Quality of government expenditure Workshop Medium-term Expenditure Planning for National Sustainable Development Quality of government expenditure Iris Claus 4 November 2015 Nadi, Fiji

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Public expenditure Public expenditure is an important contributor to economic activity in Pacific Island countries.

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Public expenditure Public expenditure is an important tool governments have to achieve economic and social objectives. Government expenditure is constrained … by the financing governments can raise … and by how many projects public servants can implement. Given these limited resources, governments need to decide what programs to fund. The economic merit of spending programs can be evaluated by their effect on (i) economic efficiency, (ii) equity and (iii) provision of safety nets.

Economic efficiency Resources are optimally allocated. Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Economic efficiency Resources are optimally allocated. There is no waste. Any changes made to assist one person would harm another. The pie is as big as possible given available resources.

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Economic efficiency Government interventions can improve economic efficiency when there are market failures. With market failures the social rate of return (cost) exceeds the private rate of return (cost) leading to a less (more) than socially optimal production of a commodity/activity. E.g., education has positive externalities. Skilled workers improve the productivity of their co-workers. More educated parents tend to have healthier children.

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Economic efficiency When people decide how much education to get, they do not take into account these positive externalities. In economist speak: The social rate of return of education is higher than the private rate of return. Hence, there is a role for government to provide education.

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Economic efficiency Another example is public goods or services, which may not be optimally provided by markets because they are … non-excludable (i.e. people cannot be prevented from using them) … and non-rival (i.e. one person’s use does not diminish another person’s use). Examples of public goods include fresh air, knowledge, public infrastructure, national security, common language(s), flood control systems, lighthouses, street lighting.

Economic efficiency Other examples of market failures Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Economic efficiency Other examples of market failures If one hotel’s promotion of a country as a tourism destination will benefit other hotels Farmers may not establish export markets or irrigation systems if other farmers would benefit at less cost Over fishing has negative externalities There may not be any fish left for future generations Not all market failures require government interventions E.g., agricultural cooperatives to establish export markets

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Economic efficiency The economic merit of government spending programs should be evaluated by their effect on economic efficiency. Low economic growth and high unemployment are undesirable outcomes. They are not market failures. Government interventions to promote certain industries and sectors could reduce economic efficiency and economic growth … if they lead to a mis-allocation of resources.

Equity People in a similar situation are treated similarly. Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Equity People in a similar situation are treated similarly. E.g., people with a similar ability to pay taxes pay similar amounts. People with similar health care needs receive similar health care. People in a different situation are treated differently. E.g., people with a greater ability to pay taxes pay more. People with greater health care needs receive more health care. The pie is distributed fairly.

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Equity Resources, wealth and income are distributed according to what people consider fair. Redistributional policies can be implemented with spending programs on social welfare and the social sectors … often more effectively than with taxes. Public spending can equalize access to opportunity. Expenditure on basic health care and education has been found to reduce inequality. Direct cash transfers and in-kind transfers can reduce inequality unless there are serious targeting problems.

Safety nets The state provides some minimum protection and security. Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Safety nets The state provides some minimum protection and security. A collection of goods and services provided by the state prevents people from falling into poverty beyond a certain level. The state provides some insurance to help deal with adverse economic shocks and personal conditions. Everyone in society always gets some piece of the pie.

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency As a general rule There is a role for government to provide infrastructure, health and education. The private sector would not build a ‘socially optimal’ road network. Non-excludability problem: People could not be prevented from using the road at least not at a reasonable cost. Non-rivalry problem: One person’s use does not diminish another person’s use. The provision of primary health care and access to basic education help achieve equity objectives. They equalize access to opportunity.

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency As a general rule Education has positive externalities, e.g. transfer of knowledge. Health care has positive externalities, e.g. reduction in communicable diseases. But it may also have negative externalities, e.g. antibiotic resistance due to overuse of antibiotics. (People with antibiotic resistance spread their diseases to others.) Not all government expenditure is equal. The upgrading of roads in higher income residential areas and subsidies for higher education and non-essential healthcare have been found to benefit higher income people more than lower income households.

Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency As a general rule Direct income support is cheaper and more effective than subsidies delivered through the tax system. Higher income households consume more and thus receive a greater benefit from, for example, reduced value added tax rates for certain goods and services and fuel subsidies than lower income people.

Assessing spending proposals Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Assessing spending proposals What is the policy trying to achieve? What will be the impact of the policy over time? Will it increase the long-run growth rate? Why is government intervention needed? What is the market failure? Why is the private sector not achieving desired outcomes? How can the government remove the barriers? What is the value of the policy? Who benefits from the policy? Do those we intended to help receive most of the benefits?

Assessing spending proposals Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Assessing spending proposals How much does it cost to implement the policy? What are the opportunity costs? What projects do we need to forego to implement this one? What are the future costs? How will they be financed? If future generations benefit from a new road, they should contribute to the cost of building it (debt financing). But current generations need to maintain the asset to pass on to future generations (recurrent expenditure financed with recurrent revenue). How will the policy interact with other policies and objectives?

Enhancing fiscal transparency Public expenditure Economic efficiency Equity Provision of safety nets As a general rule Assessing spending proposals Enhancing fiscal transparency Enhancing fiscal transparency Policy proposals should be reviewed and costed by the budget office. Subsidies (benefits given by the government to groups or individuals) and tax expenditures (subsidies delivered through the tax system) should be listed and their costs should be reported in the national budget. The effectiveness of subsidies and tax expenditure should be reviewed regularly. Ineffective subsidies and tax expenditures should be abolished.