Fiscal Space for Investment in Infrastructure in Colombia Rodrigo Suescún The World Bank January 2005

Fiscal Space for Investment in Infrastructure in Colombia Motivation Main Features of the Model The Model Simulation Results Creating Fiscal Space

Fiscal Space for Investment in Infrastructure in Colombia Motivation: In many countries productive public investment has been compressed in the process of fiscal adjustment Public investment contraction may entail a growth cost – unless offset by private initiative, which has not been generally the case This trend is not apparent in Colombia

Fiscal Space for Investment in Infrastructure in Colombia Motivation: Evaluation of Macroeconomic Policies in Colombia: Financial Programming Model

Fiscal Space for Investment in Infrastructure in Colombia Motivation: Financial Programming Model Growth rate is exogenous, independent of policies Timing of policies is irrelevant Expectations play no role No foward looking behavior No purposeful behavior

Fiscal Space for Investment in Infrastructure in Colombia Motivation: Financial Programming Model Focus on fiscal deficit and gross debt targets: distinction between current and capital spending is irrelevant Bias against public capital formation Static framework vs asset-creating nature and intertemporal trade-offs involved in public investment decisions:

Fiscal Space for Investment in Infrastructure in Colombia Motivation: Concerns Already high public debt (54% of GDP in 2003) Actual fiscal position (Overall budget deficit in 2003: 3.1% of GDP in consolidated) Future unfunded state pension deficit Risk Fiscal adjusment using capital spending (inflexible budget)

Fiscal Space for Investment in Infrastructure in Colombia General Objective: Construct a dynamic general equilibrium model to study economic behavior under alternative fiscal policies Two forces explain off-steady state dynamics 1)Fiscal polices (perfect foresight) 2)Current policies and economy off their steady state sustainable balanced growth path

Main Features of the Model Small open economy Two goods: home & foreign goods Agents: household, firms and government sector Central gov: current and capital spending, taxes on labor and capital income and consumption and domestic debt Rest of gov: operates infrastructure, current and capital spending and budget surplus target to improve combined public sector finances Upward-sloping supply of funds

Model Three reproducible factors: infrastructure capital, business capital and human capital Infrastructure capital

Model Business Capital Human capital

Model Production Function Firm’s problem: standard

Model Household’s Problem Preferences

Model Household’s Problem Budget constraint

Model Household’s Problem

Model Government

Model Resource Constraints Upward-sloping supply of resources

Figure 1 Benchmark Fiscal Policy Stance Figure 1 Benchmark Fiscal Policy Stance Figure 1 Benchmark Fiscal Policy Stance

Creating Fiscal space Golden rule Permanent balance rule Redefinition of the public sector