A glimpse into potential public spending reform

Many years ago, Mexico’s public finance analysts came to the conclusion that the composition of federal expenditure was unsuitable to drive economic development. They specifically indicated that its structure overemphasized public consumption, to the detriment of investment. In this regard, it is worth noting that arguments usually included emphatic, accurate criticisms of the inefficiency of investments. 

A glimpse into events of the past decade supports and highlights this concern. The graph illustrates the development of the two aforementioned variables, from 2007 until the first quarter of this year. (Base figures form part of national accounts.) At first sight, public consumption has clearly remained at around 12% of the GDP. The evolution of capital generation requires a more detailed explanation.

At the start of the period in question, a significant increase was observed in investment, perhaps as a Keynesian-like economic policy response to the negative impact of the Great Global Recession on aggregate demand. Investment share in GDP grew a couple of percentage points, exceeding 6%. It remained close to this level for a couple of years, but then began to decline, recently reaching just 3%.

With this background, the new government’s intention to reduce current expenditure significantly is plausible. Among the indicated (and debatable) items, the usual ones stand out: cutting the salaries of the top levels of bureaucracy; eliminating some fringe benefits; compacting social programs; etc. However, the new government also proposes increasing expenditures in other similar areas, such as pensions and assistance for young people. To my mind, the information available does not allow us to pinpoint the net impact of the changes. At the same time, it plans on increasing investment by one percentage point of the GDP. This would imply an adequate change in the trend–although not a recovery, in the strictest sense of the word --. 

Federal Public Expenditure Structure 
(% of GDP)

A glimpse into potential public spending reform


Source: INEGI (National Institute of Statistics and Geography)

In my opinion, the intended re-composition of expenditure would be more useful if, instead of indiscriminate coverage decreases (v.gr., “70% of the non-union employees”), the “pruning” is effected in the areas that have been proven to be superfluous.

The matter can be viewed from a radical perspective: a comprehensive examination of the federal government’s current efforts is crucial, as is deciding which functions are strictly its responsibility. The scrutiny should include the following obvious questions, among others: Does the expenditure in question truly serve the public interest? Is its execution the responsibility of the upper level of the administration? Could the product or service generated not be offered by the private sector? How will it be financed? What parameters will be adopted to assess its effectiveness?

In the context of “State-owned Enterprises”, in Mexico the idea that the government is, at best, a mediocre manager has, with good reason, been generalized. Insisting on performing this role goes against the modern conception of the State: an entity that sets “the rules of the game” and that intervenes selectively to remedy or, at least, mitigate the so-called “market failures”. Nothing else. 

Finally, regarding the fight against corruption, I think that eliminating as far as possible the institutional arrangements that create “perverse incentives” is a priority. This prescription is standard in the literature on this topic. 

A noteworthy example should be sufficient to illustrate this: the three branches of government have a patently excessive regulatory framework. Each official requirement that illogically limits individuals’ activities opens the door to an act of corruption. Each provision that stipulates a monopoly at the discretion of a bureaucrat generates an opportunity to extract a profit And so on, ad infinitum. In this sense, COFEMER (Federal Commission on Regulatory Improvement) has attempted to modernize and rationalize this regulatory mess, but with little success.

To conclude, perhaps we should reflect on two points: i) the core of public expenditure reform does not just lie in its composition, but also its absolute and relative level; ultimately, the latter determines the true “tax burden” on taxpayers; and ii) fighting corruption depends more on the existence of “upright” institutions, than on exhortations to changes in personal behaviors.