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Public finance and development: top reads in October 2022

Written by Tom Hart, Danielle Serebro

Expert Comment

See all blogs in our public finance and development series.

October saw the IMF and World Bank Annual Meetings. There was much concern about the impact of food price spikes on the poor and the increasing vulnerability to debt crises faced by many countries. However, according to former US Treasury Secretary Larry Summers, the meeting was ‘not going to be remembered for anything except being a missed opportunity’ for increasing support and easing the debt burden for low- and middle-income countries, and accelerating the transition to a low-carbon economy. Rathin Roy reminds us amid talk of a ‘polycrisis’ not to forget the increase in extreme poverty.

This week, we cover the IMF’s Fiscal Monitor and World Bank’s annual Poverty and Shared Prosperity report, which this year focuses on fiscal policy. We also look at some recent papers on fiscal rules, revenue forecasting and managing health spending.

Bouncing back or tightening harmfully?

The IMF’s bi-annual Fiscal Monitor reports that most of the fiscal unwinding from Covid-19 (in terms of reducing deficits) has already happened. It argues that continued fiscal tightening is appropriate to ensure the coordination of monetary and fiscal policy at a time of high inflation. It presents a survey of the actions taken by 174 countries to combat high energy and food prices (the former mostly in higher-income countries, the latter in lower-income countries). The most common measures are energy subsidies and tax waivers, which the Fiscal Monitor argues are not well targeted and do not allow price signals to work to curb energy use and increase supply.

It highlights that governments, especially in countries with high levels of debt, face increasingly difficult trade-offs in tackling the spikes in food and energy prices when the responses to the Covid-19 pandemic have exhausted fiscal space. It recommends targeted support that prioritises protecting vulnerable groups while continuing to tighten fiscal policy, and states that many low-income countries will need greater humanitarian assistance and emergency financing to cope.

Taking a longer view, what can countries do to build resilience to these kinds of shocks? The monitor outlines three sets of policy actions for countries: ensure there is a fair tax system in place, establish a scalable social protection system, and build fiscal buffers in good economic times.

A very different perspective on the fiscal tightening can be found in Eurodad’s new End Austerity report. Based on IMF projections, it points out that 143 countries – including 94 developing countries, and 85% of the world’s population – are reducing spending on education, health and social protection. Rather than cutting spending, the report argues that governments should identify alternative financing options to maintain fiscal space.

Growing fears of a global debt crisis

UNDP has identified 54 low- and middle-income countries with severe debt problems in a new report, and proposes reforms to the G20 Common Framework focusing on issues of official creditor coordination, private creditor participation, and the use of state-contingent debt clauses that target future economic and fiscal resilience.

UNAIDS warns that rising debt repayments put HIV and other health investments in danger. The 73 low- and middle-income countries eligible for the G20 Debt Service Suspension Initiative collectively spent four times more on debt repayments than health in 2020, and 37 of these countries spent more on debt service than health.

In response to these issues, the World Bank chief economist has called for ‘another round of structured debt relief, because that’s what HIPC was. The Common Framework is case by case, and case by case means the weak lose. Poor countries that can’t negotiate for themselves get a lousy deal. HIPC meant everybody got the same deal.’ Could Most Favoured Creditor clauses break the logjam in debt restructuring?

Fiscal policy to reduce poverty and inequality

Further analysis of fiscal policy options to reduce poverty and inequality come from the World Bank and my colleagues here at ODI. The second half of the World Bank’s annual Poverty and Shared Prosperity report – which updates the World Bank poverty estimates in the aftermath of the Covid-19 food and energy price shocks – looks at the impact of the fiscal policy response to Covid-19 on poverty and inequality, and how it can be improved. It finds that while global poverty may have increased by nearly 90 million people, this would have been much higher in the absence of the fiscal policy response (but while fiscal policy fully offset the impact of the pandemic on poverty in most high-income countries, upper-middle-income economies only offset one-half of the impact, and low- and lower-middle-income economies one-quarter of the impact).

In two-thirds of the 94 countries surveyed, there is a drop in income for the poorest 10% due to the impact of taxes and transfers. It recommends three sets of policy actions to correct this. First, reorient spending away from poorly targeted subsidies (such as energy subsidies that often benefit the rich) towards targeted support to poor and vulnerable groups, such as cash transfers. Second, increase public investment in human capital, infrastructure, and research and development to support long-run development. Third, mobilise revenue without hurting the poor by making personal and corporate income taxes more progressive, utilising property and carbon taxes and ensuring cash transfers offset the effect of indirect taxes on the poorest households.

My colleagues’ new paper also presents a comprehensive survey of the impact of taxes and social spending on inequality and poverty, arguing that the variation we see across countries shows scope for improved policies. This is especially important given concerns that inequality in Africa is systematically under-estimated.

There is also a new review of the evidence on social protection programmes from Nobel Prize winner Abhijit Banerjee and others, which looks at how social protection programmes can be designed in low- and middle-income countries, and how they can be targeted and implemented. It also reviews their challenges and potential. Complementary to this, the ILO has released a review of demand-side policies for employment promotion in low- and middle-income countries, and how they can support job creation in a developing country context.

Finance ministries seeking to reallocate funds towards social spending or public investment would do well to read the IMF’s new ‘how to’ note on spending reviews: ‘the process of conducting in-depth assessments of existing public expenditure in order to identify opportunities to reduce or redirect spending from low-priority, inefficient, or ineffective spending’.

Fiscal rules

Two new papers on fiscal rules argue that they need to be carefully designed to take account of the trade-offs involved. The IMF examines national fiscal rules in the aftermath of the pandemic, contending that this is an opportunity for a rethink to allow fiscal policy to be more agile without undermining sustainability. It also argues for a framework that combines standards, rules and strengthened institutions.

The OECD considers fiscal rules at the sub-national level and argues that trade-offs must be considered in their design, since it is challenging to formulate fiscal rules that simultaneously promote fiscal sustainability, foster economic stability and improve the allocation of resources.

The potential of real-time data

Statistics became a prominent part of our lives during the pandemic. Our screens were filled with journalists, experts and politicians discussing the daily, weekly and monthly movements in key trends. This new ODI paper from David Rosenfeld discusses the UK experience of using real-time indicators (RTIs) for economic decision making. He notes that ‘government can act rapidly and flexibly to develop innovative alternatives to slower, traditional statistics, with considerable impact at times of emergency’, but that the capability to do so requires investments in data skills and infrastructure well in advance of the emergence of a crisis. It also requires governments to put in place secure arrangements for sharing data across government and beyond.

In lower-income contexts where traditional statistics (such as GDP) are often produced with even longer lags and lower frequency, RTIs can be useful for policymakers who are trying to keep track of what is happening in the economy. Recent papers from the IMF and IADB use machine learning to identify RTIs that have the most predictive power for nowcasting GDP. However, as Rosenfeld notes, policymakers should view RTIs as complements to, and not substitutes for, traditional statistics. Cutting-edge techniques should not distract attention and divert resources from the hard work of building the capability to produce timely and reliable traditional statistics. After all, RTIs are of little use unless you know what they are trying to predict.

Improving revenue forecasting

On the subject of prediction, the importance of better forecasting is shown in two recent papers on the budgetary problems caused by poor forecasts and the challenges in evaluating them. ODI associate Marco Cangiano and colleagues compare the revenue and expenditure forecast in budgets in Rwanda, Senegal and Uganda with outturns and find that these countries do pretty well in forecasting revenues. Previous studies had found an average over-estimation of 10%, but average errors are significantly less in these countries over the last 20 years, although they caution that Uganda has overestimated revenues since 2008. These forecast errors, however, come from external grants, which are much more volatile, and from non-tax revenues, rather than from tax revenues.

They argue that independent scrutiny of annual government forecasts and transparency in the estimation methods deployed are essential to improve the credibility of the budget process. A recent OECD Journal of Budgeting article examines this issue in the context of economic forecasts in OECD countries, and provides some suggestions for how to do this well.

Improving the management of health spending

A blog from USAID’s Local Health System Sustainability Project reflects on how health ministries can improve budget execution, with an accompanying deep dive into Lao PDR, Malaysia and Kenya. It reminds us that finance and health ministries must work collaboratively to improve health sector budget execution; that health budget reform is a long-term commitment that should be approached incrementally; and that strengthening sub-national financial management is fundamental for improved budget execution.

The WHO has sought lessons from the pandemic on how to use PFM for effective response to health emergencies. It concludes that countries are better off strengthening their core PFM systems than setting up parallel or extra-budgetary mechanisms that exacerbate the fragmentation of health financing and that are unlikely to promote the efficient use of public resources in responding to health emergencies.

This chimes with a recent IMF review of unorthodox expenditure procedures in francophone Central and West Africa, which found that spending practices that bypass regular budget controls and rules result in the accumulation of arrears, inadequate reporting and vulnerability to corruption. Like Chesterton’s fence, we should always first ask why these procedures exist before we seek to reform them.

Is Decentralisation Friend or Foe to Agile Public Financial Management in Health? ask Thinkwell and WHO. They also emphasise the importance of sub-national PFM capacity and discuss how decentralisation has shaped PFM processes in health. They argue that decentralisation has complicated health budgeting, with misalignments in budget structures across levels of government impeding effective planning. This may be true, but it misses the point that these messier structures might actually do better than a ‘simpler’ centralised structure in raising the quality of spending. This paper draws on four country case studies and is complemented by another synthesis report on how devolution has impacted health financing functions. It argues that the continued fiscal dependence of sub-national governments on central government means that the latter will need to continue driving spending towards UHC. We agree, but since decentralisation has been a major reform in many countries over the last 30 years, the appropriate role and functions of a health ministry in a decentralised health system – and how these functions can be performed well – seems a woefully under-studied area.

Managing the transition away from development assistance for health is a major concern for many middle-income countries that are close to meeting eligibility limits. A new review highlights some of the challenges countries have faced in transitioning, and the good practices that have facilitated smoother handovers.