Government Spending on Social Welfare — Macroeconomic Policy and Credit Implications



Spring 2023

Many countries in Latin America have recently experienced social unrest, brought on by inequality, sluggish economic growth, high cost of living, and dissatisfaction with public services. These social tensions have prompted calls for greater government spending and a stronger role for the state, driving a political shift toward left-wing governments known as the second Pink Tide. 

Moody's asked the Columbia Capstone team to analyze the susceptibility of countries to social and political unrest, as well as the effectiveness of their social spending policies. As a result, the Capstone team has designed two indices: a social vulnerability index and a fiscal effectiveness index. By introducing these metrics, the Capstone team has enabled Moody's to enhance its methodological framework for evaluating creditworthiness and taking rating actions, particularly in terms of political risk and fiscal strength considerations. To create the fiscal effectiveness index, the Capstone team utilized the Data Envelopment Analysis (DEA) technique, which generated spending efficiency scores for each country for a given year. For the social vulnerability index, the team implemented two methods. The first was a bottom-up approach that incorporated Moody's existing Social Tension Index. The second was a top-down approach, in which the student team utilized the social security and security index from the Global Peace Index (GPI) as a proxy for social vulnerability expression. They then built a predictive model that forecasts changes in the GPI. 

The team suggested using the two indices alongside Moody's current sovereign rating methodology. This would provide additional quantitative analysis for factors that are mostly qualitative, such as Susceptibility to Event Risk. By incorporating these indices, Moody's could reduce discretionary analysis and have a more quantitative approach to evaluating social spending for sovereigns.