Structural factors associated with primary fiscal balances in developing countries

Abstract

The study explores the conditions under which a government in a developing country is likely to run a balanced or surplus budget. We contend that primary fiscal deficits are likely to persist where the economy is too saving constrained to raise private sector investment. To conduct the investigation, a logit model is applied to a sample of developing countries to see whether the saving constraints are associated with the fiscal stance of governments. Accordingly, income level, growth, external current account balance and foreign direct investment are used as indicators of the saving constraint. With the exception of economic growth, positive developments in these variables turned out to be significant to the likelihood of the government adopting a surplus budget.

Notes

¹ Fiscal reforms included privatisation, decentralisation, shifts in domestic tax regimes in congruence with the demands of trade liberalisation, expenditure cuts, reforms of the civil service, wage policies and reforms of social security. See for example, UNECLAC (1998).

² It has been argued extensively in the literature that persistent fiscal deficits tend to lead to rising inflation, crowding out of the private sector from domestic capital markets and to spiralling debt.

³ This is different from Keynes, in the sense that investment is not demand constrained, but instead it is savings or resource constrained.

⁴ Easterly and Servén (2003) observed that the reduction in capital spending by the State to allow the private sector to exhibit greater participation has not had glowing success in Latin America. Consequently, pressures still remain on the state to provide infrastructure to improve the welfare of the population.

⁵ See Agenor and Montiel (1996) for a review of these studies.

⁶ See of example, Schmidt (2003), Baxter and Crucini (1993) and Jansen (1996),

⁷ See appendix for a list of the countries considered.

⁸ There are difficulties in defining and standardising the fiscal stance of governments. According to Blejer and Chesty (1991), complications arise owing to differences in accounting systems, differences in the degree of coverage of government and quasi government activities, and differences in the treatment of valuations owing to exchange rate fluctuations. See Jun (1997) for an overview of intergovernmental transfers in a select group of countries.

⁹ See Cuddington (1997) for a review of some of these studies and an outline of the accounting perspective on fiscal deficits.

¹⁰ Bacha (1990) assumed crowding out in the three-gap model, based on historical evidence of how government expenditure at the developmental stages of a country tends to have a crowding-in effect. He had to assume that k was not impacted on by price, however, since high inflation rates can create uncertainty and weaken the crowding-in effect. Thus, in his model crowding-in can only apply up to a certain level of inflation.

¹¹ Jaspersen (1997) observes, for example, that East Asian economies ran budget deficits just as high as Latin America, but deficits were more sustainable in the former owing to higher growth rates and the consequent demand for financial assets.