As OECD countries struggle to reduce their fiscal deficits, consider the case of Madagascar. Half of its budget was financed by external assistance which, as a result of political turmoil in the country, has disappeared.
In response, the Government of Madagascar cut its expenditures, especially its investment outlays, to preserve fiscal stability. The budget was kept under control (around 2% of GDP), reinforcing local financial-market confidence, but marginalizing the State that today accounts for less than 6-7 % of total economic activity in the country (when the world average is around 30%). How can fiscal policy be effective under these conditions?
This note proposes three basic principles that should help the Malagasy State to play its role of providers of basic services and infrastructure as well as to protect people and property rights.
First, increases in public expenditure should follow, not lead, increases in revenue. Second, focus on the quality, rather than the level, of public spending, including that part of spending financed by foreign aid. Third, encourage synergies between the public and private sectors. While these principles seem like common sense, they are also critical to Madagascar as it navigates an extremely difficult fiscal situation.