# <u>1. INTRODUCTION AND SUMMARY</u><sup>1</sup>

For most countries, and Liberia is no exception, it is a high priority to increase fiscal space for spending in priority areas. For the case of Liberia, this note presents a set of simulations that, for the period 2013-2030, explore the effects of measures aimed at increasing the room for spending on infrastructure and human development (HD), the priority areas that are identified in Liberia’s “Agenda for Transformation” (AfT) for the period 2013-2017.<sup>2</sup> Such measures should also contribute to bringing Liberia close to the achievement of middle-income status, the objective that underlies its national vision, Liberia Rising 2030, which currently is being finalized.

The main findings are that, among the sources of fiscal space that are considered, foreign grants generate the best development outcomes followed by improvements in government allocative efficiency. Taxes (on domestic households and firms) are likely to involve trade-offs since they make less resources available for private consumption and investment, both of which contribute to stronger macro and MDG performance. However, if taxes can be targeted to avoid these drawbacks and if the uses to which additional resources are put have high payoffs, then these trade-offs may be avoidable. Foreign borrowing is a less attractive source of fiscal space: in order to make a substantial difference, the amounts borrowed would quickly add to the foreign debt, making the macro economy more prone to future crisis and reducing its flexibility. Striking the right balance between different uses of fiscal space is difficult as it depends on the marginal payoffs of different government functions; typically, they are not known and they may only appear with a considerable lag. Nevertheless, under the parameters used in the model simulations, determined in light of fragmentary evidence, the outcomes were marginally stronger under a balanced approach with scaling up of both infrastructure and HD services. Balanced expansion may also be conducive to higher efficiency and easier to undertake for political-economy reasons. A final finding is that, even though the analysis indicates that disappointing developments in the mining sector (in this note represented by a decline in export prices) would have a negative impact on Liberia’s development, it should be possible to consider fiscal space issues in isolation from the mining sector: model simulations suggest that the marginal effects of creating additional fiscal space are very similar irrespective of the level of mining export prices.

The simulations are generated by a Liberian version of a single-country Computable General Equilibrium (CGE) model, MAMS (Maquette for MDG Simulations).<sup>3</sup> The scenarios include a base scenario, designed to represent a central case for the evolution of Liberia’s economy up to 2030, and a set of alternative scenarios that modify the base scenario by introducing one or more changes that create fiscal space and use this space for spending on infrastructure and/or

> 1 The author would like to thank Errol Graham, Santiago Herrera, and Jariya Hoffman for a helpful discussion of the design of this analysis; and Damir Cosic for kindly providing historical and projected world price data for iron ore. The author is indebted to the Knowledge for Change Program (KCP) Trust Fund for funding the basic research that has permitted the development of MAMS.

> 2 In this paper, years refer to fiscal years. For example, 2013 refers to the period July 1, 2012 – June 30, 2013. 3 For an earlier MAMS-based analysis of Liberia, see Dessus et al. (2012).

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