From Cyclical Booms to Sustainable Growth: Rethinking Public Spending in the Caribbean

The unique fiscal dynamics in Latin America and the Caribbean lead to long-term spending commitments from short-term economic upswings, creating fiscal rigidity and inefficiencies. Policymakers are urged to implement innovative fiscal rules and improve public spending efficiency for sustainable growth.

The World Bank's recent report by Daniel Riera-Crichton and Guillermo Vuletin explores the unique fiscal dynamics of low- and middle-income markets in Latin America and the Caribbean (LAC). Unlike their high-income counterparts, these economies exhibit a distinctive pattern where short-term economic upswings lead to long-term spending commitments, creating fiscal rigidity. This semiprocyclical spending during economic booms contrary to traditional Keynesian theory aggravates macroeconomic volatility and hampers quality public investment. Without effective automatic stabilizers like unemployment insurance due to high informality rates, these markets rely on rigid social transfer programs, complicating fiscal dynamics and economic recovery.

Fiscal Anomalies in LAC Economies

The report identifies several anomalies in public spending policies in LAC that are absent in high-income economies. Public spending in LAC countries tends to increase during economic booms due to increased borrowing access and political pressures to address social shortfalls. However, this spending does not contract during downturns, leading to fiscal rigidity and deteriorating public investment quality. The lack of automatic stabilizers forces governments to use public employment and social transfer programs to support incomes during downturns. These programs, designed for structural poverty issues, are downwardly rigid and lack clear termination criteria, leading to persistent fiscal burdens.

Recommendations for Policymakers

The report recommends a nuanced approach to addressing these fiscal anomalies. Policymakers are urged to implement innovative fiscal rules to tame overspending during economic booms and improve the quality and efficiency of public goods. Mechanisms should be established to phase out social and employment programs for those who move out of poverty during good times without incentivizing informality. Protecting public investment during economic busts is crucial for long-term inclusive growth.

Evolution and Composition of Public Spending

The report further explores the evolution and composition of public spending in LAC countries. Unlike high-income economies where public spending is dominated by automatic spending on social security and unemployment insurance, LAC countries lean heavily on discretionary spending. This includes public consumption covering costs associated with the provision of public goods like education, health, and public safety. However, the share of public investment in LAC, though higher than in high-income economies, is not sufficient to match the public capital levels enjoyed by richer nations.

Addressing Inefficiencies in Public Spending

The inefficiencies in public spending in LAC are also highlighted in the report. These inefficiencies arise from weak public sector management, negligence, and corruption, leading to overcosts and misallocation of resources. In 2015, inefficiencies in procurement, civil service compensation, and targeted transfers represented an average waste of 4.4% of GDP in LAC, surpassing average spending in health and nearing education spending levels. Improving public spending efficiency is crucial to achieving better economic outcomes and long-term growth. The report underscores the importance of enhancing the efficiency and effectiveness of public spending. Efficiency gains can be used to smooth painful adjustments during economic downturns. Cutting spending across the board, as has been done many times in the past, especially in a recessionary environment, has strong contractionary effects. Utilizing the substantial fiscal space obtained from transforming wasteful and inefficient government spending can also contribute to growth down the road without adding to inequality.

Measuring Public Spending Inefficiencies

Looking at the LAC region as a representative of middle-income markets, the report provides a measure of the level of public spending inefficiencies on key components: the cost of goods and services, including capital expenditure; the costs of compensating civil service employees; and part of the cost of subsidies and transfers, which suffer from leakages to those who are not poor. The analysis is based on technical efficiency, assuming a reasonable allocation of expenditure by function, and hence provides estimates of the direct waste of resources reflecting overcost or overuse of inputs for a given outcome. The report shows that inefficiencies in procurement, civil service, and targeted transfers accounted for about 16% of average government spending in LAC. Public procurement, including the purchase of goods and services and capital equipment, represents about 30% of total spending in LAC countries. The waste originating in bribes and padded budgets appears to be enormous: about 26% over the cost of projects. Public procurement is a magnet for various inefficiency risks originating in waste, mismanagement, and corruption. The wage bill inefficiency in LAC is also highlighted, with an average wage premium of about 34% in favor of public sector employees. This inefficiency is driven by higher union density in the public sector and political economy considerations.

Path to Sustainable Growth

The report emphasizes the need for tailored fiscal policies that address the unique challenges faced by low- and middle-income markets in LAC. By improving the efficiency and effectiveness of public spending and implementing strategic fiscal rules, these economies can better navigate economic cycles and achieve sustainable growth. The insights provided in this report are crucial for policymakers aiming to enhance economic resilience and foster long-term inclusive growth in the region.