Smarter spending to drive growth

Rwanda's achievements over the past two decades are impressive. Almost every household now has access to mobile phones and primary education. More than half of the population has electricity, and one in five has access to clean water and sanitation. Rwandans now consume three times as much electricity and live 20 years longer.

These improvements were achieved through a relatively small increase in investment, education and health spending from $150 to $420 per person, a figure that is even lower than the sub-Saharan African average. In Rwanda, the changes played out in more efficient public spending. This strategy is a way of responding to fiscal pressures resulting from slow growth, rising debt, an aging population, and increased defense needs. The main thing is to make every penny of taxpayers count.

In our latest Fiscal Monitor report, a new study of 174 countries shows that by implementing best practices, governments can get, on average, a third more return on their spending. Through more efficient spending and more efficient allocation of existing resources, emerging market and developing countries, as well as advanced economies, could increase output by 11% and 4%, respectively, over the long term. Smarter spending is not just a fiscal tactic; it is a growth strategy.

What it means to spend money more wisely?

First, it means a better distribution of existing costs. In most countries, growth-enhancing public investment has fallen by 2 percentage points of total spending over the past two decades. A similar situation is observed in education, where government spending remains at a modest level of about 11% of total spending. At the same time, many countries face high public sector wages, which on average account for a quarter of total spending.

Second, it means improving the "technical efficiency of expenditure", i.e. the maximum output that can be achieved for a given fixed level of public expenditure. To measure this, we compare observed outcomes with best practices in governance, technology and institutional arrangements. For example, Canada spends about $2,500 per person per year on education, about $300 less than other developed countries. Yet adults spend an average of 13.7 years in school, second best in the world behind only Germany.

Significant economic benefits

Smart government spending can significantly boost long-term growth in both developed and developing countries.

According to our analysis, diverting 1% of gross domestic product from low-impact public consumption to infrastructure investment increases output by about 1.5% in developed countries and by 3.5% in emerging market and developing countries over about 25 years. Redirecting the same amount to investment in human capital, for example to modernize education systems, could lead to growth of around 3% and 6% in these two groups of countries, respectively. Importantly, this redistribution of costs can also reduce income inequality.

More efficient spending reinforces these improvements in the long run. Achieving a 10 percentage point improvement in cost efficiency can lead to an additional 1.4% increase in production. The sooner countries close these gaps, the bigger and faster the results will be.

Additional political decisions are also important. In developed countries, the combination of research and development activities with investment in human capital increases productivity. In emerging and developing countries, matching infrastructure spending with education spending balances short-term and long-term benefits: physical capital quickly spurs production, while human capital lays the foundation for future productivity.

Achieving effective reforms

Spending reforms create difficulties. Countries often set statutory minimum levels of funding for education, health care and social protection. Changing wages and pensions in the public sector is also difficult. In the world, about a third of spending is effectively "locked in", and this situation is even more inflexible in advanced economies.

But there are good examples of how to make progress. To reduce this inflexibility, Estonia and Sweden have made extensive use of multiannual fiscal planning, which requires offsetting new spending in future years. They also tied budget allocations more strictly to past indicators. This strategic approach to spending reform is more effective than across-the-board cuts that can compromise essential services and reduce efficiency.

Fighting corruption, strengthening the rule of law and increasing budget transparency are measures that can also improve efficiency. Competitive procurement processes, better management of public investments and digitization of public finances are also beneficial. In Togo, for example, investment efficiency increased by 5 percentage points after the country introduced cost-benefit analysis for all projects and multi-year planning in 2016.

Linking retirement age to life expectancy or prioritizing disease prevention to curb future health care costs can ensure long-term sustainability of social spending. It is also imperative to bring public sector compensation into line with the market and to tighten wage controls, especially in developing countries where public sector wages tend to exceed private sector wages by 10 percent or more.

Ultimately, reviewing spending based on clear goals and budget decisions helps governments identify opportunities for savings and improve outcomes. In the Slovak Republic, such revisions have shown that 7% of public expenditure can be saved.

Ultimately, improving spending efficiency and better targeting existing resources allows countries to strengthen public finances, increase resilience and promote long-term economic growth.