How Much Did It Cost to Make Budget Cuts for Fighting the COVID-19 Pandemic?
When a disaster or a crisis hits, domestic public finance is often the first port of call for governments to respond to urgent needs quickly. Governments draw down on a contingency budget or reserve funds, accumulate debt or reallocate the budget by shifting resources away from their original purpose, towards financing disaster response1. In the absence of risk transfer options or even with such options available, domestic public finance is an important source to mitigate disaster because it is usually quick to operationalize and directly within the government’s control.
How much does it cost to rely on domestic public finance?
This question is asked relatively often. There is some research on the cost of putting money in a reserve fund, especially in cases where a robust risk profile exists. It is simple to compare the opportunity cost of not financing other priorities, against the frequency of the expected disbursements.
Knowing the cost of various sources of funds is critical to decide on economic efficiency and weigh it against the benefits of timely finance for the response. This knowledge is the basis for developing comprehensive disaster risk finance strategies that usually combine many funding sources to minimize costs and maximize benefits.
However, there is little evidence to date about the cost of budget reallocations for disasters.
There are many reasons for that. This includes challenges to track reallocations ex-post when the decisions about why and how these were made are already forgotten, and the detailed data is buried underneath project-level budget execution reports.
While it is known that governments rely on budget reallocations to finance responses to major shocks and that these entail an opportunity cost in terms of returns foregone from delayed or canceled spending, the size of these reallocations and their impact is largely unknown. It is also notoriously difficult to assign a value to public expenditure, even more so to public expenditure which did not happen.
Case Study: Albania taking an initiative to quantify the impact of budget reallocation
The COVID-19 pandemic that took over the world starting in 2020 was certainly a rare and devastating disaster, but it also offered an opportunity to contribute to this evidence base. It allowed the tracking of budget reallocations and decision-making while these were being made.
In Albania, the World Bank and the Ministry of Finance and Economy set out to analyze the scale and incidence of budget reallocations, focusing on budget cuts and quantifying their impact2 The purpose of this was to contribute to the global evidence base and understand how to make better use of Albanian public finances in the wake of disasters.
This analysis used a five-step methodology that comprises: (i) understanding what sources of funding are in place; (ii) analyzing the procedures and legal frameworks of using these sources; (iii) establishing a counterfactual – a best-guess estimation of how 2020 would have looked like without the pandemic; (iv) expenditure analysis supported with BOOST data and interviews with the government; and (iv) impact analysis, to quantify the returns foregone from diverted public spending.
Budget reallocations were on course to be very substantial in Albania in early 2020 but were partially curtailed mid-year by a large increase in government borrowing. Nonetheless, by the end of 2020, over half of the national government’s budget programs underwent some cuts in relation to COVID-19. In total, budget reallocations reached lek 17.7 billion, equivalent to 93 percent of total COVID-19 expenditures in 20203,or 5 percent of total spending in 20204.
While some budget cuts came with a low or even negligible cost (because some spending was rendered non-viable due to the restrictions introduced during the pandemic), more than half incurred an opportunity cost. At the aggregate level, the estimated value forgone that was associated with COVID-19-related budget reallocations in 2020, totals lek 12.3 billion (US$113 million), or 0.76 percent of GDP. This seems modest compared to the pandemic's overall impact on the economy but is considerable when compared against lek 19 billion spent on COVID-19 measures.
It is important to remember that the more a government relies on budget reallocations, the more costly they are. This is because governments are strategic in choosing to cut the non-viable or lower priority spending first, but once these are exhausted, more difficult choices must be made.
Budget reallocations will likely forever remain among the first ports of call on domestic public finance because of their speed and flexibility. Approaching budget reallocations strategically could help save governments money, by minimizing the associated opportunity cost.
Resilience budgeting is a novel budget formulation approach which tries to do this by specifying formalized criteria for reallocation and ex-ante agreement between line ministries and central finance agencies about their priorities. With such an approach, the decision-making process about budget cuts can become more transparent, cost-effective, and quicker, while simultaneously providing line ministries with more predictability on in-year budget changes.
Figure - Framework for approaching disaster-related budget reallocations
Note: LMAs - line ministries and agencies
Resilience budgeting should be couched as one component of a comprehensive disaster risk finance approach, which together would better enable governments to sustainably and timely meet expenditure demands in the wake of a disaster mitigating the impact on lives, livelihoods, and the economy.
You can read a more detailed analysis of this in our new publication “The Impact of COVID-19-Related Budget Reallocations: Albania”.
1. Which can be done through either virements or normative (supplementary) budgets; Virements include moving funds between budget lines in a way that does not substantially overhaul the nature of public expenditure; supplementary budgets are required for more substantive changes to the budget, including changes that affect the overall budget envelope and fiscal deficit.
2. This work was supported through World Bank-SECO Sovereign Disaster Risk Financing and Insurance for Middle-Income Countries trust fund
3. This is not to imply that reallocations went to finance COVID-related expenditures. In the context of falling revenues, reallocations could also have been to protect other priority government spending, not necessarily related to COVID-19.
4. Total spending comprises spending by line ministries, debt repayment, and transfers to local government.
Financial Resilience Around the World | Blog Series
- Financial Resilience Around the World: Global Risk Financing Facility
- Three Ways Lesotho's Past Experience with Disasters Strengthen COVID-19 Response
- Three Steps to Help Albania Withstand the Financial Impacts of Disasters and Crises
- How the Pandemic Has Highlighted the Need for the Next Generation of Natural Catastrophe Impact Modeling
- How Burkina Faso is Leveraging a Credit Guarantee Scheme to Help SMEs Weather the COVID-19 Economic Crisis
- Using Satellite Data for Climate, Crisis and Disaster Risk Finance
- Learning from COVID-19 and Climate Change: Managing the Financial Risks of Compound Shocks
- Developing Disaster Risk Finance in Morocco: Leveraging Private Markets for Sovereign Risk Transfer
- Rural Resilience: It's Not Only About Insurance
- Leveraging Space Technology for Climate Risk Finance
- Resilient Finance: Closing the Protection Gap Against Disaster Risk
- Piloting the Next Generation Analytics for Climate-Related Financial Resilience of Critical Infrastructure in Southeast Asia