Public finance and development: six things to read in December

6 December 2018
Insight
Loans and repayment schedules, Mumbai, India. Photo: Simone D. McCourtie/World Bank CC BY-NC-ND 2.0

Here’s your last round-up of public finance and development reads for 2018, covering Africa’s rising debt, the challenges of financing infrastructure, and latest revenue statistics for Africa.

There’s also a major new report on spending in Latin America, some important new papers on the dilemmas of targeting expenditure, and a quick look at the challenges of health budget reform.

See you in 2019!

Is there a debt crisis brewing in Africa?

Last month ODI’s annual public finance conference focused on debt in Africa. Here are five takeaways from my colleagues Shakira Mustapha and Annalisa Prizzon (more from them soon):

  • There is no debt crisis looming for sub-Saharan Africa as a whole. Public debt levels are rising and debt service is now onerous in several countries. But data does not show the continent is on the verge of a major debt crisis like those in the 1980s and 1990s. With a few exceptions (Mozambique and Republic of Congo), countries currently in debt distress are fragile and/or those affected by large macroeconomic shocks. 
  • Don’t exaggerate China’s potential threat to debt sustainability in sub-Saharan African countries. In most African countries at high risk of debt distress, China is only one of many lenders, and is far from being the largest.
  • Political commitment is critical for ensuring debt sustainability. Presidents and prime ministers should signal that fiscal sustainability is a priority.
  • The private sector has a responsibility to ensure transparency and to carry out due diligence. Although the primary responsibility for avoiding the build-up of unsustainable debt lies with the sovereign borrower, lenders should also lend in a way that does not undermine a country’s future debt sustainability. Some positive developments are potentially on the horizon, with several large banks developing a ‘transparent lending covenant’, under which banks would make the full details of loans public.
  • Prioritise new solutions for sovereign debt restructuring. Current approaches are not fit for purpose in a world with a greater diversity of lenders. The Paris Club does not accommodate all creditors and efforts to create a multilateral framework came to a halt.

Financing infrastructure in Africa

Many governments justify borrowing on the basis that it will improve economic growth by being invested in infrastructure. But if debt needs to be limited, is private financing of infrastructure the answer?

Liberia’s former Minister of Public Works Gyude Moore tells it straight. ‘Billions to trillions’, the latest fad in development finance, does not work for Africa. Blended finance – attracting large-scale private investment flows to finance infrastructure – has only limited application here.

He calls on the World Bank and other multilateral development banks to ‘launch a realistic program for financing African infrastructure—a program that is appropriate for the realities of the region and the urgency of its infrastructure needs.’

Tax in Africa

There is not a generalised debt crisis in Africa, and there is also positive news on the mobilisation of tax revenues. The 2018 Africa revenue statistics, which cover 21 countries (including north Africa but excluding Nigeria, Ethiopia and Tanzania among others) from 1990-2016, came out at the end of October.

Key headlines include:

  • Tax take has significantly improved in almost all countries since 2000. The average increased by 5% of GDP, the same rate of improvement as Latin America. Almost all of the improvement came from direct taxes on income and profits (2.6 perecentage points) and VAT (2 percentage points).
  • Many African countries are close to collecting their full tax potential, showing that this is indeed ‘a tax era in Africa, not an aid era’. The average tax take (including social security) in 2016 was 18% of GDP. This compares to 23% in Latin America and 34% in the OECD.
  • But this varies considerably across countries. Tunisia’s tax take is 29% of GDP; others exceeding 20% are Mauritius, Morocco, Senegal, South Africa and Togo. Democratic Republic of the Congo has the lowest tax take at 7.6%, and two-thirds of countries are between 13% and 20%.
  • The composition of taxes remains dominated by indirect taxes (55%, of which VAT is 29%) and less so by direct taxes (34% of taxes). The major difference between Latin American and African countries is that the latter have much lower social security contributions due to a more informal labour market.
  • Very little is known about the taxes being collected by sub-national/local governments, with information only available for eSwatini, Mauritius, Morocco and South Africa. Even then, in eSwatini and Mauritius, sub-national revenues were less than 1% of total tax revenues, while in Morocco they were 3.5% and in South Africa they were 5%. In these four countries, property taxes made up  the vast majority (80% or more) of local taxes.

Spending in Latin America

The Inter-American Development Bank has launched a major report on public spending, Better spending for better lives: how Latin America and the Caribbean can do more with less. It reminds us of the importance of spending efficiency, not just raising tax – for example, Argentina has a tax to GDP ratio of above 40%, leaving little room for further increases.

It also highlights how rapidly aging societies will pose a major challenge to public finances in middle-income countries. This will be a growing problem in other areas of the world too – as the Financial Times highlighted in Vietnam – where rapid health improvements and reductions in birth rates will speed up demographic change. And so a big issue is how entitlements are being designed in systems now, even in poorer countries.

The need for spending efficiency is often couched in terms of ‘getting more for less’. But rationalising spending may also mean some groups (like the civil service and political elites) get less. And that means that spending decisions need to take on vested interests and public sector unions.

As expected in a report by an official development bank, this issued is only touched on in diplomatic terms! Tough decisions on spending may be unavoidable, however, as rising US interest rates are placing major pressure on governments’ fiscal position in Latin America.

Targeting in emerging welfare states

There has been a flurry of major reports and articles on social protection over the last couple of months. A series of World Bank blogs dissect the new book ‘Realizing the Full Potential of Social Safety Nets in Africa’ which highlights that although there has been rapid growth in the number of social safety net programmes in sub-Saharan African countries (all of which have at least one), most of them are small-scale.

 The financing of these programmes reflects their small scale: only 1% of GDP is spent on social safety nets, while 4% is spent on education and 3% on health. To scale these up, governments need to both improve programme efficiency, by improving administration and the targeting of intended beneficiaries, and increase funding to the programmes through improving tax and further development partner funding.

Two important academic papers draw contrasting conclusions in the debate between whether governments should target their expenditure or provide universal programmes (hat-tip to David McKenzie’s weekly round-up).

Harvard’s Rema Hanna and MIT’s Ben Olken draw on their work in Indonesia and Peru to argue that targeting works: ‘Existing targeting methods in developing countries, while imperfect, appear to deliver substantial improvements in welfare compared to universal programs’.

The opposite view is offered by Abhijit Banerjee and Tavneet Suri, both of MIT, and Paul Niehaus of University of California, who argue that there is a stronger case for universality than is often thought. There may be differences between targeting the poorest and those for whom the impact may be greatest. Because targeting limits the size of the group receiving transfers it may also limit the political pressure to sustain the scheme, and targeting may also create disincentive effects.

Budgeting for health

Jason Lakin blogs about the findings of the International Budget Partnership’s work with the World Health Organization on the role of programme budgets in the health sector. They find that the potential for programme budgeting to clearly set out the link between budget allocation and results, and assist in priority setting, is being limited by three key barriers:

  1. The absence of a common language between finance and health ministries (what are ‘programmes’, ‘outputs’ and ‘outcomes’?);
  2. The lack of a clear theoretical chain of results by which spending will lead to higher level outputs and outcomes; and
  3. Performance measures that are devised technocratically and not devised through consultation with legislators and civil society. 

Are these challenges likely to be overcome? A recent review of performance budgeting in seven OECD countries suggests caution.

It finds that even OECD countries often underestimate the administrative and analytical capacity needed for budget reforms and that the compressed annual budget process may not be the best vehicle for a considered assessment of programme performance. It also notes that while political support for budget reforms can be useful, this can also create opposition if those reforms come to be perceived as a partisan initiative.

Lakin does usefully highlight that programme budgeting can be as much about transparency – increasing the comprehensibility of the budget to the public – as about linking allocations to performance. Perhaps this more modest goal is the right place to start these reforms.