Public Investment and Fiscal Policy
Teresa Ter-Minassian
Director, Fiscal Affairs Department
International Monetary Fund
January 24, 2005
Outline of the presentation
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Public investment trends during 1970-2000
Choice of indicators/targets for fiscal policy
and its impact on public investment
A strengthened approach to safeguarding
public investment
The role of PPPs
Preliminary results of pilot projects
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Public Investment Trends, 1970-2000
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Significant variation of trends in public investment
(as a share of GDP) across countries and regions
over the last three decades
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Fell to historically low levels in a number of OECD and
Latin American countries
Also, high degree of volatility in Latin America
Declining public investment has been offset only in
part by private investment
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Public Investment Trends in Advanced OECD Countries and
Selected Latin American Countries, 1970-2000
Advanced OECD
Latin America
7
14
United Kingdom
Argentina
6
Mexico
12
10
5
OECD countries 1/
Average for selected Latin
American countries 2/
United States
8
4
Chile
6
3
Italy
4
2
Brazil
Germany
2
1
0
0
1970
1973
1976
1979
1982
1985
1988
1991
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
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Why have we seen a declining trend in
public investment?
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Short-term fluctuations mainly reflect
comparative ease of cutting investment in a
context of fiscal retrenchment.
Long-term trends may also reflect:
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Changes in preferences about the size of public sector; and
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Data coverage changes, in particular due to privatization.
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Impact of Decline in Public Investment
on Growth and Social Indicators
Empirical evidence on the long-term relation
between public investment and growth is
inconclusive.
This likely reflects a number of factors:
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Public investments that do not directly boost a country’s
productive potential.
Current spending on social programs (such as education
and health) may, in certain circumstances, be equally or
more effective in removing impediments to growth.
Not all public investment is of high quality.
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Impact of Decline in Public Investment on
Growth and Social Indicators (continued)
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Evidence on impact of infrastructure
compression on growth is more robust:
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Calderón, Easterly, and Servén (2003) study for
Latin American countries.
Other recent World Bank studies focusing on
links between infrastructure and MDGs.
The World Bank is stepping up efforts to
assess infrastructure gaps in various regions
(REDIs)
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Possible Fiscal Roots of Declines in Public
Investment
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Concerns that focus on the overall fiscal
balance and the gross public debt may unduly
constrain scope to finance public investment in
infrastructure.
Alternative suggested approach: target current
fiscal balance, excluding investment
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Pros and Cons of Targeting the
Current Fiscal Balance
Advantages:
 Would promote intergenerational equity, by spreading the costs of public
investment over time.
 Would recognize that productive public investment adds to the stock of capital
and, therefore, does not reduce the net worth of the government.
Disadvantages:
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Does not recognize possible short-term financing constraints
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May conflict with need to curb excess demand
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Does not take into account the quality of public investment projects
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May encourage creative accounting
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May detract attention from other budgetary priorities
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May create a bias against private involvement in infrastructure
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Safeguarding Government Investment:
A Strengthened Approach
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Given the significant risks entailed by a shift to a
current balance approach, and its avoidance of real
trade-offs between investment and other budget
priorities, it is preferable to continue targeting the
overall balance and the gross public debt.
However, steps can and should be taken by
governments to safeguard productive public
investment, including during fiscal retrenchment
periods.
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Safeguarding Government Investment:
A Strengthened Approach (continued)
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Such steps could include:
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Improve assessments of impact of proposed new
government investment projects on growth and the public
finances in the short to medium term
Increase focus on trends in the current fiscal balance and
government’s net worth; when appropriate, use the current
fiscal balance as a supplementary fiscal policy target.
Make greater use of mechanisms aimed at reducing the
volatility and procyclicality of fiscal policy, including when
appropriate, the adoption of structural (cyclically adjusted)
budget targets.
Improve the productivity and cost-effectiveness of
government investment.
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The Role of PPPs in Stepping up
Infrastructure Investment
PPPs should be preferred to direct public investment if they lead to efficiency
gains. Key considerations in this area include:
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The standard of services to be provided by PPPs can be adequately
specified in the contract
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There is an appropriate sharing of risks between the public and the private
sector
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The intervention of a private partner can help mobilize resources
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There is adequate competition in the bidding process, and in the
subsequent provision of services, or an appropriate regulatory framework
for the latter
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A robust institutional framework is in place
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The fiscal implications of PPPs are appropriately disclosed and accounted
for.
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What can the Fund do to Assist Countries in
Safeguarding Quality Public Investment
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Focus more systematically in surveillance on the quality of
fiscal adjustment; in particular on trends and policies to
support high quality public investment.
Ensure that additional financing for high quality infrastructure
investment is accommodated in fiscal targets of Fundsupported programs, when consistent with macro-stability and
debt sustainability.
Assist countries in:
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designing mechanisms to reduce volatility and procyclicality of their
fiscal policies
implementing the GFSM 2001, to facilitate the compilation and
analysis of statistics on the public sector’s current balance and net
worth
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Testing the Proposed Approach
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Given, in particular, the significant resource costs involved in
some of these steps, it was decided to undertake, in
cooperation with the World Bank and other MDBs, some pilot
studies to implement the steps outlined above.
To ensure representativeness of these studies, an effort was
made to span different regions and levels of development.
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Brazil, Colombia, Chile, Peru
Ethiopia, Ghana
India, Jordan
Romania, Spain
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Pilot studies: direct public investment
 The full extent and impact of the decline in
public investment is hard to gauge in some
countries:
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Effect of privatization (Peru, Brazil)
Issues of coverage of statistics and definitions
(Colombia)
Impact of efforts to improve the screening of
projects
In some cases (e.g., Peru) declining public savings,
rather than adjustment, have squeezed the room for
investment
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Pilot studies: some policy dilemmas
 Clear evidence of significant infrastructure gaps but
difficult quantification
 Constraints imposed by high public debt levels
 Other potential problems:
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currency mismatches
divergence between social and economic rates of return
 Further work is needed to better understand
relationship between public investment and growth
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Pilot studies: quality as well as quantity
 Project evaluation and selection systems need
improvement
 Inadequate funding of budgeted projects,
excessive delays in execution, and increased costs
 Poor planning and execution capacity of
subnational governments
 Poor ex-post quality control of projects
 Failure to properly maintain projects after they are
finished
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Pilot studies: PPPs
 Variety of experiences and degrees of sophistication
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Brazil—recent legislation
Colombia—simulation of costs of contingent liabilities
Peru—no registry of contingent liabilities
 Some common problems
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Costly, frequent contract renegotiation
Too often, subsidy-dependent projects are structured as
PPPs—often to bypass fiscal ceilings
 Scope for learning from leaders (Chile, Colombia)
 Careful contract design, effective regulation and careful
assessment and disclosure of fiscal risks are key.
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