11

The Macroeconomics of The Macroeconomics of Financing Basic Utilities for AllFinancing Basic Utilities for All

Terry McKinleyTerry McKinleyDirector, International Poverty CentreDirector, International Poverty Centre

““Financing Access to Basic Utilities for All”Financing Access to Basic Utilities for All”Multi-Stakeholder Consultation, Lusaka, 23-25 April 2007Multi-Stakeholder Consultation, Lusaka, 23-25 April 2007

22

Some Research BackgroundSome Research Background

UNDP has supported 25 national reports on UNDP has supported 25 national reports on Economic Policies for Growth, Employment and Economic Policies for Growth, Employment and Poverty Reduction since 2002Poverty Reduction since 2002The motivation has been to promote greater policy The motivation has been to promote greater policy dialogue and provide policy alternatives on dialogue and provide policy alternatives on economic policieseconomic policieswww.undp-povertycentre.org/reports.htmwww.undp-povertycentre.org/reports.htm

1.1. CoverageCoverage: Asia-Pacific, Eastern Europe and the CIS, Middle : Asia-Pacific, Eastern Europe and the CIS, Middle East, and sub-Saharan AfricaEast, and sub-Saharan Africa

2.2. FocusFocus: a) fiscal, monetary and exchange-rate policies and b) : a) fiscal, monetary and exchange-rate policies and b) financial liberalization, trade liberalization and financial liberalization, trade liberalization and privatizationprivatization

3.3. UNDP has also supported a global project on “Privatization UNDP has also supported a global project on “Privatization and Poverty Reduction” (most studies are in low-income and Poverty Reduction” (most studies are in low-income countries in Africa)countries in Africa)

33

The Conclusion of the StudiesThe Conclusion of the Studies

Privatisation and commercialisation of public Privatisation and commercialisation of public services are often not compatible in low-income services are often not compatible in low-income countries with achieving the Millennium countries with achieving the Millennium Development GoalsDevelopment Goals

See Working Paper #22 of the International Poverty See Working Paper #22 of the International Poverty Centre: Centre: “Can Privatisation and Commercialisation of Public “Can Privatisation and Commercialisation of Public Services Help Achieve the MDGs: An Assessment?”Services Help Achieve the MDGs: An Assessment?” www.undp-povertycentre.orgwww.undp-povertycentre.org

Also see the IPC Policy Research Brief #3:Also see the IPC Policy Research Brief #3: “Privatising “Privatising Basic Utilities in Sub-Saharan Africa: the MDG Impact” and the Basic Utilities in Sub-Saharan Africa: the MDG Impact” and the ensuing debate in One Pagersensuing debate in One Pagers

Central QuestionsCentral Questions: How will access to public : How will access to public services—such as water, sanitation and electricityservices—such as water, sanitation and electricity—be financed? What are the Macroeconomic —be financed? What are the Macroeconomic Implications?Implications?

44

Access to Electricity: Access to Electricity: Percentage of PopulationPercentage of Population

RegionRegion 19701970

TotalTotal

19901990

TotalTotal

20002000

TotalTotal

20002000

UrbanUrban

20002000

RuralRural

AfricaAfrica 1414 2525 3434 6363 1717

S. AsiaS. Asia 1717 3232 4141 6868 3030

E. AsiaE. Asia 3030 5656 8787 9898 8181

Latin AmericaLatin America 4545 7070 8787 9898 5151

All DevelopingAll Developing 2525 4646 6464 8686 5151

55

Access to Electricity: Access to Electricity: The Need for Public InvestmentThe Need for Public Investment

How to reach households without electricity?How to reach households without electricity? Two-thirds of households in Africa—83% in rural areas?Two-thirds of households in Africa—83% in rural areas? 59% of households in South Asia—70% in rural areas?59% of households in South Asia—70% in rural areas?

We have to dramatically ‘scale up’ public We have to dramatically ‘scale up’ public investment in order to expand the electrical grid investment in order to expand the electrical grid or provide alternative cheaper sources of energyor provide alternative cheaper sources of energyCosting the public investment needed to reach the MDGs Costing the public investment needed to reach the MDGs has provided a stronger impetus for a change in strategyhas provided a stronger impetus for a change in strategyA greater need for Economic Policies that support Rapid A greater need for Economic Policies that support Rapid Growth and Economic Development, not just Growth and Economic Development, not just Macroeconomic StabilizationMacroeconomic Stabilization

66

The Need for Public Investment-Led The Need for Public Investment-Led Economic PoliciesEconomic Policies

According to conservative economists, According to conservative economists, increased Public Investment willincreased Public Investment will::

1.1. ‘‘Crowd out’ (displace) private investmentCrowd out’ (displace) private investment

2.2. Cause accelerating inflation and appreciation Cause accelerating inflation and appreciation of the exchange rateof the exchange rate

3.3. Increase the Fiscal Deficit and the Public DebtIncrease the Fiscal Deficit and the Public Debt

Public Investment Has Been in Long-Term Public Investment Has Been in Long-Term Decline (See graph): Decline (See graph): From 10% to 7% of GDPFrom 10% to 7% of GDP

77

Public Investment in Developing Countries, Public Investment in Developing Countries, 1970-2000 (as a share of GDP)1970-2000 (as a share of GDP)

4

5

6

7

8

9

10

11

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Simple average Weighted average

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Why Is Increasing Public Why Is Increasing Public Investment Justified?Investment Justified?

It will stimulate private investment, not It will stimulate private investment, not dampen it dampen it (example: electricity)(example: electricity)

It will increase the productive capacity of the It will increase the productive capacity of the economy so that inflation is containedeconomy so that inflation is containedGovernments Governments shouldshould borrow to finance borrow to finance public investment (deficit financing)public investment (deficit financing)

It creates future revenue and welfare benefitsIt creates future revenue and welfare benefits CurrentCurrent revenue should cover revenue should cover currentcurrent expenditures expenditures So incurring deficits is normal for investment So incurring deficits is normal for investment

purposes (ODA finances larger deficits)purposes (ODA finances larger deficits)

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The Macroeconomic ImplicationsThe Macroeconomic Implicationsof Expanding Basic Utilitiesof Expanding Basic Utilities

Fiscal policies need to be more expansionary Fiscal policies need to be more expansionary (investment focused)(investment focused)Monetary policies should be consistent with Monetary policies should be consistent with fiscal expansionfiscal expansion

Low inflation targets (3-5%) can be counter-Low inflation targets (3-5%) can be counter-productive productive

Achieving such targets can drive up real rates of Achieving such targets can drive up real rates of interestinterest

Such interest rates slow private investment and Such interest rates slow private investment and make public borrowing more expensive: the make public borrowing more expensive: the result is a vicious circleresult is a vicious circle

1010

What Are the Alternative Sources What Are the Alternative Sources of Financing?of Financing?

For low-income countries, a dramatic scaling up of For low-income countries, a dramatic scaling up of Official Development Assistance is neededOfficial Development Assistance is needed

Such a scaling up need not endanger Such a scaling up need not endanger macroeconomic stability (e.g., accelerating inflation macroeconomic stability (e.g., accelerating inflation and causing a ‘Dutch Disease’ appreciation)and causing a ‘Dutch Disease’ appreciation)

Refer to the Conference Papers from the IPC-supported Global Refer to the Conference Papers from the IPC-supported Global Conference on “Gearing Macroeconomic Policies to Reverse Conference on “Gearing Macroeconomic Policies to Reverse the HIV/AIDS Epidemic” the HIV/AIDS Epidemic” www.undp-povertycentre.org/aids.htmwww.undp-povertycentre.org/aids.htm

ConclusionsConclusions: 1) concerns about instability : 1) concerns about instability are inflated and 2) if there are such problems, are inflated and 2) if there are such problems, they can be managed. they can be managed.

1111

Investment-Focused ODAInvestment-Focused ODA

See the New IMF Analytical Framework:See the New IMF Analytical Framework: ODA should be ‘SPENT’:ODA should be ‘SPENT’: the the

Government should spend more based on Government should spend more based on ODA financing of a larger deficitODA financing of a larger deficit

ODA should be ‘ABSORBED’:ODA should be ‘ABSORBED’: the the Central Bank should sell the ODA-supplied Central Bank should sell the ODA-supplied foreign exchange in order to finance foreign exchange in order to finance importsimports

Otherwise the purpose of ODA is defeatedOtherwise the purpose of ODA is defeated

1212

Investment-Focused ODAInvestment-Focused ODA

The recent 2007 Evaluation of PRGF The recent 2007 Evaluation of PRGF countries in sub-Saharan Africa by IMF’s countries in sub-Saharan Africa by IMF’s Independent Evaluation Office found:Independent Evaluation Office found:

Governments spent only 28% of ODA (72% Governments spent only 28% of ODA (72% was saved)was saved)

So almost three-quarters of ODA was not used So almost three-quarters of ODA was not used for development purposes!!!for development purposes!!!

Worse still, if the inflation rate exceeded 5% in a Worse still, if the inflation rate exceeded 5% in a country, only 15% of ODA, on average, was country, only 15% of ODA, on average, was spent by governmentsspent by governments

1313

Monetary Policies and InflationMonetary Policies and Inflation

But IMF now recognizes that inflation rates But IMF now recognizes that inflation rates of 5-10% need not be harmful to growthof 5-10% need not be harmful to growth

Maintaining inflation rates of 3-5%, as in Maintaining inflation rates of 3-5%, as in the past, can often be unduly restrictivethe past, can often be unduly restrictive

Empirical evidence suggests that even Empirical evidence suggests that even inflation rates up to 15% are not likely to inflation rates up to 15% are not likely to be harmfulbe harmful

Supply shocks (oil; food) can temporarily Supply shocks (oil; food) can temporarily drive inflation rates above 10%drive inflation rates above 10%

1414

Inflation Has Declined in AfricaInflation Has Declined in AfricaIt has been 5-10% since 1997It has been 5-10% since 1997

1515

The Impact of ODA The Impact of ODA

Central Banks ‘Absorbed’ only 63% of Central Banks ‘Absorbed’ only 63% of ODA (i.e., sold foreign exchange)ODA (i.e., sold foreign exchange)37% of ODA was used to build up 37% of ODA was used to build up International ReservesInternational ReservesThere are three possible uses of ODA:There are three possible uses of ODA:

1.1. Central Bank ReservesCentral Bank Reserves2.2. Private Capital OutflowPrivate Capital Outflow3.3. Financing of Imports (a transfer of real Financing of Imports (a transfer of real

resources: widening the current account)resources: widening the current account)

1616

Using ODA EffectivelyUsing ODA Effectively

Is it justifiable to use ODA to build up Is it justifiable to use ODA to build up reserves?reserves?Reserves substitute for the transfer of real Reserves substitute for the transfer of real resources into the countryresources into the countryA modest build-up could be warranted as A modest build-up could be warranted as a means to address Aid Volatilitya means to address Aid VolatilityThe ProblemThe Problem: Central Banks ‘sterilize’ the : Central Banks ‘sterilize’ the monetary impact of ODA, driving up monetary impact of ODA, driving up interest rates in order to contain inflationinterest rates in order to contain inflation

1717

A Danger of Exchange-Rate A Danger of Exchange-Rate Appreciation??Appreciation??

The IMF hypothesisThe IMF hypothesis: : 1.1. More government spending domestically (on More government spending domestically (on

non-tradables) increases inflationnon-tradables) increases inflation

2.2. Inflation appreciates the exchange rateInflation appreciates the exchange rate

3.3. Appreciation damages the international Appreciation damages the international competitiveness of exportscompetitiveness of exports

But in sub-Saharan Africa (as in Asia) aid But in sub-Saharan Africa (as in Asia) aid surges have been associated with surges have been associated with Depreciation (See Graph)Depreciation (See Graph)

1818

The Size of Aid Is Correlated with The Size of Aid Is Correlated with Depreciation in AfricaDepreciation in Africa

DZA

BWA

BFABDI

CMR

CAF

TCD

ZAR

COG

CIV

EGY

ETH

GABGMB

GHA GIN

KENLSO

MDGMWI

MRT

MAR

MOZ

NERNGA

RWA

SEN

SLE

ZAF

SDNTZA

TGO

TUN

UGA

ZMB

ZWE

5010

015

020

025

0R

ea

l Ove

rva

lua

tion

0 10 20 30 40

Foreign Aid %GNI

overvalue Fitted values

1919

A Danger of Exchange-Rate A Danger of Exchange-Rate Appreciation??Appreciation??

The danger of inflation depends on the supply The danger of inflation depends on the supply response to increased demandresponse to increased demand

Fiscal policies (that increase government Fiscal policies (that increase government spending) and monetary policies (that sell spending) and monetary policies (that sell foreign exchange) need to be coordinated foreign exchange) need to be coordinated (see IPC Working Paper #10 & Conference Papers)(see IPC Working Paper #10 & Conference Papers)

But coordination of policies on whose terms?But coordination of policies on whose terms? Fiscal policies have to be consistent with the Fiscal policies have to be consistent with the

restrictive monetary policies of the Central restrictive monetary policies of the Central Bank???Bank???

2020

Policy Coordination for Scaling UpPolicy Coordination for Scaling Up

Choose the oppositeChoose the opposite: monetary policies : monetary policies should be supportive of expansionary fiscal should be supportive of expansionary fiscal policiespolicies

Short-term inflation and even some Short-term inflation and even some appreciation could be part of the adjustment appreciation could be part of the adjustment processprocess

1.1. Relative prices need to adjust in order to Relative prices need to adjust in order to transfer resources domestically and transfer resources domestically and facilitate their import into the countryfacilitate their import into the country

The exchange rate can be managed to deal The exchange rate can be managed to deal with such short-term problems (along with with such short-term problems (along with coordinating fiscal and monetary policies)coordinating fiscal and monetary policies)

2121

The Problem of Aid VolatilityThe Problem of Aid Volatility

The volatility of aid is the chief The volatility of aid is the chief problem, not so much domestic problem, not so much domestic macroeconomic instabilitymacroeconomic instability

ODA needs not only to be scaled up but ODA needs not only to be scaled up but also made predictablealso made predictable

Otherwise it imparts instability to the Otherwise it imparts instability to the budgeting process and contributes to budgeting process and contributes to macroeconomic instabilitymacroeconomic instability