Front Matter

Editor(s):
Ke-young Chu, and Richard Hemming
Published Date:
September 1991
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    PUBLIC EXPENDITURE HANDBOOK

    A Guide to Public Expenditure Policy Issues in Developing Countries

    edited by

    Ke-young Chu and Richard Hemming

    Government Expenditure Analysis Division

    Fiscal Affairs Department

    International Monetary Fund

    Washington, D.C.

    1991

    © 1991 International Monetary Fund

    Reprinted September 1998

    Library of Congress Cataloging-in-Publication Data

    Chu, Ke-young, 1941–

    • Public Expenditure handbook: a guide to public expenditure policy issues in developing countries / edited by Ke-young Chu and Richard Hemming.

      • p. cm.

    • Includes bibliographical references.

    • ISBN 9781557752222

    • 1. Government spending policy—Developing countries.

    • 2. Developing countries—Appropriations and expenditures.

    I. Hemming, Richard.

    HJ7980.P83

    1991

    336.3’9’091474—dc20

    91-27924

    CIP

    Price: $22.50

    Address orders to:

    International Monetary Fund, Publication Services

    700 19th Street, N.W., Washington D.C. 20431, U.S.A.

    Telephone: (202) 623–7430

    Telefax: (202)623–7201

    E-mail: publications@imf.org

    Internet: http://www.imf.org

    Foreword

    Over many years, staff members of the Fiscal Affairs Department have undertaken studies on numerous aspects of public expenditure policy. The Public Expenditure Handbook is the outcome of an effort to bring together the various strands of these studies and related outside work.

    Public expenditure issues have become increasingly important in the context of both stabilization and structural adjustment programs. Yet rather little systematic guidance is available on these issues for those who must formulate public expenditure policy recommendations. The Handbook is intended to fill this gap. In so doing, it provides a blend of macroeconomic and microeconomic analysis. The aggregate level of public expenditure has to respect an economy’s overall resource constraint if macroeconomic imbalances are to be avoided. But the impact of public expenditure on the efficiency of resource use, and its equity implications, raise microeconomic issues concerning the composition of spending and the design of individual expenditure programs. Distinguishing productive from unproductive programs is central to improving the economic and social returns to public expenditure, and the basis for such a distinction—albeit a difficult one to make—is explored in many of the Handbook chapters.

    I hope that the use of the Handbook will result in a better informed discussion of public expenditure policy with country authorities. I should stress, however, that the views expressed are the responsibility of the authors and are not necessarily those of the Fund.

    Vito Tanzi

    Director

    Fiscal Affairs Department

    Acknowledgement

    The Handbook papers were prepared mostly by the staff members of the Government Expenditure Analysis Division of the Fiscal Affairs Department. Other staff members contributed in various ways. Peter Heller, who as Chief of the Division coordinated the Handbook project in its initial stage, has continued to be interested in the project after moving to the African Department and contributed a paper. Jack Diamond, Kalpana Kochhar, and Sandy Mackenzie cooperated actively after moving to other Divisions; Robert Holzmann even after leaving the Fund. Henri Lorie and Claire Liuksila, of the Fiscal Review Division of the Fiscal Affairs Department, also contributed papers.

    Anamaria Handford and Leda Montero typed and read successive drafts and revisions of the Handbook. Theresa Garrison also read the drafts and made editorial suggestions. Alicia Etchebarne-Bourdin helped with typesetting. David Driscoll, of the External Relations Department, provided editorial advice.

    The Handbook papers have benefited substantially from the comments and suggestions of many colleagues in the Fiscal Affairs Department and other Departments throughout the Fund. Having found those comments too numerous to credit customarily in footnotes in individual papers, the editors, on behalf of the authors, would like to express here their gratitude for those extremely helpful and constructive suggestions.

    The editors are also grateful to Vito Tanzi, Alan Tait, and Teresa Ter-Minassian for their guidance and support.

    Ke-young Chu and Richard Hemming

    Table of Contents

    Introduction

    Ke-young Chu

    Richard Hemming

    Public expenditure is one of many forms of government intervention designed to compensate for the failure of competitive markets and to secure distributional equity. But while its justification lies in microeconomic concerns about resource allocation, public expenditure has wide-ranging macroeconomic implications, and is therefore used also as a macroeconomic policy instrument. The Public Expenditure Handbook represents an attempt to discuss policy issues within a framework that combines both the macroeconomic and microeconomic aspects of public expenditure. It should be emphasized, however, that public expenditure is only part of a larger set of policies designed to achieve a country’s economic objectives. Where appropriate, the Handbook stresses the links between public expenditure and other policy instruments.

    Macroeconomic and Microeconomic Considerations

    The level and composition of public expenditure can have conflicting implications for growth, inflation, and the balance of payments. Balance of payments and inflation problems often require a fiscal contraction to contain aggregate demand, and the experience has been that adjustment has tended to affect the expenditure side of the budget more than the revenue side. Moreover, in face of the constraint imposed by high interest payments—especially in the heavily indebted countries—and the resilience of some other current outlays—such as defense and social spending—capital spending in general and infrastructure projects in particular have borne the burden of expenditure adjustment. While halting or delaying public investment projects may offer sizeable immediate dividends for public finances, the balance of payments, and inflation, a price could be paid in the longer term in the form of lower growth, especially if more productive investments are affected.

    By the same token, efforts to promote growth may threaten stabilization objectives. For example, an increase in foreign-financed public investment that benefits primarily the nontradable goods sector may lead to higher growth in the short run but at the same time could undermine balance of payments viability if the increase in capital goods imports outweighs the contribution of additional import-substituting or export activities to growth. To resolve these conflicts requires an appropriate blend of macroeconomic stabilization policies and microeconomic structural policies.

    Structural policies are a response to the need to ensure that, while stabilization measures may be harmful to growth in the short term, the longer-term growth objective is not jeopardized. While this clearly requires sound stabilization policies, it is also dependent upon policies to stimulate the supply side of the economy. As regards public expenditure, the challenge is to secure a level of spending consistent with macroeconomic stability, and then restructure expenditure as part of a systemic reform package aimed at raising the sustainable growth rate by promoting domestic saving, productive investment, and the efficiency of resource allocation. However, the notion of sustainability extends beyond macroeconomic stability; growth may be stable, but if little progress is made in terms of equity gains—which are also a function of public expenditure—this may undermine the social and political sustainability of growth.

    Positive and Normative Issues

    Restructuring public expenditure is a complex process. To be carried out effectively, a strategy is required, including an assessment of the objectives of government intervention, the policies needed to attain such objectives efficiently, and an evaluation of the broader implications of these policies. Thus, while it may be relatively easy to determine, for example, whether a highway has been constructed cost effectively, it is more difficult to assess whether the highway will meet transportation needs or whether such needs could be met more efficiently through some other public program. Similarly, allocating scarce resources to highway construction rather than education (or another program) involves difficult comparisons, as does choosing between public and private provision. As one moves from strictly positive to more normative questions, the answers become increasingly judgmental.

    Moreover, positive and normative questions are often linked. For example, allocating resources between highway construction (physical capital) and education (human capital) has both positive and normative aspects. It is a positive question because a severe imbalance between physical and human capital can cause economic inefficiency. And it is a normative question because the benefits provided by a new highway accrue to different people than education expenditure benefits. While the intertwining of positive and normative questions makes public expenditure policy issues complicated, this complexity can be exaggerated. If it is simply assumed that resource allocation decisions are too difficult, many opportunities to reach reasonably unambiguous conclusions and offer useful advice will be missed.

    Productive and Unproductive Expenditure

    What are the principles and criteria that should be used in assessing the level and composition of public expenditure? It is clearly necessary to distinguish productive from unproductive expenditure. This will be straightforward if the question is to choose between two expenditure programs that share an identical objective (e.g., meeting the transportation needs of an area) and the same implications (for growth, inflation, balance of payments, and equity); the government should choose the more cost-effective project. In practice, however, competing programs are not directly comparable, and setting normative priorities cannot be avoided. Moreover, productive expenditure should be distinguished from unproductive expenditure by reference not only to the cost and wider implications of achieving program objectives, but also by assessing whether the objectives are appropriate.

    Overview of the Handbook

    The opening section of the Handbook describes the analytical framework that provides a background to public expenditure analysis. In part, this addresses the link between expenditure and macroeconomic aggregates, which principally determines the appropriate level of public expenditure. While identifying relevant structural reforms focuses on microeconomic issues concerning efficiency aspects of public expenditure, the formulation of public expenditure policy does not lend itself easily to analysis within a unifying microeconomic framework, beyond the broad arguments for government intervention associated with traditional welfare theory. This contrasts with the discussion of tax policy, which benefits from the consistent application of principles deriving from more modern tax theory. The heterogeneity of expenditure, and its use to pursue a much wider range of objectives than tax policy, has yet to yield an operational framework for expenditure policy analysis. However, recent work on the role of shadow prices in assessing policy reform in the public sector provides a potential basis for the development of such a framework.

    The second section of the Handbook turns to an analysis of major expenditure categories. Although the breakdown of expenditure broadly corresponds to standard economic (as distinct from functional) categories, its motivation derives more from the issues that arise most frequently in discussions of expenditure policy with country authorities. As a result, the categories are not exhaustive. Moreover, no attempt has been made to impose a uniform structure on the notes, although each is meant to convey a clear impression of policy objectives, the problems and issues that arise in meeting them, and reform possibilities.

    Distributional aspects of public expenditure are addressed in the following section of the Handbook. While major social expenditure programs such as health, education, and pensions are usually justified by reference to the failure of the market mechanism to guarantee adequate provision, they also have distributional consequences. In many countries, the poor are not well served by such programs. Part of the longer-term strategy to reduce poverty lies in raising health and education standards of the poor, together with the provision of effective social insurance; however, short-term concerns relate more to efficient means of guaranteeing adequate consumption standards—and especially food availability—for the poor.

    The final section of the Handbook is somewhat more eclectic than the rest, drawing together notes on a group of policy issues which, although not all entirely expenditure related, do have a significant expenditure implications. These include notes on privatization and cost recovery, both examining the extent to which these policies can relieve the burden of expenditure on the government and promote increased efficiency. Another note reflects newly emerging concerns about the environment. There are also notes dealing with expenditure arrears, debt relief, and the fiscal activities of nongovernment public institutions, issues that have arisen in the context of a number of Fund-supported programs.

    It is hoped that the Handbook can provide a useful input into future policy discussions with country authorities. As such, each of the notes is intended to be a concise and self-contained briefing of key issues that can be used as background to discussions where extensive preparation is not possible. It is clear that short notes cannot provide the solution to the problems that are likely to emerge in each and every individual case. The content of the notes has to be adapted to circumstances as they emerge. At the same time, however, the recurring themes of the Handbook should remain the guiding principles in formulating public expenditure policy. The appropriate level of expenditure is constrained by the scope to raise revenue and to finance the fiscal deficit. The composition of expenditure should be consistent not only with the microeconomic objectives that justify intervention but also with macroeconomic objectives. The productivity of expenditure should be assessed by reference to program goals, the direct cost of meeting them, and wider policy implications of the program.

    Finally, it is important to note that expenditure problems derive not only from an inappropriate level and structure of expenditure, but also from administrative difficulties in controlling expenditure. Inadequate expenditure monitoring and control has been responsible for the failure of a number of Fund-supported programs to achieve their objectives. Issues relating to expenditure management are not covered in the Handbook; interested readers are referred to Government Financial Management—Issues and Country Studies, ed. by A. Premchand (Washington: International Monetary Fund, 1990).

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