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Focusing Fiscal Policy on Poverty Reduction, Reconstruction, and Growth

by Tony Addison

An effective state is characterized by an ability to mobilize revenue and to spend it on infrastructure, services, and public goods that both enhance the human capital and well-being of communities (especially the poor) as well as stimulate investment and employment creation by the private sector. An effective state also manages the public finances to ensure that macroeconomic balance is maintained, with policy neither too restrictive to discourage private investment and growth, nor too accommodative to create high inflation and crowd out private investment. Fiscal issues are therefore at the heart of the state’s role in the development process and failure in this policy area—whether it is in taxation, public expenditures or in managing the fiscal deficit and public debt—can quickly undermine growth and poverty reduction. Moreover, for countries vulnerable to violent conflict fiscal weakness can be fatal to social peace when one or more ethnic, religious, or regional group is taxed unfairly—or receives too little from the allocation of public spending.

These and other crucial issues are addressed in Fiscal Policy for Development: Poverty, Reconstruction and Growth, edited by Tony Addison and Alan Roe, and now published in paperback by Palgrave Macmillan for WIDER. The book reviews all of the major areas of fiscal policy, setting out and assessing how thinking around public spending, taxation, and the macroeconomics of fiscal reform has evolved, particularly towards poverty reduction as well as conflict prevention and post-conflict reconstruction.

Fiscal policy is central to aid effectiveness

Fiscal policy also bears on the long-standing debate over aid effectiveness. The pioneers of development economics in the 1950s and 1960s assumed that the basic structures of public expenditure management and taxation that we take for granted in rich countries would not take too long to establish themselves in post-independent Africa and Asia. However they were sorely disappointed in many of the new African states, and in some of the Asian ones as well. In the 1970s poverty reduction was, for the first time, placed at the forefront of development; aid was intended to help governments meet basic needs but the assumption was again made that the associated propoor public spending would not be too difficult a job to organize. Pessimism set in with the 1980s and aid flows became organized around highly controversial programmes of structural adjustment, including fiscal reforms that often included crude mechanisms to curb public spending and bring fiscal deficits down (often resulting in unnecessary cuts in already low levels of pro-poor spending). The 1990s witnessed a growing recognition of the fiscal burden of servicing the debt left by the accumulation of aid loans and, towards the end of the decade, the start of a shift in aid towards budgetary support and away from project aid as country ‘ownership’ came into vogue. This trend is continuing today, although it periodically stumbles over the governance dimensions of fiscal policy, not least in countries reconstructing from conflict and those in unstable regions (notably the Horn of Africa).

The debate on aid and debt relief has taken on a particular resonance over the last year, generating much heat but also some light, with a succession of key events including the UN Millennium Summit in September 2005 (and also the work of the Millennium project which recommends a major scaling up of aid), the report of the Commission for Africa initiated by UK Prime Minister Tony Blair, the G-8 summit in Scotland in July 2005 at which aid and debt relief featured heavily, as well as the Helsinki Process on Globalization and Democracy. For those of us working on development it is difficult to recall any other recent period in which development—and the needs of the world’s poorest people—have occupied so much public attention.

Inevitably much of the debate, while certainly well-meaning, has been broad-brush, sometimes simplifying the issues in order to mobilize public support for increased aid. Amidst the earnest pleas for more aid and debt relief, there are dissenting voices, arguing that the poorest countries will find it difficult to absorb and effectively use the additional resources, which the international community is devoting so much time to mobilizing. Certainly for those working on fiscal issues at the country-level how best to use aid (and domestic revenues) has always been a priority issue, and one that raises tough choices for the public finances, which cannot be glossed over. At the heart of the issue of aid effectiveness (as well as the related impact of debt relief), is state capacity in poor countries. This includes the quality and honesty of the public administration, and its ability to channel resources to the best uses, particularly to infrastructure and services which are of most benefit to the poor.

The MDGs cannot be achieved without good fiscal policy

Whether you believe that aid and debt relief can achieve their laudable goals depends therefore, in large part, on your view of the economics and politics of fiscal policy. The successful countries will be those that build effective systems of public expenditure management to transmit these extra resources into development spending and systems of taxation that mobilize domestic revenues to complement external official flows. And they will demonstrate an ability to manage the fiscal deficit and government debt burden, in particular to respond to the external (and internal) shocks which challenge policymaking in poor countries that are mostly dependent upon a narrow range of primary commodities. This is no easy set of tasks, and our ability to get anywhere near meeting the ambitious Millennium Development Goals depends to a large extent on improving the quality of fiscal policy in poor countries. This is especially the case in resource-rich countries where resource extraction is often an enclave activity (oil and natural gas in West Africa, for example) so that growth does not directly generate much in the way of increased employment; in these countries the main way that growth can reduce poverty is through the transmission of the resource revenues into higher pro-poor public spending. For the most part this is not happening, and the poor are missing out on the revenue boom provided by higher commodity prices (especially oil) with revenues instead flowing into spending for elites (or directly into their pockets). Similarly, in societies characterized by high levels of inequality in access to land and other productive assets, the best means for redistribution may not lie in redistributing these assets themselves but by incorporating redistribution into the fiscal system—through progressive taxation (of capital gains from land sales, for example) to finance public spending that creates better livelihoods and human capital for the poor. In summary, growth can contribute to poverty reduction even in societies with very high levels of asset inequality, but only if fiscal institutions are built and focused on the poor.

Fiscal Policy for Development has enjoyed considerable success and, together with the Palgrave Macmillan volume on Debt Relief for Poor Countries (co-edited by Tony Addison, Henrik Hansen and Finn Tarp), it offers what we hope is a reasonably balanced view of the issues for policymakers and researchers alike. Certainly, it is vital to improve our technical understanding of how fiscal policy works for development, but fiscal policy is more than just a question of good economics; it is also fundamental to the politics of development. Who gets what from the state, how that public spending is financed, and who pays for it, say much about how a society is governed and whether policy choices do—or do not—give priority to the poor.

Tony Addison is a Professor of Development Studies at the University of Manchester, UK. He was until recently Deputy Director at WIDER. Email: tony.addison@ manchester.ac.uk

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