Fiscal Implications of Scaling Fiscal Implications of Scaling up aid to deal with the up aid to deal with the

HIV/AIDS epidemicHIV/AIDS epidemic

Fiscal Implications of Scaling Fiscal Implications of Scaling up aid to deal with the up aid to deal with the

HIV/AIDS epidemicHIV/AIDS epidemic

Bernard Walters School of Social SciencesUniversity of Manchester

Manchester

Date: 20th – 21st November, 2006Brasilia, Brazil

Questions:Questions:

What is the correct relationship between fiscal and monetary/exchange rate policy?

Will Aid-fuelled fiscal policy choices increase the chances of Dutch Disease?

Will Aid-fuelled fiscal policy choices have an impact on inflation?

Are there likely to be diminishing returns to aid and can these be ameliorated?

The purposes of aidThe purposes of aidGupta et al. (2005) note 3 broad motives for aid

Humanitarian Relief Aid which influences long term growth Aid which influences short term growth

Aid to relief suffering from HIV/AIDS falls under 1.

Implications:

Spending decisions should be made according to characteristics of the epidemic

Reflects the notion that economic growth may be an inappropriate metric for judging aid effectiveness

The MDGs have no necessary connection with growth

So:So: This implies the need to work back from disease

characteristics, treatment technologies to spending priorities, to fiscal projections to aid needs.

But– Is a major undertaking in itself– It must incorporate assumptions about the relationship between

Commitments and disbursements Volatility of aid Predictability of aid And likelihood of aid decreasing before the end of the

programme The trajectory of domestic revenue

In addition, there is an extremely large variability in the extent of the disease in different countries– Countries differ significantly in their other social and economic

characteristics– So country specific analysis and policy design is necessary

Further observationsFurther observations Aid for HIV/Aids is going to countries, for the

most part, which are already very aid dependent– In terms of the ODA/GDP ratios– In terms of the ODA/Government Spending ratios

A general rise in aid to achieve the MDGs is proposed and is, to some extent, under way.

Context: – Spending on HIV/Aids is, in many circumstances a

relatively small proportion of the general increase in aid.

– In many cases in countries which are extremely aid dependent

Absorbing and Spending AidAbsorbing and Spending AidAid is neither absorbed nor spentAid is absorbed but not spentAid is spent but not absorbedAid is absorbed and spent

Clearly in the context of humanitarian relief aid must be both absorbed and spent

The fiscal deficit must rise, financed by the domestic counterpart to the aid inflow.

This requires fiscal and monetary policy co-ordination

The impact of aid on production The impact of aid on production possibilitiespossibilities

If all aid spent on imported goods then absorption and spending are identical; no effect on domestic production possibilities

If the aid requires complementary domestic inputs the aid allows imports to provide tradable goods from abroad releasing domestic resources, previously devoted to tradable activities.

This is usually effected by changes in the relative price between sectors

i.e. the tradable sector contracts and non-tradables expand

ObservationsObservations Spending on HIV/Aids is likely to have a very

high import content Shifts in resources between the sectors is the

correct response to the new set of relative prices– So long as expectations about aid are realised

Historically aid disbursements have been far below commitments

Aid volatility has always been high Resources can be extracted from inactivity as

well as alternative activities

Aid and Dutch diseaseAid and Dutch disease The unwelcome consequences of increased

spending are usually because there is a fear that appreciation will reduce the rate of growth

But this requires production possibilities to be endogenous to the aid inflow

e.g. Learning by doing externalities in the tradable sector

But– There are other externalities which can be positive

Externalities in the non-tradable sector Externalities flowing from import exposure

HIV/AIDS funding must be seen within the broader MDG increase in funding– There are likely to be complementarities

Production possibilities are responsive to policy

HIV/Aids spending and production HIV/Aids spending and production possibilitiespossibilities Anti-retroviral drug treatment works rapidly to

restore the ability to work– Effective labour supply will respond quickly

Over a longer period effective treatment will alter the stock and growth of human capital– Alters lifetime income– Alters life expectancy– Alters investment in children’s education– Improves intergenerational transfer of knowledge

These mechanism echo the way in which endogenous growth theory suggests increasing returns are possible

Suggests the growth dividend from rapid and effective treatment is possible

Dutch disease?Dutch disease? Evidence is extremely mixed

– Evidence that central banks are very worried about this

– For this reason cross sectional evidence is hard to interpret; many of the countries have not absorbed the aid

But– Size of the proposed increases make the recent past an

unreliable guide

– Very strong grounds for co-ordinating aid spending for other MDGs with that for HIV/AIDS

– Central Banks and Fiscal authorities need to have a co-ordinated approach

HIV/Aids spending and inflationHIV/Aids spending and inflationA variation on the literature on Dutch

disease is that increased aid will trigger an inflation which will de-stabilise the macroeconomic environment and reduce growth

Central banks have been cautious and– Adopted conservative inflation targets

Fiscal deficits have been conservative

ObservationsObservationsThe fiscal deficit is supposed to riseA change in the relative price between

sectors is a necessary condition for a resource transfer

A relative price change is most easily accommodated by a temporary inflation in that sector

Will this generate sustained inflation?

ObservationsObservations There is no reason for overall aggregate demand

and supply to be unbalanced: the rise in G should correspond to the rise in M if the aid is absorbed.

High infection countries will have a very high import content, ameliorating the necessary change in prices

Resources can be drawn from inactivity Supply constraints can be an objective of policy In the short to medium term HIV/AIDs therapies

seem likely to expand aggregate supply

SoSoNo necessary reason to expect de-

stabilising inflationBut:Spending without absorption is a recipe for

inflationSpending above absorption may occur:

– Spending may be predicated on commitments which do not translate into disbursements

Diminishing returns to Aid?Diminishing returns to Aid?

Sub-Saharan African countries have weak health care systems

Increases in aid are far larger, in many cases, than the pre-existing budgets

Human resources are a very large part of these budgets

Out-migration of the higher paid health professionals is considerable

However,However, Evidence suggests that some of these capacity

constraints are only short term Supply constraints can be addressed by policy

– Direct expenditures towards training and re-training– Structure programmes to use less well trained

outworkers– Direct expenditures to healthcare infrastructure

Donor agencies could allow greater flexibility Effective HIV/AIDS therapy will improve

productivity in this sector Other MDGs programmes should ameliorate

some of the supply constraints

Observations on fiscal Observations on fiscal sustainabilitysustainability

HIV/AIDS treatment is likely to lead to both a short term and long term improvement in revenue collection– Anti-retroviral treatment raises people’s

ability to work and pay taxes. This effect is likely to be considerable.

– Treatment reduces expenditure in the future

Fiscal SustainabilityFiscal Sustainability

Partly a function of method of aid transfer chosen– Debt relief is fully predictable

– Grants do not lead to future debt burden

– Concessional lending is more problematic as it implies a debt for which resources must be planned

Partly a function of the commitment of the donor community to delivering on its promises

ConclusionsConclusions Case studies linking disease characteristics to

fiscal and aid requirements are necessary on a case-by-case basis.– HIV/AIDs expenditures need to be co-ordinated with

other MDG policies Aid should be absorbed and spent

– There is an urgent need for fiscal and monetary policy co-ordination

There is no necessity for Dutch Disease effects but:– composition of overall aid expenditures is important– Aid needs to address supply side constraints– Disbursements need to match commitments– Volatility must be reduced

Inflation is not an inevitable consequence of increased aid inflows

A short term increase in inflation and an increased fiscal deficit are part of the process of aid spending

But– Spending without absorption or at a faster rate than

absorption are likely to inflationary

– Co-ordination of fiscal and monetary policy is necessary

– Donor behaviour must be more consistent and predictable

Diminishing returns to aid is a dangerBut

– Supply constraints can be addressed– Donors can follow more flexible policies– Interaction with other MDG policies important

HIV/AIDs therapies are likely to have positive effects on government revenues in both the short and long term

But fiscal debt sustainability remains a danger– Partly a function of composition of aid– Partly reflects donor commitment