Macroeconomics and the MDGs

While participating in an interesting and thoughtful eDiscussion organized by the UNDP on Securing Fiscal space for the MDGs, I was struck by how much different approaches to the issue-say between the IMF and the UNDP-are driven by different implicit assumptions about the likely effectiveness of additional spending. Whatever you think about the usefulness of the MDGs as the basis for organizing a development strategy (see Michael Clemens’ blog for a skeptical view) , how to manage the macro-fiscal challenges of scaling-up spending to meet social objectives is highly contentious. The IMF role, in particular, has been criticized by many.

I have been thinking about this a lot lately, drawing on my earlier experience as Deputy Director of the IMF Independent Evaluation Office (and before that as a long-time IMF staff member) and more recently as Chair of a Working Group set up by CGD to investigate IMF programs and health spending.

My own view can be summarized as follows: take care of the effectiveness of spending and the macroeconomics will take care of itself. In other words, whether or not we should worry about the macroeconomic challenges associated with an aid-financed scaling up of spending largely depends on the likely supply response.

For example, if higher aid-financed spending on non-traded goods leads to a temporary 'Dutch disease' effect, we should not be too concerned provided the longer-term effects of MDG-related spending improve competitiveness. More generally, if the additional spending eventually has a significant impact on economic capacity, it is hard to see how any of the "short-term" macro problems would be insuperable; eventually, positive supply responses would be sufficient to take care of them.

Clearly, some policy adjustments down the road would be needed, depending on how the benefits are distributed. For example, additional sources of tax revenue may be needed to finance spending with high social returns if those returns do not directly improve revenues. Also, shifts in the real exchange rate will depend on how any productivity gains are distributed between the traded and non-traded sectors. It is very difficult to predict in advance how improved health and education might influence these developments, but the point is that future policies can adjust without major hardship provided overall economic capacity is rising sufficiently.

Obviously, the motivation for MDG spending is not just to raise output-it is to improve the lives of the poor. But if (and unfortunately it is a big if) the planned MDG-related spending is effective and achieves its objectives, then it is hard to imagine that the countries' economic capacity would not be sufficient to handle any macro challenges that result. So the key challenge is not really a 'macro' one at all-it is to make sure that additional spending will be used effectively, which requires good governance, sound public financial management, and good sector-level policies.

Personally, I suspect that underlying many of the disputes about macro frameworks between the IMF and its critics are fundamentally different views about the likely effectiveness of higher spending. The IMF often seems to assume implicitly that additional public spending will have little impact on growth. In contrast, those who produce MDG-costing scenarios often seem to assume that the 'technical' costing ratios around the MDGs can be scaled up with none of the huge governance problems and 'leakages' to other types of less useful spending--let alone outright corruption-- that have been a fact of life in almost all countries. In practice, we can never know--without trying them--what the impact of more ambitious spending strategies will be. So we are really faced with a question of balancing the risk that the supply responses are too weak to prevent inflation, Dutch Disease, fiscal sustainability and other threats to macro stability against the risk of foregoing expenditure opportunities that may improve the lives of the poor and raise growth.My own view is that, because the macro starting position in most countries--in Africa and elsewhere--is so much better than a decade ago, the balance of risks should shift toward trying more ambitious fiscal/spending options if: (1) governance improvements are sufficient to give a reasonable chance of success; and (2) donors make some form of commitment that they will not pull the plug on their aid prematurely--which requires some understandings on what the true 'conditionality' is, both political and otherwise. Both of these are very big questions that need hard answers before embarking on ambitious spending strategies. But if the answers are reasonably positive, it is worth taking some risks.In many ways, the role of the IMF is central to this debate--and it has not done enough to adapt to the new challenges faced by many of its low-income member countries. To learn more, check out the final report of the CGD Working Group on IMF Programs and Health Spending, mentioned earlier, which points to the need for significant changes in the IMF way of doing business in low income countries.