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Public Expenditure in Latin America:
Trends and Key Policy Issues
Benedict Clements
Western Hemisphere Department
International Monetary Fund*
ECLAC Fiscal Policy Seminar
Santiago de Chile
January 29, 2007
* The views expressed herein are those of the author and should not be
attributed to the IMF, its Executive Board, or its management.
Outline

Latin American Public Spending: A
Discontinuous March Upward
 Key Expenditure Issues for the Region
 The Reform Agenda: Making Government
Expenditure More Efficient and Equitable
2
Outline

Latin American Public Spending: A
Discontinuous March Upward
 Key Expenditure Issues for the Region
 The Reform Agenda: Making Government
Expenditure More Efficient and Equitable
3
Trends in Public Spending
Fiscal balances have improved
in the region in recent years
Latin America: Fiscal Trends
3.0
2.5
(In percent of GDP)
Primary Balances (LHS)
Primary Expenditures (RHS)
2.0
30
28
Revenues (RHS)
26
1.5
1.0
24
0.5
22
0.0
-0.5
20
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
4
Trends in Public Spending
Primary spending, however,
has resumed its upward drift
Latin America: Primary Public Spending by Region
(In percent of GDP)
30
Latin American Average
South America & Mexico
27
Central America
24
21
18
15
1995 1996 1997
1998 1999 2000 2001 2002 2003
2004 2005 2006
5
Trends in Public Spending
Real spending has followed
a procyclical pattern
Latin America: Real GDP, Revenues, and Primary
Spending
(Annual percent change)
12
Real Revenues
10
Real Primary Expenditures
Real GDP
8
6
4
2
0
-2
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
6
Trends in Public Spending
Current spending has driven
the rise in outlays...
Latin America: Public Sector Expenditures
(In percent of GDP)
20
6.5
Current Primary Expenditures (LHS)
Capital Expenditures (RHS)
19
6.0
18
5.5
17
5.0
16
4.5
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
7
Trends in Public Spending
…while capital spending has
fallen as a share of outlays
Latin America: Average Public Sector Capital
Spending
(In percent of primary expenditures)
40
35
30
1995-1999
2000-2006
25
20
15
10
5
0
LA Average
South America and Mexico
Central America
8
Outline

Latin American Public Spending: A
Discontinuous March Upward
 Key Expenditure Issues for the Region
 Cyclicality of spending
 Public investment
 Public employment
 Social spending
 The Reform Agenda: Making Government
Expenditure More Efficient and Equitable
9
Cyclicality of Spending
Expenditure is procyclical in all
spending categories



Capital outlays
are the most
procyclical
Compared to
other developing
countries, a
higher share of
LA countries
have procyclical
spending
LA countries also
have somewhat
higher
coefficients
Estimates of the Short-Run Response
of Spending to Output Shocks
Total
Spending
Primary
Spending
Current
Spending
Wages
and
Salaries
Capital
Spending
Latin
America
1.57
1.79
1.22
1.52
5.91
Share of Latin
American
countries with
sig. coeff.
46.2
66.7
33.3
46.2
69.1
Share sig. for
35 other dev.
countries
31.3
40.0
40.0
28.1
45.2
Avg. coeff. for
35 other dev.
countries
1.18
1.75
1.03
1.20
1.38
Source: Akitoby and others (2006).
10
Cyclicality of Spending
There is no evidence of asymmetry
Response of Expenditure to Output Gaps
Dependent Variable: Primary expenditure to GDP


Output gap has a
statistically
significant impact on
spending
Positive and
negative output
gaps have different
coefficients, but the
difference is not
statistically
significant
System GMM
regressions
Lagged dependent
variable
0.44
(3.06)***
Output gap
0.08
(2.30)***
0.49
(3.50)***
Output gap (when
positive)
-0.08
(0.72)
Output gap (when
negative)
0.17
(1.78)*
Log terms of trade
0.03
(0.01)
* Significant at 10%; ** significant at
5%; *** significant at 1%.
-0.25
(0.09)
11
Public Investment
Public investment is lower
than in other developing regions
Public Investment in Latin America and Other Regions, 1990 – 2006
1990 – 94
1995 – 99
2000 – 04
2005 – 06
Latin America
4.7
4.9
4.3
4.5
Africa
7.9
7.7
7.6
8.2
Asia
9.1
8.7
8.1
8.4
Central and Eastern
Europe
3.6
3.8
3.8
3.8
12
Public Investment
Not all countries in the region, however,
suffer infrastructure “lags”
Latin America: Infrastructural Performance ― Deviation of Actual Indices
from Values Predicted by PPP-adjusted Per Capita Income
(In percent of the average standard deviation of the residuals)
Infrastructure
Panama
El Salvador
Chile
Guatemala
Uruguay
Honduras
Brazil
Colombia
Mexico
Costa Rica
Ecuador
Venezuela
Peru
Nicaragua
Argentina
Bolivia
Paraguay
-200
-150
-100
-50
0
50
100
150
200
13
Public Investment
Infrastructure lags may also reflect
inefficiencies in public investment

Efficiency can be assessed by evaluating the link
between public investment and improvements in
infrastructure

First step is to evaluate relationship between total
infrastructure spending (public and private) and
improvements in infrastructure using a
nonparametric technique
14
Public Investment
(improvements
in infrastructure
indicators)
Output
Infrastructure
Production Possibility Frontier
Efficient
C
A
Y(A)
Y(B)
D
b
X(A)
b’
B
Less Efficient
X(B)
The most efficient countries are those on the “production
frontier” (ACD)
Input
(infrastructure
spending to GDP)
15
Public Investment
Efficiency varies by country
Aggregated Public Efficiency Scores
Adjusted Public Adjusted
Efficiency 1/ 2/
Rank
Adjusted Level
of Public
Efficiency
Mexico
0.824
1
High
Chile
0.732
2
High
Peru
0.598
3
Medium
Argentina
0.530
4
Medium
Brazil
0.432
5
Medium
Colombia
0.253
6
Low
Bolivia
0.036
7
Low
1/ Efficiency in various sectors (transport, electricity, water, telecommunications)
aggregated using the share of public investment in each applicable sector.
2/ Adjusted by the effect of private sector spending on the efficiency score in each
sector.
16
Public Sector Employment
Public wage expenditure and employment
are not high by world standards…
Government Wages and Employment in
Latin America and Other Regions, 2004 or latest year
Wages, as a
percent of
GDP
General government
employment as
percent of total
employed, 1990s
Latin America
7.0
20.4
Asia
5.7
17.2
Eastern Europe and
Central Asia
7.9
42.3
Middle East and North
Africa
10.6
50.3
Sub-Saharan Africa
9.6
28.4
OECD
12.1
21.0
17
Public Sector Employment
…but the quality of government services
remains low
The Quality of the Bureaucracy
Government Effectiveness
(ICRG Index, 1990-2005)
(In percentile rank, 1996-2005)
4.0
3.5
3.0
Latin America
Asia
Eastern Europe & Baltics
Subsaharan Africa
80
Latin America
Asia
70
Eastern Europe & Baltics
Subsaharan Africa
60
2.5
50
2.0
40
1.5
1.0
30
0.5
20
1990 1992 1994 1996 1998 2000 2002 2004
1996
1998
2000
2002
2003
2004
2005
18
Public Sector Employment
Wide variance in wage bills and
quality of civil service

No relationship between wage bill and quality of
civil service
 Institutional weaknesses remain in many
countries (IADB, 2005 and Echerbarría and
Cortázar, 2005):
 Patronage in hiring and promotions
 Absence of performance evaluation
 Internal inequities in remuneration
19
Social Spending
Social spending absorbs a high share of
government outlays




Health and education
spending in line with
other regions
Social protection
spending lower than
OECD but higher
than emerging Asia
Inefficiencies in
spending have
retarded gains in
social indicators
Poverty remains high
despite substantial
social spending
General Government Social Spending in
Latin America and Other Regions, 2004
Education
Health
Social
protection
Total
1/
Latin
America
4.2
2.6
5.4
12.7
Emerging Asia
3.5
1.3
2.2
8.4
Eastern Europe
and Central Asia
4.8
4.4
12.1
22.8
Middle East and
North Africa
4.2
2.0
1.8
9.1
Sub-Saharan
Africa
5.5
2.9
3.7
13.8
OECD
6.4
6.9
17.3
32.6
1/ Total includes housing and community amenities.
20
Social Spending
The distributive effects of
social spending varies



Social spending in Latin
America is regressive –
poorest 20% receive
less than a fifth of the
benefits
Tertiary education and
social security spending
largely benefit highincome groups
Primary education and
social assistance
spending primarily
benefit the poor
Latin America: Distribution of Benefits
from Social Spending to the Top and
Bottom Quintiles
Poorest
Quintile
Richest
Quintile
20.2
20.4
Primary
29.0
7.9
Secondary
13.2
18.3
Tertiary
1.9
52.1
Health
20.6
52.1
Social security
5.6
17.6
Total social spending
15.0
30.4
Shares of quintile in
primary income
3.6
56.4
Education
Source: ECLAC
21
Social Spending
The success of targeted social
assistance programs
 Conditional
cash transfer programs have
expanded in recent years
 Benefits have been well-targeted to the
poor and have helped reduce poverty
rates
 However, these programs remain modest
in size (1 to 1 ½ % of GDP) and are a
small share of social spending
22
Outline

Latin American Public Spending: A
Discontinuous March Upward
 Key Expenditure Issues for the Region
 The Reform Agenda: Making Government
Expenditure More Efficient and Equitable
23
Taming cyclicality

Reducing spending growth during current
cyclical upswing a key challenge

Fiscal rules to reduce spending growth could be
helpful -- but need to be backed by effective
enforcement

Reducing spending volatility will help improve
the efficiency of spending
24
Making government spending
more efficient

Infrastructure lags reflect inefficiencies in public
investment


Large efficiency gains possible by adopting best
practices of most efficient countries
Quality of civil service varies widely

Reform efforts to tackle institutional weaknesses
25
Improving the equity of spending

Continued reform of social insurance schemes

Make education spending more pro-poor



Increase user fees in tertiary education, combined
with scholarships for low-income households
Improve quality of secondary education to reduce
repetition rates and broaden access to tertiary level
Expand targeted social assistance programs
26