Background
The challenge of trade-offs in government spending and taxation policy is universal across economies. However, it is particularly pressing for vulnerable nations, for whom there is less margin for error. With limited fiscal space and continuing economic uncertainty, every dollar must be used productively. This is particularly important in the polycrisis era of COVID-19, the Ukraine war, high-inflation and debt vulnerabilities, when social care costs are inflated, taxation revenues dramatically reduced, and pathways to a normalised post-pandemic period are uncertain.
Donor commitments remain unfulfilled on many fronts promises of 0.7% of GDP to international development in the Doha Declaration on Financing for Development Agenda and the Addis Ababa Action Agenda have not been met, and climate finance commitments under article 9 of the Paris Agreement are far from being reached.
Due to severely restricted fiscal space, recovery investment in developing, and particularly least developed, countries was dramatically lower than in other parts of the world. Data from the Global Recovery Observatory (O’Callaghan et al., 2021) highlights the negligible funds made available for COVID-19 recovery spending in least developed countries (LDCs) at as low as USD $64 per capita. Recovery spending from other developing nations was an order of magnitude above spending in LDCs at USD $726 per capita. Advanced economies, meanwhile, were on an entirely separate scale, with more than USD $15,000 per capita spent. While inequality within regions has grown because of the pandemic, the greatest increase in inequality is likely to come between regions. Per capita recovery spending in most African states, for instance, is less than 1/250th that of advanced economies, driving the wedge ever further between developed and developing countries, and threatening global stability.
Across the world and particularly in developing economies, increased costs, declining foreign investment under unstable conditions, and insufficient foreign aid have mounted pressure on national budgets, severely restricting the ability of governments to invest in recovery initiatives made necessary by the devastation of the COVID-19 pandemic, and exacerbated by the Ukraine war and high inflation. Operating with already limited fiscal space, governments worldwide must now cope with expanded health and social care costs, while taxation revenues have collapsed. Pre-existing development challenges have seen their difficulty and urgency magnified by the effects of the pandemic.
Experience and research both show that there are opportunities, in recovery spending and elsewhere, to achieve progress simultaneously on climate and the economy (Hepburn et al., 2020; O’Callaghan et al., 2022; O’Callaghan and Murdock, 2021), but so far this opportunity has been lost in most developing economies (O’Callaghan et al., 2021).
Need for evidence based fiscal policy
In many nations, significant policy decisions are often made with incomplete or imperfect information. Policymakers lack necessary details on the potential environmental, social, and development impacts of available policy options. As such, it is very difficult to understand the alignment of policy options with national sustainable development objectives.
Poor information can hence bring unintended costs for citizens, businesses, the environment, and future generations, or failure to provide intended benefits. It can also lock-in unsustainable consumption and production patterns, misaligning private sector incentives, which, in turn, influence investment decisions (including for national sustainable development objectives), thereby completing the cycle. In simple terms, incomplete information leads to sub-optimal fiscal decisions which, in turn, leave potential development gains uncaptured.
Effective fiscal management, for the purpose of maximising wellbeing, is a core objective of any democratic government. Yet, complex, highly interconnected and difficult-to-predict economic systems make optimizing fiscal allocations for future societal benefit no easy task. In many vulnerable nations, fiscal planning systems do not exist or are unfit for purpose. Where systems do exist, they often focus disproportionately on traditional economic criteria like fiscal multipliers and job creation, neglecting other essential influencers of human development like natural and social capital.
This policy brief introduces the Sustainable Budgeting Approach (SBA) as a tool to help governments easily consider the potential environmental, economic, and social consequences of policy options in their fiscal decision making. The SBA was successfully piloted in Gabon in 2021 and has been developed by the Smith School of Enterprise and the Environment at the University of Oxford with support from the United Nations Environment Programme. It was also endorsed in the official communiqué of the International Cooperation Forum and Meeting of African Ministers of Finance, Economy and Environment in Egypt during the run up to COP 27.
In contrast to other approaches, the SBA’s fiscal taxonomy groups policy based both on shared economic and environmental characteristics. For policy impact assessment, the approach relies on leading academic knowledge, synthesised in a format useful to policy makers. The SBA is designed to be flexible to national context and modular so that governments might analyse policy options based on their internal priorities.
What is the Sustainable Budgeting Approach
The Sustainable Budgeting Approach (SBA) is a framework for helping finance ministry officials make informed and high-impact budgetary decisions, particularly under constrained fiscal space. The SBA incorporates leading socio-economic and environmental science to give automatic perspectives on the potential developmental (e.g., jobs, growth), environmental (e.g., climate mitigation, climate adaptation, nature, air pollution), and social (e.g., wealth inequality, gender inequality, rural-urban inequality) consequences of budget options.
The approach defines ~250 policy archetypes, each of which are assessed for their potential impacts against the social, economic, and environmental criteria, using the latest in available research and evidence. These assessments can be fine-tuned based on domestic context and priority criteria defined by the government. It allows for informed tradeoffs in policy decision making (figure 1) while also allowing for more informed budget tracking/tagging and comparisons across time. In this way, the SBA helps improve transparency and can signal commitment to aligning national economic policymaking with sustainable and inclusive growth pathways. This is an important step in negotiating multilateral partnerships for development.
Figure 1. Example trade-off with the Sustainable Budgeting Approach, considering two spending policies in Gabon. On the left, public investment in a natural gas plant. On the right, public investment in a solar plant. All assessments of potential impact are only indicative and intend to give a broad unquantified perspective on potential impact. Policy decisions should certainly include consideration of other impacts not in this figure, for instance: health, education, and security, amongst others.
Advantages of the Sustainable Budgeting Approach
The Sustainable Budgeting Approach (SBA) first asks policy makers what objectives matter most to their constituents (e.g., long-term growth, job creation, climate mitigation). It then helps policy makers build generalised assessments to understand how different policy archetypes might meet those objectives. Ultimately, this lets a policy maker categorise any policy option into an archetype and quickly understand its likely directional economic, social, and environmental impacts. In this way, the SBA acts both as a decision-making tool and an aggregated policy assessment tool to understand the likely directional impacts of an entire budget or subset of fiscal policies.
Importantly, the SBA is malleable to the unique circumstances of any country. Across countries, policy archetypes remain the same, but potential policy impacts change. Policy makers can take the guidelines and examples contained within this document as resources to develop their own policy impact assessments. They can then use these assessments systematically to assess fiscal options, guide decisions, and understand the aggregated impact of their budgets. Importantly, assessments included in this document are intended to be only a starting point from which interested parties might develop their own context-specific mapping.
To some degree, implementing the SBA is about fundamentally shifting the mindset of decision makers. This can happen with long-term assistance from partner agencies, but the initial push must come from within. The SBA is not intended as a silver bullet for fiscal planning, but rather a powerful first step requiring relatively little in the way of policy maker capacity. For nations with more advanced fiscal planning processes, the static economic assumptions in SBA assessments could be adapted to incorporate dynamic considerations, or instead existing dynamic models might be adapted to incorporate all kinds of environmental impact assessments alongside traditional economic measures.
Objectives of the SBA
Core objective
The primary purpose of the SBA is to help government officials make better informed fiscal decisions by providing evidence-based perspectives on the potential economic, environmental, and social impacts of different policy types. To this end, the SBA is likely to be most useful in budgetary offices and ministries that lack or wish to strengthen systematic, evidence-based, and multi-dimensional planning procedures.
Supplementary objectives
For policymakers
Alongside its role supporting decision making, the SBA can be used by policymakers to:
- Systematically identify new policy ideas. The GRO, in its tracking of COVID-19 measures, already provides over 8,000 examples of fiscal policy categorised in 221 sub-archetype categories. This list includes over 1,000 examples of green policies with descriptions and sources. As the SBA is applied to ‘normal’ budgeting cycles, even more policies will be identified and categorised, expanding the set that a policy maker might learn from.
- Track the overall environmental, development, or social characteristics of an entire budget. Once all budget policies have been categorised using the SBA fiscal taxonomy, the user of the SBA can compute the aggregate performance of a budget (or budget subset) on any of the SBA’s economic/development, social, or environmental criteria. These figures could be tracked over time to understand trends in fiscal impact and/or compared to other nations. Note that at this stage the SBA does not incorporate interaction effects between policies, potentially impacting the accuracy of figures on aggregate budget impact.
- Support debt programs. Many sovereign debt initiatives—including debt swaps, debt holiday programs, sovereign-sovereign guarantees, and bond issuances—can be usefully paired with development and/or environmental priorities. For instance, restructuring tools like debt for climate swaps and debt for nature swaps, as well as new debt issuance options like sustainable sovereign-sovereign guarantees, green bonds, blue bonds, and SDG bonds. For many of these tools, creditors and other stakeholders are often looking for ways of tying credit to sustainable investment. The SBA could be used for such a purpose; it could be used to identify suitable categories for spending and for tracking progress against a definite base case scenario (i.e., the fiscal position prior to the issuance of new debt).
While the core objective of the SBA might be most relevant to vulnerable countries without effective fiscal planning processes, these supplementary objectives are useful for all kinds of governments—even those already employing robust trade-off procedures in decision making.
For other users
For civil society, the SBA can act as a transparency tool to highlight the characteristics of a government’s fiscal actions in comparison to other nations. This is particularly important as a number processing bias means that members of the public do not fully appreciate the relative magnitude of different fiscal investments. A lack of familiarity with large numbers means that they might not always be properly processed by the human brain—indeed, neuropsychological research suggests that large numbers are often processed logarithmically while small numbers are processed linearly (Dehaene et al., 2009; Hyde and Spelke, 2009). As they have done with GRO data, civil society could use SBA data comparisons as an input to advocacy efforts calling for changes in fiscal allocations.
For businesses and investors, SBA data could be a useful indicator on government priorities and the future direction of an economy. In turn, this could shape investment decisions and patterns. With significantly more data, over several years, businesses might also use SBA records to understand which geographies might best benefit from their services or be positioned for expansion.
For researchers, the highly detailed SBA datasets open countless new opportunities for fundamental research. As an indication, the GRO dataset is already being used in econometric, machine learning, and policy research applications. Wide dissemination of SBA data in research communities might also help direct new research to the areas that are receiving greatest policy attention (and highlight which areas perhaps need greater advocacy to prompt more policy attention). Finally, as a leading indicator on future changes in climate emissions, SBA fiscal data could be integrated into climate models to improve accuracy.
For development partners, SBA could usefully provide measures on the aggregate environmental and social characteristics of national budgets. This could be used as an additional indicator to shape how and where to direct future aid disbursements. It might also be used to inform which sectors in a particular economy might best benefit from support and collaboration. As in the case of businesses and investors, credible and transparent data on national or sub-national policy choices and their alignment with long-run growth and environmental objectives could also help lower sovereign borrowing costs (Dibley et al., 2021).
Limitations
Several core limitations must be addressed from the outset. First, ex-ante assessments of policy impact are a coarse placeholder for detailed ex-post studies; they are more useful as a directional indicator than for quantifying impact. Second, in its current form, the SBA assumes static economic conditions and ignores the dynamic interaction effects of policies introduced simultaneously. Third, the success of SBA relies on policy maker willingness to change. Finally, SBA findings depend on government-provided descriptions of policy actions, which might lack appropriate detail.
Authors:
Himanshu Sharma and Brian O’Callaghan
Bibliography:
Hepburn, O’Callaghan, Stern, Stiglitz, Zenghelis (2020), Will Covid-19 fiscal recovery package accelerate or retard progress on climate change?
O’Callaghan, Yau, Hepburn (2022). How Stimulating Is a Green Stimulus? The Economic Attributes of Green Fiscal Spending.
O’Callaghan, Adam (2021). Are COVID-19 fiscal recovery measures bridging or extending the emissions gap?
Dehaene, Izard, Spelke, Pica (2009). Lor or Linear? Distinct institutions of the number scale in Western and Amazonian indigene cultures
Hyde, Spelke (2009). All Numbers Are Not Equal: An Electrophysiological Investigation of Small and Large Number Representations.
Dibley, Wetzer, Hepburn (2021). National COVID debts: climate change imperils countries’ ability to repay.
