The Role of Fiscal and Monetary Policies in Reducing Poverty and Promoting Shared Prosperity
Your Excellencies, Ladies and Gentlemen,
It is a pleasure and honor for me to attend this meeting today and speak on a topic close to my heart: the role of fiscal and monetary policies in reducing poverty and promoting shared prosperity.
As you know, this topic is broad and I will focus on a few key issues.
Let me begin with what we all know -- the most important function of fiscal and monetary policies is to maintain macroeconomic stability. A stable macro environment is an essential prerequisite for reducing poverty and promoting shared prosperity for two reasons.
First, without macro stability it is impossible to sustain the growth we need to improve the welfare of the extreme poor as well as of those at the bottom of the income distribution.
Second, the clearest manifestation of macro instability – high and variable inflation – hurts the poor the most.
From the East Asian Crisis to the Global Crisis
I know that I don’t need to stress the importance of macroeconomic stability to this audience. Historically, the countries of this region have had strong macroeconomic fundamentals, as the World Bank’s East Asian Miracle study, among others, recognized this over 20 years ago. However, the East Asian crisis in 1997 and subsequent collapse in growth showed us all that macro stability could not be taken for granted.
But the countries in this region recovered quickly with strong stabilization measures and applying the right lessons. So, policymakers in this region were ready when a global crisis threatened economic stability and growth in 2008. Today, developing East Asia – including ASEAN – is the fastest-growing part of the developing world and one of the engines of global economic growth.
So, what do these two crises and the responses to them show us about fiscal and monetary policies? I think three key measures have helped ASEAN countries to be more resilient today: -- the need to be fiscally prudent; to use monetary policies to target low inflation; and to maintain flexible exchange rates.
On aggregate fiscal policy, ASEAN countries have done well in rolling back the stimulus programs they implemented in the wake of the global financial crisis and in reducing fiscal deficits.
Monetary policies, implemented by generally independent central banks, have also been tightened from their accommodative stances in the aftermath of the crisis so as to target low and stable inflation.
Finally, more flexible exchange rates have helped to manage current account balances and foreign exchange reserves better than in the past.
These aggregate fiscal and monetary policies are essential for maintaining stability and necessary for eliminating poverty and boosting shared prosperity. But they are not enough. Let me suggest two specific aspects of fiscal and monetary policies that can further support the focus on poverty and shared prosperity within ASEAN.
Rebuilding Fiscal Space and Using It Well
Among the priorities for the countries in ASEAN is the need to rebuild fiscal space. By this I mean the ability to mobilize resources for public spending without adversely affecting the sustainability of the government’s fiscal position or that of the economy. There are both short- and long-term reasons for countries in ASEAN to expand fiscal space at this time.
In the short term, countries in ASEAN as elsewhere need to be ready to adopt counter-cyclical fiscal policies if the global recovery were to slow significantly. As the World Bank’s recent Global Economic Prospects report suggests, counter-cyclical fiscal policy works most effectively when economies have fiscal space, i.e., low fiscal deficits and moderate debt burdens. Where countries have fiscal space, their fiscal multipliers can be 20 percent larger.
This was one reason that the stimulus packages that many ASEAN countries used in 2008 and 2009 were effective -- they were implemented in contexts where fiscal buffers had been rebuilt. However, those stimulus packages also meant that deficits and debt climbed steeply thereafter. And while ASEAN economies have generally done well in reducing deficits and restoring fiscal buffers, debt burdens still remain large in many economies.
Rebuilding fiscal space is also important for the longer term since ASEAN countries will need to finance infrastructure as well as health care and long-term care costs as their populations’ age. Developing East Asia will require about US$ 750 billion annually to finance new infrastructure. Beyond this gap, infrastructure investment is contributing much less to growth than is consumption, in part because public investment has fallen both due to budgetary restraint and implementation constraints. While we need private financing on board, experience from richer OECD economies shows that the public sector will need to continue to have a major role particularly in infrastructure and health care spending.
How can this fiscal space be created? Increasing revenues is the most important priority. A number of ASEAN countries collect revenues of the order of only about 15 percent of GDP, which is low by the standards of comparable low- and middle-income countries. They need a stronger effort to raise revenues through reforms in tax policy as well as improvements in tax administration. In most ASEAN countries, more than a third of all government expenditures and a significant share of service delivery have now been decentralized. So, increasing the capacity and responsibilities for revenue mobilization by local governments will be critical.
Finally, many countries in ASEAN also have the scope to increase revenues through reducing tax expenditures – a topic that my colleague discussed in an earlier session in the context of reducing tax competition.
Not only does fiscal space need to be rebuilt; the available fiscal resources obviously also need to be used well. Improving the quality of public spending by reallocating expenditures to more productive uses that are better targeted to the poor is particularly important in this regard.
Reducing energy subsidies is one way to achieve this. It can help by freeing up the space for expansions in pro-poor areas like health, education and social protection. Energy subsidies are typically regressive in that they benefit the relatively well off. Such subsidies have other costs as well: they encourage waste and discourage investments in a more diversified energy mix that increases the share of renewables. In the long run, they lower the energy supply and impose environmental costs by worsening pollution and congestion.
The recent dramatic fall in oil prices offers an exceptional opportunity for subsidy and tax reforms in oil-importing countries, especially since these low oil prices will likely persist for some time. Among ASEAN countries, Indonesia and Malaysia have already used this opportunity to take the politically-difficult step of reducing fuel subsidies. But sustaining this policy shift in the long run will be more challenging.
Governments will need to ensure that energy prices are market based so that when prices rise, the price increase is passed on to consumers without hurting the poor. This may require building safety nets to soften the impact of higher prices.
Even where countries do not subsidize petroleum products, lower oil prices offers an opportunity to consider raising revenues in a much less distortionary way than through taxes on labor or capital. Generally, petroleum products within the ASEAN are lightly taxed at present suggesting that revenues could be raised by adjusting tax rates.
Strengthening the Institutional Foundations for Monetary Policy
Effective monetary policies play a key role in reducing extremely poverty and promoting shared prosperity by helping protect the poor against high and variable inflation. They can also help foster financial deepening and financial inclusion. Achieving these goals can be a difficult balancing act given the openness and global integration of ASEAN economies and the volatility of financial flows and exchange rates. The divergence of monetary policies among the advanced economies and the possibility that U.S. interest rates will rise in the coming months add to the challenge of implementing monetary policy.
Given these complex challenges, many ASEAN countries face the task of strengthening the institutional foundations for conducting monetary policy. By this I mean three things.
First, efforts to enhance Central Bank independence need to continue while the technical capacity to conduct monetary policy is strengthened.
Second, monetary policy needs to be made more rules based. Here, experience elsewhere suggests that inflation targeting (or in some cases, targeting nominal GDP) can be an effective rule to follow even in middle-income countries. Moving away from targeting monetary aggregates or exchange rates provides greater flexibility to policy makers and transparency for enterprises and individuals.
Finally, as the ASEAN Economic Community comes into being at the end of this year, and integration moves beyond trade in goods to trade in services, especially in the financial sector, there will be greater need for policy coordination and cooperation across the Community.
So, despite the progress that has been made, there remains an unfinished agenda to ensure that fiscal and monetary policies play their role in eliminating poverty and boosting shared prosperity. Thank you once again for giving me this opportunity to share my thoughts on these issues.