Public Spending Policies in Latin America and the Caribbean: When Cyclicality Meets Rigidities (Latin American Development Forum)

Description

This report highlights structural differences in public spending policies between emerging markets and industrialized nations. Emerging markets commit to long-term (rigid) spending based on short-term (cyclical) economic conditions, causing challenges in addressing fiscal imbalances and prompting changes in public spending composition. In this book, we analyze the cyclical behavior of individual components beyond overall primary spending. We identify three prevalent spending policy anomalies in emerging markets. First, public spending in emerging markets is semi-procyclical during economic upswings. In prosperous times, governments increase spending due to temporary economic growth and greater borrowing access. This spending involves downwardly-rigid commitments that persist during downturns. This approach not only heightens macroeconomic volatility but also diminishes the quality of public investment. Secondly, high levels of labor market informality in emerging markets render automatic stabilizers like unemployment insurance impractical. Instead, governments resort to public employment and social transfer programs during economic downturns. These programs are inherently downward-rigid. Ultimately, the downward rigidity of certain spending components and the need for fiscal sustainability necessitate adjustments, resulting in significant changes in spending composition. This, in turn, leads to biases against pension benefits and public investment as these categories offer flexibility and discretion.