The COVID-19 pandemic, and the effects of the associated lockdowns and border closures, have caused many to question the ability of governments to manage their public finances, and plan and prepare for fiscal risks. How shocks are handled is often indicative of a country’s larger public financial management system, which is tasked with numerous duties, including domestic revenue mobilization, budget planning and execution, public procurement, and debt management. While seemingly separate from the discussion of democracy, the mismanagement and corruption of public finances negatively affects how citizens view their government and reduces their confidence in their elected officials.
This relationship between government trust and public financial management was recently highlighted in the session “Money Matters: Building Fiscal Resilience in Turbulent Times” at USAID’s 2021 Democracy, Rights, and Governance (DRG) Conference. During this session, USAID’s Steve Rozner, Nina Bowen, Carrie Gruenloh, and DevTech’s Mark Gallagher discussed how opaque and corrupt management of public finances can lead to conflict. The recent protests in Colombia, where historically high levels of corruption caused citizens to organize against tax increases, and those in Lebanon in late 2019, which were spurred by a tax on WhatsApp calls, highlight how laws regarding public finances, and their implications for citizens’ daily lives, can be the catalyst for violence and mistrust.
The Money Matters panel sought to raise participants’ awareness of the linkages between fiscal resilience and broader DRG objectives and pique their interest to learn more about how USAID can leverage public finance programming, and non-programming approaches, to help reduce fragility and political instability in partner countries. The panel touched on several topics, including why and how public finance matters to democratic governance and stability; why DRG officers should integrate it in their work; and how USAID officers might approach strengthening fiscal resilience in their partner-country contexts.
When conducting most public financial management, countries often work under the assumption of continued stability, where their regular activities of revenue collection and expenditures continue without increased demand for support from their citizens and firms. However, in the past year, we have seen that governments need to prepare for unforeseen shocks as it is necessary not only for their development but also for insuring against their de-development. Mark Gallagher emphasized this point during the session, and highlighted that the need to prepare for fiscal risks is not new. Various financial crises during the last 30 years, numerous natural disasters, and unsustainable debt levels have all indicated that governments need to acknowledge and prepare for fiscal shocks in their economic planning. When shocks aren’t incorporated into budgets, there are significant costs which affect all levels of society; these include debt defaults, the inability to pay workers, and the reduction of allocated funds to important government provided services, like education and healthcare.
Accounting for fiscal risks is easier said than done, largely due to their unknown probability and size. However, USAID and other donors can help partner countries identify, measure, and prepare for these risks. The following are steps and questions that can help countries better prepare for turbulent times:
Looking Backwards with Consideration for the Future: As clichéd as it sounds, history often repeats itself. The impact and slow recovery from the Asian Financial Crisis in the late 1990s can provide a cautionary tale of how fixed exchange rates can lead to disaster.
Evaluation of Current Policies and their Risks: In the face of certain shocks, such as a pandemic, can a country continue to provide free healthcare to its citizens? In the face of an aging population, is the current social security system stable? For example, the Public Pension System in Guatemala is not funded in the long-term but is actually taken out of the yearly budget. Is that sustainable in the face of reduced revenue collection?
Prospective Estimation of Negative Shocks: This step aims to tackle when a shock will occur, its size, and its impact. This estimation requires a clear understanding of a country’s context, and both its obvious and underlying issues.
Conducting Stress Tests: These tests allow a country to see the impact of one or more contingent liabilities on their economy and fiscal state. In order to get a sense of the implications leaving the European Union following Brexit, the United Kingdom traced through all sectors of its economy, including trade.
Implement Regulatory Changes: If the government is aware of risks related to the financial market, then regulatory reforms need to be implemented to reduce their occurrence.
Provisioning for Shocks: By estimating a shock’s probability and possible costs, countries can budget for them, provide necessary services to their citizens, and smooth their economic cycle. For example, in the Philippines where the government is aware that they are at risk for natural disasters, like volcano eruptions, they can set aside funds to support future government operations.
Accommodation of Fiscal Risks: While not the most optimal solution, countries can estimate and predict a fiscal risk and then simply state that they are not going to take additional measures in preparation. This can provide useful information to international institutions to better understand how they can help when a country does not have the capacity to provision for a risk.
All of these components lead to the development of timely and accessible Fiscal Risk Statements, which provide governments, citizens, creditors, and donors with the needed information on how to deal with fiscal risks. Without this analysis, a country’s public financial management system cannot be transparent, and the measures a government takes after a shock can be the final straw that causes a country to descend into conflict.
USAID’s Fiscal Accountability and Sustainable Trade (FAST) project at DevTech Systems, Inc., which is led by Dr. Gallagher as the Chief of Party, has conducted annual research on countries’ macroeconomic resilience. In 2020, FAST assessed the macroeconomic resilience of most developing countries by measuring their degree of fiscal and monetary space as an indicator of their ability to respond to shocks, such as COVID-19. The full report can be accessed here.