Financing strategies to achieve the MDGs Example from Latin America Workshop Tunis 21-24 24 January,, 2008 Rob Vos Director Development Policy and Analysis Division Department of Economic and Social Affairs United Nations, New York
Introduction Is Latin America on track to achieve the MDGs? Can the MDGs be achieved through adjusted policies? How much additional public spending will be needed and how can this be financed? Which trade-offs need to be taken into account when identifying a preferred financing strategy? 2
Is Latin America on track? 0 50 100 150 200 250 MDG1: Extreme poverty (% living on less than $1 a day) 10 9 8 5 "off track" MDG2: Primary education (net enrolment rate) 87 97 100 100 "on track" MDG4: Child mortality (under five deaths per 1,000 live births) 21 18 31 54 probably "on track" MDG5: Maternal mortality (per 100,000 live births) \a 47 187 192 195 "off track" MDG7: People using improved sanitation (% of total) 68 77 84 84 "on track" 1990 2005 Projection (linear) to 2015 Target 2015 3
Really, is LAC on track? The Millennium Development Goals Report 2007 (UN): LAC is on track to achieve universal primary education, reduced child mortality, improved access to water and sanitation; LAC is off track to achieve poverty reduction, reduced maternal mortality Problematic concept: linear projection Instead: model-based business-as-usual (BAU) scenario, taking into account economy- wide trade-offs and a continuation of current policies 4
Some key questions regarding MDG strategies What does it take to achieve the MDGs? What are MDG determinants? How would MDG achievement influence other aspects of economic and social development? Do we know how much it will cost and can we afford achieving the goals? What policy options do we have in financing the MDG strategy? What are the trade offs when: Scaling up aid or borrowing abroad? Enhancing domestic resource mobilization? 5
UN/DESA-UNDP UNDP-World Bank Public policies for MDGs project MAMS: Maquette for MDG Simulations. Economy-wide (dynamic CGE) simulation model to analyze MDG strategies in different countries. Dynamic MDG module Sector analysis of MDG determinants and of interventions needed to achieve MDGs in education, health, water and sanitation Microeconomic analysis of determinants of access to schooling, infant mortality, etc. Costing exercise, considering household behaviour Microsimulation methodology Translate labour market outcomes of CGE simulations into impact on poverty and income distribution at household level using micro datasets 6
MDG determinants and costing Macro-micro linkages Dynamic CGE Model (MAMS) Microsimulations Macroeconomic Environment and Economic Structure Structural features, Infrastructure Financing constraints General equilibrium effects Required public investment for MDGs Factor markets MDG achievement Factor markets Segmentation and factor mobility Wage determination Employment, productivity Distribution of factor income Poverty and inequality Households Household characteristics: Physical and human capital Demographic composition Preferences Access to markets 7
MDG determinants What is needed to get all children in school and make them complete all grades? Build more school infrastructure? Improve quality of other school inputs (teachers, textbook supplies)? Increase access to school by improved household income and demand subsidies? All of the above? What is needed to reduce child mortality? Better nutrition? Expansion of immunization programs? Improving maternal-child health facilities? Better education? All of the above? Are there synergies across the MDGs? What is the direct cost of interventions to achieve MDGs? Are there diminishing marginal returns to the inputs? 8
MAMS: Determinants of MDG outcomes MDG Service per capita or student Wage incentives Consumption per capita Public infrastructure Other MDGs 2 Primary schooling X X X X 4 4-Under-five mortality X X X 2,5,7a,7b 5-Maternal mortality X X X 2,4,7a,7b 7a-Water X X X 7b-Sanitation X X X 9
Macroeconomic influences on cost estimates Synergies among MDGs: : is achieving all MDGs simultaneously cheaper than pursuing them one by one? Complementary investment requirements, especially in infrastructure Macro Macro analysis: economy-wide effects matter for the (relative) cost estimates (labour costs and constraints, prices, growth effects) 10
MDG simulations BAU: projection without policy change MDG scenarios: Optimize to reach MDGs Each MDG separately Simultaneously Different financing strategies Foreign aid Foreign borrowing Domestic borrowing Tax increases 11
Ecuador: Progress towards MDGs MDG 7b Sanitation MDG 7a Drinking water supply MDG 4 Maternal mortality MDG 3 Child mortality MDG 2 Primary school completion MDG 1 Extreme poverty 2 4 6 8 10 2001 2005 BAU 2015 Target 2015 12
Is LAC on track under BAU? MDG 1 MDG 2 MDG 4 MDG 5 MDG 7a MDG 7b Argentina -- Bolivia -- Brazil -- Chile Colombia Costa Rica Cuba Dominican Republic Ecuador El Salvador Guatemala Honduras Jamaica Mexico Nicaragua Paraguay Peru -- Uruguay LAC -- 13
Ecuador: Synergy among MDGs and effect on costs (Required additional public spending on MDG services, % of GDP, difference from baseline) Additional annual cost per annum (AVERAGE 2005-2015) Social spending in base year Only MDG2 Only MDGs 4&5 Only MDG7 All MDGs Primary Education 1.1 0.8 0.8 - Current expenditures 1.0 0.7 0.7 - Investment 0.1 0.1 0.1 Health 2.0 0.6 0.4 - Current expenditures 1.6 0.3 0.2 - Investment 0.4 0.3 0.2 Water and sanitation 0.3 0.1 0.3 0.3 Total 3.4 0.8 0.7 0.3 1.5 1.8 14
but there are increasing marginal costs (Required additional public spending on MDG services, % of GDP, difference from baseline) Primary Education - Current expenditures - Investment Health - Current expenditures - Investment Water and sanitation Total Social spending in base year 1.1 1.0 0.1 2.0 1.6 0.4 0.3 3.4 Additional annual cost per annum (END OF PERIOD 2010-2015) Only MDG2 1.2 1.2 1.2 Only MDGs 4&5 1.6 0.9 0.7 0.1 1.7 Only MDG7 0.5 0.5 All MDGs 1.1 1.1 1.0 0.6 0.4 0.5 2.7 2.4 15
Ecuador: less expensive with foreign borrowing.. (but not necessarily best financing strategy) Average 2005-15 per year Incremental costs Synergy effect Foreign borrowing 1.3 1.1 0.3 Domestic borrowing 1.4 1.2 0.3 Direct tax increase 1.5 1.2 0.2 16
Latin America Chile and Cuba meet MDGs 2-77 under BAU All other countries in this study could reach the MDGs through additional public spending of between 1 and 6 percent of GDP Additional spending requirements are lower in the case of external finance - through aid or foreign borrowing Additional spending requirements are higher in the case of domestic finance - through borrowing or taxation - owing to crowding out effects and consumption compression 17
What are realistic financing options Required additional public spending is just one criterion for assessing desirability of a financing strategy Other criteria: Sustainability Macroeconomic trade-offs Institutional constraints and political economy considerations Models only analyze pure financing strategies, but mixed strategies may be preferable 18
Macroeconomic trade-offs More public spending could generate RER appreciation: Dutch disease effects? Crowding out of private investment because of increased public domestic borrowing Tax increase could affect real disposable household income Labour market adjustment: Skilled labour shortage?? No labour shortage, but wage pressures? 19
Ecuador: strong RER appreciation with foreign borrowing 1 0.98 Real exchange rate (index) 0.96 0.94 0.92 0.9 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 BAU Foreign borrowing Taxes Domestic Borrowing 20
Ecuador: Lower export growth under MDG strategy 10,000 9,000 8,000 7,000 6,000 5,000 2001 2002 2003 Export volume ($ mln) 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 BAU Foreign borrowing Taxes Domestic Borrowing 21
LAC: MDG financing and erosion of exports Annual average difference in export-to-gdp ratio 0.5 ARG ECU PER -11.5-9.5-7.5-5.5-3.5-1.5 CRI 0.5 JAM PRY BRA COL NIC -1.5 Foreign borrowing Foreign grant aid Taxes GT M BOL HND MEX URY SLV DOM -3.5-5.5-7.5-9.5 Annual average difference RER index (base year = 100) -11.5 22
Ecuador: crowding out of private investment strongest under domestic borrowing scenario 7,000 6,000 5,000 4,000 3,000 2001 2002 Private investment (volume, $ mln) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 BAU Foreign borrowing Taxes Domestic Borrowing 23
Ecuador: also GDP growth less under domestic borrowing scenario 32,000 Real GDP (mln $) 27,000 22,000 17,000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 BAU Foreign borrowing Taxes Domestic Borrowing 24
.. but domestic debt would increase to unsustainable levels 30 25 Domestic public debt (% GDP) 20 15 10 5 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 BAU Foreign borrowing Taxes Domestic borrowing 25
Also external borrowing strategy would raise debt to unsustainable levels 70 65 External public debt (% GDP) 60 55 50 45 40 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 BAU Foreign borrowing Taxes Domestic borrowing 26
Ecuador: direct tax burden would have to increase from 1.5 a 4.6 % of GDP 5 4 Direct taxes (% GDP) 3 2 1 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 BAU Foreign borrowing Taxes Domestic borrowing 27
LAC: Feasible financing options Foreign aid Tax increase Tax increase combined with foreign aid Tax increase combined with foreign borrowing Tax increase with public expenditure reform and other Argentina Bolivia Brazil Colombia Costa Rica Dominican R Ecuador El Salvador Honduras Jamaica Guatemala Mexico Nicaragua Paraguay Peru Uruguay 28
Ecuador: MDG strategy increases supply of skilled labour 5000 4000 3000 2000 1000 Unskilled (primary or less) Labour supply (thousands) Semi-skilled (secundary) Skilled (tertiary) 0 2001 2003 2005 2007 2009 2011 2013 2015 29
Ecuador: falling wage gaps 10 8 6 4 Skilled (tertiary) Real wage per worker (thousands of $) Semi-skilled (secundary) 2 0 Unskilled (primary or less) 2001 2003 2005 2007 2009 2011 2013 2015 30
Trade-offs and MDG-1 MAMS does not provide for an explicit MDG-1 1 strategy Changes in extreme poverty are modelled as results of the other MDG strategies and related trade-offs, in combination with microsimulation methodology 31
.but not good enough to meet poverty reduction target MDG1: Extreme poverty incidence ($1 per day) 15 10 Target 5 0 2002 2005 2010 2015 BAU Taxes Domestic borrowing Fofreign borrowing 32
LAC: mixed results for MDG1 Main results: 7 countries reach MDG 1 under BAU, and 8 under the MDG scenario (incl. Honduras) Progress in poverty reduction is mostly explained by average income and employment growth both under BAU and MDG scenarios High income inequality remains an obstacle to increased poverty reduction in LAC 33
LAC: employment-output output nexus under BAU and MDG strategy 4.0 Total employment growth (annual average in % 3.0 2.0 1.0 URY JAM BRA NIC PRY BOL ARG GTM SLV ECU COL HND PER MEX DOM CRI BAU scenario MDG financing scenario 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 GDP growth (annual average in %) 34
Trade-offs and MDG-1 Change in income poverty and per capita GDP growth under the BAU scenario and under the MDG scenario Change in share of population living on less than $1 a day (abs.change between base year and 2015) 1 CRI URY SLV PER -12.0 2.5 3.0 3.5 4.0 4.5 5.0 MEX 5.5 6.0 COL ARG DOM -3 BOL JAM -5 BRA HND -7 ECU -9 GTM -11 NIC -13 PRY -15 GDP growth (annual average in %) 35
Conclusions and recommendations Affordable: the the cost of reaching MDGs is not prohibitive, but most LAC countries need extra efforts to achieve the goals (BAU not good enough) Tax Reform Reform: analysis of macroeconomic trade- offs suggest tax reform is best strategy in most countries (as main emphasis: mixed financing strategies may be better) Efficiency increases in social spending: : MAMS assumes efficient efficient spending on MDG services to reach goals, but in practice space to improve efficiency in public spending to create more fiscal space 36
Conclusions and recommendations Socially responsible macroeconomic policies: broad perspective on macro policies beyond stabilization and inflation targeting: growth, adequate social spending, employment growth and inter-temporal temporal objective of human development Structural adjustment: need need to generate more productive employment and reduce inequality: : MDG strategy per se insufficient to meet poverty reduction target 37
Conclusions MAMS gives stylized picture of economy. Results are sensitive to model assumptions and parameter estimates Always imperfect instrument, but provides integrated and consistent picture Instrument to help policy dialogue Important task ahead to convert your model into such an instrument 38