Fiscal disequilibrium in developing countries

World Development, Vol. 10, No. 12, pp. 1069-1082, Printed in Great Britain.

Fiscal Disequilibrium

1982.

0305-750X/82/121069-14$03.00/0 o 1982 Pergamon

Press Ltd.

in Developing Countries

VITO TANZI’

International Monetary Fund, Washington, D.C. Summary. - Fiscal equilibrium necessitates that ‘permanent’ government expenditures be covered by ‘permanent’ government revenues. The concept of ‘permanent’ government expenditures and revenues takes into account future revenue from capital investments as well as temporary windfalls. Hence, equilibrium may exist despite temporary imbalance between revenue and expenditure. The causes of disequilibrium can be classified into five categories: export boom; price-inelastic tax system; public enterprise performance; increased expenditure produced by political exigencies or administrative weaknesses; and worsening terms of trade. In practice, unrealistic customs valuations, specific as opposed to ad valorem taxes and administrative difficulties have been the most common sources of declining government revenue as a percentage of gross domestic product. Increased subsidies both to consumer goods and to public enterprises as well as inadequate control mechanisms have been the most frequent causes of rising government expenditure.

2. THE MEANING OF FISCAL DISEQUILIBRIUM

of these key prices are the exchange rate, the rate of interest, the wage rate, the price of some important commodities such as energy, and the prices of public enterprises’ output. Although not always directly or necessarily engaged in the sale of a particular output or a particular service, there is also an implicit price for the activity of the public sector. In general, the total cost of public sector activities must be covered by current or ordinary revenue. Prices should clear markets in the absence of constraints in order to claim to be equilibrium prices. Thus, an exchange rate that brings about an equilibrium between imports and exports would not be a truly equilibrium one if this equality depended upon an extensive use of restrictions; and an interest rate that brought about equality between the demand for and the supply of credit by extensive use of credit rationing would, equally, not be a truly equilibrium one. The concept of fiscal equilibrium is somewhat more ambiguous for the public sector. Commonly it is assumed that there is fiscal equilibrium in a country when, in a given year, total governmental expenditure is covered by total governmental current revenue. However, closer inspection indicates that equality of revenue and expendi-

Although all prices are of some importance, in all economies some prices assume key roles. In equilibrium these prices must bring about a stable equality between the demand for and the supply of the particular commodity or factor of production to which they are related. Examples

* The views expressed here are strictly personal and do not necessarily reflect the International Monetary Fund’s official position. In the preparation of this paper, I have benefited from the help provided by many colleagues.

1. INTRODUCTION

This paper deals with fiscal disequilibrium in developing countries. The code is made up of three relatively distinct sections. Section 2 discusses some difficulties in the definition of fiscal disequilibrium. It argues that, in a macro sense, the equality of revenue and expenditure for a given year is not a sufficient condition for fiscal equilibrium. A (maintainable) fiscal equilibrium must show an equality between ‘permanent’ government expenditure and ‘permanent’ government revenue. In Section 3, five scenarios associated with real-world fiscal disequilibrium are outlined. These scenarios attempt to discuss ways in which fiscal disequilibrium is generated. In Section 4, an attempt is made to classify countries according to each of these scenarios. This attempt is only partly successful, as often the causes of fiscal disequilibrium are multiple. The emphasis in the paper is on the macro (or stabilization) aspects of fiscal equilibrium. Because of this, only casual references are made to allocative and equity aspects.

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ture in a particular year does not necessarily imply an equilibrium. Consider the following aspects.

(a)

Time horizons

The question immediately arises as to the period over which expenditure and revenue of the government must be equal. Should this equality be over a month, a year, the business or commodity cycle, or in a more permanent sense? Here, in a way, we have the same problem highlighted by some of the theories of the consumption function. In general, because almost universally the budget covers a 12month period, there is a tendency to relate revenue to expenditure for that length of time. But there is nothing special about one year. In fact, if one gives the government a stabilizing function over the economy, along the lines popularized by Keynes and his followers, then one would not want an equality between expenditure and revenue for each year; a more appropriate period for that equality might be the cycle. But even this period raises questions. The cycle might be the appropriate period from a stabilization point of view but might not be the proper period from an allocation point of view. A government that wants to engage in substantial capital spending to promote the future growth of the economy, where that spending is justified by proper efficiency criteria, might feel that at least part of the capital expenditure should be covered by debt, as the induced higher future growth of the economy would facilitate repayment of the country’s debt. This consideration applies regardless of whether the borrowing is from domestic or foreign sources. However, if one approaches the issue from this point of view, then the only proper basis for evaluation would be that the present discounted value of all future expenditure must be covered by the present discounted value of all future revenue. The trouble with this approach is that sharp differences between expenditure and revenue in any particular period might themselves create economic problems with implications for the future performance of the economy. For example, if the capital spending is financed by domestic monetary expansion, immediate problems would result. If it is financed by capital inflows, other problems (such as appreciation of the exchange rates, inflation in the non-traded goods sector, etc.) might result,

(b) Dynamic vs static equilibn’um Another issue related to the time horizon emphasizes a different, and perhaps more important, aspect. Should the relevant equivalence be between a permanent level of expenditure and a permanent (or maintainable) level of revenues? Or, should it be between annual revenue and annual expenditure, regardless of whether they are maintainable? This question is important for developing countries where revenue and, perhaps, expenditure often do not have a ‘permanent’ character. Disequilibrium in the fiscal sector of developing countries has often had its genesis when the price of a key export (e.g. coffee, copper, rubber, oil, etc.) has sharply increased, thus generating additional revenue for the govemment. Recognizing that the increase in govemment income is not likely to last, the government should not, in these circumstances, increase expenditures by the same amount. Assume, however, that expenditures are raised by the same amount; for the short run, the budgetary outcome would not be affected.’ What will happen, however, when the export boom comes to an end? The answer to this question depends on whether the government will then be able to reduce its expenditure by an amount equal to the fall in revenue. If the increase in expenditure has been of a permanent nature, as is often the case, then a fiscal disequilibrium will develop or become more serious. If the increase in expenditure has been of a temporary nature, then perhaps equilibrium can be restored. To a large extent, current expenditure has had a tendency to be more ‘permanent’ than capital expenditure. Therefore, if the boom-induced increase in public expenditure has been associated with an expansion of current expenditure, a fiscal disequilibrium becomes likely. Capital expenditure can generally be more easily reduced.

(c) Macro vs sectoral equilibtium Another difficulty with the concept of fiscal equilibrium has to do with the fact that the public sector is not represented by a monolithic entity with one budget and one decision-making centre. Rather, the public sector is fragmented, composed of parts such as the central govemment, the local governments, the social security nationalized public enterprises, institutions, marketing boards, special funds, etc. This fragmentation raises the question of whether revenue and expenditure should be equal in a

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macro or overall sense, or whether each important part of the government should be in equilibrium. If capital markets (domestic and international) were perfect, and the budgetary process worked optimally, then perhaps only broad equality would matter. In this particular case, deficits in any one part of the government could be covered by surpluses in other parts, so that the overall picture would be a relevant one. Unfortunately, in most countries the capital markets are far from perfect and the budgetary process is not well-functioning. Therefore, a surplus that originated in one part of the public sector would not automatically find its way to the part where there is a deficit. As a result, there could be serious distortions within the economy. To take an extreme example, suppose that the surpluses of the local governments are not automatically made available to the central government (by, for example, being deposited in the central bank) due to limitations in capital markets or to political decisions; suppose that the central government deficit is financed by borrowing from the central bank. In such a situation, monetary disequilibrium could exist even in the presence of an overall balance in the fiscal sector. Of greater significance is the fact that the part of the government that has the capacity to develop a surplus might have an incentive to spend that surplus in relatively unproductive activities rather than make it available to the other parts. A common example of this occurs when profit-generating public enterprises overinvest rather than transfer the profits to the central government. A truly optimal equilibrium in the public sector must not only satisfy stabilization criteria, but also allocative and equity criteria. These allocative and equity criteria are very However, in important. macro analyses emphasizing stabilization they are normally ignored. In the remaining sections of this paper they will also be ignored, but a reference to them is essential at this point.

(d) Micro or allocative equilibn’um It is possible for a government to show overall budgetary equilibrium (even within each of its parts) but, nevertheless, to have allocated public expenditure in such an inefficient way that marginal social cost could be very different from marginal social benefit for each line of activity. This consideration is, of course, important also on the revenue side, whereby if taxes are inefficiently raised, the social cost of

the last dollar raised from each group or each activity could be, at the margin, very different from that raised from other groups or other activities. Over the long run a dynamically efficient economy would require that all resources, both private and public, be efficiently utilized. Therefore, although allocative equilibrium may seem inconsequential for short-run stabilization, it is clearly essential for long-run performance.

(e) Distributional equilibtium Just as allocative considerations cannot be totally ignored in a discussion of fiscal equilibrium, the same is true for distributional considerations. The promotion of an equitable income distribution is one of the fundamental objectives of public policy. Therefore, no true equilibrium will be possible over the long run if there is a widespread perception that the incidence of taxes and of public expenditure does not conform with prevalent social norms. But again, these considerations may not be relevant in a discussion of short-run fiscal sector equilibrium.

3. FISCAL

DISEQUILIBRIUM

SCENARIOS

It is unrealistic to attribute fiscal disequilibrium - defined simply as substantial and prolonged differences between government expenditure and ordinary revenue’ -to single causes as it is often the result of a multiplicity of factors. However, it may be useful to present a few stylized situations that put the spotlight on predominant causes. Among these situations, or scenarios, we can distinguish between those that are mainly of a structural nature and those that are of a more political nature. The structural ones are often linked with the foreign sector.

(a) Export boom and fiscal disequilibrium This scenario has characterized countries that are highly dependent on the export of particular agricultural or mineral products such as coffee, cocoa, tin, copper, and the like. In some of these countries one single product accounts for an overwhelming share of total exports and, directly or indirectly, for a large share of government revenue. Suppose that, in a given year, the price of the product rises sharply so that foreign earnings also rise sharply.

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If the product is either a government monopoly or one subject to ad valorem export taxes, government revenue will rise directly. If the product is not subject to ad valorem export taxes, the increase in revenue will be indirect, but equally likely. It may, for example, come from additional import duties or from higher taxes on income and domestic consumption. Only in the extreme case, where there are no income taxes and all existing indirect taxes are specific, will revenue not increase to any significant degree. The government finds itself in the same situation as the winner of a lottery prize. Should it continue to spend in relation to its ‘permanent’ income; or, should it raise the level of its expenditure to the current level of revenue? The most important considerations are the following: (a) its expectation about the permanence of the current level of revenue; (b) the immediate investment opportunities for the transistory portion of current revenue; (c) the political pressure on the government for additional spending; and (d) the government’s perception of the political and economic benefits of additional spending. There are three possible general uses for the ‘windfall’ revenue: (a) current expenditure could be increased; (b) the additional revenue could be spent on domestic capital projects; or (c) it could be invested abroad in financial or real assets (including in this the repayment of past foreign debt).3 If the increase in revenue is likely to be temporary, the first of these three options is Unfortunately, clearly the least attractive. there are plenty of examples of countries that, faced with a commodity boom, have sharply increased the current, and thus the more permanent, component of their public expenditure, perhaps under the mistaken belief that the commodity boom would be permanent. If the increase in expenditure is just equal to the increase in revenue, and the fiscal sector had been in balance, then concentration on the short-run fiscal situation would not reveal the incipient fiscal disequilibrium. Thus the concepts of ‘permanent’ income and ‘permanent’ consumption are as relevant for the government as they are for individuals4 However, while for individuals they are positive concepts, i.e. describing how individuals actually behave, for governments they are normative concepts, i.e. implying desirable behaviour. A government faced with a temporary increase in revenue that, by expanding public employment, raising wages, creating new entitlements, increasing the scope brings about permanent of subsidies, etc.,

increases in expenditures, is sowing the seeds of inevitable future fiscal disequilibrium. Some countries have allocated the additional revenue to capital expenditure rather than to current expenditure. This is a wiser course but not one without danger. First, even when total expenditure is covered by current revenue, when the level of expenditure rises dramatically over the short run, inflationary pressures will develop because of supply rigidities caused either by the impossibility of sharply increasing the importation of tradable goods or by higher demand on non-tradables. Second, a sudden increase in capital spending is likely to be associated with inefficient projects as there may not be enough time to carry out detailed studies or there may not be enough managerial ability to supervise them. Third, capital projects will inevitably have recurrent components (e.g., roads have to be repaired) that will increase future public expenditure (see Heller, 1974). Finally, the commodity boom may come to an end before the projects are completed. There are examples of countries that have been thrown into serious fiscal crisis when revenues fell to their permanent level while the capital projects were only partly completed. In many ways the most attractive alternative for a country experiencing a sudden and possibly temporary increase in revenue is to sterilize this revenue by investing abroad.’ A few of the oil-exporting countries have chosen to follow this path and some of them have accumulated considerable assets abroad either by purchasing foreign financial assets or by investing directly in foreign real assets. These foreign assets can be reduced in times of unusually low current revenue so that the level of public expenditure can be maintained. Three papers could be mentioned in connection with this particular scenario. The first, by Horst Struckmeyer, provides a descriptive analysis of the effect of high coffee prices on the Central American economies. Although fiscal equilibrium is not the major focus of this paper, its analysis supports the outlines of the scenario described above (Struckmeyer, 1977). by Charles Mansfield, The second paper, describes a norm for a stabilizing budget policy in countries with substantial fluctuation in government revenues brought about by large changes in the prices of key exports. Manfield’s analysis consists of developing what he calls a ‘neutral revenue trend’, defined as the level of government revenue that would have occurred if export earnings had been on trend, and comparing this with what he calls ‘allowable defined as a constant ratio of expenditure’,

FISCAL DISEQUILIBRIUM government expenditure to neutral revenue. An ‘implicit deficit’ is defined as one equal to trend revenue, minus allowable expenditure (Mansfield, 1980). The third paper, by David Morgan, is of direct relevance to oilexporting countries. Morgan argues that government expenditure abroad does not add directly to domestic demand, and therefore does not increase domestic employment and output. Similarly, government receipts from abroad do not directly reduce private domestic resources. Therefore, for these oil-exporting countries the relevant budget that must be in equilibrium is the domestic budget, rather than the overall budget. This domestic budget balance represents the difference between domestic public spending and domestically generated revenue. Morgan finds that, for the six oil-exporting countries that he analysed, there was a close relationship between domestic budget deficits, domestic liquidity expansion, and inflation (Morgan, 1979). A recent paper by Harberger is also interesting in this context (Harberger, 198 1).

(b) Price - inelastic tax systems and fiscal disequilibrium In this situation inflation accelerates for any reason, not excluding the attempt on the part of the government to finance additional expenditure through direct money creation. However, as the tax systems of some countries are characterized by: (a) long lags between the time when a tax liability occurs and the time when the government actually receives the corresponding payment (collection lag); (b) widespread use of specific, ad rem rates for both excise taxes and customs duties; (c) increasingly unrealistic customs valuations for determining import duties;6 and (d) controlled prices for some taxed products; the ratio of taxes to gross national product declines (Tanzi, 1977). This decline, if unaccompanied by an equivalent reduction in public expenditure, leads the government to rely even more on deficit financing through the central bank. However, as the rate of inflation accelerates, reducing the real stock of money, deficit financing through monetary expansion (corresponding to the same amount of real expenditure) comes to be associated with a progressively larger rate of inflation. Thus, in this situation, the fiscal deficit is partly the cause of inflation and partly the result of it. A theoretical model of such a scenario has been developed in a paper by the author (Tanzi, 1978). That paper shows that the literature on

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inflationary finance has dealt with an unrealistic situation as it has assumed that inflation leaves the real revenue from the tax system unaffected. However, in most cases, inflation brings about positive or negative changes in real tax revenue and these changes must be added to, or subtracted from, the gains from the inflation tax. A model for a situation in which the price elasticity of the tax system is unity and the average collection lag is significant is developed. It is shown that total government revenue from taxes and inflationary finance - at given rates of inflation will depend on the values of the following: (a) the ratio of total tax revenue to national income at zero inflation; (b) the average collection lag for the tax system; (c) the ratio of money to income at zero inflation; and(d) the sensitivity of the demand for money with respect to the rate of inflation. A simulation exercise using realistic figures for the above variables shows that, given the assumption about the price elasticity of the tax system, the net gain from inflationary finance is likely to be significantly less than would be expected from traditional theory. The model was applied to Argentina for the 1968-1976 period. Its empirical relevance shown by the was comparisons of simulated and actual results for A related analysis applied to that country.7 Brazil, Colombia, the Dominican Republic, and Thailand was developed by Aghevli and Khan (1978). Of interest also is Mansfield’s paper on Ghana (1980).

(c) Public enterprises and fiscal equilibn’um One could present several scenarios of the widening disequilibrium in public enterprises in many countries. Some of these would emphasize would external causes; others emphasize domestic factors. Assume, for example, that the rate of inflation increases for any reason. The government may attempt to slow down the rate of growth of prices by constraining the prices that public enterprises charge for their output. This control over the prices charged by public enterprises could be justified also on the ground of slowing down wages or for equity reasons. Additionally, if the output of the public enterprises is subject to specific excise taxes, these taxes may be kept unchanged in the face of inflation so that their implicit ad valorem rates fall. As a result of these actions, the public enterprises begin to show losses, or higher losses than previously. And because the country relies on excise taxes, tax revenue also falls. This

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may, at first, lead to some build-up of arrears in the payments that these enterprises make, including those to the government or to other public enterprises. This build-up of arrears is followed, or accompanied, by additional domestic or foreign borrowing. Eventually the government is compelled to increase its budgetary transfers to the public enterprises, thus internalizing their deficit. Therefore, if one concentrates on the fiscal deficit of the central government, the deteriorating fiscal situation of the public enterprise sector will be seen as an increase in public expenditure (through the budgetary transfers). However, if one concentrates on the fiscal deficits of the total public sector, the deteriorating fiscal situation will be associated with a fall in public sector revenue.8 One common example of disequilibrium in public enterprises comes when the government tries to insulate prices from increases in costs. In such cases, the quality of the services falls and/or budgetary transfers increase. An alternative channel through which disequilibrium can come to the public enterprise sector has a more directly political origin. In some countries thegovernment has attempted to promote employment policies by requiring that the public enterprises expand their employment beyond efficient levels. As an example, in some countries, the public enterprises have been required to hire all high school or university graduates. This policy has increased the costs of these enterprises and, as prices have not been allowed to increase accordingly, the inevitable result has been a widening of their deficit, with obvious budgetary consequences. Still an alternative version of disequilibrium may come not because of the two factors indicated above but because of over-ambitious investment programmes by some public enterprises, coupled with an inability or an unwillingness on the part of governments to control their expenditures. In some countries these public enterprises have been almost totally free from financial controls and have engaged in borrowing, to an extent that in time could not fail to jeopardize their economic situation. In many cases, this borrowing has been from foreign sources; in other cases these enterprises have managed to get their funds directly from the monetary authorities at highly subsidized rates. In both of these cases, there could be considerable monetary expansion in the country without any corresponding increase in the size of the deficit of the central government. Therefore, the fiscal deficit, as normally measured, could at times understate the inflationary impact of the public sector as a whole.

To my knowledge there has been little formal analysis of the role of public enterprises in fiscal disequilibrium and of the link between that disequilibrium and inflation. An interesting attempt at analysing the relationship between distortions in the relative prices of Argentine enterprises and the rate of inflation has been made by Ke-Young Chu and Andrew Feltenstein (1978). They constructed a monetary model in which demand for real balances was determined by inflationary expectations, while the supply of money was a function of: (a) the balance of payments; (b) the nominal deficit of the central government; and (c) the level of credit to the rest of the economy. This credit was, in turn, a function of distortions in the economy’s relative price structure. The price distortions referred not only to public enterprises, which received direct subsidies from the government, but also to private firms which borrowed from commercial banks to finance the losses that the price controls had forced upon them. The price distortion was derived from a dynamic inputoutput matrix. The banks, by receiving rediscounts from the central bank, caused a monetary expansion to take place. The model was estimated on a quarterly basis. Price distortions were found to be highly significant in explaining the rate of inflation.

(d) Public expenditure

expansion

In this situation, increases in expenditure that cannot be financed through tax increases or ‘permanent’ grants occur either for purely reasons - because the government political decides to increase the level of public expenditure - or because the government is not administratively able to control the expenditure of thevarious spending units. When the problem is one of expenditure control, particular units (ministries, public enterprises, etc.) begin to build up arrears and the government sooner or later has to come in and foot the bill. In some of these cases the government may be trying to promote a particular objective, such as the generation of new employment, or income through maintenance redistribution and additional expenditure. In other cases the government may be trying to maintain the price of a commodity consumed by the masses by subsidizing the producer or the importer. In still other cases, the government may be influenced by international demonstration effects and may try to introduce welfare programmes that cannot possibly be financed at the present level of development. What

FISCAL

DISEQUILIBRIUM

makes this situation different from some of the previous ones is that no structural causes, or external causes, are necessary to bring about fiscal disequilibrium. This is essentially an indigenous problem of course, although, structural causes may aggravate the situation.

(e)

Worsening of the terms-of-trade scenario

This situation could be brought about by a drastic fall in the price of exported commodities and would, thus, be the reverse of the export boom scenario. However, a more general situation common in recent years is associated with a drastic and possibly permanent increase in the price of some important imported commodity, such as oil. In such a situation, the increase in the price of the imported product should be passed through to the domestic consumers, thus leading to a reduction in their real incomes and, thus, expenditure; and the government itself should reduce the level of its real expenditure. Some countries have, however, prevented this pass-through and, in doing so, have contributed to the fiscal disequilibrium. This has happened, for example, when the government has decreased the taxes on the product in order to neutralize the real price increase for domestic consumers; or, when it has subsidized the domestic use by, say, providing budgetary transfers to the main users such as enterprises engaged in public transportation. Either the fall in taxes or the increase in expenditure caused by the subsidy has contributed to an enlargement of the fiscal deficit. The above scenarios are somewhat stylized, but they cover most of the essential elements that have brought about fiscal disequilibria in many countries. In a real-world situation one may not be able to classify a country according to just one of those scenarios. One may find, rather, several of the factors described above all interacting and playing a role. A fiscal disequilibrium situation will often start with one main factor but then, after a while, it will become difficult to separate causes from effects or structural from political factors.

4. FISCAL DISEQUILIBRIUM EXPERIENCES In this section information about a group of countries undergoing fiscal disequilibrium has been assembled to attempt to classify them according to the various scenarios outlined above. Tables l-5 show the level of several

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important fiscal variables, as percentages of gross domestic product (GDP) for 23 countries. The choice of countries was determined by: (a) availability of data; (b) the existence of fiscal deficits over several years; (c) the relative importance of the country; and (d) the necessity to limit the sample. In no way must inclusion in this sample be assumed to imply that the fiscal situation in the countries included was necessarily worse than that in the countries excluded. One can easily think of many excluded countries with far worse fiscal situations than some of the included countries. Before commenting on the data, a note of warning is necessary. First, as anybody who has worked in this area would immediately the kind of information gathered recognize, in the tables is not available from any single source. Although the sources used were the most reliable ones available, there remains an issue of comparability: in some countries the information relates to the central government; in a few the information relates to broader concepts. Furthermore, the comparability of this information is also limited by the quality of the national accounts statistics. The data are more useful to compare countries over time, rather than for cross-sectional comparisons. Another problem with the information presented is that it could not be gathered for many years; a cut-off point was set for 1974/1975. However, in some of these countries significant fiscal disequilibrium preceded that date. Thus, the period shown does not always allow firm conclusions about the genesis of the fiscal disequilibrium. For this reason later comments may not always appear substantiated by the data. Table 1 shows that, in some countries, fiscal deficits have been very large, in some cases exceeding 20% of GDP. The variability of these ratios from year to year is also remarkable. At times this deficit has varied by over 10% of GDP in a single year. In order to attempt to classify these countries according to the five scenarios described above, I have presented separate information conceming the behaviour of revenue and expenditure. Table 2 provides information on ordinary revenue of the government, expressed also as a percentage of GDP. This table shows that in many cases revenue fell as a proportion of GDP, either over the period or from a peak reached during the period. For example, in Bolivia, the ratio shown in the table fell from 17.4% in 1977 to 11.8% in 1980; in Costa Rica, from 25.1 to 21.4%; in Egypt, from 34 to 29% and rose again to 43.3% in 1980; in Ghana, from around 15% to around 9%; and in the Ivory

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Table 1. Selected

Argentina Bangladesh Bolivia Costa Rica Egypt Ghana Haiti Ivory Coast Jamaica Kenya Malawi Mexico Morocco Nigeria Pakistan Peru Portugal Sri Lanka Sudan Tanzania Turkey Zaire Zambia

countries:

fiscal deficit,

1974-1980

(in % of GDP)

1974

1975

1976

1977

1978

1979

1980

n.a. 5.0 n.a. 1.3 n.a. n.a. n.a. n.a. n.a. 6.4 n.a. 3.9 n.a. -6.9 10.9 3.1 n.a. n.a. n.a. n.a. n.a. 18.4 -4.5

14.7 9.0 7.7 6.0 26.5 14.2 n.a. n.a. na. 6.0 7.5 4.5 9.5 7.0 9.6 5.6 5.4 10.0 8.5 15.5 1.3 11.8 20.0

10.5 8.0 10.6 5.4 18.9 11.5 3.4 4.2 18.8 5.3 5.6 5.6 18.1 6.9 8.6 6.4 7.0 10.3 8.4 5.7 2.0 14.6 14.0

3.9 10.0 11.3 8.3 15.5 12.1 4.7 -0.4 16.1 4.4 6.1 3.7 16.8 7.2 8.0 7.5 7.4 7.7 5.8 11.1 6.1 9.6 12.9

4.9 9.0 9.7 10.1 21.2 5.0 4.8 9.6 13.7 8.5 8.7 3.0 11.0 2.1 8.8 5.1 11.4 13.7 8.7 23.7 4.1 11.1 9.2

3.8 12.0 8.4 11.1 21.1 6.0 3.8 11.5 12.1 8.0 9.0 3.5 10.0 2.5 6.2 0.8 9.9 13.8 8.4 21.9 4.0 4.2 11.5

4.6 10.6 7.5 12.7 14.1 n.a. 5.2 13.0 17.4 10.6 9.5 n.a. 10.2 0.5 4.6 3.3 10.9 21.1 13.2 n.a. 4.6 0.9 16.2

Sources: IBRD, World Tables; IMF, Government various national sources.

Table 2. Selected

Argentina Bangladesh Bolivia Costa Rica Egypt Ghana Haiti Ivory Coast Jamaica Kenya Malawi Mexico Morocco Nigeria Pakistan Peru Portugal Sri Lanka Sudan Tanzania Turkey Zaire Zambia

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countries:

Finance Statistics;

ordinary

revenue,

IMF, International

1974-1980

Financial Statistics;

and

(in % of GDP)

1974

1975

1976

1977

1978

1979

1980

n.a. 5.0 n.a. 25.1 n.a. na. n.a. n.a. n.a. 25.3 na. 8.9 n.a. 23.0 14.3 15.2 n.a. n.a. n.a. n.a. n.a. 32.1 35.0

16.6 9.0 15.3 22.7 29.0 14.7 n.a. 21.7

19.0 9.0 15.7 23.6 30.0 12.7 14.6 37.0 21.8 23.1 14.3 10.9 20.2 20.6 14.7 14.5 28.6 17.9 16.2 33.5 21.5 19.5 24.0

23.3 9.0 17.4 23.9 33.6 8.9 14.1 32.5 20.5 29.1 15.4 11.4 22.9 21.7 15.2 14.6 27.5 20.6 15.5 33.1 2 1.5 20.5 26.0

25.6 10.0 15.1 24.3 33.9 10.9 15.8 31.0 26.1 28.1 17.6 12.1 21.1 17.4 15.1 15.8 27.6 26.2 14.6 34.1 22.3 16.5 30.0

24.4 10.0 14.3 23.8 29.5 9.2 14.7 25.9 25.8 30.1 20.0 12.1 22.1 21.2 16.3 18.2 27 .O 23.0 13.8 35.3 23.2 19.3 24.0

26.9 10.3 11.8 21.4 43.3 n.a. 13.6

2::; 15.4 10.4 23.3 22.1 14.8 16.0 26.1 21.0 20.1 30.4 20.4 24.9 29.0

Sources: IBRD, World Tables; IMF, Government various national sources.

Finance Statistics;

IMF, International

Financial Statistics;

2% 31.5 19.1 n.a. 21.7 25.5 16.9 21.0 30.5 18.9 14.4 n.a. 19.0 25.1 26.0 and

FISCAL

DISEQUILIBRIUM

Coast, from 37 to 26%. Sharp falls were also registered by Sudan, Sri Lanka, Zaire and Zambia.’ Turning now to public expenditure, Table 3 shows the behaviour of the ratio of total expenditure to GDP. The table indicates noticeable increases in many countries such as Bangladesh, Costa Rica, the Ivory Coast, Kenya, Malawi, Portugal, Sri Lanka, Tanzania and Zambia. In order to permit a closer examination of the reason for fiscal equilibrium, Table 3 has been split into two parts, one relating to capital expenditure and one relating to current expenditure. Table 4 pertains to current expenditure and Table 5 to capital expenditure. Table 4 indicates that over the periods shown, current expenditure increased significantly in Bolivia, Costa Rica, the Ivory Coast, Jamaica, Kenya, Malawi, Mexico, Nigeria, Portugal and Tanzania. On the other hand, some reduction in the ratio of current expenditure to GDP was experienced by Egypt, Ghana, Pakistan and Zaire. For Egypt and Zaire, the decline was from the very high levels reached in the early 1970s. When we turn to Table 5, which shows the ratio of capital expenditure to GDP, we notice a few countries in which this ratio has increased sharply. These include Bangladesh, Costa Rica, Egypt, Kenya, Malawi, Morocco, Nigeria, Portugal and Sri Lanka. On the other hand, the majority of the countries shown in the table experienced a fall in the ratio of capital expenditure to GDP over the period. This implies that current public expenditure was often crowding out public investment. This crowding out of public investment could have long-term implications for the performance of these economies. This change in the composition of public expenditure can easily be explained by the government’s greater discretion over capital expenditure than over current expenditure. In the countries in which capital expenditure kept increasing in spite of the fiscal disequilibrium, the reason was often found in the difficulty that the government had in controlling (politically or administratively) the activities of the public enterprises. In Tables 6 and 7, an attempt has been made to identify factors that have contributed significantly either to the fall in revenue (Table 6) or to the growth in public expenditure (Table 7). The factors contributing to the fall in revenues can be classified as: (a) decline in export prices; (b) unrealistic customs valuations; (c) widespread use of specific (ad rem) taxes; (d) increasing use of (quantitative) import

1077

restrictions; (e) substantial collection lags; (f) administrative difficulties; and (g) increasing exemptions granted to investors and importers. Table 6 is largely self-explanatory. The factors that could specifically be identified as having brought about falls in revenue are marked in the table. This table shows that unrealistic customs valuations, extensive use of specific taxes, and administrative difficulties were common factors. This table obviously reflects a qualitative judgment; to some extent all the factors listed above played some role. The growth in public expenditure can be attributed to five factors, namely: (a) subsidies to consumers; (b) subsidies to enterprises; (c) wage increases; (d) administrative difficulties in controlling expenditure; and (e) capital spending. Table 7 shows the widespread use of subsidies to consumer goods which, in some countries, have significantly contributed to the fiscal disequilibrium. Subsidies to public enterprises are ‘seen to be prevalent with the majority of countries providing them. Difficulties in controlling expenditure also played an important role. In a few countries, other factors such as wage increases may also have been important. On the basis of the information provided in Tables 6 and 7 and of other qualitative information, an attempt has been made to classify countries according to the five scenarios. This has been done in Table 8. In this table, most of the countries fall under scenario 5, which relates to the growth of public expenditure. In fact, it turned out to be difficult to separate scenario 2 from scenario 5, as often the growth in public expenditure took place through considerable expansion of the sector of public enterprises, so that in some cases it was necessary to classify the countries in both of these categories. It was equally difficult to classify countries to the export boom scenario, especially on the basis of the statistics provided in the tables. In some cases, the export boom scenario was clearly relevant to the fiscal disequilibrium that existed in the 1974-1980 period. However, it would have been necessary to extend the period backward to the early 1970s to fully justify the placing of a country in that category. Few countries could be allocated to the inelastic tax system scenario. These included Argentina in the early part of the period, Bolivia, Costa Rica, Ghana, Sri Lanka and Sudan, Finally, the worsening of the terms of trade scenario could not be specifically connected with the fiscal deterioration of any country although it clearly played some role in many countries.

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WORLD Table 3. Selected countries:

Argentina Bangladesh Bolivia Costa Rica Egypt Ghana Haiti Ivory coast Jamaica Kenya Malawi Mexico Morocco Nigeria Pakistan Peru Portugal Sri Lanka Sudan Tanzania Turkey Zaire Zambia

total expenditure,

1974-1980

(in % of GDP)

1974

1975

1976

1977

1978

1979

1980

n.a. 10.0 n.a. 27.0 n.a. n.a. n.a. n.a. n.a. 32.7 n.a. 12.8 n.a. 16.1 25.3 18.4 n.a. n.a. n.a. n.a. n.a. 50.5 30.3

31.3 19.0 23.1 28.7 55.5 29.0 n.a. n.a. n.a. 32.8 24.8 15.0 32.3 29.1 24.9 21.6 31.5 31.1 28.5 50.3 21.6 36.8 38.0

29.5 17.0 25.9 29.0 48.9 24.2 18.0 31.9 40.6 28.7 21.2 16.7 39.3 27.5 23.5 20.9 35.6 28.2 24.6 44.1 23.4 34.1 38.3

27.2 19.0 28.5 32.3 49.6 20.9 18.8 36.7 36.6 35.7 23.6 15.3 41.5 28.9 23.5 22.1 34.9 28.3 21.3 49.3 27.5 30.1 35.4

30.5 19.0 25.1 34.4 55.6 15.9 20.6 42.0 40.4 38.1 29.4 15.2 30.8 19.5 25.0 20.9 39.0 40.1 23.2 65.3 26.4 27.5 35.2

28.2 22.0 21.9 35 .o 51.7 14.9 18.5 42.5 37.8 39.3 32.7 15.7 33.9 23.7 23.2 18.9 36.9 37.0 22.1 66.6 27.2 23.5 42.2

31.5 20.9 19.4 34.1 57.4

Sources: IBRD, World Tables; IMF, Government various national sources.

Table 4. Selected countries:

Argentina Bangladesh Bolivia Costa Rica Egypt Ghana Haiti Ivory coast Jamaica Kenya Malawi Mexico Morocco Nigeria Pakistan Peru Portugal Sri Lanka Sudan Tanzania Turkey Zaire Zambia

DEVELOPMENT

Finance

1r-G 38.8 41.8 43.4 34.4 n.a. 32.6 26.0 22.2 24.3 41.4 40.1 27.6 n.a. 23.6 25.9 n.a.

Statistics; IMF, International Financial Statislics; and

current expenditure,

1974-1980

(in % of GDP)

1974

1975

1976

1977

1978

1979

1980

n.a. 6.0 n.a. 20.7 n.a. n.a. n.a. n.a. n.a. 22.3 n.a. 8.6 n.a. 5.6 15.3 13.9 n.a. n.a. n.a. n.a. n.a. 28.6 21.0

25.9 12.0 11.8 20.2 39.1 17.9 n.a. n.a. n.a. 21.5 12.8 9.7 20.1 10.0 14.5 16.5 28.6 21.9 21.5 27.6 18.0 28.0 36.0

21.5 10.0 12.3 20.2 34.3 15.0 8.5 17.3 27.7 19.8 13.0 10.6 19.5 7.5 12.8 16.0 31.4 18.6 18.0 28.9 18.1 25.5 29.0

18.9 10.0 13.5 21.1 30.7 16.2 8.1 14.6 26.2 24.1 13.5 10.8 19.6 8.6 14.0 18.3 29.5 22.5 14.9 29.8 20.8 23.2 31.0

22.7 7.0 13.5 23.8 32.0 12.4 9.1 18.8 29.3 25.7 15.9 10.9 18.8 7 .o 14.5 17.4 30.9 27.6 18.4 41.2 2 1.4 22.6 30.0

21.7 9.0 12.9 25.5 31.3 12.7 9.3 20.9 29.7 27.0 16.7 10.9 19.4 9.3 13.8 14.7 30.8 22.8 16.7 42.4 22.8 20.7 29.0

25.5 8.9 13.6 25.2 36.8 n.a. 10.0 23.0 32.1 29.6 18.2 n.a. 21.3 9.0 13.1 19.1 34.3 21.4 20.1 n.a. 19.9 22.2 34.0

Sources: IBRD, World Tables; IMF, Government various national sources.

Finance Statistics; IMF, International Financial Statistics; and

FISCAL

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DISEQUILIBRIUM

Table 5. Selected countries: capital expenditure, 1974-1980 (in X of GDP) 1974

1975

1976

1977

1978

1979

1980

Argentina Bangladesh Bolivia Costa Rica Egypt Ghana Haiti Ivory Coast Jamaica Kenya Malawi

n.a. 4.0 n.a. 6.3 n.a. n.a. n.a. n.a. n.a. 10.3 n.a.

5.4 7.0 11.3 8.5 16.4 11.1 n.a. n.a.

8.0 7.0 13.6 8.8 14.6 9.2 9.5 14.6 12.9

8.3 9.0 15.0 11.2 18.9 4.8 10.7 22.1 10.4

7.8 12.0 11.6 10.6 23.6 3.5 11.5 23.2 11.1

6.5 13.0 9.0 95 20.4 2.2 9.2 21.6 8.1

6.0 12.0 5.8 9.0 20.6 n.a. 8.9 15.8 9.1

8.9

11.6

12.4

12.3

13.8

12.0

8.2

10.1

13.5

16.0

16.2

Mexico Morocco Nigeria Pakistan Peru Portugal Sri Lanka Sudan Tanzania Turkey Zaire Zambia

4.2 1:s 10.0 4.5 n.a. n.a. n.a. n.a. n.a. 21.9 6.0

5.3 12.2 19.1 10.4 5.1 2.9 9.1 7.0 22.8 3.6 8.0 9.0

6.1 19.8 20.0 10.7 4.9 4.2 9.6 6.6 15.3 5.3 8.6 6.0

4.5 21.9 20.3 9.5 3.8 5.4 5.8 6.4 19.4 6.1 6.9 5.0

4.3 12.0 12.5 10.5 3.5 8.1 12.5 4.8 24.2 5.0 4.9 5.0

4.8 14.5 14.4 9.4 4.2 4.4 14.2 5.4 24.3 4.4 2.9 3.0

1Yi

Ini? 17.0 9.1 5.2 7.1 18.9 7.4 n.a. 3.1 3.7 6.0

Sources: IBRD, World Tables; IMF, Government Finance Statistics; IMF, International Financial Statistics; and various national sources.

Table 6. Selected countries: factors contributing to fall in revenue FalI in export prices Argentina Bangladesh Bolivia Costa Rica Egypt Ghana Haiti Ivory Coast Jamaica Kenya Malawi Mexico Morocco Nigeria Pakistan Peru Portugal Sri Lanka Sudan Tanzania Turkey Zaire Zambia

Unrealistic customs’ valuations

Ad rem taxes

Import restrictions

X

Collection lags X

Administrative difficulties

Exemptions

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X X

X

X

X

X

X

X

X

X X

X X X

X

X

X

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DEVELOPMENT

Table 7. Selected countries: factors contributing

Subsidies to consumer goods Argentina Bangladesh Bolivia Costa Rica Egypt Ghana Haiti Ivory coast Jamaica Kenya Malawi Mexico Morocco Nigeria Pakistan Peru Portugal Sri Lanka Sudan Tanzania Turkey Zaire Zambia

Subsidies to enterprises

to growth in public expenditure

Wage increases

Limited expenditure control

x

Capital spending

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X X

X

X

X

X

X

X X

X X

X

X

X

X

X

X

X

X

X

X

X

Table 8. Classification of coun tries by scenan’os Scenario Export boom

1

Bolivia Costa Rica Ivory coast Malawi Nigeria Zaire Zambia (early period)

Scenario 2 Public enterprise

Scenario 3 Inelastic tax system

Brazil Egypt Malawi Peru Portugal Sri Lanka Sudan Tanzania Turkey

Argentina Bolivia Ghana Haiti Sri Lanka Sudan

Scenario 4 Terms of trade

Scenario 5 Growth in public expenditure Bangladesh Costa Rica Egypt Ivory Coast Jamaica Kenya Malawi Morocco Nigeria Pakistan Peru Portugal Sri Lanka Tanzania Zambia (late period)

FISCAL DISEQUILIBRIUM 5. GENERAL

CONCLUSIONS

In this paper an attempt has been made to define the concept of fiscal disequilibrium with special reference to developing countries. Subsequently, various fiscal scenarios were outlined, describing in a stylized fashion the patterns followed by countries in developing fiscal disequilibria. The basic conclusion was that equilibrium in the fiscal sector requires that ‘permanent’ expenditure be covered by ‘permanent’ revenues. This implies that, for example, increases in non-permanent revenues (or, for example, those derived from an export boom or from once-for-all grants) should not be allowed to raise permanent expenditure as this would inevitably create conditions for fiscal disequilibrium. This way of looking at the fiscal situation of a country implies that an analysis that concentrates only on the difference between revenue and expenditure for a given year may totally miss the structural aspects of fiscal disequilibrium. Short-run results must be evaluated in the context of longer-run trends if reliable conclusions are to be derived from them. Or, putting it more strongly, the fiscal outcome of a particular fiscal year may tell little about the basic fiscal trends characterizing the economy of that country. If the fiscal situation in that year was improved by temporary increases in revenues or by temporary cuts in permanent expenditures (say, through deferral of inevitable wage

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increases), there would be little scope for optimism. The reverse is, of course, also true. A country that has suffered a temporary loss in revenue or that is engaging in a oncefor-all expenditure may show a large fiscal deficit while its structural fiscal situation may be much better than that. Once again, only an analysis that puts the current fiscal year in a longer-term context will give a correct assessment. The attempt to classify countries according to factors that caused fiscal disequilibrium proved only partly successful. This approach requires far more information than is possible to gather in a limited period of time. In any case, it can be concluded that the most common cause of fiscal disequilibrium in developing countries has been the growth of public expenditure and particularly the growth of current public expenditure. Capital spending, however, has also played an important role in a few countries. In several cases, the growth of public expenditure can be traced back to an export boom, which occurred either recently or in the recent past. The various scenarios outlined earlier have been presented as alternatives; however, in reality, countries can often only be classified according to more than one of these scenarios. A more detailed research effort, attempting to quantify the importance of the factors listed in Tables 6 and 7, would be required to provide a more firmly based classification of countries in the above-described scenarios.

NOTES 1. However, the balanced budget theorem tells us that aggregate demand would be likely to expand and would probably contribute to inflation. The same conclusion is reached by analyses that emphasize the ‘domestic budget balance’.

4. To my knowledge these concepts have never been applied to government behaviour, while the permanent income hypothesis of consumer behaviour is one of the major tenets of macroeconomics.

2. In this definition, by ordinary revenue we simply mean revenues that are sustainable over the long run. They need not be limited to sustainable tax revenue but could include grants and concessional foreign financing provided that these can be expected to continue for many years.

5. Margaret Kelly has pointed out to me that temporary increases in revenues can also be sterilized by placing them in blocked accounts in the central bank. The advantage of investing abroad is that the country earns additional foreign exchange in terms of interest.

3. Of course, if the country had been running a deficit, it might do none of the above but simply reduce the size of that deficit. If it had not been running a deficit, it might reduce its accumulated public debt. These alternatives are not discussed above.

6. In one particular country, the customs administration was using import prices which were four years old to determine customs duties. In others, the exchange rate used to determine the domestic values of imports may not reflect the actual domestic value of those imports.

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7. The same model was also applied to Turkey for which the price elasticity of the tax system was greater than one (see Erbas, 198 I). 8. I owe this clarification

9. In Argentina, the ratio of revenue sharply in 1975 and 1976. Unfortunately, data are not available.

to GDP fell comparative

to Linda Koenig.

REFERENCES Aghevli, Bijan B. and Mohsin S. Khan, ‘Government deficits and the inflationary process in developing countries’, IMF Staff Papers, Vol. 25 (September 1978), pp. 383-416. Chu, Ke-Young and Andrew Feltenstein, ‘Relative price distortions and inflation: the case of Argentina, 1963-76’, IMF Staff Papers, Vol. 25 (September 1978), pp. 452-493. Erbas, S. N., ‘Effects of inflationary finance on tax revenue under progressive tax structures with collection lags: an application to Turkey’, mimeo (17 April 1981). Harberger, Arnold C., ‘Dutch disease -how much sickness, how much boom?‘, mimeo (October 1981). Heller, Peter S., ‘Public investment in LDCs with recurrent cost constraint: the Kenyan case’, Quarterly Journal of Economics, Vol. 88 (May 1974), pp. 251-277. Mansfield, Charles Y ., ‘A norm for a stabilizing budget

policy in less developed countries’, The Journal of Development Studies, Vol. 16 (July 1980), pp. 401-411. Mansfield, Charles Y., ‘Tax base erosion and inflation: Ghana’, Finance and Development, Vol. 17 (September 1980). Morgan, David, ‘Fiscal policy in oil exporting countries, 1972-78’, IMFStaffPapers, Vol. 26 (March 1979), pp. 55-86. Tan;;, Vito, ‘Inflation, lags in collection, and the real value of tax revenue’, IMF Staff Vol. 24 _. Papers, . (March 1977), pp. 154-167. Tanzi, Vito, ‘Inflation, real tax revenue, and the case for inflationary finance: theory with an application to Argentina’, IMF Staff Papers, Vol. 25 (September 1978). pp. 41745 1. Struckmeyer Hdrst .I., ‘The effect of the present high coffee prices on the Central American economies’, mimeo (20 April 1977).