163

Public Spending, Aid Effectiveness and Poverty
Reduction in Lao PDR
Keoviengxay SOURYA*
Saykong SAINASINH**
Phanhpakit ONPHANHDALA***
Abstract
The allocation of the budget（both domestic resource and foreign aid）is a key
instrument for governments to promote economic development and reduce absolute
poverty. Its role has become even more prominent in recent years as donors concerned
the implementation of national poverty reduction strategy is a conditional on theincrease of spending labeled as “pro-poor”. In the case of Lao PDR, the government anddonors have increased their spending significantly over the past decades. The criticalchallenge is how to strike the right balance between the spending by domestic/foreign
fund and by sector that focuses primarily on reducing poverty.
Existing studies face a debate on the methodology intensively used time-series,
cross-countries and CGE analysis. The paper attempts to revisit this issue by provincial
panel data analysis using public spending and aid over 1995/96 to 2011/12. This study
finds that both domestic budget and foreign aid contribute to the poverty reduction,
though statistically insignificant. The major determinants are initial poverty level andthe scale effect of each province’s population. This means the current success in poverty
reduction is more pronounced relatively to less poor and large provinces. Moreover,expenditure on education is significantly helpful compared other sectors. Therefore,both the Lao government and donors should strengthen the cooperation to tailor thebudget allocation in further fighting against the poverty in Lao PDR.

＊ PhD candidate at National University of Laos, and Kunming University of Science and Technology＊＊ Associate Professor, Vice President to National University of Laos＊＊＊ Corresponding author. Visiting Associate Professor at GSICS, Kobe University. Lecturer at Faculty of
Economics and Business Management, National University of Laos（Contact: phanhpakit@hotmail.com）

Journal of International Cooperation Studies, Vol.21, No.2 & 3（2014.1）

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Keywords
Panel Analysis, Disaggregated Data, Provinces, Laos
JEL Classification Codes
H50, I32, P33
1. Introduction
Back in 1940, the political scientist Valdimer O. Key presented the basic budgetingproblem: ‘On what basis shall it be decided to allocate x dollars to activity A instead ofactivity B’（Key, 1940）. In the context of the modern challenge of promoting pro-poor
growth, this problem is as real and contemporary as ever. What can be said about thegrowth and poverty reduction effects of a dollar spent in one sector compared withanother? The allocation of the budget（both domestic resource and foreign aid）is a key
instrument for governments to promote economic development and reduce absolute
poverty. Its role has become even more prominent in recent years as donors concerned
the implementation of national poverty reduction strategy is a conditional on theincrease of spending labeled as “pro-poor”.
Public spending has the potential to affect growth and poverty reduction in two
ways: it can raise the overall growth performance of the economy, and it can increase
the chance of the poor to contribute to the growth process（mainly by strengthening
human capabilities and reducing transaction costs）. The critical challenge is how
to strike the right balance between spending that focuses primarily on growth andspending that aims at reducing poverty. But it is difficult to quantify the impact ofpublic spending as its effects are complex and may vary depending on the compositionof growth, policies and country conditions. Moreover, the landscape of aid policy haschanged in the last decade. The basic objective of development（usually interpreted as
GDP growth）in the recipient country has been replaced by the objective of poverty
reduction（World Bank, 2000）, so that for most donors growth in the developing worldis only valuable if it can be construed as pro-poor.
This paper explores how the composition of public spending and aid, and themanner in which the resources are spent may have affected the poverty reduction
through the case study of Laos over 1995/96 to 2011/12. Following a review of thePublic Spending, Aid Effectiveness and Poverty Reduction in Lao PDR

165

principles guiding public spending and foreign aid determining the impact on the poorin Section 2, we overview the changes in fiscal management, and then formalizes the
structures of public spending and foreign aid by center-province relations and bysectors in Section 3. A brief description of conceptual model and data is presented in
Section 4. Moreover, we examine the evolution of the composition of expenditures, theextent to which resource or sector expenditure was benefited to poverty reduction
outcomes in Section 5. Section 6 ends with some concluding remarks.
2. Literature Review
Public spending and aid effectiveness studies reveal a micro-macro paradox.
Consideration of specific projects or operations financed by public spending and aid
most often leads to a positive appreciation of their results, whereas the macroeconomic
studies of government expenditure and aid effects seem to lead to more nuanced
results. The paradox may result from the methodological pitfalls of the macroeconomic
studies, or of, less frequently stressed, microeconomic ones. For instance, it could result
from negative externalities generated by public spending and aid specific projects, notcaptured by microeconomic studies. But, as we shall see, government expenditure andaid projects are also likely to generate positive externalities, not easily captured at the
micro level. Here we focus on a review of macroeconomic and cross-sectional studies of
the contribution of public spending and aid to poverty reduction.
2.1. Public Spending and Poverty Reduction
Public spending can affect growth and poverty reduction in two ways: it can raise
the overall growth performance of the economy, and it can increase the chance of thepoor to contribute to the growth process（mainly by strengthening human capabilities
and reducing transaction costs）. Both types of expenditures may reduce poverty, but
in the case of more growth-oriented expenditures, the poverty impact is usually moreindirect. For both types of expenditures, the impact on poverty levels is likely to beexperienced with a time lag.
The 1990s brought a new paradigm for fighting poverty by the World Bank withemphasis on strengthening capabilities of the poor and an increased focus on the nonincome dimensions of poverty. Public intervention was supposed to follow a twofold

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strategy, promoting labor-intensive growth and investment in human capital via
primary health care, primary education and targeted social spending to reduce poverty,
thus, avoiding a trade off between growth and poverty reduction. The experience of
the East Asian Miracle economies with their high investment in human capital（first,
universal primary education, followed by the increasing availability of secondary
education and skill building）resonated well with this view（World Bank, 1993）.Later inthe decade, public investment in infrastructure was emphasized as a means for poverty
reduction by facilitating access to markets and reducing the high transactions costs ofpoor households（World Bank, 1994）.
The Millennium Development Goals adopted in 2000 also encouraged social
sector spending by broadening poverty objectives to include non-income dimensions.
In their aspirations to meet MDG related goals, countries may focus too much on
achieving individual targets rather than pursuing integrated cross-sectoral policies taking into account the impact of interventions on other targets. This calls for a better
understanding of the multi-sectoral nature of interventions and development goals（Leipziger et al., 2003）; and more evidenced based analysis on what steps need to betaken to achieve these goals.
Concerns are also being raised that the observed shift to social sector expenditures
was implemented in an ad hoc manner without a better understanding of how different
expenditure options help to address country specific bottlenecks to growth; andwithout a rigorous economic analysis of their projected impact on poverty and growth.
There are also concerns that necessary public investment in infrastructure has been
constrained by fiscal stabilization programs to the detriment of economic growth.
Finally, there is a growing recognition in many countries that the effectiveness of public
expenditures directed to the poor was undermined by weak targeting, elite capture, andan overall poor quality of the public service delivery mechanisms（Wilhelm and Fiestas,2005）.
2.2. The Allocation of Public Spending and Aid, and its Impact
The broad principles for guiding public expenditure allocations are based on theneed to address market failure（public goods, externalities）to promote growth, andimprove distribution and reduce poverty through public interventions. However, thePublic Spending, Aid Effectiveness and Poverty Reduction in Lao PDR

167

notion of what constitutes a public good may change over time, and what is considereda market failure may vary with country conditions.
Many studies have attempted to analyze the impact of government spending（education, health, infrastructure, agriculture, or a combination thereof）on economic
growth and poverty reduction. Their results vary significantly in terms of the detected
effect and efficiency of different expenditure categories in various countries, as theimpact of public spending is limited by various factors and constraints. However, a clear
understanding of these factors is needed to determine if, and how to intervene.
Expenditure policy interventions can be complementary in two ways as theycan either enhance or diminish the desired outcome. First, the benefits of higher
expenditure on a particular sector may not be fully realized unless expenditure onother sectors is increased. For example, a better access to basic infrastructure services（water and sanitation）has an important role in improving infant mortality and childhealth outcomes. Similarly, the construction of rural roads is critical for access to
education and education investment may enhance the marginal return of irrigation
projects. Better targeting of services is essential for reaching the poor. Specific country
conditions, such as urbanization, demographics, and regional poverty patterns can also
play an important role in the efficiency of public expenditures. Moreover, countries
with better governance tend to have faster growth in the poorest quintile than poorly
governed countries（Wilhelm and Fiestas, 2005）.
Finally, the impact of public expenditures on income growth is subject to lags as
outcomes may be achieved in a direct or indirect way. While well-targeted transfer
schemes usually have a direct and immediate impact on the poor by raising theirincomes, targeted investment in education has a lagged effect via improved educational
attainment, thus increasing the chances of the poor to participate in the growth
process in the future. Targeted infrastructure investments can have both, a direct
and immediate effect on income as well as an indirect lagged effect via human capitalformation（i.e. clean water effect on health outcomes）. Investments in agriculturalresearch can lead to increased productivity which directly affects the income of poor
farmers, or can have an indirect effect on the poor through cheaper food or higher
wages as a result of increased demand for farm and non-farm employment in rural
areas（Fan et al., 1999）.

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Table 1: The Effect of Government Expenditures on Poverty Reduction
Country

Authors

PeriodMethodChina

Fan & Hazell, 2001

1970-1997

Regression
Analysis+++

Crosscountry

Gomanee et al. 2003 1980-1998

Regression
Analysis

（+）

+

Ghana

Dabla-Norris &Matovu, 2002

1999

Dynamic CGE

India

Fan et al. 1999

1970-1995

Regression
Analysis

+

+

+

++

SubSaharanAfricaLofgren & Robinson, 1998-2015
2004

Dynamic CGE

++

+

+

+

+

+

Tanzania Jung & Thorbecke, 1992
2003

Agriculture Education Health Infrastructure++

UgandaFan et al. 2004

1992, 1995, Regression
1999
Analysis+++

VietnamFan et al. 2004

1993-2000+++

ZambiaJung & Thorbecke, 1995
2003

CGE

+

++

CGE

Regression
Analysis+++

Source: Wilhelm and Fiestas（2005）

The summarized findings shown in Table 1 have important implications for the
combination and sequencing of public spending across sectors and at the sub-sectorallevel.
2.3. Aid Effectiveness and Poverty Reduction
Following the adoption of the MDGs, particularly the first one that is to reducepoverty by half between 1995 and 2015, numerous studies have examined how external
aid can contribute to their achievement. The formula “doubling aid to reduce thepoverty by half” relied on the implicit assumption that aid was an effective instrument
for poverty reduction. The formula and corresponding assumption have of course
been debated. Two opposite views have clearly appeared, one, well represented byJeffrey Sachs in his End of Poverty, underlining the need for a big push to get low income
countries out of poverty traps, the other one, exemplified by the attacks of William

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Easterly against aid, a big push and the idea itself of a poverty trap, but also includingarguments about a limited absorptive capacity. The absorptive capacity of aid depends
on aid modalities and can be enhanced by a reform of aid.
As summarized by Guillaumont（2009）, there are mainly three macroeconomic
channels of aid effectiveness for poverty reduction as of: 1）the growth-poverty channel;
2）the public expenditure channel; and 3）the stabilization channel.
The first, traditional channel is from aid to growth and from growth to poverty
reduction. In the late 1990s was a watershed in the literature of aid effectiveness, fromthe circulation and publication of the paper by Burnside and Dollar（1997, 2000）,and thedebate which followed. The most innovative aspect of the Burnside-Dollar paper was toassess aid effectiveness by a way where it depends on specific features of the recipient
countries（macroeconomic policy, an average of indicators of openness of fiscal balanceand of monetary stability）. Its most debatable aspect was to consider the country
policy as the only such feature. The next step, Collier and Dollar（2001, 2002）, aimed at
designing an optimal aid allocation among countries in order to minimize the numberof the poor in the world. These two papers used another concept and measurementof policy, the “Country Policy and Institutional Assessment”（CPIA）index, reflecting
the World Bank staff opinions on the recipient countries used for the allocation of IDA
funds. This “ABCD paradigm”（for Assessing, Burnside, Collier, Dollar）, has been very
influential in donors, bilateral as well as multilateral aid policies. However, the aidgrowth relationship has been extensively debated. Several kinds of criticism of the
ABCD paradigm have been pointed such as the measurement, the specification of
the model and the robustness of the econometric, and other conditioning factors（seeGuillaumont, 2009 for a review）.
The second channel involves the impact of aid on the volume and composition of
mainly social public expenditures, particularly on education and health, and the impactof these expenditures on corresponding poverty indicators. The impact of aid may
involve its total amount or its social expenditures allocation, which raises a problem offungibility. The various kinds of public expenditures likely to be influenced by aid havedifferent effects on poverty reduction. Thus, we have to disentangle lessons from theliterature on how aid can influence the structure of public spending in favor of the poor.
Special attention will be paid to the kinds of conditionality attached to aid given in the

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form of budget support.
Numerous works have examined to what extent aid increases total public revenue,
considering possible crowding-out of domestic sources of revenue. A positive impact of
aid on public revenue is found in most of the panel works recently done, as well as inseveral country studies using time series analyses. This result is explained by the factthat aid can improve the effectiveness of public administrations in order to compensate
for the negative effect due to additional funding（for a survey of the literature, see Brunet al. 2008）.
The third channel, to some extent neglected in the literature, has been linked tothe macroeconomic stabilizing effect of aid, as suggested in several previous works.
The effect of aid on economic growth, and the contribution of growth to poverty
reduction are linked to their stabilizing impacts. By making growth less volatile, aidboth accelerates growth and makes it more pro-poor. With more equivocal findings,
this double stabilizing effect on poverty may be supplemented by a third one, as public
expenditures are influenced by macro economic instability. Paying a special attention
to macro-vulnerability issues is needed for an analysis of aid effectiveness focusedon poverty, particularly in the present world economic context（see Chauvet andGuillaumont, 2009 for a review）.
Above existing studies have their advantages and limitations. An appropriate
specification of the models used, including conditional and non-linear effects, may
address this issue to some extent. However, the quality of statistics, as well as therelevance of the aid concept, is often criticized. Country regressions used to test theeffect of aid on any variable have been highly criticized for their inability to take theheterogeneity of the country situations into account（Bourguignon and Leipziger, 2007）.
For an improvement against the issue, this study applies the unified aid concept andstatistics by provincial level of one country.  
3. Background of the Study in the Lao Context
3.1. Fiscal Management and the Decentralization
Raising the revenue effort and improving the efficiency in public spending havebeen longstanding objectives in Lao PDR. At around 13 percent of GDP, Lao PDR had
a low revenue effort in 2003/04, severely constraining the government’s ability to meet

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the country’s pressing development needs. The sharp decline in revenues in early 2000s
partly reflected lower resource revenues（timber royalties）, following the government’s
decision to impose a ban on the export of unprocessed logs in 2002. A rationalization of
the finances of the state-owned commercial banks and state-owned enterprises had also
reduced income taxes and dividends from the state sector. Weak technical capacity had
also played a role. However, a decentralized revenue administration, in which provinces
have responsibility for collecting major taxes, was widely seen as the most important
contributory factor（IMF, 2006）. Currently, the bulk of revenues are collected at
the provincial level. All import duties, natural resource taxes, timber royalties andmore than half of profit and income taxes, turnover and excises are collected by theprovinces. Apart from SOE dividends and hydro-royalties, the only revenues collectedby the center are from few hundreds largest taxpayers administered by the central
large taxpayer’s unit（LTU）.
Reforming the current fiscal system is difficult because provinces have historically
been very powerful in Lao PDR（see Box 1）. Provincial governors have strong support
from regional factions within the party hierarchy and are also individually powerful,often outranking cabinet ministers. Central control over fiscal affairs in the provinces
has therefore tended to be weak. The power of the provinces also explains why efforts
to centralize fiscal management may not succeed in the absence of broader reforms tocenter-province relations.
In sum, the lack of central control over revenue and treasury operations in theprovinces has long been seen as a key impediment to raising national revenues andimproving fiscal management in Lao PDR. However, there has been greater recognition
in recent years that reform of center-province fiscal relations is central to making
progress in these areas. This reflects the fact that powerful provinces are unlikely
to cede control over revenue and treasury functions until a credible revenue-sharing
mechanism is in place. Moving towards a centralized or deconcentrated fiscal system
will be difficult. The focus, therefore, needs to be on establishing a robust decentralizedfiscal system.

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Box 1: A chronology of decentralization in Lao PDR
Historically, local governments have enjoyed considerable autonomy in Lao PDR. Traditionally,
the core political entity was the meuang（or district）. Smaller meuangs were nested into regional
meuangs, which were led by princes from aristocratic families. Although all the regional meuangs
accepted the king of the Lao kingdom as the sovereign, the regional meuangs were extremely
powerful.
1975

Since the formation of Lao People’s Democratic Republic in 1975, all political power has been
vested in the Lao People’s Revolutionary Party. The Party permeates and controls thegovernment, bureaucracy and the military at both central and provincial levels. In each province,
power is vested in the hands of governors, who are Party members and hold ministerial ranks. The
central authority is composed of the Party Central Committee, the Government and the Supreme
People’s Council. Even when the party attempted to establish a centrally planned economy after
independence, much of the country was only loosely connected to the center, and the governors
used their discretion to adapt central instructions to the local context.

1986

A “New Economic Mechanism” was introduced, which reflected an overt policy of decentralization and led to substantial devolution of power to the provinces. The central government largely
ceded control over the management of resources in the provinces. Provincial tax administrations
no longer had direct communications with the central Tax Department in Vientiane. The provincial governments were permitted to conclude trade agreements with bordering foreign states.
Even the State bank was decentralized, with branch managers appointed by local authorities, andthe banks even set their own exchange rates in each province. By triggering a collapse in government revenues and a large increase in the budget deficit, these reforms led to a period of severe
macroeconomic instability.

1991

To address these problems, a new Constitution was introduced in 1991, which sought to reassert
central control over fiscal management. The new constitution, which laid the foundation for
the first national budget, was based on the concept of a unitary “deconcentrated state”. In thedeconcentrated system, government policy was to be implemented by administrators appointed
in the provinces. However, this attempt to recentralize did little to reduce the authority of theprovincial governors, which if anything was strengthened by the abolition of provincial people’s
councils, which had been a forum for popular participation in local government.

1992- First National Budget is approved since 1975, which includes both central and local government
expenditures.

1994- New budget law is approved, which establishes the principles of State Budget formulation.

2000

Towards the turn of the century, there was a new move towards decentralization with the
adoption of the Prime Ministerial Decree 01 on March 11, 2000. The stated objective of thedecree was to “establish provinces as the strategic unit, districts as the budget planning unit andvillages as the implementing unit”. The decree was meant to develop a “bottom-up” approach tobudget planning, with the center retaining control over budget execution. In practice, many of themost powerful provinces interpreted the decree as a mandate to take on greater responsibility forrevenue administration and budget management in their jurisdictions.
- Decree 192/PM on the Implementation of the Budget Law- Instruction 475, defining revenue sources by levels of government.
- Instruction 128, detailing planning responsibilities at each level of government.

2007- New Budget Law. Orders the centralization of Treasury, Customs and Tax Administration
functions.

2008- National Budget Law Implementation Decree

2011

Ninth Party Congress Resolution on decentralization by reinforcing the PM Decree 01/2000, known
as “the Three Builds” - which aims to transform the province into strategic units, the district ascomprehensive units, and villages as development units.

Source: IMF（2006）, Gomez et al.（2008）and LPRP（2011）

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3.2. Aid Profile
During 1975 and 1985, Laos received foreign aid（both grant and loan）in total
amount of 2.5 billion USD. In this period, the regime received aid dominantly fromthe socialist countries, which accounted 77.9% of the total. The remainders were frommultilateral and international organizations 16.6%. Only 5.6% of aid was from westerncountries. Between 1986 and 1990, Laos had gradually opened the country to theworld. Of 1.4 billion USD, the proportion of aid from the socialist countries dramaticallydeclined to 44.5%, and the shares of aid from western countries, and multilateral andinternational organization increased significantly up to 32.5% and 22.9%, respectively（MoFA, 2006）.
Over 1991-1995, after the collapse of former Soviet Unions, Laos was forced toreform the aid policy. It showed that the share of aid from western countries accountfor 67.4% and the rest was from multilateral and international organizations. Since 1996,
the aid profile has no distinction in wording of neither socialist nor western countries.
The government has categorized aid received by type of bilateral, multilateral, NGO
and institutions. As shown in Table 2, over 1996-2010, Laos has increasingly absorbed
foreign aid from various sources. Roughly one-half of the total aids are from bilateral
cooperation. The second largest assistance is from international financial institutions
such as ADB and IDA. As to be noted, though still a small share, the role of NGOs is
increasing significantly（MoFA, 2006 and MPI, 2012）.

Table 2: Aid Statistics 1996-2010 by type1996-2000

2001-2005

2006-2010

Value

Share

Value

Share

Value

Share

Bilateral Cooperation

709.2

47.3

1,019.2

50.8

1,277.1

52.8

Multilateral Cooperation

141.9

9.5

168.4

8.4

203.4

8.4

Cooperation with EU

33.8

2.3

46.7

2.3

66.2

2.7

International Financial Institutions

578.5

38.6

673.8

33.6

698.5

28.9

Mekong River Commission

10.1

0.7

15.4

0.8

55.9

2.3

NGOs

26.0

1.7

83.9

4.2

115.7

4.8

1,499.6

100%

2,007.3100%

2,416.7100%

Source: MoFA（2006）and MPI（2012）（Unit: Million USD）

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In November 2006, the government of Lao PDR and 25 partners（countries
and international agencies）had signed the “Vientiane Declaration”, which is the Laoversion for the Paris declaration on aid effectiveness. The action plan formed the aid
coordination scheme under the initiative of the Lao government and UNDP in May
2007, which each sector-working group would target the priority sectors under the
National Socio-Economic Development Plan. Since then, the government is monitoring
the progress of aid management platform with the assistance of UNDP.
Table 3 shows the top bilateral aid profile to Laos over 2006-2011. Japan, South
Korea, Australia and European nations are major donors. Despite the global financial
crisis, most donors continue to support Laos at about the same level. In recent
years, the neighboring countries such as Thailand, Vietnam and China has increased
the amount of aid to Laos year by year. In terms of multilateral and internationalorganizations, ADB and IDA are top two major donors largely providing aid to Laos asshown in Table 4.

Table 3: Top Bilateral Aid Profile to Laos（Unit: Million USD）
Year

st

1 RankNation2nd Rank

Value

Nation

3rd Rank

Value

Nation4th Rank

Value

Nation5th Rank

Value

Nation

Value

Total

2006

Japan

64.1

Sweden23.7

France22.9

Germany

18.3

S. Korea

13.6

201.2

2007

Japan

81.5

France35.5

Germany

23.8

Australia

20.3

Sweden

19.8

239.6

2008

Japan

66.3

Germany

28.8

Australia

28.1

France25.4

Sweden

20.8

225.2

2009

Japan

92.4

Australia

29.6

Germany

27.4

S. Korea

25.1

France

19.1

260.0

2010

Japan

121.5

Australia

32.7

S. Korea

27.8

Germany

24.8

Switzerland

16.4

285.9

2011a

S. Korea

65.3

Japan

64.4

Thailand

54.2

Malaysia

32.5

Vietnam

31.9

375.5

Source: OECD/DAC Online Statistics and a MPI（2012）

Table 4: Top Multilateral and International Organization Aid Profile to Laos（Unit: Million USD）
Year

1st Rank
AgencyValue

2nd Rank
Agency3rd Rank

Value

Agency4th Rank

Value

Agency5th Rank

Value

Agency

Value

Total

2006

ADB

57.9

IDA

35.1

EU

8.8

GFATM

7.2

IFAD

4.5

123.7

2007

ADB

57.1

IDA

31.7

GFATM

11.6

EU

8.9

Nordic D.F.

6.1

132.2

2008

IDA

39.3

ADB

39.2

IFAD

19.2

EU

18.7

GFATM

14.6

147.6

2009

ADB

44.2

IDA

30.5

EU

25.9

GFATM

13.2

UNDP

6.1

136.9

2010

IDA

36.7

ADB

24.2

EU

16.0

GFATM

7.1

UNDP

6.0

105.5

2011a

ADB

102.6

IDA

67.4

NGOs

43.2

UNDP

21.9

Global Fund

19.6

329.3

a

Source: OECD/DAC Online Statistics and MPI（2012）

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Table 5: Progress in Poverty Reduction in Laos, 1992-2012
No.

Province

Initial

1992/93

1997/98

2002/03

2007/082012a

1997-20121

Phongsaly

PSL

72

58

50.8

46.0

40.4

-17.6

2

Luang Namtha

LNT

41

51

22.8

30.5

25.2

-25.8

3

Oudomxay

ODX

46

66

45.1

33.7

44.2

-21.8

4

Bokeo

BK

42

39

21.1

32.6

19.2

-19.8

5

Luang Prabang

LPB

59

41

39.5

27.2

12.8

-28.2

6

Xayabury

XYB

22

18

39.8

15.7

3.6

-14.4

7

Huaphanh

HP

71

71

51.5

50.5

44.8

-26.2

8

Xiengkhuang

XK

63

43

39.8

42.0

8.8

-34.2

9

Vientiane C.

VTC

34

14

16.8

15.2

0.1

-13.9

10

Vientiane P.

VTP

31

28

20.9

28.0

5.2

-22.8

11

Borikhamxay

BRK

17

28

28.8

21.5

15.1

-12.9

12

Khammouane

KM

47

45

33.8

31.4

4.8

-40.2

13

Savannakhet

SVN

53

42

43.3

28.5

10.8

-31.2

14

Champasack

CPS

41

37

18.4

10.0

2.8

-34.3

15

Salavan

SRV

44

39

54.5

36.3

15.5

-23.5

16

Sekong

SK

67

50

41.9

51.8

29.8

-20.2

Attapeu

ATP

61

48

44.0

24.6

29.4

-18.6

46

39

34.0

27.6

13.0

-26.0

17

Lao PDRa

Source: Results from LECS series 1992/93 to 2007/08 and MPI（2013）

3.3. Progress in Poverty Reduction
The poverty in Laos has been steadily reduced over the past decades. As shownin Table 5, the average poverty level has declined from 46% of total population in
1992/93 to 13% of total households in 2012. However, there exists a large different
among provinces. Generally, provinces in the northern areas e.g. Phongsaly, Oudomxay
and Huaphanh tend to have a higher poverty level than provinces in the central andsouthern areas. At the present, Vientiane capital succeeded in poverty eradication.
Major cities such as Luang Prabang, Savannakhet and Champasack also achieved asignificant progress in poverty reduction, whereas some provinces are still facing a big
challenge in fighting against poor.
4. Conceptual Model and Data Source
Most studies have examined the impact of aid on poverty measured by thegrowth channel（e.g. rate of economic growth and per capita income）. Some studies

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have considered the effect of aid on the change in the level of another indicators ofdevelopment or of welfare, such as the Human Development Index, infant mortality, andschool enrolment ratio（see Guillaumont, 2009 for a review）. Nevertheless, for instance,
Calderon et al.（2006）and Mosley and Suleiman（2007）have applied the traditional
indices of monetary income poverty such as the headcount index or the poverty gap
been directly examined. This paper utilizes their attempt.
Moreover, Clemens et al.（2004）and Reddy and Minoiu（2006）have emphasized
the need of disaggregating aid flows and considering their impact on various time
horizons, since the concept of net ODA flows, set by OECD and used in most of thepapers, obscures its heterogeneous composition. One can also wonder which typeof expenditure benefit the most the poor? For instance, expenditures dedicated toagriculture are generally pro-poor, as found by Mosley and Suleiman（2007）. However,Berthelemy（2006）argued that public education expenditures are not necessarily propoor as they are mainly for secondary and tertiary education and are biased against
primary education in most African economies, leading to an unequal distribution ofhuman capital. Similar findings for health expenditures are evidenced by Berthelemy
and Seban（2009）. In this paper, we test expenditures（both sourcing by domestic andforeign fund）by four sectors including agriculture, infrastructure, education and health.
While most studies utilize time-series or cross-countries data in their analysis of
the effect of public spending on poverty reduction, in this study, we attempt to apply
panel data analysis method using provincial（disaggregated）data collected from
unpublished official statistics from Ministry of Finance and Ministry of Planning andInvestment over fiscal year 1995/95 to 2011/12. The econometric regression models aredescribed as below:


（1）

 （2）

Public Spending, Aid Effectiveness and Poverty Reduction in Lao PDR

177

Variable

Definition/Description

Unit

y

Poverty incidence measured by headcount

Percentp0

Initial poverty level in 1992/93

Percent

pop

Population size for control the scale effect in 2005

Personspub

Public spending sourcing by domestic fundMillion kips

aid

Aid sourcing by foreign fundMillion kips

d-agri

Expenditure on agriculture by domestic fundMillion kips

d-inf

Expenditure on infrastructure by domestic fundMillion kips

d-edu

Expenditure on education by domestic fundMillion kips

d-hl

Expenditure on health by domestic fundMillion kips

f-agri

Expenditure on agriculture by foreign fundMillion kips

f-inf

Expenditure on infrastructure by foreign fundMillion kips

f-edu

Expenditure on education by foreign fundMillion kips

f-hl

Expenditure on health by foreign fundMillion kipsiEach province（all 17 provinces）-

j

Each panel year［1997/98（1995/96-1997/98）;2002/03（1998/99-2002/03）;
2007/08（2003/04-2007/08）;and 2012（2007/08-2011/12）］-

Residuals-

5. Findings and Discussion
5.1. Public Spending by Source, Region and Sector
As shown in Figure 1, we find that the total expenditure is rising steadily from
17.0% of GDP in 2003/04 to 27.1% of GDP in 2011/12. Gauging from its share toGDP, the government has been increasing the role on economic growth and poverty
reduction. Using the unpublished official data from Ministry of Finance and Ministryof Planning and Investment, however, we find that the Lao government has a limited
ability to mobilize the domestic fund and heavily rely on foreign fund（see Table 6a andTable 6b）. Although expenditures by source, region and sector are largely fluctuatedfrom time to time, we observe that most of the budget has been spent in central level
rather than in provincial level. Within domestic fund, the majority of budget is allocatedto provinces. In other word, since most foreign fund is concentrated on central level, thegovernment shall allocate the domestic fund back to provinces.
With respect to expenditures by sector, similar trend can be observed（see Table
6a and Table 6b）. Both domestic and foreign funds have allocated budget primarily toforeign fund is concentrated on central level, the government shall allocate the domestic fund back toprovinces.
178

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Figure 1: the Lao Government Revenue and Expenditure, 2003/04 to 2013/14
Figure 1: the Lao Government Revenue and Expenditure, 2003/04 to 2013/14

Source: MoF（2013）.（Unit: Percent of GDP, *estimate）
Source: MoF (2013). (Unit: Percent of GDP, *estimate)infrastructure sector especially for road construction. Education sector has also received
With respect to expenditures by sector, similar trend can be observed (see Table 6a and Tablea substantial budget in particular to primary education.  Agriculture and health sectors
6b). Bothdomestic
and foreign
funds
have allocation.
allocated budget primarily to infrastructure sector especiallyhave
received
relatively
lessbudgetfor road
construction.
Education
sector important
has also received
budgetin particular
primary
Agriculture
remains
the most
sectora substantial
in Lao PDR,
accounting
for toone-thirdof
GDP andprovidingfor received
some 70relatively
percentlessofbudget
the workforce.
education.
Agriculture
and employment
health sectors haveallocation. Because of
its strong growth over the last decade, agriculture has been the most important driver
Agriculture remains the most important sector in Lao PDR, accounting for one-third of GDP

in reducing rural poverty, but agriculture’s share of total public expenditure decreased
and providing employment for some 70 percent of the workforce. Because of its strong growth over theslightly in recent years. Moreover, centrally approved budgets often do not materialize
lastthedecade,agriculture
has been
the most
important driverin reducing
rural poverty, percentage
but agriculture’s
atprovincial
level.
Capitalexpenditures
account
for substantial
of

total
sectorexpenditure
anddecreased
remain slightly
biased intowardphysicalinvestments,
without
share oftotal public
expenditurerecent years.
Moreover,centrally approved
appropriate
consideration
recurrent
requirements.
Furthermore,thebudgets often do
not materializefor
at theprovincial spending
level. Capital
expenditures accountfor substantial

government should achieve a better redistribution of public funds between richer andpercentage of total sector expenditure and remain biased toward physical investments, without

poorer provinces. Equally important is to promote agricultural research and provide
appropriate consideration for recurrent spending requirements. Furthermore, the government should

more effective extension services and rural credit to strengthen farmers’ capacity andachieve a better redistributionof public
funds between
richer and poorer
provinces.as
Equally
competitiveness.
Redressing
geographicalinequalities
is importantwell. important
HelpingPublic Spending, Aid Effectiveness and Poverty Reduction in Lao PDR

179

Table 6a: Expenditures by Source, Region and Sector in 2001/02 and 2005/06
2001/02

2005/06

Domestic

Foreign

Total

Domestic

Foreign

Total

Budget（Billion Kips）

892

1,158

2,050

323

2,759

3,082

by administrative（%）

43.5

56.5

100

10.5

89.5

100

Central

26.4

59.3

45.0

44.1

63.6

61.5

Provinces

73.6

40.7

55.0

55.9

34.4

38.5

Agriculture

28.2

9.6

17.7

9.1

13.7

13.2

Infrastructure

25.3

34.6

30.5

39.2

47.9

47.0

Education

8.0

14.1

11.4

10.2

22.2

21.0

Health

3.7

12.5

8.7

4.0

6.3

6.0

by Sector（%）

Source: Authors’ calculation（Unpublished official statistics）.

Table 6b: Expenditures by Source, Region and Sector in 2007/08 and 2011/12
2007/08

2011/12

Domestic

Foreign

Total

Domestic

Foreign

Total

Budget（Billion Kips）

568

2,509

3,076

1,962

5,641

7,603

by Administrative（%）

18.5

81.5

100

25.8

74.2

100

Central

46.4

73.9

68.8

67.6

92.5

86.1

Provinces

53.6

26.1

31.2

32.4

7.5

13.9

by Sector（%）
Agriculture

9.8

9.3

9.4

7.5

10.8

9.9

Infrastructure

27.8

36.7

35.0

34.0

47.5

44.0

Education

9.0

18.9

17.0

8.9

33.7

27.3

Health

3.6

4.1

4.0

2.9

2.6

2.7

Source: Authors’ calculation（Unpublished official statistics）.

subsistence-based communities become more productive and market-oriented is also a
key task in the medium term.

Road travel is the dominant mode of transportation in Lao PDR. Nevertheless, it
is vulnerable during the rainy season. The spending on road construction improved
the network and connected an increasing number of rural inhabitants to both markets
and social services, resulting in significant socioeconomic benefits. Looking forward,
the government will face competing demands for road maintenance, providing allweather road access to district centers and villages, and upgrading primary roads tohandle growing traffic. However, the available financial and human resources will be
far from adequate to meet all of these needs. The government should make more effort

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to increase the efficiency and cost-effectiveness of road spending. This can be achievedby strengthening local institutional capacity and by promoting market competition andprivate sector participation in delivering road works.

Education development in 2000s has recovered strongly after the collapse in public
expenditure in the late 1990s. A high proportion of education spending consisted ofcapital spending, mainly externally financed. Salary increases for teachers were a highpriority, under teachers’ conditions in the past, many graduates did continue to takejobs outside teaching and caused a continuing shortage of teachers, especially in poorand remote districts. In recent years, the Lao government has increased the proportionof national resources allocated to education. A sharp salary increases for teachers isachieved in 2012/13, but this put a significant challenge to tackle jointly the problem ofrecurrent and capital budgeting.

Health outcome indicators in Lao PDR have improved over the past decades, fromits significantly low level. The government is facing challenges in delivering adequate
public health services to the population. The coverage of key maternal and child healthprograms is low. Capital expenditures account for a substantial share of government
health expenditures, reflecting significant donor support. However, there is a shortage ofrecurrent funds for the operation of health services. Domestically financed government
health expenditure is declining slightly and is biased toward the central level. The
government should strengthen the targeting of the poor to ensure that they have accessto essential health services and are protected from catastrophic health expenditures.
Low execution rates reflect a need for strengthening financial management systems
to ensure transparent execution and effective monitoring of public spending. It also is
important for the GOL to harmonize and align its own and donor programs with its
health sector priorities.
5.2. Difference between Domestic and Foreign Funding by Province
Figure 2a and Figure 2b show the difference between domestic and foreign
funding by province. Most of the expenditures at provincial level are funded by foreignaid, except for some provinces.  Overall, the accumulated budget allocation to province
has declined during 2008/09-2011/12 compared to 2003/04-2007/08, despite the increasein the total expenditure over that period.

Public Spending, Aid Effectiveness and Poverty Reduction in Lao PDR

181

During 2003/04 to 2007/8, in all provinces, the accumulated foreign funding
arrangement was dominated domestic source. In opposite, over 2008/09-2011/12, fewer
foreign funding
areconferences
allocated
to provinces,smallerdomestic
PDR hasarrangements
hosted many internationaland events
such as the 25theven
SEA Gamesin 2009 thanandfunding in someprovinces.
is dueto thenational
calendarthat Lao PDR has hosted
the 9th ASEM
Summit inThis
2012. Thus,
the budget
allocationis concentrated
th on central government in
PDR has hosted many international conferences and events such as the 25 SEA Games in 2009 andline ministries.
Consequently, there is a growing concern the decline in public spending and aid at
the 9th ASEM Summit in 2012. Thus, the budget allocation is concentrated on central government inprovincial level will affect on the progress of poverty reduction in the nationwide.
line ministries. Consequently, there is a growing concern the decline in public spending and aid atFigure 2a: Structureof will
Domestic
Foreignby Province, 2003/04provincial level
affect on theandprogressof povertyFunding
reduction inArrangements
the nationwide.
2007/08
Figure 2a: Structure of Domestic and Foreign Funding Arrangements by Province, 2003/04-2007/08
Figure 2a: Structure of Domestic and Foreign Funding Arrangements by Province, 2003/04-2007/08

Source: Author’s compiled (Unpublished official statistics). (Unit: Billion Kips)
Source: Author’s
compiled（Unpublished official statistics）.（Unit: Billion Kips）
Source: Author’s compiled (Unpublished official statistics). (Unit: Billion Kips)

Figure 2b: Structure of Domestic and Foreign Funding Arrangements by Province, 2008/09-2011/12

Figure 2b: Structure of Domestic and Foreign Funding Arrangements by Province, 2008/09Figure 2b: Structure of Domestic and Foreign Funding Arrangements by Province, 2008/09-2011/12
2011/12Source: Author’s compiled（Unpublished official statistics）.（Unit: Billion Kips）

Source: Author’s compiled (Unpublished official statistics). (Unit: Billion Kips)
182
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Figure 3:Figure
Per Capita
PublicSpending
Aid by Province,
2008/09-2011/12
3: PerCapitaPublicand
Spendingand Aid by
Province, 2008/09-2011/12

Source:Author’s
compiled
official
statistics）.（Unit: Million Kips）（UnpublishedSource: Author’s
compiled(Unpublishedofficial statistics).
(Unit:
Million Kips)

Figure 3 shows a different view on per capita accumulated public spending and aid bymany international conferences and events such as the 25th SEA Games in 2009 andprovince over 2008/09-2011/12. We find that there exists a significant gap in the distribution of budget

the 9th ASEM Summit in 2012. Thus, the budget allocation is concentrated on central
among provinces.
As presented
in Table
5 above, per capita
spending andaid doesthe
notdecline
fit with
government
in lineministries.
Consequently,
there public
is a growing
concerninandprovince.
aid at For
provincial
willAttapeu,
affect Luangon theNamtha,
progressof poverty
thepublic
povertyspending
level of each
instance,level
Sekong,Vientiane
capitalreduction in the nationwide.

and Bekeo provinces in orderly have received a very high per capita public spending and aid, whereas

Figure 3 shows a different view on per capita accumulated public spending andthe ranking of poverty incidences are Sekong, Huaphanh, Phongsaly, Xiengkhuang and Salavan inaid by province over 2008/09-2011/12. We find that there exists a significant gap
2007/08.
As a result, thepovertyprovinces.
reduction inAs
Huaphanhand Phongsaly
behindinthe distributionof progress
budget inamongpresented
in Tableis5lagged
above,
percapitapublic spending and aid does not fit with the poverty level of each province.
other provinces.
For instance, Sekong, Attapeu, Luang Namtha, Vientiane capital and Bekeo provincesin orderly have received a very high per capita public spending and aid, whereas the
5.3. Panel Data Analysis on Poverty Reduction

ranking of poverty incidences are Sekong, Huaphanh, Phongsaly, Xiengkhuang andIn this session, econometric models are tested using panel data techniques in order to find theSalavan in 2007/08. As a result, the progress in poverty reduction in Huaphanh anddeterminantsisoflagged
povertybehind
reductionin Lao
PDR over 1995/96 to 2011/12. The estimated coefficients
Phongsaly
otherprovinces.
could be interpreted directly since we have unbalanced panel, namely first period has 3 years data,second and third periods have 5 years data each, and fourth period has 4 years data. Nevertheless, threemethods of OLS, fixed effect and random effect are applied to both basic and extended models.

Public Spending, Aid Effectiveness and Poverty Reduction in Lao PDR

183

5.3. Panel Data Analysis on Poverty Reduction
In this session, econometric models are tested using panel data techniques in order
to find the determinants of poverty reduction in Lao PDR over 1995/96 to 2011/12. The
estimated coefficients could be interpreted directly since we have unbalanced panel,
namely first period has 3 years data, second and third periods have 5 years data each,and fourth period has 4 years data. Nevertheless, three methods of OLS, fixed effect andrandom effect are applied to both basic and extended models.
The result of the regression of basic model is presented in Table 7 using fixed
effect model. This study finds that both domestic budget and foreign aid contributeto the poverty reduction as both coefficients show a negative sign, though they arestatistically insignificant. The major determinants are initial poverty level and the scaleeffect of each province’s population. The estimated initial poverty level is positive withstatistically significant at 99%. This means the current success in poverty reduction ismore pronounced relatively to less poor provinces, not to those having a high poverty
incidence. The result is consistent with observed statistics shown in Table 5 thatprovinces having a relatively low poverty incidence tend to succeed in accelerating
poverty reduction. Furthermore, provinces having a larger population are likely toachieve a faster poverty reduction. Therefore, the result shows that current statusof poverty reduction in Lao PDR is pro-rich rather than pro-poor. This shows theimplication for both Lao government and donors to improve and/or reform the policythat better targeting to the poor provinces.
The result of the regression of extended model is presented in Table 8 using
random effect model. The estimation shows that initial poverty level and population
size remain the significant determinants. Regarding to domestic spending and foreign
aid allocation by sector, only domestic spending on education and health sectors are
statistically significant. Of which, expenditure on education sector shows a negative
sign, meaning that domestic spending on this sector is contributing to poverty reduction
over the period of study. In opposite, expenditure on health sector shows a positive sign,
meaning that domestic spending on health does not contribute to poverty reduction.
This is perhaps expenditure on health sector has indirect effect on poverty reduction
and it is more pronounced for mid- and long-term rather than short-term. Moreover,the estimated coefficients of domestic expenditure to infrastructure, foreign spending

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Table 7: Estimation Result of Basic Model
Coefficient

Std. Err.

Initial Poverty（p0）0.481491

Population（pop）-0.000017

Domestic fund（pub）
Foreign fund（aid）
Constant

t-statistics

P-value

0.077293

6.23

0.000

7.51e-06

-2.31

0.025

-5.66e-06

0.000032

-0.18

0.860

-3.74e-06

0.000010

-0.37

0.715

15.86214.8522

3.27

0.002

Number of Observations = 68（4×17）
R-squared: 0.373
Huasman Test: chi2 = 0.02［Prob>chi2 = 0.9999］,use Fixed Effect Model

Table 8: Estimation Result of Extended Model
Coefficient

Std. Err.

t-statistics

P-value

Initial Poverty（p0）0.446603

0.106224

4.20

0.000

Population（pop）-0.000019

8.94e-06

-2.15

0.031

d-agri0.000092

0.000067

1.38

0.167

d-infra-0.000136

0.000136

-1.00

0.316

d-edu

-0.001030

0.000503

-2.05

0.040

d-hl

0.001885

0.000921

2.05

0.041

f-agri-0.000026

0.000054

-0.48

0.628

f-infra0.000014

0.000018

0.78

0.435

f-edu

0.000083

0.000149

0.56

0.578

f-hl

-1.85e-06

0.000067

-0.03

0.978

20.31476.6286

3.06

0.002

Constant

Number of Observations = 68（4×17）
R-squared: 0.457
Huasman Test: chi2 = 19.03［Prob>chi2 = 0.0147］,use Random Effect Modelto agriculture and foreign aid on health show negative sign, meaning that they are on
direction of reducing poverty though statistically insignificant, while other expenditures
have no significant impact on reducing poverty.
This result raises a question to both Lao government and donors to reconsider
their priorities in allocating budget to each sector. It is particularly true for foreign
aid that needs further improvement for restructuring the allocation. All together, thefinding shows that both Lao government and donors should further allocate the budget
to education sector in order to enhancing capability of human resources that needed for
all activities of development agenda.

Public Spending, Aid Effectiveness and Poverty Reduction in Lao PDR

185

6. Concluding Remarks
The allocation of the budget is a key instrument for governments to promoteeconomic development and reduce absolute poverty. The critical challenge is how to
strike the right balance between the expenditure by domestic/foreign fund and bysector that contributes to pro-poor.
In the case of Lao PDR, the government and donors have increased their spending
significantly over the past decades. Although overall poverty incidence has declined
significantly from 46% in 1992/93 to only 13% in 2012, this study finds that the total
budget allocation remains concentrated on central government rather than provincial
level. Most foreign aid focuses on the central, though domestic fund pay more attention
on provinces but it constraints with limited budget. Moreover, there are also imbalanced
in budgeting between rich and poor provinces. By using public spending and aid byprovincial panel data over 1995/96 to 2011/12, this study finds that both domestic
budget and foreign aid weakly contribute to the poverty reduction with statisticallyinsignificant. The major determinants are initial poverty level and the scale effect ofeach province’s population. This means the current achievement in poverty reduction
is more pronounced to less poor and large provinces, or so-called pro-rich. Moreover,among sectors, we find that expenditure on education is significantly contributing
to the poverty reduction in Laos. Thus, both the Lao government and donors should
strengthen the cooperation to improve the efficiency in each spending and to tailor thebudget allocation right to appropriate region and sector.
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