Tuesday, July 9, 2019

Macro-criticality of social spending

Social spending plays a vital role in people’s lives, especially those of vulnerable, marginalized, and elderly. It an important part of inclusive economic growth and poverty alleviation strategy. It promotes financial security (to smooth consumption over lifetime) and social cohesion. 

According to the IMF, social spending covers (the first two are traditionally thought of as social protection):
  • Social insurance: financed by contributions or payroll taxes (such as public pension, health, unemployment, sickness and maternity leave 
  • Social assistance: financed from general government revenue (such as universal and targeted transfers, child benefits, active labor market policies
  • Public spending on health and education 
Social spending matters now more than ever because countries face a declining workforce but an increasing number of retirees (mostly in developed countries), negative effect of technology on work and wages for some workers with particular skills set, rising inequality (both income and opportunity), barriers to women’s labor force participation, and climate change, among others. 
  • Advanced economies need to strengthen their health and pension systems to enhance spending efficiency and to expand coverage.
  • Growing youth population and low women LFPR mean that emerging markets and developing countries have to absorb more women and youth into employment. Social benefit systems (and their financing) need to support, rather than disincentivize, their employability. For this education and training systems are critical.
  • Technological change is transforming labor markets as mobility of labor across sectors increases and flexible work arrangements (part-time and temporary work, self-employment) become popular. These bring in more volatility to careers and income streams. AI and robotics could render a range of skills redundant and disrupt labor market. Adaptable education and training are crucial for continuously upgrading skills, and these should be complemented by policies to facilitate labor market matching.
  • Climate change means increased risk from extreme weather events and natural disasters, severely affecting low-income and small island states and pushing many households into poverty. It will require enhancing capacity of their social safety nets. 
Therefore, social spending should be an integral part of macroeconomic policy. So how do we design the most effective social spending given fiscal space constraints? 

A recent IMF paper sheds light into this aspect.  Fiscal space is required to increase spending in education (free primary and secondary school education), healthcare (free basic healthcare), unemployment and elderly allowance, public pension, guaranteed minimum wage, etc.  These are also a part of SDGs and could be thought of as investment. These investments should be
  • Adequate (spending adequacy): Higher social spending is required to fill the gap in education, healthcare and social protection coverage— especially important to achieve the SDGs. It is crucial to successfully transition to more normal career/life choices or outcomes.  
  • Efficient (spending efficiency): High spending alone may not translate into high social outcomes. For instance, high education and health expenditure alone may not translate into higher graduation or enrollment and health outcome index. Such programs should not also create significant work disincentives, which could result in high unemployment and spending. Avoiding duplication of social spending programs is important to avoid high and inefficient administrative costs.
  • Financed sustainably (fiscal sustainability): Sustainable financing requires an appropriate balance between financing, revenue mobilization, and spending in social protection transfers and investment in education, health and physical infrastructure.
The IMF considers social spending to be “macro-critical” through these three key channels. Also, choosing either universal or targeted transfers should be country-specific (social and political preferences) but consistent with fiscal and administrative constraints. The IMF will design programs and conditionality by considering social spending needs too. It will help countries strengthen tax capacity, improve the quality of social spending, and address data and information gaps. 

Financing strategy could include effective strategies to improve tax compliance; progressive personal income taxes for higher income groups; effective taxation of corporate income; a broad-based consumption tax; efficient taxation of goods with negative consumption externalities such as fossil fuels, tobacco and alcohol; and plugging in tax evasion and avoidance. 

Here is link to the background papers for IMF's engagement on social spending. Case studies here.