Spending Smarter: How Efficient and Well-Allocated Public Spending Can Boost Economic Growth
May 2018
[$token_name="PublicationDisclaimer"]
The broad-based acceleration of global growth in 2017 is reflected in the solid gains posted by the economies of the United States and Canada, both of which are expected to grow above potential in the near term. More broadly, growth in both advanced and emerging market and developing economies is expected to gain further momentum in 2018 and 2019, reflecting the effects of expansionary US fiscal policy, favorable global financial conditions, and improved prospects for external demand. Risks to the outlook are broadly balanced in the near term. Over the medium term, however, global growth is expected to soften, and risks are tilted to the downside, owing to the possibility of a sharp tightening of financial conditions, escalating trade tensions and risks of a further shift toward protectionist policies, and geopolitical strains.
The world economy and global trade are experiencing a broad-based cyclical upswing. Since October 2017, global growth outcomes and the outlook for 2018–19 have improved across all regions, reinforced by the expected positive near-term spillovers from tax policy changes in the United States. Favorable global financial conditions, despite some tightening and market volatility in February and March, have been providing support to economic recovery. Higher commodity prices are contributing to an improved outlook for commodity exporters. The US and Canadian economies posted solid gains in 2017 and are expected to grow above potential in the near term. Despite the improved near-term outlook, however, medium-term prospects are tilted downward. Growth prospects for advanced economies are subdued, and many emerging market and developing economies are projected to grow in per capita terms more slowly than advanced economies, raising concerns about income convergence. While risks appear broadly balanced in the near term, they skew to the downside over the medium term, including a possible sharp tightening of financial conditions, waning popular support for global economic integration, growing trade tensions and a shift toward protectionist policies, and geopolitical strains. In this context, policies should focus on building buffers, improving financial resilience, and strengthening the potential for higher and more inclusive growth
Following a contraction in 2016, growth in Latin America and the Caribbean turned positive in 2017, owing to both a favorable external environment and improving domestic conditions. Growth is expected to gain further momentum in 2018 and 2019. The recovery is broad-based across the region. In the near term, Mexico, Central America, and parts of the Caribbean are benefiting from stronger growth in the United States, while potential implications of the US tax reform and ongoing renegotiations of the North American Free Trade Agreement (NAFTA) are creating uncertainties. Growth in South America is being led by the end of recessions in Argentina, Brazil, and Ecuador; higher commodity prices; and a moderation of inflation that has provided space for monetary easing. But economic adjustment remains unfinished business. In particular, further fiscal consolidation is needed in many countries to restore sustainability, notably by calibrating the quality, speed, and composition of fiscal adjustment. Elections this year across the region might lead to heightened economic and policy uncertainty. Looking beyond the near term, the region faces serious medium-term structural challenges. Despite the faster-than-expected recovery, Latin America’s output growth is returning to an underwhelming mean, with downside risks to prospects over the medium term. This calls for a comprehensive structural reform agenda, aimed at strengthening institutional and policy frameworks, boosting productivity, and increasing trade and financial liberalization to help secure strong, durable, and inclusive growth.
The inflationary impact of large and persistent exchange rate depreciation has prompted a reexamination of the monetary policy response of central banks in Latin America in the face of large external shocks. How monetary policy should respond to such shocks and how these decisions should be communicated publicly are key questions. This chapter argues that central bank credibility— reflected by the degree of anchoring in inflation expectations—plays a critical role in policy decisions in response to these shocks and can benefit immensely from transparency and clear communication. In this context, stronger transparency frameworks and communication strategies—that is, how openly and how well the central bank communicates in guiding markets—are found to be associated with more predictable policy decisions and a better anchoring of inflation expectations. This, in turn, can provide greater room to maneuver interest rate policy in the face of transitory inflation shocks through enhanced central bank credibility.
Lower global commodity prices, slower growth, and the past use of expansionary policies have contributed to rising public debt in many countries in Latin America and the Caribbean, precipitating a need for fiscal consolidation. But will this policy hinder the region’s nascent recovery? Using a new database of fiscal policy actions, fiscal multipliers in the region are estimated to lie between 0.5 and 1.1––suggesting that consolidation will be more contractionary than previously thought. Nevertheless, these estimates are small enough to suggest that consolidations will improve the region’s debt dynamics, even in the short run. Since expenditure multipliers vary according to the type of instrument used, consolidation plans should preserve public investment to support growth and employment.
Latin America has made impressive progress in reducing inequality and poverty since the turn of the century, although it remains the most unequal region in the world. The declines in inequality and poverty were particularly pronounced for commodity exporters during the commodity boom. Much of the progress reflected real labor income gains for lower-skilled workers, especially in services, with a smaller but positive role for government transfers. With the commodity boom over, a tighter fiscal envelope, and poverty rates already edging up in some countries, policies will have to be carefully recalibrated to sustain social progress. Increasing personal income tax revenues while rebalancing spending could help maintain key social transfers and infrastructure spending. Better targeting of social transfers and reforming decentralization frameworks also have an important role to play.
