Fiscal Space for Investment in Infrastructure in Colombia

For the evaluation of macroeconomic policies Colombian authorities rely heavily, if not exclusively, on the operational framework known as the Financial Programming Model developed by the IMF in the 1950s. Based on this static framework, the formulation of fiscal policy in the country, just as in various Latin American countries, focuses primarily on fiscal deficit and gross debt targets. However, the type of fiscal policy advice derived from it is not useful for understanding the asset-creating nature and the intertemporal trade-offs involved in public investment decisions. This paper develops a perfect foresight, dynamic small open economy model to provide an alternative framework for fiscal analysis and policy purposes. It is shown that the two competing frameworks deliver differing paths for the expected behavior of the Colombian economy. The proposed framework is then used to study the likely consequences of using public capital spending to achieve deficit targets since, in addition to an already high public debt, in the years ahead unfunded pension obligations will put enormous pressure on the Colombian government's solvency. The results indicate that public capital compression is costly in terms of foregone growth and very ineffective in achieving fiscal consolidation. The adoption of fiscal rules such as the golden rule or the permanent balance rule to shield public investment from undue budgetary pressures makes little sense in the presence of sustainability concerns. The paper shows that a transitory capital spending increase is not self-amortizing in the long run; hence an extra peso of public capital spending deteriorates the intertemporal fiscal position. A permanent increase largely pays for itself in terms of additional tax revenue but this effect is offset by a deterioration of infrastructure user charges, as long as public prices are determined competitively