Public Spending and Long-Run Growth in Practice: Concepts, Tools, and Evidence
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stabilization and long-run growth (see box 2.1 for how fiscal policy was conducted in the Republic of Korea). During past crises, the majority of developing countries had to reduce public spending as a result of limited fiscal space. By contrast, prior to the most recent global crisis many developing countries had stronger fiscal positions, including far smaller fiscal deficits and lower debt burdens (IMF 2010), than in previous downturns. These stronger positions allowed many developing countries to implement a countercyclical fiscal policy—indeed, according to the IMF (2010), 81 percent of low-income countries and about 69 percent of emerging market economies increased public expenditure in real terms. Whereas most low-income countries experienced declines in public revenue—the median decline in revenue in all low-income countries amounted to 0.3 percent of GDP and to 2.1 percent of GDP among commodity exporters (IMF 2010)—only a few countries chose or were forced to adjust spending to the revenue shock to avoid unsustainable debt. Low-income countries used domestic sources, external loans, and grants to finance domestic revenue shortfalls (IMF 2010). In the past, fiscal adjustments have often involved cuts in productive public expenditure, which suggests that there are trade-offs between achieving debt sustainability and promoting long-run growth, depending on public spending composition. Although those cuts may improve the short-term cash flow indicators (deficit and gross debt), they are likely to prove counterproductive in the long run: less productive expenditure may reduce long-run output growth, which then lowers future revenue flows (Easterly, Irwin, and Servén 2007). In this sense, growth-enhancing policies help ensure that government debt is sustainable. As for the composition of stimulus packages during the global crisis, no systematic information for all countries is available. However, evidence from a limited sample of low-income countries suggests that, in addition to spending on social safety nets, health and education spending and public investment generally increased. For example, several countries implemented labor-intensive public works programs, including Bangladesh, Cambodia, Kenya, Rwanda, Sierra Leone, and Tanzania. It is possible that the composition of the stimulus packages in some countries was motivated in part by the expected long-run growth effects of public investment and of health and education spending, while reanimating the economy in the short term. However, there are still