1. Public Expenditure in the new Development Consensus Anand Rajaram, PRMPS PEAM Core Course January 12, 2004

2. A.Rajaram PEAM 20042 Outline Role of PE in the new development consensus The challenge for PE work Substance – policy and institutions Process – collaborative Elements of a new approach

3. A.Rajaram PEAM 20043 Development Assistance In 2001, ODA from the DAC countries was US$57.9 billion. In 2001(FY02), Bank lending amounted to $ 19.5 billion of which 50% was adjustment lending. In the context of the MDGs, there has been a lot of debate as to how much more aid is needed to reach targets set for 2015 – (est. $16 billion-$50 billion) Presumption – aid, and, by extension, public spending, is a critical constraint to outcomes

4. A.Rajaram PEAM 20044 Aid, Policies and Institutions While a part of the development discourse is about increasing aid, there is still limited recognition that institutions and policies matter for aid (and the public spending it finances) to improve outcomes We know from Dollar, Pritchett, et.al. that institutions and policies also matter for growth

5. A.Rajaram PEAM 20045 Aid can have perverse effects Governments are besieged by demands from interest groups – including diverse donors with financial influence and agendas Such pressures often contribute to sub-optimal outcomes where capacity is weak Policy “steering” by aid agencies (undermines ownership and weakens internal policy debate) Competitive donor promotion of projects, corruption Capacity diminution - donors poach limited capacity to staff PIUs Little attention to budgeting, public administration or service delivery In this scenario, countries develop in spite of, not because of, development assistance

6. A.Rajaram PEAM 20046 A revealing experiment - recent 18 country exercise to evaluate prospects for the MDGs Difficult for a number of reasons Limited time –had to rely on existing analysis Aid-growth-MDG links are difficult to assess Projecting growth using ICORs – not very robust since composition of investment matters Time frame – 12 years – some constraints can be relaxed which implies Non-linearities Direct and indirect effects have to be factored Cross sector effects are important No ready methodology to assess impact of investment in rural roads or safe water on maternal or infant mortality

7. A.Rajaram PEAM 20047 We know economic growth is an important influence on development outcomes (WDR 2004)

8. A.Rajaram PEAM 20048 But public spending on directly related sectors and outcomes are often weakly related (WDR 2004)

9. A.Rajaram PEAM 20049 Missing variables Intuitively, differences in policies and institutions could explain the weak relationship across countries WDR identified some core elements: Budget policy and management Organization of tiers of government Quality of public administration

10. A.Rajaram PEAM 200410 MDG exercise..roughly Identified country specific policy and institutional constraints based on knowledge of country team, and derived Actions to stimulate private sector Actions to improve public sector capability Actions to improve basic service delivery to poor Results under 2 scenarios –status quo and with better policies/institutions and more aid

11. A.Rajaram PEAM 200411 With reform, aid could help achieve many, but not all MDGs

12. A.Rajaram PEAM 200412 Consistent with the Monterrey partnership, the DC concluded that.. “Developing countries will have to strengthen policies and governance so as to ensure that domestic resources, private inflows and aid can be used effectively in spurring growth, improving service delivery and reducing poverty.” “Developed countries will need to move vigorously in supporting these efforts with more and better aid, debt relief and improved market access.” Dev.Committee Communique, Sept.2003

13. A.Rajaram PEAM 200413 What must change to implement this consensus? Home grown policy – from PRSP or other process, responsive to country priorities Effective resource management by country to implement policy Support from donors to help strengthen, not undermine, govt. capacity to manage resources This requires a better understanding of govt. policies, institutions, systems and processes and medium to long term strategies to improve them (no quick fixes)

14. A.Rajaram PEAM 200414 This New Development Consensus Raises the Bar and the Challenge for PE work Will need to undertake more systematic assessment of public finance (tax and spending) and its impact on growth and poverty Country level PE work will have to clarify and check the links between public spending and outcomes Cannot assume that allocations get translated into service delivery Will require more work at lower levels of government – assessment of the central government budget will not suffice Must be able to assess overall government budget, not a selective appraisal

15. A.Rajaram PEAM 200415 PE work has two main strands

16. A.Rajaram PEAM 200416 The Basis for PE Policy analysis derives from Public Economics Competitive markets yield Pareto efficient outcomes, for any given distribution of income (Fundamental theorem of welfare economics) But state intervention may be needed when : Lack of competition Incomplete market Public good (non-rivalry in consumption, non-excludability) Externality (social cost/benefit differs from pvt.cost/benefit) Macroeconomic instability Equity concerns provide another reason for intervention, through public finance

18. A.Rajaram PEAM 200418 Even with a market failure, some interventions may not be efficiency enhancing Inefficient program administration weakens the case for intervention If taxation or borrowing depresses private production or investment, it would offset some or all of the benefit Other sessions today and tomorrow will show how these ideas can be applied to sector analysis

19. A.Rajaram PEAM 200419 But efficiency is a static concept How does one assess the composition of the budget in terms of its contribution to growth or medium term poverty reduction? Need integrative next-level analysis to take assessment of sector expenditure in terms of standard static efficiency-equity to take account of dynamic, cross-sector interactions.

20. A.Rajaram PEAM 200420 Basis for PE Management Analysis is New Institutional Economics The budget is a common property resource and subject to problems of collective action (free rider behavior, prisoner’s dilemma) Pradhan and Campos (1996) defined it in terms of the “tragedy of the commons”. Effective systems devise institutional arrangements and incentives to enable achievement of budgetary goals at 3 levels Fiscal discipline Strategic resource allocation Technical efficiency Sessions tomorrow will discuss how a budget system can be assessed in terms of its capability to achieve these goals

21. A.Rajaram PEAM 200421 On Bank and Fund collaboration Collaboration has been less than perfect Fund takes the lead on advising on the aggregate fiscal stance, the Bank on composition of public spending Recently, greater flexibility in Fund on what the appropriate fiscal stance could be ( see IEO paper and Balducci, et.al.) On PEM, both institutions have a role

22. A.Rajaram PEAM 200422 Internal Bank collaboration Needs to be improved No network has the full range of skills to assess PE policy and institutions But collectively, skills exist On institutions, PREM, FM and Procurement have forged closer relations On policy, we need to initiate cross network collaboration of broad scope (PREM-HD underway, others to follow)

23. A.Rajaram PEAM 200423 PER coverage

24. A.Rajaram PEAM 200424 New approach to PE work Support country-owned PE reform strategy Coordinate diagnostic work among donors to reduce transaction cost for countries Coordinate technical and advisory assistance to countries Measure performance of PE system periodically

25. A.Rajaram PEAM 200425 Strengthened Approach to Public Expenditure work 2 Government PFM Reform Strategy and Action Plan Coordinated program of capacity building work Donor country Assistance Strategy Government/Donor Policy Dialogue Standardized Assessment Performance indicators