Transcript David Bevan - International Policy Centre for inclusive Growth

Macroeconomic Policies for
Combating HIV and AIDS
Conference organized by UNDP Poverty Centre
Brasilia, November 20-21 November 2006
David Bevan
Department of Economics
University of Oxford
Introduction
• Aid flows have tended
– to become more concentrated
– hence sometimes large relative to the recipient economy
• Present efforts, if successful, will tend to reinforce this
• Current concerns about aid absorption
– aid has often been poorly managed and ineffective in the past
– but also reflect the worry that aid may become problematic when
it is large relative to the economy, even if it is well-managed
• Narrow and broad interpretations of macroeconomic
hazard.
– macroeconomic hazards given the institutional and political
framework
– possible adverse impacts on this framework, which may make
macroeconomic problems worse
2
The institutional and political framework
Concerns about possible adverse impacts
• Aid dependency
– ‘no representation without taxation’
• Corruption and rent-seeking
• Weakened process of institutional improvement
Implications
• Evidence that weak institutions leads to poor
macroeconomic policies and performance
• Focus on institutional reform as part of the aid ‘package’
3
The potential problem of real exchange rate
(RER) appreciation 1
The usual diagnosis
• Export growth and diversification seen as important for
economic growth
• Part of aid will be spent on nontradable goods, driving up
their price – so that the real exchange rate appreciates
• This makes exporting less profitable, so export volumes
suffer
• Hence the aid comes at a potential price in reduced
growth
4
The potential problem of RER appreciation 2
Some qualifications to this diagnosis
• In practice, countries appear to be able to absorb very
high aid inflows without suffering growth reductions
• While some aid goes to enhance current consumption (so
just adds to demand) much of it goes into investment (so
has an effect on supply also)
– If the productivity increase is specialized in nontradables, their
supply may expand as fast or faster than demand, leading to a
depreciation
– If it is specialized in exportables, exports may still increase rapidly
despite the depreciation (profitability
• Relief of bottlenecks
• Depends on the relative impact on supply and demand
5
The potential problem of RER appreciation 3
Implications
• Whether there will be a problem is not a given, but
contingent on country specifics and on policy design
• Very difficult to judge what is the case, so may often be
best to ignore the issue
• However, there are two special situations where this is not
so
– Gradual changes may be more easily absorbed than rapid ones
– There will be differences in the speed of the supply pay-off – for
example, between spending on physical infrastructure/income
generation versus that in the social sector
6
Medium-run supply responses
E
E-biased supply response
Neutral supply response
D-biased supply response
D
7
Figure 1
Aid and the Export Real Exchange Rate
Real Exchange Rate
(PE/PD)
1.02
1.01
1.00
0.99
0.98
0.97
0.96
0.95
0.94
0
1
2
3
4
5
6
7
8
9
10
Simulation Period
Base Case
Neutral
Export-Bias
Domestic-Bias
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Figure 2
Total Exports
1600
Total Exports
1550
1500
1450
1400
1350
1300
1250
0
1
2
3
4
5
6
7
8
9
10
Simulation Period
Base Case
Neutral
Export-Bias
Domestic-Bias
9
Real Disposable
Household Incomes
Figure 3
Real disposable incomes
10,200
10,000
9,800
9,600
9,400
9,200
9,000
8,800
8,600
8,400
0
1
2
3
4
5
6
7
8
9
10
Simulation Period
Base Case
Neutral
Export-Bias
Domestic-Bias
10
Figure 4
Growth Externalities and gestation lags
1550
Total Exports
1500
1450
1400
1350
1300
1250
0
1
2
3
4
5
6
7
8
9
10
Simulation Period
LBD and gestation lag
Neutral
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Inconstancy of aid flows 1
Long-run movements in the aid-GDP ratio
• Large increases/decreases problematic even if
– Completely predictable
– Recipient government allowed unrestricted freedom to smooth
• Would still pose a severe management/political problem
• In practice, neither condition likely to hold
• An extended aid ‘pulse’ will typically have to be spent
more or less simultaneously
• Very difficult to know when a change is likely to be
transient and when it may persist
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Inconstancy of aid flows 2
Medium-term fluctuations and falling
commitments
• Government spending needs to be planned over the
medium or longer term
• Most donor commitments are firm only over relatively
short horizons
• It is costly to embark on programmes that have to be cut
back because of funding problems
• But the converse is also true
• Is it always prudent to be conservative?
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Inconstancy of aid flows 3
Short-term volatility and cyclicality
• Even when aid flows are reasonably stable in the
medium term, they may be volatile in the short run
• Move to budget support, may make matters worse
• Domestic revenues in low-income countries have also
tended to be volatile
• These two sources of instability have tended to reinforce
rather than offset each other
• Volatility a particular problem if financial depth is lacking
• May imply higher foreign exchange reserves needed
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Inconstancy of aid flows 4
Implications for policy
• Macroeconomic policy management is substantially
more difficult than in industrialized countries
– Greater volatility to cope with, in real economy as well as budget
– Shocks of uncertain duration rather than fairly regular cycles
– Fewer and less potent instruments
• What is best response to a shock?
– Smooth a temporary shock
– Accommodate to a permanent one
– Recognition problem
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Inconstancy of aid flows 5
• Consider an addition to recurrent public health
expenditure (g), initially grant financed for several years,
but falling back into the domestically financed budget
subsequently (say after year T)
• It produces a flow benefit valued at b
• The domestic tax system inflicts marginal and average
deadweight losses on the private sector θm > θa > 0
• For example, a marginal dollar of revenue costs the
private sector $(1 + θm)
• The government discount rate is r
• Suppose first that all of b is “psychic” as opposed to
money income
• The tax rate is

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Inconstancy of aid flows 6
• Then we should require a benefit cost ratio:
b
 rT
 (1   m )e
g
• If b takes the form of money income, this would be:
(1   m )e
b

g 1   ( m   a )
 rT
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Conclusion
• Risk of Dutch disease problems is real but has probably
been exaggerated
– Not inevitable
– Can be managed
– But management may be unpalatable
• Risk of inconstancy probably more severe and certainly
less tractable
– Always costly to handle
– In case of HIV/AIDS even more so
– Crucial to find ways of handling this
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