Journal Issue

Making room for public investment

International Monetary Fund. External Relations Dept.
Published Date:
October 2004
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How to find public money to invest in infrastructure has become a hot topic in Latin America, where large external debt burdens have placed tight constraints on fiscal policy. The IMF finds itself at the center of this debate because of its ability to influence fiscal policy in countries it has lent money—a fact that applies to many countries in this region. Some European countries are also looking for ways to increase public investment. One issue here is how to invest more without infringing on the rules of the Stability and Growth Pact (SGP). Public-private partnerships (PPPs) are seen as a possible answer, but the IMF is concerned that new guidelines from the European Union’s (EU’s) statistical agency could be used to find a way around the SGP. Camilla Andersen of the IMF Survey spoke with Teresa Ter-Minassian and Richard Hemming, respectively Director and Senior Advisor in the IMF’s Fiscal Affairs Department, about the challenge of reconciling the need for public investment with a sound fiscal policy.

Many governments are becoming increasingly worried that a decline in public investment is holding back economic growth in their countries. The problem is felt most acutely in Latin America, where public investment declined throughout the 1990s (see top chart, page 300) and where economic growth has been disappointing in many countries. At a recent United Nations conference on hunger and development, Brazil’s President Luiz Inacío Lula da Silva called on the IMF to allow infrastructure investments to be excluded from the fiscal targets countries must meet to qualify for financial assistance. President Vicente Fox of Mexico made a similar proposal last year at a Group of Eight summit in Evian, France.

A number of factors have contributed to the decline in public investment in Latin America, including privatization and other policies aimed at reducing the role of government in the economy. Yet many people see the IMF as the main culprit. According to Ter-Minassian, “the IMF is considered responsible for this problem because the decline in investment has occurred in an environment of overall fiscal retrenchment, often associated with IMF programs.” But, she says, “the blame is only partly justified. While the IMF might recommend cutting public expenditure, it does not typically have an opinion on where expenditure cuts should occur—except when it comes to protecting essential social programs.” By and large, she says, how to carry out the adjustment—the emphasis to put on revenue raising versus expenditure cutting—is a country’s own choice.

Public investment has declined in both Latin American and OECD countries

(percent of GDP)

1Includes public enterprises.

2Unweighted average for Argentina, Brazil, Chile, Colombia, Ecuador, and Mexico.

3Unweighted average for Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Norway, Portugal, Spain, Sweden, United Kingdom, and United States.

Data: International Finance Corporation and Organization for Economic Cooperation and Development (OECD)

Public investment has suffered, Ter-Minassian explains, because it is much easier for governments to cut capital spending on infrastructure and other public projects than to trim current spending, which includes civil service wages and social security transfers. Cuts in current spending almost invariably affect interest groups with political influence, and reducing such spending becomes even more difficult if it is undertaken in a climate of low economic growth and rising unemployment.

Should the IMF change its approach?

So what can the IMF do to help countries boost investment in infrastructure? The governments of Brazil and Mexico have proposed that the IMF target the current fiscal balance—which excludes investment—instead of the overall fiscal balance—which includes all government spending—in its loan programs. IMF staff just completed a study of this proposal, concluding that there are serious risks in such an approach. Ter-Minassian notes that “an exclusive focus on the current balance guarantees neither macroeconomic stability nor debt sustainability—not to mention the quality of the investment.”

The IMF is proposing instead to maintain the primary focus on the overall fiscal balance, but it will at the same time pay more attention to trends in the current balance and, more generally, to the balance between public saving and investment. “Where there has been an excessive compression of public investment, the staff will encourage countries—including those with IMF programs—to protect public investment spending while undertaking fiscal adjustment,” Ter-Minassian says. This should result in a better balance between public savings and public investment. Hemming adds that the IMF staff will encourage countries to develop their capacity to assess, prioritize, and manage public investment, but will leave project selection to countries. “The IMF will certainly not be ‘cherry picking’ projects—this is not a game we wish to get into,” he says.

Assessing the scope to increase public investment is one goal of several pilot studies currently under way in Brazil and other countries. According to Ter-Minassian, “the pilot studies will seek to make such an assessment within a responsible fiscal framework consistent with macroeconomic stability and public debt sustainability.” The pilot studies will be completed by the end of 2004 and will inform the IMF’s further work.

Coverage of fiscal statistics

Latin American countries also complain that the IMF is treating them unfairly in another area: fiscal statistics. Whereas the statistics used by the IMF for European countries are limited to the general government, and in other parts of the world often cover only the central government, the entire public sector in Latin America is covered—including all public enterprises, regardless of whether they are commercially run or not. Latin American leaders argue that this puts the region at a disadvantage by constraining infrastructure investment and making fiscal deficits seem larger than elsewhere.

“It is important to recognize that we have broader coverage in Latin America,” Hemming says, “because there is a history of public enterprises engaging in fiscal activities on behalf of the government. This contributed significantly to the debt crisis of the 1980s.” But the IMF recognizes that the approach is unfair—countries should be treated equally. It is therefore proposing to exclude all public enterprises that are commercially run from the fiscal statistics it uses for surveillance and programs in Latin America. As a general rule, these statistics will cover the general government plus those public enterprises that are not commercially run and carry out significant quasi-fiscal activities, according to Ter-Minassian. Criteria for deciding whether public enterprises are being run on commercial terms are being tested as part of the pilot studies currently under way.

Other ways to increase investment?

While the problem of declining public investment is felt most acutely in Latin America, there are also problems elsewhere, including in Europe (see bottom chart, page 300). Members of the EU have complained that the SGP, with its strict limits on fiscal deficits, limits their room for maneuver when it comes to public investment. For much of the rest of the world, data problems make it difficult to ascertain the extent of the problem. “But there is no doubt that there are infrastructure gaps in most developing countries and emerging market economies. These countries will be looking with interest at how this issue plays out in Latin America,” Hemming says.

Meanwhile, countries are exploring other avenues. The United Kingdom, which suffered from low public investment for a number of years, has been a pioneer in finding ways to boost capital spending. “The United Kingdom introduced a golden rule that allows the government to borrow to invest in infrastructure and other public goods,” Hemming says. This was made possible by a low level of debt, a focus on achieving value for money in public spending, and a high level of fiscal transparency. As a safeguard, the golden rule is combined with a debt rule.

Public-private partnerships

The United Kingdom has also helped secure greater involvement of the private sector in infrastructure and other public services through PPPs. These are now being used successfully in other countries, including Chile, Ireland, and Italy, and interest in them is growing.

Hemming explains how PPPs work: “The government asks the private sector to build an asset—such as a prison or a road—and then provide services either to the government in the case of a prison or to the public in the case of a road.” If successfully implemented, PPPs can provide a significant boost to overall investment. But, says Hemming, “PPPs should be treated with care, because they give governments the opportunity to move traditional public investment off budget, and liabilities off the government balance sheet.” And there are no guarantees PPPs will offer better value for public money than traditional public investment and government services.

A key, therefore, is to get the fiscal accounting and reporting right. In particular, the full fiscal implications of PPP projects—including future fiscal risks—must be properly accounted for. If a project is undertaken by the private sector but the government is absorbing much of the risk—for instance by guaranteeing the income earned by a private partner—then this should be reflected in the fiscal accounts, Hemming says.

The accounting problem is magnified by the fact that there is currently no international accounting standard for PPPs, so countries are either following their own rules or are relying on regional organizations to tell them what to do. Because of the interest in PPPs in many EU countries, Eurostat recently developed new guidelines for classifying PPPs as either private or public investment. But while it welcomes Eurostat’s initiative, the IMF is concerned about the effect of the guidelines. “The problem with Eurostat’s approach is that it ignores many categories of PPP risk,” Hemming says. “It will allow EU countries to disregard the fiscal implications of many PPPs and could provide a means by which euro area countries can get around the fiscal constraints of the SGP.”

Ter-Minassian adds that “even if Eurostat’s criteria for classifying PPPs as private or public investment are followed, there should still be full disclosure of fiscal costs and risks so that at least the taxpayer is aware of the burden that the government is undertaking for the future. This would also allow the European Commission to take PPPs into account when assessing member countries’ fiscal policies.”

For more information on this topic, please refer to the papers “Public Investment and Fiscal Policy” (SM/04/93) and “Public-Private Partnerships” (SM/04/94), both of which are available on the IMF’s website (

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