Financing human capital

different sources, different effects

In discussing the financing of the enhancement of human capital, and particularly the access of the poorest to the conditions for obtaining and retaining the employment they need to overcome and stay out of poverty, we examine three areas:

universal health coverage, education and skills systems, and social protection.

National-level education and health sectors require large expenditures, beyond what the governments of most developing countries currently invest, if they wish to ensure that poorer

members of society can obtain the employment they need to overcome poverty. The Chronic Poverty Report (CPAN, 2014b:128-131) shows that although public spending in developing countries overall tripled between 2000 and 2011 this rise conceals huge variations. Thus around 2.5 billion people live in multidimensional poverty in countries where governments spend less than $1,000 per person per annum and of these around 540 million live in 44 countries where the governments spend less than $500 per person per annum, mainly in SSA and South Asia. Levels of public expenditure in these 44 countries are not projected to increase adequately by 2030.

Looking towards 2030 the Chronic Poverty

Figure 6.6 | The role of policy for mobilisation and effective finance for human

Ecuador underwent a major experiment in social development under the leadership of President Rafael Correa, who has been in office since 2007.

The CI identifies a number of enablers including (a) a strong and lasting political settlement around the person of the president, backed up by a clear vision and development philosophy entitled ‘Buen Vivir’ or ‘Sumak Kawsay’, which critically includes the country’s large indigenous population; (b) the enhancement of human capital through better education and health policy coverage;

(c) improved quality of public institutions, in particular the tax revenue system and organisations implementing health, education and social-protection policies; and (d) trade, in particular the sustained rise in international oil prices and revenues (apart from a dip in 2009) and the overall stability of the US economy.

The results of this effort have been substantial. Inequality has dropped in both urban and rural areas (Gini index down from 0.505 to 0.487 between 2006 and 2010). Poverty and extreme poverty have also declined (from 60% to 53% and 17% to 13% respectively in the same period). There is also greater equality and fewer pockets of poverty. The coverage of the national Conditional Cash Transfer programme (the Bono de Desarrollo Humano, which provides $35 per month, conditional on 75% school attendance and monthly health check-ups of the beneficiaries’ children) has increased from 1.1 to 1.8 million of the country’s 13 million inhabitants. Social security has been extended to 55% of workers employed in the formal economy, which is about half of all employment. Primary and middle education (grades 1–10) is now free of charge and access barriers (fees, uniforms, etc.) have been eliminated. As a result education up to 10th grade is now universal. The employment of children aged between five and 17 years has fallen from 30% to 17% of the labour force. Health care is also offered free to all citizens.

The financing of this major effort in social development has been achieved largely by a substantial improvement in tax collection, the careful management of external debt and the use of reserves (international monetary reserves and sovereign stabilisation funds).

External sources, including ODA (0.5% of GDP), remittances (going mainly to better-off families) and FDI (although foreign investors have been reticent following the renegotiation or nationalisation of the oil-extraction industry and mobile telephone companies) have been negligible in providing finance for development, although China has provided up to $6 bn partly in loans and partly through oil purchases. Following the national financial crisis in 1999, value-added tax (VAT) was increased (from 10% to 12%) and coverage substantially extended, and income tax rose from around 1.5% to 4.5% of GDP between 2000 and 2012. These improvements in tax revenues were helped by specific policies for DRM based on a thorough overhaul of the tax service in the 1990s and the renegotiation of licenses for oil extraction and for mobile telephony, giving the government a much greater share of the revenue in both sectors. Tax coverage has been greatly extended by improving efficiency, systematic enforcement, legal action against tax evasion and simplified processes for small traders and producers to bring more of the informal economy into the system. In terms of expenditure, social spending increased from 2.9% of GNP in 2000 to 9.7% in 2010 and, while in the first half of the decade the government devoted 19% of its budget to social services, in the latter half this figure rose to 27%.

A key policy for the effective use of finance was the decision to use the US dollar as the national currency following the 1999 crisis.

This stabilised the economy and controlled inflation, but it also removed the government’s ability to use macroeconomic policy instruments and increases the importance of fiscal instruments in managing the economy. The ‘dollarisation’ policy carries potential risks, as does the continued heavy dependence of the economy on oil extraction and the need to make loan repayments to China.

Box 6.9 | Financing social development – lessons from the Ecuador Country Illustration

Figure 6.7 | Sources of healthcare financing by region, 2011 (as a percentage of GDP)

Source: CI by Borja and Ordóñez (2015)

Source: ILO (2014).

Note: Regional averages weighted by total population 9

8 7 6 5 4 3

0

% of GDP

2 1

Public Private

Wester n Eur ope

Public Private Public Private Public Private Public Private Public Private Public Private Public Private

North America

Central and Easter

n Eur ope

Asie and the Pacific

Latin America andthe Caribbean

MiddleEast Africa World

General government expenditure on health except social security funds Social security expenditure on health OOP

Private prepaid plans Other private health expenditure

Financing health care for human capital

As Figure 6.7 shows, there are huge regional variations in the patterns of public and private financing of health care. In Western Europe and North America public expenditure on health is more than twice as high as private expenditure, whereas in other regions the two are more even,

and in Africa and in Asia-Pacific private finance outstrips public spending. Within private finance OOP payments that undermine poverty-reduction efforts and increase impoverishment, are consistently more important than private pre-paid plans, but the difference is particularly marked in regions that have a larger number of developing countries.

The World Health Organization (WHO) has played a strong role in developing the international consensus reached in 2008 that UHC can be achieved only with a massive increase in public expenditure, whether into an insurance-risk pool to which both public and private providers contribute or into a publicly funded service. The 49 LICs need to raise public expenditure from $32 to $60 per person to achieve UHC. ‘The practical difficulties in collecting tax and health insurance contributions, particularly in countries with a large informal sector,

are well documented. Improving the efficiency of revenue collection will increase the funds that can be used to provide services or buy them on behalf of the population. Indonesia has totally revamped its tax system with substantial benefits for overall government spending, and spending on health in particular’ (WHO, 2010). The importance of this is also stressed in the Indonesia CI, while the CIs on Ecuador and Tanzania underline the need to reform and strengthen taxation in order to raise domestic revenue.

The private sector also plays a prominent role in providing basic education in many developing countries, although it seldom helps to reduce poverty or inequalities directly (CPAN, 2013).

Some private schools are fully or partially publicly funded while others are exclusively privately funded. In LICs, fragile states and post-crisis countries, domestic financing of education may be limited due to limited fiscal space and state capacity. In such cases, ODA may be crucial (Vegas et al., 2011).

Aid to education represents 8.5% of gross bilateral ODA, but has declined recently (Development Initiatives, 2013; Global Campaign for Education, 2013). The proportion allocated through public budgets has also fallen while the share of ODA that is channelled via general or sector budget support, the most effective form of support, has remained below 5% and has also fallen recently.

Finally, ODA for the education sector is remarkably uneven among countries. Rose (2013) calculated that the cost of providing primary education is around $130 per child, whereas LICs on average allocate $41 from their own budgets and receive

$16 from donors. Even around this low average there are huge variations. ‘For instance, while aid to basic education in 2011 was $39 per child in Afghanistan, it was only $4 in Chad, which has some of the poorest education indicators in the world’ (Rose, 2013). Support for basic education is also plummeting, including in LICs. The bulk of ODA for education goes to secondary and post-secondary education, although this includes scholarships and imputed student costs incurred by donor countries hosting them (Global Campaign for Education, 2013). ³⁹

The level of decentralisation and source of public finance affects distributional outcomes. Part of the challenge is that education financing is often decentralised. In both Kenya and Thailand, for instance, this helps to explain why education outcomes have been quite regressive. The typical policy response is to standardise spending per pupil. However, this is not strong enough to

counter the biases against children from poor backgrounds or in poor regions, or the cost differences between different school areas, as was found in the USA (Li and Wang, 2014). Equity can be defined as service provision that meets a minimum absolute standard, where educational resources and outcomes are within an acceptable range, or where they are not affected by an area’s wealth.

The focus of progressive policy-making has typically been on improving enrolment, improving gender equity, and, linked to this, providing conditional or (more rarely) unconditional cash transfers to encourage children from poor families to remain in school longer. Although the policy focus on access to primary education is very important ‘the sheer act of enrolment does not by itself help children or their families emerge from poverty’ (CPAN, 2014b). To achieve upward mobility, several years of post-primary education and the acquisition of skills that are useful in the labour market are critical (Shepherd, 2011). In many countries, however, the focus on the interventions required to make education a real motor of poverty eradication (access by underprivileged children to pre-school education, helping children from poor families to complete primary and lower-secondary education and then into paid work) has been weak, with the exception of the above two issues. Moreover, ‘if education is of poor quality, it greatly constrains its utility [...].

Where demand for labour is low or labour markets are discriminatory, education may not make as much a difference as it could’ (Shepherd, 2011).

Education equity is a relatively recent policy discussion in many developing countries.

Mauritius introduced universal education in 1976, but in Ecuador this choice was not made until 2007. Similarly, China formulated its first education equity policy only in 2004/5 in response to growing disquiet over the excessive fees charged by some largely urban private educational establishments, the under-funding of rural schools, and the inadequate educational Financing education for human capital

Most governments recognise that education is critical to economic success, and may therefore be more inclined to invest public resources in this sector rather than in health or social protection (CPAN, 2014b). Ecuador, Indonesia and Tanzania, for instance, have explicitly chosen to spend tax revenue on education and health in order to develop their national human capital. Despite the greater commitments made by many governments to education compared to health, there remains a major funding deficit for education, and many children in countries that spend significantly less than UNESCO’s estimate of basic education costs are deprived of a decent education.

In general, countries raise revenues for education from public, private and international sources (Vegas et al., 2011). The largest share comes from the public sector (central, regional, local) (Saavedra, 2002; Figure 6.8). Public financing includes both direct public expenditure on education and subsidies (e.g. scholarships, tax reductions, loans).

According to the Leading Group on Innovative Funding for Development (2010), governments in developing countries typically spend 4% of their GDP on education. Increasingly, national governments are decentralising the responsibility for raising and managing education funding to subnational levels (Vegas et al., 2011), although

‘without central government-led equalization schemes to compensate for varying fiscal capacity across jurisdictions, fiscal decentralization can lead to wide disparities in resources available for learning’ (Vegas et al., 2011). Furthermore,

‘requiring local governments to raise all their own revenue for education is likely to result in an unacceptably high degree of inequality in pupil spending’ (Vegas et al., 2011). The role of local government in social spending is discussed in more detail in the next section.

4 3 2 1 0

Low

income Low middle

income Upper middle

income High

come 5

6

2000 2010

% GDP

Source: Authors’ illustration based on WDI data, accessed June 2014

Figure 6.8 | Public spending on education in country income groups in 2000 and 2010

Private sources represent close to 20% of total national educational finance (Saavedra, 2002).

These sources include households, communities, CSOs (including some that are faith-based), and the private sector.

Household expenditure is a crucial component of education finance. Households incur direct costs (e.g. tuition fees, transport, uniforms, materials, student loans) and indirect costs (such as the opportunity cost of having children in full-time education rather than in productive employment) (Saavedra, 2002). While fees constitute a major source of revenues for the education system, in many LICs they also represent a large share of total household spending, particularly for the poor, and so place a disproportionate burden on them (Vegas et al., 2011). It has been argued, however, that abolishing school fees can result in a drastic decline in the quality of schooling in the absence of alternative sources of funding (Ladd and Fiske, 2008).

39 Largely because higher levels of education per student cost so much more than basic education.

countries, with the largest number of extreme poor and high projected population growth rates for decades to come (ERD 2013), are likely to experience only slow growth in public expenditure up to 2030. At the same time, international public finance currently accounts for 65% of the resource inflows in countries with public expenditure levels of below $200 per person per year, so ODA will continue to be a vital source for them not least as a catalyst for improving the mobilisation and use of resources (CPAN, 2014b).

Despite the scale of this challenge the ILO’s Advisory Group on Social Protection points out that various populous middle income countries such as China, Indonesia, Brazil, India and Thailand have introduced and expanded large-scale social floor programmes in the last 15-20 years. Even poorer countries such as Ethiopia have done so, albeit with external support (Box 6.14). Examining various costing studies thus leads the Group to conclude that even the poorest countries can afford to implement nationally defined social protection ‘floors’ (Bachelet, 2011). The ILO’s costing studies on a basic package of social protection for a selected set of LICs and MICs in SSA and Asia show that the cost of a cash- benefit package, including old-age and disability pensions and family allowances, but excluding health care, is between 2.2% and 5.7% of GDP (ILO, 2008). Even in the absence of high growth, it is possible to enhance fiscal space if the prevailing political settlement supports this. The debate on affordability has generated significant interest in the international development community.

Affordability is not an absolute but rather a question of political preferences and trade-offs among competing goals in a context of limited resources (Hagen-Zanker et al., 2010; World Bank, 2012).

6.3.2 The role of policies and finance