Robust structural determinants of public deficits in developing countries

ABSTRACT

Many macroeconomic, institutional, demographic, social and political variables have been proposed by previous studies as significant determinants of public deficits in developing countries. This paper asks whether their estimated impact on public deficits is robust under thousands of possible alternative specifications. We deal with model uncertainty using Sala-i-Martin’s Extreme Bound Analysis. Our results clearly show that external shocks, the debt ratio, financial development, the level of democracy and government control over expenditures are robustly associated with fiscal deficits. Public deficits are lower in countries which provide better stability of public expenditure in the face of revenue instability and which are less exposed to negative external shocks. In contrast, fiscal deficits increase with the debt ratio, financial development and the level of democracy. The relative importance of external shocks in all the regressions argues in favour of greater economic diversification in order to mitigate the impact of negative shocks on public finances.

KEYWORDS:

• Fiscal policy
• budget deficits
• sensitivity analysis
• robust regressions

JEL CLASSIFICATION:

• E62
• H61
• H62
• C31.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ See the list of countries in Annexe A-1..

² These variables are defined according to the World Bank classification: East Asia and the Pacific (EAP), Europe and Central Asia (ECA), Latin America and the Caribbean (LAC), Middle East and North Africa (MENA), Sub-Saharan Africa (SSA).

³ See Appendix A-2.

⁴ See also Fernández, Ley, and Steel (2001a) for more details on this issue.