Fiscal Space for Investment in Infrastructure in Colombia

1. Fiscal Space for Investment in Infrastructure in Colombia Rodrigo Suescún The World Bank January 2005

2. Fiscal Space for Investment in Infrastructure in Colombia Motivation Main Features of the Model The Model Simulation Results Creating Fiscal Space

3. Fiscal Space for Investment in Infrastructure in Colombia Motivation: In many countries productive public investment has been compressed in the process of fiscal adjustment Public investment contraction may entail a growth cost – unless offset by private initiative, which has not been generally the case This trend is not apparent in Colombia

6. Fiscal Space for Investment in Infrastructure in Colombia Motivation: Evaluation of Macroeconomic Policies in Colombia: Financial Programming Model

7. Fiscal Space for Investment in Infrastructure in Colombia Motivation: Financial Programming Model Growth rate is exogenous, independent of policies Timing of policies is irrelevant Expectations play no role No foward looking behavior No purposeful behavior

8. Fiscal Space for Investment in Infrastructure in Colombia Motivation: Financial Programming Model Focus on fiscal deficit and gross debt targets: distinction between current and capital spending is irrelevant Bias against public capital formation Static framework vs asset-creating nature and intertemporal trade-offs involved in public investment decisions:

9. Fiscal Space for Investment in Infrastructure in Colombia Motivation: Concerns Already high public debt (54% of GDP in 2003) Actual fiscal position (Overall budget deficit in 2003: 3.1% of GDP in consolidated) Future unfunded state pension deficit Risk Fiscal adjusment using capital spending (inflexible budget)

10. Fiscal Space for Investment in Infrastructure in Colombia General Objective: Construct a dynamic general equilibrium model to study economic behavior under alternative fiscal policies Two forces explain off-steady state dynamics Fiscal polices (perfect foresight) Current policies and economy off their steady state sustainable balanced growth path

11. Main Features of the Model • Small open economy • Two goods: home & foreign goods • Agents: household, firms and government sector • Central gov: current and capital spending, taxes on labor and capital income and consumption and domestic debt • Rest of gov: operates infrastructure, current and capital spending and budget surplus target to improve combined public sector finances • Upward-sloping supply of funds

12. Model • Three reproducible factors: infrastructure capital, business capital and human capital • Infrastructure capital

13. Model • Business Capital • Human capital

14. Model • Production Function • Firm’s problem: standard

15. Model • Household’s Problem Preferences

16. Model • Household’s Problem Budget constraint

17. Model • Household’s Problem

18. Model • Government

19. Model • Resource Constraints • Upward-sloping supply of resources

33. Creating Fiscal space • Golden rule • Permanent balance rule • Redefinition of the public sector