Is Fiscal Policy Procyclical in Developing Oil-Producing Countries?

A new IMF working paper by Nese Erbil "examines the cyclicality of fiscal behavior in 28 developing oil-producing countries (OPCs) during 1990-2009. After testing five fiscal measures - government expenditure, consumption, investment, non-oil revenue, and non-oil primary balance - and correcting for reverse causality between non-oil output and fiscal variables, the results suggest that all of the five fiscal variables are strongly procyclical in the full sample. Also, the results are not uniform across income groups: expenditure is procyclical in the low and middle-income countries, while it is countercyclical in the high-income countries. Fiscal policy tends to be affected by the external financing constraints in the middle- and high-income groups. However, the quality of institutions and political structure appear to be more significant for the low-income group."

Excerpts (notes excluded):

Both the neoclassical and Keynesian theories support the idea that effective fiscal policy should smooth the volatility of output during the business cycle. Barro’s (1973) ―tax-smoothing‖ hypothesis of optimal fiscal policy suggests that, for a given path of government expenditure, tax rates should be held constant over the business cycle, and the budget surplus should move in a procyclical fashion. According to the Keynesian approach, however, if the economy is in recession, policy should increase government expenditure and lower taxes to help the economy out of the recession. During economic booms, the government should save the surpluses that emerge from the operation of automatic stabilizers and, if necessary, go further with discretionary tax increases or spending cuts. As a result, fiscal policies are expected to follow countercyclical patterns through automatic stabilizers and discretionary channels. In other words, one would expect a positive correlation between changes in output and changes in the fiscal balance or a negative correlation between changes in output and changes in government expenditure.

However, empirical studies show that fiscal policies are procyclical in developing countries and in OPCs.5 They increase spending with an increase in oil revenue during an oil price boom. They are forced to reduce spending because of a revenue decline as a result of a drop in oil prices. Since, in general, these countries are not able to accumulate savings in years with high oil revenues, they can only finance deficits by cutting expenditure during revenue shortfalls. Fouad and others (2007), Abdih and others (2010), and Villafuerte and Lopez-Murphy (2010) find that oil-producing countries followed procyclical fiscal policies during the recent oil price cycle. Baldini (2005) and De Cima (2003) also present evidence for the procyclicality of fiscal policies in two oil-producing countries, Venezuela and Mexico. More recent studies, e.g. Ilzetzki and Vegh (2008), find, using instrumental variable regression, strong evidence of procyclical fiscal policy in developing countries.

Two broad arguments that have been proposed as an explanation for procyclical policies in developing counties also apply to OPCs: constraints on financing (or limited access to credit markets) and factors related to the structure of the economy ( the budget, political, power, and social structure, and weak institutions). In general, these factors are presented separately but they go together and are likely to reinforce each other. For example, weak institutions, the budget structure, or a corrupt government may hinder prudent fiscal policies, which may, in turn, affect fiscal sustainability and creditworthiness by amplifying the financing constraints.

Liquidity and borrowing constraints emerge when a developing country needs financing the most--during a downturn--and that is when it is least likely to be able to obtain it. Many countries do not have significant foreign assets or developed domestic financial markets to raise funds. When these countries face large terms of trade shocks (i.e., a sharp fall in oil prices in the case of OPCs), investors may lose confidence and be less likely to lend, because they fear that the lack of policy credibility and discipline may force the government to run up large budget deficits and to default.6 Governments in this situation will also experience recurring credit constraints in world capital markets (―sudden stops,‖ as explained in Calvo and Reinhart (2000)), which hamper their ability to conduct countercyclical policies.

Oil stabilization funds have been increasingly used by OPCs as an instrument to cope with oil revenue volatility. These funds are aimed at stabilizing budgetary revenues: when oil revenues are high, some portion of the revenue would be channeled to the stabilization fund; when oil revenues are low, the stabilization fund would finance the shortfall. However, the creation of such funds is found to have no impact on the relationship between oil export earnings and government expenditure in countries where no sound and transparent fiscal and macroeconomic policies were implemented.7 Moreover, some oil funds have operated outside existing budget systems and are often accountable to only a few political appointees. This makes such funds especially susceptible to abuse and political interference. Therefore, stabilization funds should not be regarded as a substitute for sound fiscal management.

The other argument proposed to explain the difficulty in implementing countercyclical policy focuses on procyclical government spending due to three aspects of the economy and the government: the budget structure, the weak political structure and institutions, and corruption in government.

First, developing countries run procyclical fiscal policies because of their budget structure. These countries have a few automatic stabilizers built into their budgets. As a result, government spending in developing and emerging countries displays less of a countercyclical pattern than in industrial countries. For example, Gavin and Perotti (1997) note that Latin American countries spend much less on transfers and subsidies than do richer OECD economies (24 percent of total government spending, compared with 42 percent in the industrial countries). Furthermore, most developing countries and OPCs cannot raise revenue effectively through taxes since they usually suffer from inefficient tax collection systems, owing to the low level of compliance with tax laws, insufficient political commitment, and a lack of capacity, expertise, and resources.8 Additionally, non-oil tax bases in these countries are in general very low.9

Second, weak institutions and political structure encourage multiple powerful groups in a society to attempt to grab a greater share of national wealth by demanding higher public spending on their behalf. This behavior, called the ―voracity effect‖ by Tornell and Lane (1999), results in fiscal procyclicality arising from common pool problems, whereby a positive shock to income leads to a more than proportional increase in public spending, even if the shock is expected to be temporary. This is discussed extensively in ―resource curse‖ literature as a reason for low economic growth in resource-rich countries.10 Moreover, fiscal policies are more intense in countries with political systems having multiple fiscal veto points and higher output volatility (Stein, Talvi, and Grisanti, 1998;and Talvi and Végh, 2000). Similarly, Lane (2003) and Fatas and Mihov (2001) find that countries with power dispersion are likely to experience volatile output and procyclical fiscal behavior.

Lastly, Alesina and Tabellini (2005) argue that a more corrupt government displays more procyclical fiscal policies as voters, who do not trust the government, demand higher utility when they see aggregate output rising. This behavior would be more prevalent in democracies since a corrupt government is accountable to the voters, whereas, in a dictatorship, the government would not be accountable and, even if corruption were widespread, voters could not influence fiscal policy. Alesina and Tabellini conclude that corrupt governments in democracies, rather than credit market imperfections, are the underlying cause of procyclical fiscal policy.


[...]


The results confirm that political and institutional factors, as well as financing constraints, play a role in the cyclicality of fiscal policies in the OPCs. Most of the variables on the quality of institutions and the political structure appear to be significant for the low- income group. Two of the variables are significant for the middle-income countries: the composite institution index and checks and balances. None of the institutional variables turns out to be significant for the high-income countries.21 Domestic financing constraints seem to matter for the low-income group. But fiscal policy is affected more by the external financing constraint in the middle- and high-income groups, as they may be more integrated into the global financial system than the low-income countries.

Despite their many differences, all the OPCs face volatile and unpredictable oil revenues, a situation that makes fiscal management challenging. For this reason, it is imperative for them to formulate effective countercyclical fiscal policies by which they can smooth government expenditure, decouple it from the volatile oil revenues, and prevent boom-and-bust cycles. Breaking away from a procyclical fiscal policy will enable them to sustain long-term growth and keep the safety net that the poor need. Sound fiscal policies and discipline require strong institutions, a higher-level bureaucracy, and more transparency. Strong institutions and transparency would also help reduce the ―voracity effect,‖ which, in turn, would facilitate the accumulation of financial assets and build up confidence among investors to raise funds when needed.

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IMF working paper: Iran — The Chronicles of the Subsidy Reform

A recent IMF Working Paper by staff of the Middle East and Central Asia Department, "Iran — The Chronicles of the Subsidy Reform," [1] analyses the December 2010 changes in subsidies of domestic energy and agricultural prices, which increased about 20 times, making it the first major oil-exporting country to reduce substantially implicit energy subsidies.

Their paper reviews the economic and technical issues involved in the planning and early implementation of the reform, including the transfers to households and the public relations campaign that were critical to the success of the reform. It also looks at the reform from a chronological standpoint, in particular in the final phases of the preparation. The paper concludes by an overview of the main challenges for the second phase of the reform.

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Excerpts:

On Saturday, December 18, 2010, at 9:00 p.m. Tehran time, speaking in a televised “conversation with the nation”, President Ahmadinejad announced the start of what he termed the most sweeping economic “surgery” in Iran’s modern history. Just after midnight on December 19, Iranian media began releasing announcements detailing the new price structure for liquid fuels. Within twenty-four hours, new natural gas, electricity, and water tariffs were published, and allowable ceilings for the increase in taxi and public transport tariffs followed. At the time, close to 80 percent of Iran’s population was granted unrestricted access to compensatory payments that had been deposited in specially-created bank accounts starting in October 2010.

The reform, officially referred to as Targeted Subsidies Reform, made Iran the first major energy producing and exporting country to cut drastically massive indirect subsidies to energy products and replace them with across the board energy dividend transfers to the population. It is estimated that the price increases removed close to US$50–US$60 billion dollars in annual product subsidies. By December 2011, in the first 12 months following the price increase, Iranian households will have received at least US$30 billion in freely usable cash, and another $10–$15 billion will have been advanced to enterprises to finance investment in restructuring aimed at reducing energy intensity.

[...]

Although oil and gas production has accounted for an increasingly smaller share of real GDP, oil and gas revenues remain the main source of foreign exchange earnings and fiscal revenues. The share of oil in real GDP fell from an average of 40 percent of real GDP in the 1960s to about 10½ percent in the last decade, reflecting average annual non-oil GDP growth rate of 5.7 percent compared to only 4.4 percent for oil and gas GDP. Oil and gas receipts accounted for about 72 percent of export revenues in the last decade, despite rapid non-oil export growth.  Oil and gas revenues also account for 65 percent of fiscal revenues, and are likely to remain the main source of financing for development projects in the foreseeable future notwithstanding recent efforts to diversify fiscal revenues.

Iran’s high dependence on oil export revenues has had a profound impact on its business cycle. In the most recent business cycle during 2002-2008, fiscal spending and credit growth increased at the same time as export revenues and oil prices, resulting in an overheating of the economy and a surge in inflation. The subsequent tighter monetary and fiscal policies coincided with the sharp fall in oil exports caused by the international recession of 2008-2009. As a result, inflation and output declined sharply.

Domestic energy prices have historically been set administratively in Iran, as in the majority of oil exporting countries. They were set at a level high enough to cover production costs and have been changed only occasionally. This worked well when international oil prices were relatively stable and low, and close to production costs. However, when international prices began to rise after 2002, low domestic energy prices became increasingly out of line with the market value of oil. In addition, high domestic rates of inflation and subsequent exchange rate depreciations contributed to further erode domestic energy prices vis-à-vis their international benchmarks. The March 2002 unification of exchange rates and the resulting rial depreciation also accentuated a growing disparity between domestic and international energy prices.

Increasingly cheaper energy stimulated demand, making Iran the country with the highest level of energy subsidy. Not surprisingly, domestic energy use and energy intensity in Iran, as in many other energy producing countries, increased rapidly. Cheap domestic energy prices led to a rapid increase in domestic energy consumption. As a result, Iran became one of the most energy-intensive economies in the world. The high domestic absorption of crude oil distillates, natural gas, and electricity reduced the availability of these energy products for the export market. Iranian oil energy companies were also increasingly starved of funds needed for investment since domestic energy prices were set at barely cost recovery levels. Environmental pollution and its impact on human health, as well as the time lost due to traffic congestion on Iranian roads provided additional urgency for the reform. Not surprisingly, by 2007 some analysts started questioning not only Iran’s plans to increase its oil production capacity, but also its ability to stop a decline in oil production and exports.


[...]

The Iranian authorities were clear from the outset that the main reform objective was to reduce waste and rationalize consumption. By compensating households for the energy price increases, most consumers would be better off because the higher energy price would discourage some marginal gasoline consumption, while the cash compensation would allow consumers to buy more other goods and services.

[...]

The reform would also improve social equity in the distribution of Iran’s hydrocarbon wealth. For the poor who benefited little for cheap domestic energy price, the compensation would represent a large share of their income, lifting virtually every Iranian out of poverty.  This gave the government a powerful public relations and moral argument in support of the reform.

The likely large substitution effect triggered by large price increases could provide a significant stimulus to Iran’s domestic production and further diversification efforts, particularly given the slow growth in recent years, and relatively high, double-digit unemployment. The distribution of about $30 billion in annual compensatory payments directly to the population would support domestic demand and nonenergy sector growth.  The reform was not expected to contribute to fiscal consolidation. The reform legislation, and the political debate that preceded it, ruled out using the reduction of energy subsidies to improve the country’s fiscal balance. To the contrary, Iranian reforms, including the privatization program launched in 2006, aimed at reducing the size and the role of the public sector in the economy. However, potential large savings in domestic energy use could make significant quantities of crude oil and refined products available for exports (Box 2). The revenue from such exports could support a virtuous cycle of investment in the energy sector that would add production and refining capacity and further increase exports.


References

[1]  Dominique Guillaume, Roman Zytek, and Mohammad Reza Farzin: Iran — The Chronicles of the Subsidy Reform. July 2011.

Statements by the Parti communiste des ouvriers tunisiens/حزب العمال الشيوعي التونسي‎

Statements by the Parti communiste des ouvriers tunisiens/حزب العمال الشيوعي التونسي‎
http://themoornextdoor.wordpress.com/2011/07/13/studies-i-pcot-on-foreign-affairs-i/

1. Libya

PCOT: “Statement on the military intervention in Libya”
LINK: http://www.albadil.org/spip.php?article3741
DATE: 20 March, 2011
A number of imperialist countries (France, the United States, etc.) have launched air and missile attacks on sites said to belong to Mu’amar al-Qadhafi. These attacks came after the decision of the “Security Council,” which gave the green light to initiate military operations in Libya.
The Tunisian Communist Workers’ Party is concerned that the purpose of this intervention is not the protection of the Libyan people from the oppression of Qadhafi, but instead the occupation of the country, to subjugate its people, plunder its resources and use its territory to establish military bases for the control of North Africa in order to ensure the security of the Zionist Entity and safeguard the interests of the imperialist powers in the region. France, the United States and all western countries which have launched attacks on Libya today have no interest in the triumph of the popular revolts blowing down Arab regimes, corruption and unemployment, things which long found support and backing from the colonial powers, so today we see they are quick to take the necessary precautions so as not to let things get out of hand.
The brotherly Libyan people will be able to overthrow Qadhafi, depending on their capabilities and the support of other Arab peoples (and all the revolutionary forces of the world), and are not in need foreign intervention which will only bring them more killing and destruction, as well as violations of their sovereignty and the occupation of their land and the plunder of their resources.
The Tunisian Communist Workers’ Party expresses its rejection of the military intervention and calls for their immediate halt. It also calls on all anti-imperialist forces in the Arab and Islamic world at large to move and calls on all the peoples of the world to come out in marches and demonstrations and engage in all forms of struggle in order to stop this interference.
Long live the struggle of Arab peoples for freedom, dignity and the fall of the Arab regimes and corrupt puppets. Down with the imperialist enemies of the people and the protectors of the Zionist Entity.
– The Tunisian Communist Workers’ Party, 20 March, 2011.

2. Palestine

Tunisian Union of Communist Youth: “On the Anniversary of Land Day: Let the Revolution of the Arab Peoples be a step in the direction of the liberation of Palestine”
LINK: http://www.albadil.org/spip.php?article3754
DATE: 30 March, 2011
Let the Palestinian people be revived today, the thirty-fifth anniversary of Land Day under the obnoxious Zionist occupation and under political division, which has bedeviled Palestinian ranks and prevented success in stopping the gushing of settlements, which seek to obliterate the Arab identity of Palestinians towns and villages under the mantle of “more land and fewer Arabs”. The celebration of this anniversary in these particular circumstances mark national resistance and are a reminder of the persistence of resistance in the face of this racist [regime] which does not hesitate to use the dirtiest and most arrogant methods to swallow up the Palestinian territories. There is no doubt that the return of sovereignty to the Arab peoples, especially the Tunisians, will provide strong support for the Palestinian cause after the removal Ben Ali and Mubarak, who dedicated themselves in service of the occupation and forced their people to remain silent and easily suppressed demonstrations and campaigns [against Israel] in obedience to the racist entity to provide a good “neighborhood” and faith.
The Tunisian Union of Communist Youth salutes the steadfastness of the Palestinian people, reiterates its absolute support as it has since its establishment as an advanced and progressive site for the Palestinian national cause and:

• That the unity of the Palestinian ranks, nation, resistance, democracy best answers and expresses the demands of the Palestinian reality, especially with the failure of successive governments to put an end to the barbaric and racist policy back up by the United States of America and employed by the regimes of the Arab countries;
• That the Tunisian people, on the day after their glorious revolution bear more responsibility on the basis of national and humanitarian bonds to provide support for the brotherly Palestinian people in regaining their usurped land and their right to impose their sovereignty in the context of a progressive and democratic state.

Thus it emphasizes breaking all forms of normalization with the Zionist enemy and annulling all secret treaties which the previous regime spent its time on.
It calls for all the activities of the community of activists, parties, organizations, associations and personalities toward the activation of solidarity with and to publicize the Palestinian cause and to celebrate this anniversary in a manner fitting of its symbolism.
Long live the Palestinian people.
Downfall to Zionism, imperialism and reactionary Arabs.
Long live the Tunisian Revolution supporting the brotherly Palestinian people.
Immortality to the martyrs and victory to the resistance. 
– Tunisian Union of Communist Youth. Tunis, 30 March, 2011.

3. Syria

Article by Samir Hammouda: “Syria: The Pending Dictatorship…”
LINK: http://www.albadil.org/spip.php?article3755
DATE: 1 April, 2011
The Arab masses continue to make history. Current events in Syria today developed from ideological struggle and political fact. The most notorious dictatorships, including those hide by painting themselves as “nationalist” and “resisting Zionism” also downfall by means of mass vibrations.
From its start till now the popular uprising in Syria proceeds with more than 150 martyrs and hundreds of wounded after only a few days. The martyrs and the wounded are not the result of Zionist bombing or terrorism. Instead they come from the bloody repression of the “nationalist” Syrian regime.
In that country, as in Tunisia, Egypt, Yemen, Bahrain, Algeria, Morocco and Libya events are in essence repeating by similar ways, despite different specificities in this or that country, for be sure that the catastrophe is the Arab reality and true despotism for all Arab regimes.
The uprising of the masses in Syria is the result of the same underlying social, economic and political causes which shook the pillars of dictatorship in the rest of the Arab world. Syria is also a country of poverty, unemployment, regional disparities and is penetrated by liberal capitalism. In Syria, too, there is a total absence of freedoms, suppression of the opposition for the sake of maintaining sectarianism and smashing people’s most basic political, economic and cultural rights. In Syria corruption is rampant and the minority of the local bourgeoisie holds a monopoly on the country’s economy and wealth and the control of the political police has a hold on the judiciary and the throats of the citizens.
The policies and words of the Syrian regime in the face of popular protests and its suppression and distortions are of the same version know  to Arab peoples under the despotic regimes in Tunisia, Egypt, Yemen and other countries. If Bashar al-As’ad accused his opponents of being controlled by outsiders and the public of a tendency to drift along according to foreign schemes hostile to the country’s interests this is not the best political speech since Ben Ali and Mubarak or Qadhafi and Ali Saleh. All dictatorships, whatever their ideological dress — “nationalist” or “socialist” or “Islamic” — resort to the same outdated and false arguments to justify tyranny and the depravation of the people’s liberties as is necessary for political and social emancipation. While the Syrian regime boasts of thousands at the demonstrations of its supporters its security and military apparatus massacres and tortures its opponents. But history does not run out of lessons. Yushenko was boasting thousands at his crowds before his downfall, Ben Ali bragged of two million members in his own party a few days before fleeing.
But the popular uprising in Syria increases the taste for blood and for politics and other dimensions at the local level as in the rest of the Arab world. The Syrian regime is the last in a series of regimes that embraced the Ba’th project on the basis of Arab nationalist aspirations for unity, socialism and liberation from colonialism and Zionism. In recent decades, the Syrian regimes support has been an important component in Arab power, not only on the nationalist file, but also on the leftist and Islamist ones. This was done under the banner of “nationalism” and claiming that the Syrian regime is part of the nationalist forces that stand on the front lines of confrontation with the Zionist Entity.
We have stood on many occasions against political forces urging us to overlook the dictatorial approach of this regime on the pretext of standing against the Zionist Entity and we consider this approach opportunistic, harmful and against the development of the revolutionary movement and combativeness in the Arab world and national liberation. Patriotism and resistance to colonialism and to Zionist and imperialist plans facing us cannot be in contradiction with the people’s enjoyment of their full democratic and political freedoms, or their condition at the forefront. It is true that political freedoms alone are not sufficient to realization of national aims, but the sovereignty of the Arab peoples and the revival of the Arab world and unity in the face of imperialism will not be achieved without them. Why would democracy for the Arab peoples not antagonize the Zionist Entity if this were not a threat to its very existence?! And why has America supported and still support the tyranny of Arab regimes if these do not serve its interests and objectives?! And how can our peoples achieve unity and finally dispose of the poisons of religious conflict, sectarianism, tribalism and local infighting among their parties without citizenship and equality without democracy and the triumph of citizenship and equality without conquering discrimination based on classism, sectarianism, religion, gender or ideology?!
The failure of the Syrian regime once again confirms the failure of authoritarian regimes in achieving national goals: unity and socialism and liberation from colonialism and Zionism. If bourgeois democracy is the gateway to the dismantlement of Arab dictatorships and despotic regimes then the Arab people are not doomed to merely copy them and are instead able to overcome their shortcomings and negative aspects toward  broader and greater democracy, democracy responsive to the grassroots, national political ambitions and economic and cultural rights.
No one today can predict how events in Syria will evolve, nor the depth or extent of the preparedness of the Syrian people to topple Bashar al-As’ad yet it is certain the Syrian regime will not respond to calls for political reform for it is not in its character or interest of a single Arab dictatorship to respond to the people’s demands for freedom. The regime that represses its people and harasses its opponents does have a future or a way out of crisis and collapses by its own internal rot, the laws of its own design and by the advancement of the masses, sooner or later.
– Samir Hammouda, 1 April, 2011