Aid Effectiveness and Fiscal Space Issues

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Public Disclosure Authorized

Public Disclosure Authorized

The World Bank Group Public Disclosure Authorized

November, 2005 Aid Effectiveness and Fiscal Space Issues

Background

The global community is focused on international health policy on humanitarian, foreign policy, and national security grounds in a way it has never been before. This has resulted from the confluence of a number of political and economic factors, including:

· recent decisions by the G-8 concerning debt forgiveness and doubling aid to Africa, · decisions by the European Commission (EC) and other countries to scale up aid commitments to the level of 0.7 percent of GNI as set by the Monterrey principles, · increased revenues that will be available as a result of the International Finance Facility for Immunization (IFFIm) and aviation taxes adopted by several countries, · the international community’s commitment to reduce poverty and achieve the Millennium Development Goals (MDGs), · the involvement of new foundations with significant resources, and · the emergence of new global health threats such as avian flu and SARS which have captured the attention of the international community in an unprecedented manner.

These myriad factors have generated a substantial increase in development assistance overall and for the health sector in particular. Indeed, development assistance focused on the health sector has risen from about US$2 billion in 1990 to a level in the US$10 billion range in 20031. Both traditional and new public and private donor sources have contributed to this increase. In addition, most of the recent increases in Development Assistance for Health (DAH) are through disease or intervention-specific programs.

Based on this large actual and the proposed future increases in DAH, the international community has raised serious questions about the effectiveness of this aid. Thus, the next Chair of the G-8 will be expected to address a variety of aid effectiveness issues – including levels, predictability, and sustainability – which are discussed in more detail below.

A protracted debate over the last several years on aid effectiveness has generated the following findings concerning foreign aid:

· aid has diminishing returns; · countries’ absorptive capacity is limited;

1 Michaud, Catherine. Development Assistance for Health (DAH): Recent Trends and Resource Allocation. Paper prepared for the Second Consultation Commission on Macroeconomics and Health, World Health Organization, Geneva. October 29-30, 2003.

2 · aid is fungible overall and among sectors; · aid achieves better results in good policy environments; · aid requires ownership by countries, for example, donor-imposed conditionalities rarely work; · aid is related to increased investment and growth; · debt repayments have a negative impact on economic growth; · aid has high transaction costs for countries; · aid makes governments accountable to donors as opposed to their citizens2.

Key policy issues concerning aid effectiveness on both the donor and recipient country sides are at the forefront of the policy discussions of the G-8, EC, OECD, World Bank, IMF, bilateral donors, and the rest of the donor community.

Donor Aid Effectiveness Issues

On the donor side questions arise regarding:

· harmonization among donors of procedures and requirements related to reporting, monitoring and evaluation, etc.; · whether aid is provided as general budget support, through projects, or off- budget; · the impact of disease and intervention-specific programs on health systems; and, · aid predictability, volatility, and short-term nature; and, · donor conditionalities.

Each donor has its own procedures and priorities, which create large transaction costs for the recipient countries and fragment the potential impacts of the overall aid flows. There is also a concern that, to the detriment of the overall health system, disease and intervention-specific programs result in countries neglecting less well-funded areas and that the few qualified staff from other key priority areas are hired away, resulting in silos for each disease or intervention. Most aid is short term (2-3 years) and volatile, and is subject to the political preferences of the donor country. Further, actual disbursements rarely match donor commitments. This severely complicates budget management in highly aid dependent countries (e.g., in some 12 African countries external assistance accounts for over 30 percent of health sector financing).

In addition, half of all aid is off-budget. For example, some 20 percent does not even enter into the balance of payments (e.g., foreign consultants hired by donors) and another 30 percent does not enter the budget as it is directly passed on to non-governmental organizations (NGOs) and the private sector. Additionally, of the 50 percent of aid that is on-budget, some 30 percent of that is earmarked, leaving only about 20 percent of all DAH as general budget support available for use by countries to implement their

2 World Bank, Health Financing Revisited, Conference Version, World Bank, Washington, D.C., 2005.

3 programs3. Moreover, since aid is fungible, if there are differences between donor and country preferences, countries will often reduce support from their domestically mobilized resources to sectors or programs receiving aid, resulting in diminishing the additivity of the aid for the specific donor program. Therefore, because of fungibility, conditionalities generally are ineffective. Indeed, the evidence supports this, showing that fewer conditions are more effective. There is growing acceptance of the need for donors to provide aid in the form of general budget support for a mutually agreed upon, country-led program. Ministers of Finance are the key persons to involve in the discussions regarding increased aid flows and their meritorious use for the health sector. The Ministry of Finance can help to prepare different scenarios for health spending based on different projections of DAH and revenue levels, to help donors understand what services can be provided at different funding levels.

To alleviate the problems caused by the volatility and unpredictability of donor aid, mechanisms to smooth aid flows and buffer against the fluctuations in aid are needed to address the budgetary planning and management uncertainties experienced at the country level. While these proposals remain controversial and are the subject of much debate at the current time, an aid stabilization fund (sometimes knows as a ‘buffer fund’), initially proposed by DFID, is being discussed at the global health policy level4.

Recipient Country Aid Effectiveness Issues

On the recipient side there are many issues related to the ‘absorptive capacity’ of countries to productively use aid. These issues relate to country-specific macroeconomic, budgetary, institutional, and health-sector constraints on the absorption of these funds as well as the increasing pressure from donors on countries to show ‘results’.

One particularly important issue that has received a great deal of attention lately is the issue of “fiscal space”, or the “availability of budgetary room that allows a government to provide resources for a desired purpose [such as health] without any prejudice to the sustainability of a government’s financial position”5, 6. In principle, a government can create such fiscal space in several ways:

· additional revenues can be raised through tax measures or by strengthening tax administration; · lower priority expenditures can be cut in order to make room for more desirable ones; · resources can be borrowed, either from domestic or from external sources;

3 Foster, Mick. Millennium Development Goal Sector and Poverty Reduction Strategies: Lessons from Experience. Health, Nutrition and Population Unit Discussion Paper. The World Bank. October 2005. 4 Foster, Mick. Fiscal Space and Sustainability – Towards a Solution for the Health Sector. Discussion Paper prepared for the High Level Forum on the Health MDGs, November 2005. 5 Heller, Peter. Understanding Fiscal Space. International Monetary Fund Policy Discussion Paper. March, 2005. 6 Williams, Gareth and Roger Hay. Fiscal Space and Sustainability from the Perspective of the Health Sector. Background paper prepared for the High Level Forum on the Health MDGs, November 2005.

4 · governments can use their power of seignorage (having the central bank print money to lend it to the government); and, · governments may also receive grants from outside sources.

Other ways countries can create fiscal space include exploring flexible hiring arrangements, contracting with the private sector, and using short term employment. In addition, strengthening financial management and budgeting capacity could help to dismantle a key constraint to the creation of fiscal space.

While fiscal space is not a health sector specific issue per se, the scaling up of health aid can have significant macroeconomic and ‘fiscal space’ implications, given the large increases in DAH (both committed and needed) to reach the MDGs, the recurrent nature of most of the costs supported by this increased health spending, and the fact that much of this aid – at least in Africa – is targeted to increasing the health work force which has potentially large implications for the civil service wage bill.

Summary

In summary, the highest priority for donors is making more resources available at the country level in accessible, sufficient, long-term, predictable ways. In addition, donor countries will need to harmonize their efforts and reconcile national political interests with global needs to decrease the burden placed on the budgetary management and planning systems in all developing countries. Developing countries need to assure that increased public spending ‘buys’ better health and human development outcomes for the poor. To do this, recipient countries need to improve governance and their macroeconomic and budgetary management capacity, reduce corruption, assure that they have functioning health systems supported by long-term sustainable financing, and achieve results in terms of improving their human development indicators.