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Recurrent Cost Problems in Less Developed Countries
May 1982
>> This Is USAID >> USAID Policy Papers >> Recurrent Cost Problems in Less Developed Countries
Executive Summary III. Causes of Recurrent Cost Problems
V. Solutions to Recurrent Cost Problems
VI. Conclusions and Recommendations
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[Download original document] I. Introduction
The past five years have seen a continuation if not worsening of the adverse international economic environment which threatens the ability of the less developed countries to grow at a rate necessary to maintain current levels of economic activity, let alone reduce the level of poverty in which the majority of their populations find themselves. Deteriorating terms of trade brought on by the rise in oil prices together with recession and inflation in the developed market economies has led to stagnation in most of the low income countries of the Third World, and dimmed prospects for future growth.
A 1981 PPC/EA study noted that nineteen out of the twenty-six largest USAID recipients are currently undergoing a crisis severe enough to require an IMF standby or Extended Fund Facility agreement. In most cases, such an agreement will require not only improved management of the balance of payments, but a reduction in government expenditures. For low income countries as a group the total standby and EFF agreements have grown from 421 million SDRs in 1977 to 3,382 SDRs in 1980, an eight fold increase. As a result, we can expect that a large number of USAID recipients will be finding it increasingly difficult to finance the recurrent costs of their existing development project portfolio, let alone new project starts.
These government budgetary problems can have a devastating effect on USAID programs. Roads without maintenance, schools without materials, and clinics without health workers are prevalent enough already. Indications are that these problems are likely to increase rather than diminish. This is particularly distressing for USAID, since projects in the sectors of primary concern to the Agency have tended to have high recurrent cost ratios. Table I presents an illustrative summary of the ratio of the annual value of recurrent costs for each dollar of investment ("r" coefficients) over a twenty-year life of project. Note the high recurrent costs of health, education and rural development as compared with those of industry and trunk roads.
TABLE I
Illustrative Summary for the Recurrent
Expenditure Implications of Projects as a
Proportion of Investment Expendituresa
("r" Coefficients)Forestry 0.04 General Agriculture 0.10 Livestock 0.14 Rural Development 0.08 - 0.43 Agricultural Colleges 0.17 Polytechnics 0.17 Primary Schools 0.06 - 7.0 Secondary Schools 0.08 - 0.72 Universities 0.02 - O.Z2 District Hospital 0.11 - 0.30 General Hospital 0.183 Rural Health Centers 0.27 - 0.71 Urban Health Centers 0.17 Housing 0.03 Manufacturing 0.01 Feeder Roads 0.06 - 0.14 Trunk Roads 0.03 - 0.07 Source: Peter Heller, "The Underfinancing of Recurrent Development Costs,"
Finance and Development, March, 1979.a These coefficients are drawn from a very restricted sample of developing countries and are meant to illustrate the variability one can observe across sectors and projects. Example: If a polytechnic school costs $1 million to construct and equip, on the basis of an "r" coefficient of 0.17, we can estimate that it would cost on average $170,000 in each subsequent year to pay the teaching staff, to operate the facilities, and to maintain the building. As a result of these financial difficulties LDC governments will increasingly be forced to resort to one of the following unhappy choices: (a) shift resources from the capital budget to the recurrent budget; (b) rely increasingly on deficit financing with the consequent inflationary pressures; (c) reduce expenditures on social services and human resource development; or (d) continue to underfinance development projects with the resultant deterioration of services and under-utilization of capacity.
There are, of course, other somewhat happier solutions, which may be attempted. These include the improvement of the efficiency of the tax system, reform of economic policies that tend to result in sluggish growth of revenues or rapid growth of expenditures, redesign of projects so as to minimize the recurrent burden, resort to a greater degree to user charges and local financing of development projects, and seek explicit donor financing of recurrent costs. None of these are easy choices, and considerable effort will be necessary both by donors and LDC governments to find solutions. The purpose of this paper is to examine the recurrent cost problem and suggest ways in which USAID can respond so as to help LDC's deal with it.
This paper is divided into six sections. The next section discusses definitional problems in addressing recurrent costs. Section III describes the underlying causes of recurrent cost problems. Section IV is a short disucssion of the methodology to be used in identifying recurrent cost problems. The fifth section is the core of the paper and describes the appropriate responses for USAID. The final section summarizes the arguments presented. In addition there are two appendixes, the first of which presents the main argument of this paper mathematically, and the second of which demonstrates how the use of shadow prices for government revenues and recurrent costs might affect the choice of projects.
1Tom Morrison, "Major Macroeconomic Issues in USAID countries: Implications of the CDSS Review," June, 1981.
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