide tradable goods from abroad releasing domestic resources, previously devoted to tradable activities. • This is usually effected by changes in the relative price between sectors • i.e. the tradable sector contracts and non-tradables expand

8. Observations • Spending on HIV/Aids is likely to have a very high import content • Shifts in resources between the sectors is the correct response to the new set of relative prices • So long as expectations about aid are realised • Historically aid disbursements have been far below commitments • Aid volatility has always been high • Resources can be extracted from inactivity as well as alternative activities

9. Aid and Dutch disease • The unwelcome consequences of increased spending are usually because there is a fear that appreciation will reduce the rate of growth • But this requires production possibilities to be endogenous to the aid inflow • e.g. Learning by doing externalities in the tradable sector • But • There are other externalities which can be positive • Externalities in the non-tradable sector • Externalities flowing from import exposure • HIV/AIDS funding must be seen within the broader MDG increase in funding • There are likely to be complementarities • Production possibilities are responsive to policy

10. HIV/Aids spending and production possibilities • Anti-retroviral drug treatment works rapidly to restore the ability to work • Effective labour supply will respond quickly • Over a longer period effective treatment will alter the stock and growth of human capital • Alters lifetime income • Alters life expectancy • Alters investment in children’s education • Improves intergenerational transfer of knowledge • These mechanism echo the way in which endogenous growth theory suggests increasing returns are possible • Suggests the growth dividend from rapid and effective treatment is possible

11. Dutch disease? • Evidence is extremely mixed • Evidence that central banks are very worried about this • For this reason cross sectional evidence is hard to interpret; many of the countries have not absorbed the aid • But • Size of the proposed increases make the recent past an unreliable guide • Very strong grounds for co-ordinating aid spending for other MDGs with that for HIV/AIDS • Central Banks and Fiscal authorities need to have a co-ordinated approach

12. HIV/Aids spending and inflation • A variation on the literature on Dutch disease is that increased aid will trigger an inflation which will de-stabilise the macroeconomic environment and reduce growth • Central banks have been cautious and • Adopted conservative inflation targets • Fiscal deficits have been conservative

13. Observations • The fiscal deficit is supposed to rise • A change in the relative price between sectors is a necessary condition for a resource transfer • A relative price change is most easily accommodated by a temporary inflation in that sector • Will this generate sustained inflation?

14. Observations • There is no reason for overall aggregate demand and supply to be unbalanced: the rise in G should correspond to the rise in M if the aid is absorbed. • High infection countries will have a very high import content, ameliorating the necessary change in prices • Resources can be drawn from inactivity • Supply constraints can be an objective of policy • In the short to medium term HIV/AIDs therapies seem likely to expand aggregate supply

15. So • No necessary reason to expect de-stabilising inflation • But: • Spending without absorption is a recipe for inflation • Spending above absorption may occur: • Spending may be predicated on commitments which do not translate into disbursements

16. Diminishing returns to Aid? • Sub-Saharan African countries have weak health care systems • Increases in aid are far larger, in many cases, than the pre-existing budgets • Human resources are a very large part of these budgets • Out-migration of the higher paid health professionals is considerable

17. However, • Evidence suggests that some of these capacity constraints are only short term • Supply constraints can be addressed by policy • Direct expenditures towards training and re-training • Structure programmes to use less well trained outworkers • Direct expenditures to healthcare infrastructure • Donor agencies could allow greater flexibility • Effective HIV/AIDS therapy will improve productivity in this sector • Other MDGs programmes should ameliorate some of the supply constraints

18. Observations on fiscal sustainability • HIV/AIDS treatment is likely to lead to both a short term and long term improvement in revenue collection • Anti-retroviral treatment raises people’s ability to work and pay taxes. This effect is likely to be considerable. • Treatment reduces expenditure in the future

19. Fiscal Sustainability • Partly a function of method of aid transfer chosen • Debt relief is fully predictable • Grants do not lead to future debt burden • Concessional lending is more problematic as it implies a debt for which resources must be planned • Partly a function of the commitment of the donor community to delivering on its promises

20. Conclusions • Case studies linking disease characteristics to fiscal and aid requirements are necessary on a case-by-case basis. • HIV/AIDs expenditures need to be co-ordinated with other MDG policies • Aid should be absorbed and spent • There is an urgent need for fiscal and monetary policy co-ordination • There is no necessity for Dutch Disease effects but: • composition of overall aid expenditures is important • Aid needs to address supply side constraints • Disbursements need to match commitments • Volatility must be reduced

21. Inflation is not an inevitable consequence of increased aid inflows • A short term increase in inflation and an increased fiscal deficit are part of the process of aid spending • But • Spending without absorption or at a faster rate than absorption are likely to inflationary • Co-ordination of fiscal and monetary policy is necessary • Donor behaviour must be more consistent and predictable

22. Diminishing returns to aid is a danger • But • Supply constraints can be addressed • Donors can follow more flexible policies • Interaction with other MDG policies important • HIV/AIDs therapies are likely to have positive effects on government revenues in both the short and long term • But fiscal debt sustainability remains a danger • Partly a function of composition of aid • Partly reflects donor commitment