1. Public Expenditure in Latin America: Trends and Key Policy Issues Benedict Clements Western Hemisphere Department International Monetary Fund* ECLAC Fiscal Policy Seminar Santiago de Chile January 29, 2007 January 29, 2007 * The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

2. 2 Outline  Latin American Public Spending: A Discontinuous March Upward  Key Expenditure Issues for the Region  The Reform Agenda: Making Government Expenditure More Efficient and Equitable

3. 3 Outline  Latin American Public Spending: A Discontinuous March Upward  Key Expenditure Issues for the Region  The Reform Agenda: Making Government Expenditure More Efficient and Equitable

4. 4 Fiscal balances have improved in the region in recent years Trends in Public Spending

5. 5 Primary spending, however, has resumed its upward drift Trends in Public Spending

6. 6 Real spending has followed a procyclical pattern Trends in Public Spending

7. 7 Current spending has driven the rise in outlays... Trends in Public Spending

8. 8 …while capital spending has fallen as a share of outlays Trends in Public Spending

9. 9 Outline  Latin American Public Spending: A Discontinuous March Upward  Key Expenditure Issues for the Region Cyclicality of spending Cyclicality of spending Public investment Public investment Public employment Public employment Social spending Social spending  The Reform Agenda: Making Government Expenditure More Efficient and Equitable

10. 10 Expenditure is procyclical in all spending categories  Capital outlays are the most procyclical  Compared to other developing countries, a higher share of LA countries have procyclical spending  LA countries also have somewhat higher coefficients Cyclicality of SpendingTotalSpending Primary Spending Current Spending Wages and Salaries Capital Spending Latin America 1.571.791.221.525.91 Share of Latin American countries with sig. coeff. 46.266.733.346.269.1 Share sig. for 35 other dev. countries 31.340.040.028.145.2 Avg. coeff. for 35 other dev. countries 1.181.751.031.201.38 Estimates of the Short-Run Response of Spending to Output Shocks Source: Akitoby and others (2006).

11. 11 There is no evidence of asymmetry Cyclicality of Spending System GMM regressions Lagged dependent variable 0.44(3.06)***0.49(3.50)*** Output gap 0.08(2.30)*** Output gap (when positive) -0.08(0.72) Output gap (when negative) 0.17(1.78)* Log terms of trade 0.03(0.01)-0.25(0.09) Response of Expenditure to Output Gaps Dependent Variable: Primary expenditure to GDP  Output gap has a statistically significant impact on spending  Positive and negative output gaps have different coefficients, but the difference is not statistically significant * Significant at 10%; ** significant at 5%; *** significant at 1%.

12. 12 Public investment is lower than in other developing regions Public Investment 1990 – 94 1995 – 99 2000 – 04 2005 – 06 Latin America 4.74.94.34.5 Africa7.97.77.68.2 Asia9.18.78.18.4 Central and Eastern Europe 3.63.83.83.8 Public Investment in Latin America and Other Regions, 1990 – 2006

13. 13 Not all countries in the region, however, suffer infrastructure “lags” Public Investment

14. 14 Infrastructure lags may also reflect inefficiencies in public investment  Efficiency can be assessed by evaluating the link between public investment and improvements in infrastructure  First step is to evaluate relationship between total infrastructure spending (public and private) and improvements in infrastructure using a nonparametric technique Public Investment

15. 15 Infrastructure Production Possibility Frontier Input (infrastructure spending to GDP) Output (improvements in infrastructure indicators) Y(A) Y(B) Public Investment X(A)X(B) A B C D b’ b Efficient Less Efficient The most efficient countries are those on the “production frontier” (ACD)

16. 16 Efficiency varies by country Public Investment Adjusted Public Efficiency 1/ 2/ Adjusted Rank Adjusted Level of Public Efficiency Mexico0.8241High Chile0.7322High Peru0.5983Medium Argentina0.5304Medium Brazil0.4325Medium Colombia0.2536Low Bolivia0.0367Low Aggregated Public Efficiency Scores 1/ Efficiency in various sectors (transport, electricity, water, telecommunications) aggregated using the share of public investment in each applicable sector. 2/ Adjusted by the effect of private sector spending on the efficiency score in each sector.

17. 17 Public wage expenditure and employment are not high by world standards… Public Sector Employment Wages, as a percent of GDP General government employment as percent of total employed, 1990s Latin America 7.020.4 Asia5.717.2 Eastern Europe and Central Asia 7.942.3 Middle East and North Africa 10.650.3 Sub-Saharan Africa 9.628.4 OECD12.121.0 Government Wages and Employment in Latin America and Other Regions, 2004 or latest year

18. 18 …but the quality of government services remains low Public Sector Employment

19. 19 Wide variance in wage bills and quality of civil service  No relationship between wage bill and quality of civil service  Institutional weaknesses remain in many countries (IADB, 2005 and Echerbarría and Cortázar, 2005): Patronage in hiring and promotions Patronage in hiring and promotions Absence of performance evaluation Absence of performance evaluation Internal inequities in remuneration Internal inequities in remuneration Public Sector Employment

20. 20 Social spending absorbs a high share of government outlays  Health and education spending in line with other regions  Social protection spending lower than OECD but higher than emerging Asia  Inefficiencies in spending have retarded gains in social indicators  Poverty remains high despite substantial social spending Social SpendingEducationHealth Social protection Total 1/ Latin America 4.22.65.412.7 Emerging Asia 3.51.32.28.4 Eastern Europe and Central Asia 4.84.412.122.8 Middle East and North Africa 4.22.01.89.1 Sub-Saharan Africa 5.52.93.713.8 OECD6.46.917.332.6 General Government Social Spending in Latin America and Other Regions, 2004 1/ Total includes housing and community amenities.

21. 21 The distributive effects of social spending varies  Social spending in Latin America is regressive – poorest 20% receive less than a fifth of the benefits  Tertiary education and social security spending largely benefit high- income groups  Primary education and social assistance spending primarily benefit the poor Social Spending Poorest Quintile Richest Quintile Education20.220.4 Primary Primary29.07.9 Secondary Secondary13.218.3 Tertiary Tertiary1.952.1 Health20.652.1 Social security 5.617.6 Total social spending 15.030.4 Shares of quintile in primary income 3.656.4 Latin America: Distribution of Benefits from Social Spending to the Top and Bottom Quintiles Source: ECLAC

22. 22 The success of targeted social assistance programs  Conditional cash transfer programs have expanded in recent years  Benefits have been well-targeted to the poor and have helped reduce poverty rates  However, these programs remain modest in size (1 to 1 ½ % of GDP) and are a small share of social spending Social Spending

23. 23 Outline  Latin American Public Spending: A Discontinuous March Upward  Key Expenditure Issues for the Region  The Reform Agenda: Making Government Expenditure More Efficient and Equitable

24. 24 Taming cyclicality  Reducing spending growth during current cyclical upswing a key challenge  Fiscal rules to reduce spending growth could be helpful -- but need to be backed by effective enforcement  Reducing spending volatility will help improve the efficiency of spending

25. 25 Making government spending more efficient  Infrastructure lags reflect inefficiencies in public investment Large efficiency gains possible by adopting best practices of most efficient countries Large efficiency gains possible by adopting best practices of most efficient countries  Quality of civil service varies widely Reform efforts to tackle institutional weaknesses Reform efforts to tackle institutional weaknesses

26. 26 Improving the equity of spending  Continued reform of social insurance schemes  Make education spending more pro-poor Increase user fees in tertiary education, combined with scholarships for low-income households Increase user fees in tertiary education, combined with scholarships for low-income households Improve quality of secondary education to reduce repetition rates and broaden access to tertiary level Improve quality of secondary education to reduce repetition rates and broaden access to tertiary level  Expand targeted social assistance programs