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Public finance and development: top things to read in July 2021

Written by Tom Hart

See all blogs in our public finance and development series.

It is hard to be optimistic this summer. Low- and middle-income countries are now bearing the brunt of the global pandemic. Vaccinating the world is the only way out of the pandemic, but both the G7 and G20 finance ministers’ meeting have failed to take the actions needed to speed this up, despite this being an action that would pay for itself: the heads of the International Monetary Fund (IMF), World Bank (WB), World Health Organization (WHO) and World Trade Organization (WTO) have called for an additional $50 billion of spending to end the pandemic, while forecasting that stronger economic growth would yield more than $1 trillion in additional tax revenues in advanced economies.

The IMF forecasts that high-income economies are going to recover quickly from the coronavirus crisis thanks to their large increases in public spending and relatively rapid roll-out of vaccines. But low- and middle-income economies, with the exception of China, are going to have slower recoveries, with output in 2024 still 8% below pre-pandemic forecasts. The latest World Bank estimates are that the crisis has led to nearly 100 million more people living in poverty in 2020. And it projects that poverty will continue to increase in low-income countries: ‘in the poorest countries of the world, the impact of COVID-19 on poverty is not only still present, but it is worsening’.

Where can we look for bright spots? The confirmation at the G7 and at the G20 finance ministers’ meeting of the deal on issuing $650 billion of Special Drawing Rights (SDRs) will give a much needed financial boost. But it is yet to be decided how to allocate the SDRs to ensure that they benefit the countries facing the largest fiscal pressures. And there is fierce debate on whether the global minimum 15% corporate tax rate will actually benefit developing countries.

A new Washington Consensus?

The 2021 Fiscal Monitor pointed out that whilst the increase in fiscal deficits in advanced economies was down to a roughly equal split between reduced revenues and increased spending, in low-income countries it came primarily from a collapse in revenues. It calls for policy-makers to balance the risks of growing debt with the premature withdrawal of fiscal support, which could slow the recovery, and to do this through credible medium-term fiscal frameworks, including improved fiscal rules, or ‘preapproving’ tax reforms. The fact that the IMF proposed a temporary ‘solidarity tax’ on high incomes or wealth to help protect spending on basic services and social safety nets made many headlines. A recent paper from the Center on International Cooperation takes a historical look at solidarity taxes.

While the Fiscal Monitor calls for more and better investment in education, health, early childhood development and social safety nets, other reports paint a more sobering picture. UNICEF points out that 20% of low- and middle-income countries spent more on debt service than on education, health and social protection combined, even before the coronavirus crisis. A report from Columbia University’s Initiative for Policy Dialogue examining the IMF’s projections warns of a premature and severe ‘post-pandemic fiscal austerity shock’ with spending cuts planned in 154 countries in 2021, and 50 countries projected to be spending less in 2021/22 than in 2018/19. They call for increased international support as well as for countries to examine whether a combination of increased tax revenues, a looser macroeconomic framework that allows higher spending, and reallocation of public expenditure can protect social spending. It is probably too soon to conclude that there is a new Washington Consensus in favour of big spending on basic services, fiscal stimulus and taxing the rich.

Benin has issued Africa’s first Sustainable Development Goals-related bond of around $590 million. It will use the proceeds to finance high impact Sustainable Development Goals projects and it has transparently set out the process and the framework for how it will use these funds. Ghana has also announced its intention to sell social and green bonds this year. A new book on debt in Africa argues that using such thematic bonds may be a good way for African countries to ensure that they borrow with purpose as well as build a sustainable brand.

Prospects for health spending

A new World Bank paper finds that unless countries increase the share of health in national budgets, health spending per capita will fall in 2021 and 2022. It calls for ministries of health and finance to work together on shared challenges of expanding fiscal space, increasing government funding for health, and improving the equity and efficiency of health spending.

A major challenge facing ministries of finance and health now is the financing and procurement of vaccines. A CABRI report and event surveyed the financing and procurement of vaccines by African governments, but found that there is limited public information on this. This is concerning as they point out that the uncertainties in pricing, volumes and timing of Covid-19 vaccines purchases require an unusual degree of budget flexibility, which calls for greater than usual levels of transparency. Keep an eye on their Covid Public Finance Response Monitor for further work on this.

To increase fiscal space, increasing health taxes on tobacco, alcohol and sugar holds potential. This thread and article take stock of sugar taxes in seven African countries. Five of the countries (Kenya, Zambia, Rwanda, Tanzania and Uganda) have taxes on non-alcoholic beverages, but these appear to be based on revenue rather than health concerns, unlike South Africa, which was the first country in sub-Saharan Africa to introduce a tax on sugary beverages for health reasons. A systematic literature review of sin taxes in Latin America reaffirmed the effectiveness of such taxes, finding that they reduced consumption of tobacco and sugary drinks, increased revenues and led to improved population health.

To increase government spending on health and improve its effectiveness, governments will need to cut wasteful or ineffective programmes and protect the most effective spending such as on essential medicines, immunisation and nutrition programmes, and primary health care. This is an example from Kenya of the kind of analysis governments should be drawing on to make these decisions.

But why might finance ministries reject even spending proposals with large future benefits? Using an example from the UK, the Institute for Fiscal Studies argues time-inconsistency, uncertainty over future effects and the need to make multiple trade-offs on multiple spending decisions at the same time may lie behind such decisions.

At the start of the pandemic, the success of countries such as Finland, New Zealand and Taiwan led many to ask if female leadership was making the difference. While the jury is still out on this, a new study does find that female leadership does impact health spending. For a sample of 155 countries between 2000 and 2016, having a female head of government leads to higher health spending. This joins older evidence from India that female-headed local governments had different spending priorities, spending more on the public investments that matter to women such as water.

Climate and public finance

Responding to climate change will require big fiscal outlays – even if some of these can be recouped through carbon taxes – but the most climate-vulnerable countries could face a double-penalty of higher borrowing costs as well, according to recent IMF research: ‘An increase of 10 percentage points in climate change vulnerability is associated with an increase of over 150 basis points in long-term government bond spreads of emerging markets and developing economies’.

How should countries track their spending on climate initiatives? That is the subject of a new World Bank report that reviews the experience of climate-budget tagging methodologies in 19 countries, and provides a useful summary of precursors to climate tagging: poverty tagging, gender-budget tagging, and budgeting for international development goals.

It finds that the main benefit of climate-budget tagging has been to increase transparency, but it is not clear if it helped to increase resources for climate activities or improve programme design. Major weaknesses include putting too much emphasis on quantifying climate spending, and not enough on the policy alignment, effectiveness and efficiency of spending, and not taking into account either spending which could have an adverse impact on climate or revenues which have climate impacts.

The report also notes that climate tagging can be a significant burden on budget officials. This needs to be taken into account in the design of systems, or they are unlikely to be sustained without ongoing external support. This is reflected in the key lessons, many of which are about ensuring that tagging systems are designed so that they help align spending with domestic climate policy goals and generate information that decision-makers can act on.

The report also reviews the lessons of climate-budget tagging for ‘green bonds’. As both require the definition of eligible expenditures and processes to select and report on expenditures, a climate-budget tagging system could support the issuance of green bonds, as has happened in Indonesia.

How should public financial management (PFM) systems take climate change into account? My colleagues Mark Miller and Bryn Welham take a sceptical look at Public Expenditure and Financial Accountability’s (PEFA) pilot climate change module. Just as climate-budget tagging has focused too much on ‘how much’ and not enough on ‘how effective’, they argue that this assessment will lead finance ministries to focus too much on PFM processes that may be fairly marginal for overall climate policy, and not enough on whether government policy as a whole (e.g. covering state-owned enterprises, local governments and regulation of the private sector) is meeting climate goals.

Last, but not least, we have also launched a new blog series on digitalisation and public finance, Budgets and Bytes. This first post covers the launch of the World Bank’s new GovTech Maturity Index.

Thanks to Shakira Mustapha for her inputs into this round-up.

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