Are fiscal rules a recipe for growth in developing economies?
Date
2016
Authors
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Publisher
University of Delaware
Abstract
This paper empirically investigates the impact of national fiscal rules in the economic growth of developing countries, and supranational fiscal rules on the growth of developing countries which are currency union members. Using the recent IMF 2013 fiscal rule database, a standard neo-classical growth model with short-run dynamics is estimated for 17 developing countries and three currency unions: the Eastern Caribbean Currency Union, the Central African Economic and Monetary Community and the West African Economic and Monetary Union. System GMM, Difference GMM and Dynamic Fixed Effects estimates suggest that the impact of national fiscal rules on growth is positive, but they are inconclusive when it comes to statistical significance. However, the evidence is slanted toward an insignificant effect implying so that fiscal rules do not matter. Moreover, when national fiscal rules are present with formal enforcement procedures or any mechanisms outside the government that monitor the compliance of rules, the differential effect of fiscal rules with enforcement has a negative effect on growth, decreasing the magnitude of the total positive effect of fiscal rules with enforcement. This is likely due to the governments’ behavior in developing countries which when faced with a binding budget constraint; they tend to reduce public investment rather than current expenditures. However, even when rules have exclusion clauses regarding public investment or any other priority items, their impact on growth is negative as these types of rules create incentives for “creative accounting” techniques. Nevertheless, whether the effect of fiscal rules with enforcement or fiscal rules with exclusions is significant cannot be determined. As a result, developing countries should not be following blindly advanced economies when regulating their fiscal policies. On the other hand, there is evidence that the presence of supranational fiscal rules in currency union members has a positive and significant impact on the economic growth of these countries.