Developing countries
Todayโs low-income countries spend more than twice on average than todayโs advanced economies spent more than a century ago (Figure 1). To be sure, this difference reflects the lack of the tax instruments and systems we have today. From 1850 until the early 1900s, customs duties and excises provided the bulk of government revenues, while the personal income tax and VAT were not introduced in countries until later. Moreover, societyโs expectations from the government were much different then. In 1900, for example, spending on unemployment, health, pensions, and housing amounted to only 1.1 percent of GDP in the Scandinavian countries on average and to 0.7 percent of GDP in the U.S. Even with low level of government spending, economic development was brisk in most of the Advanced 14 at the turn of the 20th century, with infrastructure improvements financed by private capital and the strong expansion of primary and secondary education.
And here lies the lesson for todayโs developing economies: While working on strengthening domestic taxation and raising more revenues to finance public goods, the priority needs to be on improving the business environment to attract private capitalโmobilizing private finance for development.
Figure 1. Governments of todayโs low-income countries spent more on average in 2018 than todayโs advanced economies did in 1900 (in percent of GDP)
Governments of todayโs low-income countries spent more on average in 2018 than todayโs advanced economies did in 1900
Source: IMF Prudence and Profligacy Database, IMF Fiscal Monitor 2018, World Bank WDI, and authorsโ estimates.
Note: LIC = low-income countries; SSA = Sub-Saharan Africa; A14 = the average of the Advanced 14 in the figure. GDP per capita of the Advanced 14 in our sample averaged $2,722 in todayโs prices during the last decade of the 19th century; In 2016, per capita GDP in sub-Saharan Africa averaged $2,757.Government spending in the Advanced 14 increased substantially since 1960 as they reevaluated the role of government amid rapid industrialization and globalization and new taxes became commonplace (Figure 2). The shift from agrarian to industrial to post-industrial economies required different worker skills. Economic disruptions reshaped governments in the past, as is happening now with the changing world of work, leading to a large expansion of social insurance and protection spending.Government spending among the advanced economies has increased, but so has its variability. Before 1913, spending among the advanced economies ranged from less than 2 percent of GDP in Japan to 13 percent in Italy, or a span of 11 percentage points. Today, the span of spending among the advanced economies is 39 percentage points: from 17.3 percent in Hong Kong to 56.4 percent in France.
Development paradigms vary among todayโs advanced and developing countries. Robust growth can happen with a smaller or a larger government, in general. Too large of a redistribution, however, may create substantial disincentives to work and invest, or lead to tensions between formal and informal workers, employees of large companies or state-owned enterprises and small private firms. This danger now is clearer than ever: The changing world of work is clashing with persistent informality in developing countries and social protection systems that cover only part of the population.must for todayโs developing countries, especially for those with abundant natural resources. However, there is overwhelming evidence that fiscal policy has been consistently pro-cyclical in developing countries, resulting in profound macroeconomic imbalances, unproductive debt build-ups, and ongoing instability.any of todayโs poorest countries do not collect adequate revenues to build the human capital, infrastructure, and institutions needed for stronger growth and faster poverty reduction. In sub-Saharan Africa, for example, 15 of the 45 countries have revenues lower than 15 percent of
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