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A Renewed Faith in Public Investment

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In the lead-up to the World Bank-IMF Annual Meetings, the Latin America and Caribbean Region VPU of the World Bank is co-hosting and attending the Americas Conference.

As the dust settles in Latin America in the wake of the global financial crisis, along with the tough challenges ahead for the economic recovery, there seem to be unique opportunities to improve our region’s long-term outlook.

I have no doubt that this important Miami Conference –where Latin America converges in many ways, cultural and economic- is the ideal place to bring these ideas to the table and kick off a fruitful debate.

One such opportunity is the chance to wave goodbye to the region’s traditional economic volatility.

Here’s how I think it would happen: I think the financial crisis has led to a renewed faith in the power of public spending as a tool to manage short-term growth.

ImageIn the weeks following the fall of investment powerhouse Lehman Brothers –which revealed the crisis’ depth– most Latin American countries announced fiscal stimulus packages, including those who couldn’t afford it. The packages varied in size, but all of them included public investment as a measure to jolt the economy and create jobs, as these World Bank papers show.

The message couldn't be clearer: when consumption drops and turns installed capacity into idle capacity, the State steps in to fill the gap.

Welcome to the world of counter-cyclical fiscal policy. It has the potential to change the region’s public investment mechanisms rendering them unable to remain a government funding source that dries up when private capital revenues fall or expenditures grow.

In other words, it should be taken away from State hands in its present form.

In the early nineties, concerns over inflation forced the region’s governments to abandon money-printing as a source for funding of fiscal deficits. The job was passed over to independent central banks which were given the mandate to achieve price stability by meeting “inflation goals”. Right now, unemployment concerns could force governments to formally link public investments to growth prospects.

It would make them set “growth targets” and push countries to systematically save during good times in order to increase investments during bad times.

This simple but powerful principle made its debut during this crisis in Chile, and has proven to be such a political and economic success that –I’m convinced- many will try to adopt similar policies.

Obviously, formally linking public investments to growth prospects can have many additional benefits. It would provide investment expenditures with a clear strategic mission: this is about growth, not social assistance, regional compensation or political need.

ImageIt would channel marginal dollars to projects that attract more private investment, as they have a greater impact on growth. It would also speed up efforts to improve the business environment and investment promotion. And it would streamline design, implementation, monitoring and assessment tools for public projects.

Certainly, setting growth goals involves considerable political and institutional challenges. And we still lack a sound theory to set growth goals.

However, the crisis opens a window to start thinking about this issue.




Marcelo Giugale

Director, Poverty Reduction and Economic Management

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