1 The External Debt-Servicing Constraint and Public Expenditure Composition in Sub-Saharan Africa by Augustin Kwasi FOSU UN University-WIDER Helsinki, Finland For presentation at the African Economic Conference (AEC), “Fostering Development in an Era of Financial and Economic Crises” Addis Ababa, Ethiopia November 2009

2 Outline Introduction Theoretical Framework Estimation Sector Spending Trends Results Conclusion

3 Introduction Two main strands of existing relevant literature: – Debt impact on growth (for published papers see, e.g., Elbadawi et al. [1997]; Fosu [1996, JED; 1999, CJDS]) – Aid effect on public expenditures (see, e.g., Cashel-Cordo & Craig [1990, JDE]; Feyzioglu et al [1998, WBER]; Gang & Khan [1990, JDE]; Gbesemete & Gerdtham [1992, WD]; Ouattara [2006, EM]) Evidence on debt and public expenditures is scant, especially for low-income economies (e.g., Cashel Cordo & Craig [1990, JDE]; Mahdavi [2004, WD]; Ouattara [2006, EM]). Specific evidence on debt and the functional composition of public expenditures even more scant (e.g., Ouattara [2006, EM]; Fosu [2007, WD; 2008, ODS]) Present study extends analysis to include six functional sectors: agriculture, capital, economic services, education, health, and public investment.

4 Theoretical Framework The government maximizes for J sectors: (1)U(G 1, G 2,…, G J ), subject to the budget constraint (2)Σ j G j = R, R is government revenue, which may be expressed as (3)R = N + F – D, The first-order conditions are: (4)U 1 = U 2 =...= U J (5)Σ j G j = R = N + F – D The demand functions are: (6)G j = G j (R X ;W) R X is exogenous component of R; W is country-specific factors defining the social welfare function.

5 Estimation Estimating model: (8 j )g j = g j (D X, F; Q,A, P, T; u j ), j = 1,…, J g j : share of government expenditure in sector j D X : exogenous component of external debt service F: foreign aid; ODA as a proportion of GDP Q: income; per capita GNP A: economic structure; agricultural share of the population P: political structure; constraint on the executive T: set of time-period dummy variables u j : stochastic disturbance term Debt-service prediction model (PREDSR=D): (9)D = NETDEBTX n =94, R 2 =0.597 (8.32) (4.31)

Sector Spending Trends Figure 1. Trends in Sector Expenditures Shares in African Economies,

7 Sector Spending Trends (cont’d) Figure 2: Trends in Real Sector Expenditures on the Social Sector in African Economies,

Results

Results Cont’d, using DSR

10 Results (cont’d)

11 Conclusion The debt-servicing constraint: – affects the composition of public expenditures in African economies – is essentially a social-sector phenomenon – reduces expenditure shares of both education and health about equally – exhibits a partial elasticity of approx. 1.5 for social sector – is more important than ODA, inter alia, affecting public budget allocation decisions Actual debt service ratios are a poor measure of the debt-servicing constraint Spending on the social sectors of education and health has been trending upward even following SAP

Thank you! 12