Achieving the MDGs in Kenya – some aid and reallocation of public expenditures* Jörgen Levin Jane Kiringai Work in Progress Presentation at Business School, Nairobi University, August 21, 2008 *Part of this power-point presentation is based on Lofgren, Diaz-Bonilla and Timmer (2007), Presentation for the Public Finance Analysis and Management Core Course, PREM Learning Week, April 27, 2007

Vision 2030 and MDGs The Government plans to sustain and accelerate GDP growth up to 10 percent by 2012 (Republic of Kenya, 2008). The strategy essentially involves: –Macro-economic stability –Deepening of various structural reforms including governance –Financial sector reforms –Restructuring and privatizing state-influenced enterprises and –reorienting expenditures towards priority areas. The main focus of the medium term plan is to move decisively towards the Millennium Development Goals (MDGs). A MDGs status report on Kenya indicates that significant progress has been made towards achieving the goal of universal primary education. However, the Government will need to scale-up its efforts substantially beyond the current momentum, if the other goals are to be realised by The strategy involves achieving: rapid and sustainable economic growth in order to reduce poverty on a sustainable basis; and reallocate public resources towards the infrastructure investments and social services.

Policy issues The policy issue we discuss is whether the strategy proposed by the Government would achieve the MDGs. We also discuss the impact of additional external resources. The paper is organised as follows: –The second chapter explains the model and the data used in the study. –In the third section we present and discuss our baseline scenario. –Chapter four discusses alternative financing scenarios and the impact of additional resources on the achievement of MDGs. In chapter five we also highlight allocation of public expenditures. –The final section concludes. –The appendix describes the underlying database in more details.

MDG strategies Key policy questions for MDG strategies: – What is the required expansion of public spending? – What are the effects on the labour market, foreign trade and exchange rates? – What are the roles of synergies between different MDGs? – How does growth in private incomes interact with public spending? – How do the effects depend on the mix between domestic and foreign financing? – What is the impact of back- and front-loading public service expansion? – If all MDGs cannot be met, what are the trade-offs between human development (HD) and infrastructure?

Model Structure In this paper we use a version of the MAMS model (Bourguignon et al, 2007) calibrated for Kenya. MAMS may be described as an extended, dynamic- recursive computable general equilibrium (CGE) model designed for MDG analysis. Motivation behind the design of MAMS: –An economywide, flexible-price model is required. –Standard CGE models provide a good starting point –But Standard CGE approach must be complemented by a satisfactory representation of 'social sectors'.

MAMS – Maquette for MDG Simulations The MAMS is a dynamic computable general equilibrium (CGE) model which has been extended to include a module that covers MDGs related to poverty, health, education, and water-sanitation. – The within-period module captures the bulk of the production, consumption, investment and trade decisions of the economy in any given time period. – The between-period module provides linkages over time by updating selected parameters on the basis of exogenous trends and past endogenous variables. – The MDG module captures the processes that determine MDG achievement, most importantly the provision of services in the areas of education, health, water and sanitation.

Stylized Model Structure Activities Commodity Markets Factor Markets Rest of the World HouseholdsGovernment Sav./Inv. Factor Costs Wages & Rents Intermediate Input Cost Sales Private Consumption Taxes Domestic Private Savings Government Consumption Gov. Savings Investment Demand ImportsExports Foreign Savings Transfers Foreign Transfers

Modelling MDGs MDG 2 – MDG 7 are covered in an additional set of functions that link the level of each MDG indicator to a set of determinants. The determinants include the delivery of relevant services (in education, health, and water-sanitation) and other indicators, also allowing for the presence of synergies between MDGs, i.e. the fact that achievements in terms of one MDG can have an impact on other MDGs. In education, the model tracks base-year stocks of students and new entrants through the three cycles. In each year, students will successfully complete their grade, repeat it, or drop out of their cycle. Student performance depends on educational quality (quantity of services per student), household welfare (measure by per-capita household consumption), and level of public infrastructure, wage incentives and health status (approximated by MDG 4).

Government sector Government services are produced using labor, intermediate inputs, and capital Government consumption is classified by function: social services (education, health, water-sanitation), infrastructure and “other government”. Government spending is split into –Recurrent: consumption, transfers, interest –Capital Government spending is financed by taxes, domestic borrowing, “money printing”, foreign borrowing, and foreign grants. Model tracks government domestic and foreign debt stocks (including foreign debt relief) and related interest payments.

Data Basic data needs are similar to other CGE models: –Social Accounting Matrix (SAM); factor and population stocks; shares and elasticities in trade, production, and consumption Data (and model) disaggregation highly flexible outside the government and the labor market Data requirements specific to MAMS: –In SAM: government consumption and investment disaggregated by MDG- related functions; labor disaggregated by educational achievement; –Education parameters: stocks of students by educational cycle; student behavioral patterns (ex: rates of passing, repetition, dropout); population data with some disaggregation by age; –MDG data: base-year indicators; elasticities; service expansion required to reach MDGs (MDG scenarios) Other worksheets –Ex: debt, foreign debt relief, growth rates

Kenya Model Modified Kenya 2003 SAM (Thurlow, Kiringai and Wanjala, IFPRI 2006) Public MDG sectors: –Primary education –Secondary education –Tertiary education –Health –Water and sanitation –Infrastructure Public non-MDG sectors: –Other government Private “non-MDG” sectors (MDG 1 only): –Agriculture –Industry –Services Private MDG sectors: –Primary education –Secondary education –Tertiary education –Health

Kenya Baseline scenario

Kenya baseline scenario

Baseline and MDG results

Enrollment primary education

Primary completion rate

Enrollment secondary education

Enrollment tertiary education

Real wages

Unemployment

Achieving the MDGs In the baseline scenario there is some progress across all MDGs but not sufficient to reach all the targets. Additional resources are required to reach the MDGs and the financing options available to the government are either to increase taxes (mdg-tax), borrow domestically (mdg-db), foreign borrowing (mdg-fb) or grant aid (mdg-fg). In practice a combination of the four financing options is used to finance operations within the public sector. Here we are interested in the amount of resources that would be required and the economy- wide impact of each alternative financing option.

Achieving the MDGs The different financing scenarios will have a different impact on GDP performance in the economy. Taxation and domestic borrowing tends to withdraw savings and hence lover investments and hence reduce GDP growth. Compared to the baseline scenario public spending does only need to increase slightly in order to achieve all the MDGs. In the case of domestic borrowing the domestic debt-GDP ratio would increase to 68.6 percent in order to finance the necessary interventions. In the case of foreign borrowing the debt-GDP ratio in 2015 would stand at close to 60 percent. Relying on taxation implies that the tax-GDP ratio needs to increase to around 30 percent. In the case of grant-aid it has to increase to a level around 2.8 percent of GDP. The major risk with a significant increase in grant aid (as well in the alternative of foreign borrowing) is the possibility of Dutch Disease. In both externally financed scenarios the real exchange rate appreciates by an annual average rate of 2.4 percent, which is slightly higher than the alternative scenario where domestic resource mobilization is used.

Fiscal space? It is possible to achieve the MDGs under certain assumptions on GDP growth and enhanced public spending. But is it a feasible strategy, what is the macroeconomic impact of a scaling-up strategy or can the government create the necessary fiscal space? –The macroeconomic impact of enhanced public spending in order to meet the MDGs was not extremely large. –Still, undertaking a strategy which would increase the domestic debt- ratio to close to 70 percent or alternatively a strategy relying on foreign borrowing seems not to be a viable strategy. –Foreign grants would be the preferred option and the amount of resources is not extremely high. In addition, the additional resources would not have any major impact on the real exchange rate.

Government expenditures A strong result coming out from this analysis is that an efficient and an optimal allocation of public expenditures seem to be very important whether Kenya will achieve the MDGs or not. How should public expenditures be allocated across functional categories in order to achieve the MDG targets? –Increased allocations in all sectors are needed but some sectors would require a higher share of public resources: –In the education sector both current and capital expenditures needs to increase significantly at both secondary and tertiary level. –Significant amount of resources are needed in the water sector, in order to achieve the targets. –Continued high investments in infrastructure will be important, in particular to increase total factor productivity and growth, which in turn will reduce poverty.

Government expenditures (% annual average growth )

Foreign aid required

Future work Data issues: –Improve database (update SAM, labour market, household etc.) –Poverty methodology (include representative household groups and/or micro-simulation module in the model) –Government data Applications: –Regional analysis – allocation of government spending and MDGs at regional level. This would be a useful exercise as it would be able to shed some light on regional inequalities in Kenya. –Allocation of government expenditures – reallocation from MDG sectors to public administration –Trade-offs between spending on HD and INFRA –Vision 2030

Conclusions If the Government succeeds in deepening its reform efforts this could trigger additional aid-flows. If the resources are effectively used and targeted to MDG sectors they could have a substantial impact on whether Kenya would reach the MDGs or not. –Some targets seem to be easier to reach than others. The target of 100 percent completion in primary school can be achieved with some additional resources targeted to the primary sector. –However, a substantial increase of resources is needed at secondary and tertiary level of education to reach other goals set by the Kenyan government. –Even if higher investment in all MDG-sectors is needed the water sector seems to be requiring a substantial increase compared to what have been invested in the past. –Important is also to scale-down investment in the other government sector and increase investments in MDG-sectors. A clear prioritization would be needed from the Government.