Posted by Brett Inder on January 15, 2016
It has been a controversial few months in Timor-Leste Fiscal Policy. After much debate and discussion, the Parliament finally approved the Budget for 2016, only to have it vetoed by the President just before the end of 2015. Then last week, the Parliament reconsidered the budget, and decided unanimously to make no changes (see ETAN TLGov post, Jan 9th). The ball is now back in The President's court...
I'll leave the constitutional and political aspects to others, but will make a few comments on the economics.
There are several potential criticisms of how the budget is allocated, but here is a few that I hear often. The President’s Press Release focuses on points 3 and 4.
1. Overall spending is unsustainable - in recent years, drawings on the Petroleum Fund have well exceeded the pre-determined "sustainable level". At this rate, this Fund will run out within 10 years or even sooner.
The budget papers acknowledge this, and refer to it as front-loading spending - overspend now to invest in key projects, with the hope that they will generate future economic activity and revenue, that will 'kick-start' the economy. They acknowledge this front-loading cannot be sustained, and suggest it will stop in a few years. That’s going to be tough politically – expense-cutting governments are rarely popular!
Currently the budget (and most of the economy) is financed by Petroleum Fund reserves. If spent at the “sustainable rate”, these reserves would be available for many years into the future, even if income from new Oil and Gas royalties stopped now. Put simply, the looming “post-oil economy crisis” is not a problem of revenue: it is largely one of spending above sustainable levels.
2. The Veteran's Pension takes too much of the budget. Numbers here are quite substantial: over $100m of the $1.4billion budget is spent funding these regular payments to those approved as veterans. This exceeds the total Health and Agriculture Ministries’ budgets combined. All other social transfers (aimed at children, families, elderly, etc) are tiny in comparison with this one.
What is the rationale? The veteran's payment are seen as compensation for past contribution to building the nation, and are a key strategy in retaining stability and peace now. Timor-Leste’s story of peace and stability is indeed a miracle. But I wonder how much the Veteran’s Pension can take credit for that, and what else that money could be used for?
3. Big spending on major projects of dubious economic value. We are all familiar with the criticism of projects like the Oecusse ZEESM, Suai Supply Base, airport and port developments, etc. A big share of the budget expenditure is going to these kinds of initiatives. The key question from a budgeting point of view is: will they will produce the boost in economic growth that justifies the expense?
4. Not enough spending on the basics that affect the vast majority of the population - especially health, education and agriculture (which links to food security, basic livelihoods). Why is there so little of the budget allocated to these Ministries, and why is it declining this year compared to previous years?
One response could be that the government is prioritising long term investment in the infrastructure that underpins a prosperous, post-oil economy. Then there will be ongoing funds to support public investment in health and education, etc. There is also a concern that simply allocating more money to these areas will not necessarily deliver the ultimate outcomes (better education, health and agricultural productivity); the critical issue is not money, it is greater capacity to design and implement effective programs.
Where do you sit on these issues? Are you persuaded by the arguments on either side? There is much detail and analysis to be done on each issue. The Parliament and key political leaders see things very differently to those in the President’s Office and many others in civil society. How does a society promote healthy public debate about these and so many important issues?
Too many questions…
Posted by Brett Inder on January 05, 2016
In my last post I wrote about the hazards of projecting costs and benefits of large scale infrastructure projects. Here I want to write about some academic research on the topic. It turns out that there is a pattern of underestimating costs, and overstating benefits.
Bent Flyvbjerg (Professor of Economic Geography at Oxford University) is a leading researcher in the area of planning for large scale infrastructure projects. With his colleagues, he assembled a big database of large scale transportation projects. He finds 90% of projects went way over budget (ie underestimated costs), and a similar % significantly over-predicted demand (mainly traffic flow). These systematic biases have persisted for decades, and it appears that the lessons are not being learned: the biases are still there in more recent projects.
So why do so-called experts consistently overestimate benefits and underestimate costs?
Flyvbjerg suggests 3 possible reasons:
1. Technical forecasting errors - experts use complex models to try and project into the future, and with much uncertainty, there is always going to be some error. Unforeseen circumstances always arise.
2. Optimism bias - psychologists argue that often in situations of uncertainty, planners and politicians err on the optimistic side, understating costs and overstating benefits.
3. Political incentives - often those who are developing the plans and proposals have an interest in seeing the project supported and receive funding. Consultants earn future work, politicians get a legacy, public servants get achievements next to their resumes. This gives all an incentive to exaggerate their project's benefits and understate costs.
Looking at the evidence, there are certainly cases where all three possible explanations apply, but the third seems to be most prominent. The first two reasons are possible in particular cases, but implausible across so many projects over a long period of time. Why would experts consistently get it wrong? If planning was a purely technical exercise, surely they would learn from previous mistakes and over time, forecasts would improve. Systematically biased forecasts, with no sign of learning from this, are unlikely.
How does political incentives thwart the objective nature of these cost-benefit analyses? In many ways, but imagine a scenario like this: Development Advisers encourage the government to modernise their infrastructure, especially those that provide the public face of the country, like the main international airport. Government leaders are persuaded by the arguments, but due diligence requires employing an international consultant to undertake a feasibility study. The consultant knows the mood of the government is favourable to the project, so makes assumptions which err on the side of delivering the message they know the client wants to hear - that way their report will get a much easier run, and a favourable report may well lead to more work in future!
Acknowledging the inherently political nature of cost-benefit analyses in large scale projects, what can be done to avoid these problems? There are many suggestions in the literature.
Here are a few that stand out to me, as being relevant to Timor-Leste:
* Transparency: providing as much information as possible to the public about the rationale, the models and assumptions, etc, and allowing these to be challenged. No outside consultant knows the specific situation in Timor-Leste as well as the collective voice of the people.
* Peer review: don't just listen to one consultant or adviser's advice: get other experts (independent) to review an analysis or recommendation.
* Ask for a 'reality check' on projected costs and benefits by examples of similar completed projects in other countries, where actual costs and benefits are documented (this is a simplified version of Reference-class forecasting).
* Design Public-Private Partnerships to ensure significant risk lies with the private partners. There is much more to say about this PPP topic, for another time, but the key point here is that partnerships with shared risk can be a good way to ensure the projections are realistic. Private investors who are putting their own money at risk tend to be much more careful with questioning and challenging the forecasts, because their profit is at stake if the numbers are wrong!