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Key Text Making Fiscal Policy Work for the Poor. How to implement Pro-poor Fiscal Policies in Developing Countries?

Author: R Weeks
Date: 2004
Size: 35 pages (216 KB)

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Summary

What constitutes pro-poor fiscal policy? What fiscal measures are necessary to achieve pro-poor growth? This paper by the United Nations Development Programme (UNDP) is a synthesis of the fiscal policy detailed in seven country studies carried out by the UNDP as part of the Asia-Pacific Programme on Macroeconomics of Poverty Reduction (MPAP). The paper argues that public investment is a key fiscal measure and a necessary component of a pro-poor macro strategy.

Pro-poor growth is defined as growth that disproportionately benefits the poor. This implies that fiscal policy promotes growth and redistributes the increased income generated by growth towards the poor. The importance of fiscal policy is underlined in the MPAP country studies, covering Bangladesh, Cambodia, China, Indonesia, Mongolia, Nepal and Vietnam. Fiscal policy that fosters pro-poor growth needs to take into account the relationship between growth and distribution. A pro-poor fiscal strategy should ensure that growth leads to a more equal distribution.

Public investment is a key element of pro-poor growth. Developing countries are constrained in achieving other fiscal measures such as progressive taxation and redistribution, while one-off policy interventions have little impact on the sustainable growth rate. The country studies also highlight that:

Public investment stimulates growth through demand management and creation of assets. It affects redistribution by creating income-earning opportunities for the poor, for example, through infrastructure projects.
Public investment can facilitate private investment and growth.
In all countries except Mongolia, public investment could be responsibly financed by borrowing or through development assistance.
Increasing expenditure on social sectors is almost always pro-poor. However, in Bangladesh, Cambodia and Nepal, shifting expenditure to social sectors reduced expenditure on economic sectors, adversely affecting growth.
Value Added tax (VAT) may not be revenue neutral. For example, in Nepal, it created revenue shortfalls.
Donor and lender conditionality restricts domestic borrowing for public investment.

Active and innovative fiscal policies, such as investment-led growth, are possible or feasible in all countries studied. However, for fiscal policy to foster pro-poor growth, several issues must be considered:

Fiscal policy must be sustainable, which implies that fiscal deficits should be manageable. However, deficit targets should not reduce a government’s ability to improve the welfare of its citizens.
Switching towards pro-poor expenditure is more complicated than a relative increase in allocations to social sectors.
The examples of China and Vietnam show that successful transitions from central planning to market economies that support private sector investment require active fiscal policies, with an emphasis on public investment.
The neutrality of VAT needs to be reconsidered as VAT is not pro-poor.
The assertion that domestic borrowing is always a bad thing needs to be reassessed. Domestic borrowing can be an important source of resource mobilisation for public investment.
Resources mobilised through domestic borrowing must be used for pro-poor public investment. This may not always happen. For example, in Indonesia, the fiscal surplus has been used to pay back bad private sector debt.

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Source: Weeks, J., Roy, R. 2004, ‘Making Fiscal Policy Work for the Poor. How to Implement Pro-poor Fiscal Policies in Developing Countries’ Global Development Network, New Delhi
Author: Rathin Roy , rathin.roy@undp.org