Fiscal Policy Space and Economic Performance: Some Stylized Facts

This paper complements the cross-country approach by examining the correlates of GDP per capita growth acceleration around "significant" public expenditure episodes by reorganizing the data around turning points, or "events". Here we define (i) a growth event as an increase in average per capita growth of at least 2 percentage points (pp) sustained for 5 years, (ii) fiscal event as an increase in the primary fiscal expenditure annual growth rate of approximately 1 pp sustained for 5 years and not accompanied by an aggravation of the fiscal deficit beyond 2% of GDP. These definitions of events are applied to database of 140 countries (118 developing countries) over 1972-2005, providing a summary but encompassing description of "what is in the data". For this sample, the probability of occurrence of a fiscal event is about 10%, and, for a large range of parameter values for the selection of a "significant" event, the probability of a growth event once a fiscal event had occurred is in the 22%- 28% range. The probability of occurrence of a fiscal event is higher for the bottom half of the income distribution of countries, but the probability that this fiscal event is followed by a growth event is higher for the third quartile, corresponding to middle income countries (which are largely in Latin America). The probability of a fiscal event not followed by a growth event is significantly higher for the Middle East and Africa region. The description of the changes in expenditures components during fiscal events shows that, for developing countries, there are notable differences underlying fiscal events followed by growth events: they occur under situations of (i) significant lesser deficit, (ii) fewer resources devoted to non-interest General Public Services and (iii) shift in discretionary expenditures towards Transport & Communication. After controlling for the growth-inducing effects of positive terms-of-trade shocks and of trade liberalization reform, probit estimates indicate that a growth event is more likely to occur in a developing country when surrounded by a fiscal event. Moreover, the probability of occurrence of a growth event in the years following a fiscal event is greater the lower is the associated fiscal deficit, confirming that success of a growth-oriented fiscal expenditure reform hinges on a stabilized macroeconomic environment (through limited primary fiscal deficit).