Financing strategiesFinancing strategiesto achieve the to achieve the MDGsMDGs inin

Latin America and the CaribbeanLatin America and the Caribbean

Rob Vos

(UN-DESA/DPAD)

Presentation prepared for the inception and training workshop ofthe project “Assessing Development Strategies to Achieve the MDGs in Asia and the Pacific, Bangkok, 20-22 August, 2008.

UNDP UN-DESA UN-ESCAP

IntroductionIntroductionIs Latin America Is Latin America ““on trackon track”” to achieve the to achieve the MDGsMDGs? ? Can the Can the MDGsMDGs be achieved through be achieved through adjusted policies? adjusted policies? How much additional public spending will How much additional public spending will be needed and how can this be financed?be needed and how can this be financed?Which tradeWhich trade--offs need to be taken into offs need to be taken into account when identifying a preferred account when identifying a preferred financing strategy? financing strategy?

Is Latin America on track?Is Latin America on track?

10

87

54

187

68

9

97

31

192

77

8

100

21

195

84

5

100

18

47

84

0 50 100 150 200 250

MDG1: Extreme poverty (% livingon less than $1 a day)

MDG2: Primary education (netenrolment rate)

MDG4: Child mortality (underfive deaths per 1,000 live births)

MDG5: Maternal mortality (per100,000 live births) \a

MDG7: People using improvedsanitation (% of total)

19902005Projection (linear) to 2015Target 2015

probably "on track"

"on track"

"on track"

"off track"

"off track"

Really now, is LAC Really now, is LAC ““on trackon track””??The Millennium Development Goals Report The Millennium Development Goals Report 2007 (UN)2007 (UN): : –– LAC is LAC is on trackon track to achieve to achieve

universal primary education, universal primary education, reduced child mortality, reduced child mortality, improved access to water and sanitation; improved access to water and sanitation;

–– LAC is LAC is off trackoff track to achieve to achieve poverty reduction,poverty reduction,reduced maternal mortalityreduced maternal mortality

Problematic concept: linear projectionProblematic concept: linear projectionInstead: modelInstead: model--based based ““businessbusiness--asas--usualusual””(BAU) scenario, taking into account economy(BAU) scenario, taking into account economy--wide tradewide trade--offs and a continuation of current offs and a continuation of current policiespolicies

Some key questions Some key questions regarding MDG strategiesregarding MDG strategies

What does it take to achieve the What does it take to achieve the MDGsMDGs? ? –– What are MDG determinants?What are MDG determinants?–– How would MDG achievement influence other aspects How would MDG achievement influence other aspects

of economic and social development?of economic and social development?Do we know how much it will cost and can we Do we know how much it will cost and can we afford achieving the goals?afford achieving the goals?What policy options do we have in financing the What policy options do we have in financing the MDG strategy? What are the trade offs when:MDG strategy? What are the trade offs when:–– Scaling up aid or borrowing abroad?Scaling up aid or borrowing abroad?–– Enhancing domestic resource mobilization?Enhancing domestic resource mobilization?

UN/DESAUN/DESA--UNDPUNDP--UN/ESCAPUN/ESCAPPublic policies for Public policies for MDGsMDGs projectprojectMAMS: MAMS: MaquetteMaquette for MDG Simulations.for MDG Simulations.–– EconomyEconomy--wide (dynamic CGE) simulation model to analyze MDG wide (dynamic CGE) simulation model to analyze MDG

strategies in different countries.strategies in different countries.–– Dynamic MDG moduleDynamic MDG module

Sector analysis of MDG determinants and of Sector analysis of MDG determinants and of interventionsinterventions needed to achieve needed to achieve MDGsMDGs in education, in education, health, water and sanitationhealth, water and sanitation–– Microeconomic analysis of determinants of access to schooling, Microeconomic analysis of determinants of access to schooling,

infant mortality, etc.infant mortality, etc.–– Costing exercise, considering household Costing exercise, considering household behaviourbehaviour

MicrosimulationMicrosimulation methodologymethodology–– Translate Translate labourlabour market outcomes of CGE simulations into impact market outcomes of CGE simulations into impact

on poverty and income distribution at household level using micron poverty and income distribution at household level using micro o datasetsdatasets

MacroMacro--micromicro linkageslinkagesCGE Model Micro-

simulations

MacroeconomicEnvironment

and Economic Structure

Structural features, InfrastructureFinancing constraintsGeneral equilibrium effects

Factor markets

Factor marketsSegmentation and factor mobilityWage determinationEmployment, productivityDistribution of factor income

HouseholdsHousehold characteristics:

Physical and human capitalDemographic compositionPreferencesAccess to markets

Povertyand

inequality

MDG achievement

DynamicMDG

determinants and costing

Required public

investment for MDGs

(MAMSMAMS)

MDG determinantsMDG determinantsWhat is needed to get all children in school and make What is needed to get all children in school and make them complete all grades?them complete all grades?–– Build more school infrastructure?Build more school infrastructure?–– Improve quality of other school inputs (teachers, textbook supplImprove quality of other school inputs (teachers, textbook supplies)?ies)?–– Increase access to school by improved household income and demanIncrease access to school by improved household income and demand d

subsidies?subsidies?–– All of the above?All of the above?What is needed to reduce child mortality?What is needed to reduce child mortality?–– Better nutrition?Better nutrition?–– Expansion of immunization programs?Expansion of immunization programs?–– Improving maternalImproving maternal--child health facilities?child health facilities?–– Better education?Better education?–– All of the above?All of the above?Are there synergies across the Are there synergies across the MDGsMDGs??What is the direct cost of interventions to achieve What is the direct cost of interventions to achieve MDGsMDGs??Are there diminishing marginal returns to the inputs?Are there diminishing marginal returns to the inputs?

MAMS: Determinants of MDG MAMS: Determinants of MDG outcomesoutcomes

4XXXX2–Primary schooling

7a,7bXXX4-Under-fivemortality

7a,7bXXX5-Maternal mortality

XXX7a-Water

XXX7b-Sanitation

Other MDGs

Public infra-

structure

Wageincen-tives

Consump-tion percapita

Serviceper capita or studentMDG

Macroeconomic influences on Macroeconomic influences on cost estimatescost estimates

Synergies among Synergies among MDGsMDGs: is achieving all : is achieving all MDGsMDGs simultaneously cheaper than simultaneously cheaper than pursuing them one by one?pursuing them one by one?Complementary investment requirements, Complementary investment requirements, especially in infrastructureespecially in infrastructureMacro analysis: economyMacro analysis: economy--wide effects wide effects matter for the (relative) cost estimates matter for the (relative) cost estimates ((labourlabour costs and constraints, prices, costs and constraints, prices, growth effects) growth effects)

MDG MDG simulationssimulationsBAU: BAU: projectionprojection withoutwithout policypolicy changechangeMDG MDG scenariosscenarios::–– OptimizeOptimize toto reachreach MDGsMDGs

EachEach MDG MDG separatelyseparatelySimultaneouslySimultaneously

–– DifferentDifferent financingfinancing strategiesstrategiesForeignForeign aidaidForeignForeign borrowingborrowingDomesticDomestic borrowingborrowingTaxTax increasesincreases

Ecuador: Ecuador: ProgressProgress towardstowards MDGsMDGs

0.0 20.0 40.0 60.0 80.0 100.0

MDG 1 Extreme poverty

MDG 2 Primary schoolcompletion

MDG 3 Child mortality

MDG 4 Maternal mortality

MDG 7a Drinking watersupply

MDG 7b Sanitation

2001 2005 BAU 2015 Target 2015

Is LAC Is LAC ““on trackon track”” under BAU?under BAU?

√√√LAC √√--Uruguay

--√Peru

Paraguay

Nicaragua √√√√Mexico

√Jamaica

Honduras √Guatemala

√El Salvador

√Ecuador √√

Dominican Republic

√√√√√Cuba √√√Costa Rica √√√Colombia √√√√√√Chile √√--√Brazil

--Bolivia --Argentina

MDG 7bMDG 7aMDG 5MDG 4MDG 2MDG 1

Ecuador:Synergy among MDGs and effect on costs(Required additional public spending on MDG services, % of GDP, differencefrom baseline)

1.50.30.70.83.4Total0.30.30.10.00.3Water and sanitation0.20.00.30.00.4- Investment0.20.00.30.01.6- Current expenditures0.40.00.60.02.0Health0.10.00.00.10.1- Investment0.70.00.00.71.0- Current expenditures0.80.00.00.81.1Primary Education

AllMDGs

OnlyMDG7

OnlyMDGs4&5

OnlyMDG2

Social spending in base year

Additional annual cost per annum(AVERAGE 2005-2015)

1.8

… but there are increasing marginal costs(Required additional public spending on MDG services, % of GDP, difference frombaseline)

2.70.51.71.23.4Total0.50.50.10.00.3Water and sanitation0.40.00.70.00.4- Investment0.60.00.90.01.6- Current expenditures1.00.01.60.02.0Health0.00.00.00.00.1- Investment1.10.00.01.21.0- Current expenditures1.10.00.01.21.1Primary Education

AllMDGs

OnlyMDG7

OnlyMDGs4&5

OnlyMDG2

Social spending in base year

Additional annual cost per annum(END OF PERIOD 2010-2015)

3.4

Ecuador: less “expensive” with foreign borrowing….. (but not necessarily best financing strategy)

0.21.21.5Direct tax increase

0.31.21.4Domestic borrowing

0.31.11.3Foreign borrowing

Synergyeffect

Incremental costs

Average2005-15 per year

Latin America: Latin America: MDG costing resultsMDG costing results

Chile and Cuba meet Chile and Cuba meet MDGsMDGs 22--7 under 7 under BAUBAUAll other countries in this study could All other countries in this study could reach the reach the ‘‘nonnon--povertypoverty’’ MDGsMDGs through through additional public spending of between 1 additional public spending of between 1 and 6 percent of GDPand 6 percent of GDPImportant increasing marginal costsImportant increasing marginal costsNot very high, yet significant synergy Not very high, yet significant synergy effects in most countrieseffects in most countries

Financing strategies and MDG Financing strategies and MDG costing resultscosting results

Additional spending requirements are Additional spending requirements are generally lower in the case of external generally lower in the case of external finance finance -- through aid or foreign borrowing through aid or foreign borrowing –– than in case of domestic resource than in case of domestic resource mobilizationmobilizationAdditional spending requirements are Additional spending requirements are higher in the case of domestic finance higher in the case of domestic finance --through borrowing or taxation through borrowing or taxation -- owing to owing to crowding out effects and consumption crowding out effects and consumption compressioncompression

What are realistic financing What are realistic financing options?options?

Required additional public spending is just Required additional public spending is just one criterion for assessing desirability of a one criterion for assessing desirability of a financing strategyfinancing strategyOther criteria: Other criteria: –– SustainabilitySustainability–– Macroeconomic tradeMacroeconomic trade--offsoffs–– Institutional constraints and political economy Institutional constraints and political economy

considerationsconsiderationsModels only analyze pure (singleModels only analyze pure (single--source) source) financing strategies, but mixed strategies financing strategies, but mixed strategies may be preferablemay be preferable

MacroeconomicMacroeconomic tradetrade--offsoffsMore More publicpublic spendingspending couldcould generategenerate RER RER appreciationappreciation: : DutchDutch diseasedisease effectseffects??CrowdingCrowding out out ofof privateprivate investmentinvestment becausebecauseofof increasedincreased publicpublic domesticdomestic borrowingborrowingTaxTax increaseincrease couldcould affectaffect real real disposabledisposablehouseholdhousehold incomeincomeLabourLabour marketmarket adjustmentadjustment: : SkilledSkilled labourlabourshortageshortage? No ? No labourlabour shortageshortage, , butbut wagewagepressurespressures??

Ecuador: Ecuador: strongstrong RER RER appreciationappreciationwithwith foreignforeign borrowingborrowing

0.9

0.92

0.94

0.96

0.98

1

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

BAU Foreign borrowing Taxes Domestic Borrowing

Real exchange rate(index)

Ecuador: Ecuador: LowerLower exportexport growthgrowthunderunder MDG MDG strategystrategy

5,000

6,000

7,000

8,000

9,000

10,000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

BAU Foreign borrowing Taxes Domestic Borrowing

Export volume($ mln)

LAC: MDG financing and LAC: MDG financing and erosion of exportserosion of exports

NIC

GTM

HND

Foreign borrowingForeign grant aidTaxes

ARG

BOL

BRA COL

CRI

DOM

ECU

SLV

JAM

MEX

PRYPER

URY

-11.5

-9.5

-7.5

-5.5

-3.5

-1.5

0.5

-11.5 -9.5 -7.5 -5.5 -3.5 -1.5 0.5

Annual average difference RER index (base year = 100)

Ann

ual a

vera

ge d

iffer

ence

in e

xpor

t-to-

GD

P ra

tio

Ecuador: Ecuador: crowdingcrowding out out ofof privateprivateinvestmentinvestment strongeststrongest underunder domesticdomesticborrowingborrowing scenarioscenario

3,000

4,000

5,000

6,000

7,000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

BAU Foreign borrowing Taxes Domestic Borrowing

Private investment(volume, $ mln)

Ecuador: Ecuador: alsoalso GDP GDP growthgrowth lessless underunderdomesticdomestic borrowingborrowing scenarioscenario

17,000

22,000

27,000

32,000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

BAU Foreign borrowing Taxes Domestic Borrowing

Real GDP (mln $)

……. but domestic debt would . but domestic debt would increase to unsustainable levelsincrease to unsustainable levels

5

10

15

20

25

30

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

BAU Foreign borrowing Taxes Domestic borrowing

Domestic public debt(% GDP)

AlsoAlso externalexternal borrowingborrowing strategystrategywouldwould raiseraise debtdebt toto unsustainableunsustainable

levelslevels

40

45

50

55

60

65

70

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

BAU Foreign borrowing Taxes Domestic borrowing

External public debt(% GDP)

Ecuador: Ecuador: directdirect taxtax burdenburden wouldwould havehavetoto increaseincrease fromfrom 1.5 a 4.6 % 1.5 a 4.6 % ofof GDPGDP

0

1

2

3

4

5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

BAU Foreign borrowing Taxes Domestic borrowing

Direct taxes(% GDP)

LAC: LAC: ““FeasibleFeasible”” financing optionsfinancing options

√Uruguay √√√Peru

√Paraguay √Nicaragua

√Mexico √Guatemala √Jamaica

√Honduras

√El Salvador √Ecuador

√Dominican R √√√Costa Rica

√Colombia √Brazil

√Bolivia √Argentina

Tax increaseForeign aidTax increase with public

expenditure reform and other

Tax increase combined with

foreign borrowing

Tax increase combined

with foreign aid

TradeTrade--offs and MDG 1offs and MDG 1

MAMS does not provide for an explicit MAMS does not provide for an explicit MDGMDG--1 strategy 1 strategy Changes in extreme poverty are modelled as Changes in extreme poverty are modelled as results of the other MDG strategies and results of the other MDG strategies and related traderelated trade--offs, in combination with offs, in combination with microsimulationmicrosimulation methodology using CGE methodology using CGE outcomes for labour market and labour outcomes for labour market and labour supply compositionsupply composition

Ecuador: MDG Ecuador: MDG strategystrategy increasesincreasessupplysupply ofof skilledskilled labourlabour

0

1000

2000

3000

4000

5000

2001 2003 2005 2007 2009 2011 2013 2015

Labour supply(thousands)

Unskilled(primary or less)

Semi-skilled(secundary)

Skilled (tertiary)

Ecuador: Ecuador: fallingfalling wagewage gapsgaps

0

2

4

6

8

10

2001 2003 2005 2007 2009 2011 2013 2015

Real wage per worker(thousands of $)

Unskilled(primary or less)

Semi-skilled(secondary)

Skilled (tertiary)

…….but not good enough to meet .but not good enough to meet poverty reduction target poverty reduction target

0

5

10

15

2002 2005 2010 2015

BAU Taxes Domestic borrowing Fofreign borrowing

Target

EcuadorMDG1: Extreme povertyincidence ($1 per day)

LAC: mixed results for MDG1LAC: mixed results for MDG1

Main results: Main results: –– 7 countries reach MDG 1 under BAU, and 8 7 countries reach MDG 1 under BAU, and 8

under the MDG scenario (incl. Honduras)under the MDG scenario (incl. Honduras)–– Progress in poverty reduction is mostly Progress in poverty reduction is mostly

explained by average income and explained by average income and employment growth both under BAU and employment growth both under BAU and MDG scenariosMDG scenarios

–– High income inequality remains an obstacle to High income inequality remains an obstacle to increased poverty reduction in LACincreased poverty reduction in LAC

MDG strategy does not necessarily MDG strategy does not necessarily strengthen employmentstrengthen employment--output nexusoutput nexus

ARG

BOL

BRACOL

CRI

DOM

ECU

SLVGTM

HND

JAM

MEX

NIC

PRY

PER

URY MDG financing scenario

BAU scenario

0.0

1.0

2.0

3.0

4.0

2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0

GDP growth (annual average in %)

Tot

al e

mpl

oym

ent g

row

th (a

nnua

l ave

rage

in %

Investments towards MDGs 2-7 do not necessarily accelerate progress towards MDG 1

ConclusionsConclusions andand recommendationsrecommendationsAffordableAffordable:: thethe costcost ofof reachingreaching MDGsMDGs isis notnotprohibitiveprohibitive, , butbut mostmost LAC LAC countriescountries needneed extra extra effortsefforts toto achieveachieve thethe goalsgoals (BAU (BAU notnot goodgoodenoughenough) )

TaxTax andand spendspend: : analysisanalysis ofof macroeconomicmacroeconomictradetrade--offsoffs suggestsuggest taxtax reformreform shouldshould be be atat centre centre ofof financingfinancing strategystrategy ((thoughthough mixedmixed financingfinancing may may be best in be best in mostmost cases)cases)

EfficiencyEfficiency increasesincreases in social in social spendingspending: : MAMS MAMS assumesassumes effectiveeffective allocationallocation toto reachreachgoalsgoals, , butbut in in practicepractice spacespace toto improveimprove efficiencyefficiencyin in publicpublic spendingspending toto createcreate more fiscal more fiscal spacespace

ConclusionsConclusions andand recommendationsrecommendationsSociallySocially responsibleresponsiblemacroeconomicmacroeconomic policiespolicies: : broadbroadperspectiveperspective onon macro macro policiespolicies beyondbeyondstabilizationstabilization andand inflationinflation targetingtargeting: : growthgrowth, , adequateadequate social social spendingspending, , employmentemploymentgrowthgrowth andand interinter--temporal temporal objectiveobjective ofofhuman human developmentdevelopment

StructuralStructural adjustmentadjustment: : needneed totogenerategenerate more more productiveproductive employmentemployment andandreduce reduce inequalityinequality: MDG : MDG strategystrategy perper se se insufficientinsufficient toto meetmeet povertypoverty reductionreduction targettarget

CaveatsCaveatsMAMS MAMS givesgives stylizedstylized picturepicture ofof economyeconomy. . ResultsResultsare are sensitivesensitive toto modelmodel assumptionsassumptions andand parameterparameterestimatesestimatesAlwaysAlways imperfectimperfect instrumentinstrument, , butbut providesprovidesintegratedintegrated andand consistentconsistent picturepicture–– BetterBetter costingcosting instrumentinstrument–– ImprovedImproved identificationidentification ofof ““on trackon track”” vs vs ““off trackoff track””–– Link Link macroeconomicmacroeconomic andand social social policiespolicies

NeedNeed toto avoidavoid itsits use as use as ““black boxblack box””, but see as , but see as instrument to help policy dialogueinstrument to help policy dialogue