Bogotá — Chile boasts the highest technical efficiency in public spending in Latin America, while regions like Central America are facing challenges regarding payroll inefficiencies, with higher public sector salaries compared to the private sector, according to experts from the Inter-American Development Bank (IDB).
In response to a series of questions put forward by Bloomberg Línea, the IDB stated that Latin American and Caribbean countries have technical inefficiencies ranging from 1.8% to 7.2% of GDP or 7% to 25% of total public spending, based on the latest available data. Spending efficiency is a challenge for the entire region, especially in relation to pensions, subnational spending, and the quality of human capital, the development bank said.
“In terms of technical efficiency (without taking into account allocative inefficiencies), Chile is the country with the least inefficiency in spending on purchases, transfers, and payroll. Additionally, according to the existing data, it is one of the few countries with relatively good allocative efficiency,” the IDB stated via e-mail. In Andean countries, high spending on public purchases of goods and infrastructure remains a challenge.
In Latin America, there are several areas with challenges in terms of efficiency, both technical (doing more with fewer resources) and allocative (distribution in line with government priorities) in public spending. If the countries in the region do not consider the possibility of reforms, they will continue to face fiscal problems: deficits, increased debt, insolvency, and ultimately, the possibility of default. On the other hand, with significant allocative inefficiency, the challenge of achieving economic growth in these countries can become even more difficult, further complicating fiscal sustainability, and consequently, the issues of poverty and inequality.
IDB
These challenges have persisted since the publication of the IDB’s report on public spending inefficiency in Latin America and the Caribbean, in 2018. That’s why “structural reforms are required, as well as modifying budgetary and fiscal institutions,” the institution told Bloomberg Línea.
The latest available data shows that the potential inefficiency of public spending relative to GDP is highest in Argentina (7.2%), followed by El Salvador (6.5%), Bolivia (6.3%), Nicaragua (5%), Colombia (4.8%), Mexico (4.75), and Costa Rica (4.7%). Further down the list are Honduras (4.6%), Paraguay (3.9%), Brazil (3.9%), the Dominican Republic (3.8%), Panama (3.8%), Uruguay (3.7%), Guatemala (2.7%), Peru (2.5%), and Chile (1.8%), as the most efficient.
The landscape of public spending in Latin America
Central government spending in Latin America and the Caribbean increased from 17.7% in the year 2000 to 24.1% as a percentage of GDP in 2020, primarily due to expenses in areas such as health, education, and social protection, according to data from the Economic Commission for Latin America and the Caribbean (ECLAC).
José Andrés Rueda, a professor at the School of Economic and Administrative Sciences at Universidad de América, explained that in countries like Colombia, public spending has reached 35% of GDP; in Brazil, it’s 32.2%; in Mexico, it’s 21%; and in Panama, 19.3%, according to data from the World Bank.
He noted that this is a wide range compared to developed economies like Switzerland, where it clocks in at 19.9%.
Although in other European countries like France, spending is 49.9% of GDP, in Sweden, it’s 33%, and in Denmark, it’s 37.8%.
“Governments must spend because they are there to provide the public goods that societies need,” but “there is much room for improvement in the area of government spending in Latin America,” he considered.
Despite the increase in public spending, especially during the COVID-19 pandemic, Latin America and the Caribbean face the challenge of managing these funds more efficiently, as the region has misspent about $220 billion, equivalent to 4.4% of GDP, according to the latest data from the IDB.
To put it in perspective, in the case of public procurement, the region wastes more than 20%, while the European Union wastes an average of 10%.
According to the IDB, in the case of social transfers, Latin American countries redistribute eight times less than EU countries.
At the same time, while transfers and direct taxes reduce inequality in Latin America and the Caribbean by 5%, in advanced countries, they reduce it by nearly 40%.
To address this situation, José Andrés Rueda adds that the OECD’s proposal is to align with medium and long-term plans, establish performance evaluations, improve budget execution, and enhance audits. All of this is aimed at improving and refocusing public spending to have an impact on people’s quality of life. Governments should focus on spending that can promote their countries’ growth and generate greater well-being, he added.
The impact of inefficiency in public spending in Latin America and the Caribbean
According to various sources consulted by Bloomberg Línea, simply reducing misspending and inefficiencies may not have a significant impact on the macroeconomy, because better and more efficient investments are also necessary.
This remains one of the major challenges in Latin America, as a high level of public sector inefficiency reduces people’s confidence in the government, according to experts.
“One sign that public spending is inefficient is if it is being allocated to areas where there can be private spending substitution” or to sectors where “there can be competition from private companies,” said David Pérez-Reyna, a professor at the Faculty of Economics at the University of the Andes, in an interview with Bloomberg Línea. He believes that Chile, along with Uruguay and Panama, is currently the most efficient in distributing these funds.
For the academic, “a significant advantage of making public spending more efficient is that more can be done without the need to increase taxes or cut spending elsewhere. One way to do this can be by focusing spending where there is no clear private spending substitution.”
“An example of the opposite situation would be, for instance, using public spending to establish a brewery. There is no reason to believe that the private sector could not do it. Stopping that type of spending can be beneficial for efficiency,” he commented.
To achieve greater spending efficiency, improvements can be promoted in social transfers, public procurement, and human resources policies. The adoption of digital tools can also contribute to these improvements by facilitating access to public services and promoting inclusion.
Reducing transaction costs associated with public procedures not only helps reduce costs but also makes the government more accessible in general, benefiting particularly the more remote and disadvantaged segments of society that have difficulty accessing these services, according to various sources consulted by Bloomberg Línea.
The main signs of inefficiency in public spending are: evidence of significant leakage in procurement, public sector payroll, and transfers. Second, there is evidence of misallocation of resources that could be used differently and promote greater economic growth.
IDB
What more can be done to improve public spending efficiency?
The IDB suggests that countries in the region could consider a priority budget, meaning “considering two or three national priorities based on a causal model and evidence, the progress of which can be measured year by year.” For both technical and allocative efficiency, they also suggest accompanying reforms with “smart” reviews of public spending, as well as medium-term expenditure frameworks that are currently lacking in the region.
In this regard, “it is advisable for national governments to have bodies that deal with these spending issues and have the capacity to set rules and coordinate expenses. Therefore, one option is the creation or modification of public spending quality units that concentrate, coordinate, and seek to reduce technical and allocative inefficiencies,” emphasized the experts from the IDB.
Another alternative they propose to address short-term spending challenges in some countries is to consider forming an independent spending efficiency council, composed of independent experts, academics, and policymakers, who can generate analyses of these issues, propose solutions, evaluate programs, and serve as observers regarding how governments spend.
Ultimately, they add, “each country’s analysis regarding the relevance of institutional change can ensure that public spending does not engage in practices that have not been beneficial in the past in countries of Latin America and the Caribbean.”
Technology in the service of public spending
According to a recent report from the World Bank, the use of networks and digital tools can help reduce the significant percentage of GDP - up to 4% - wasted on inefficiencies related to public spending.
This “savings” can be redirected towards social or growth-related investments, according to the document. According to the organization, “digital solutions for public finance management help subnational governments, where management capabilities are often lower. Digitalizing tax collection can increase public revenues by reducing the 6% of GDP estimated to be lost due to evasion.”
On the other hand, thanks to technological solutions, digital provision of public services is cheaper and quicker to deliver, cutting off sources of corruption. This is relevant in the sense that a third of Latin Americans paid a bribe to access a transactional public service, according to World Bank figures. Therefore, says the organization, digital provision of public services “can expand the government’s reach and, by reducing interactions between officials and citizens, decreases opportunities for bribery and corruption.”