How Procyclical Has Fiscal Policy Been in CEMAC?

One objective of fiscal policy is to stabilize a country’s macroeconomic environment. Countercyclical fiscal measures intend to offset the effects of the economic cycle on a country’s economy. For example, they include increasing public spending or cutting taxes to stimulate the economy during an economic slowdown. Countercyclical fiscal policy reduces economic fluctuations and helps ensure macro-fiscal stability. What has been the experience in developing countries? And what has been the experience in the CEMAC zone? 

The empirical literature finds that while fiscal policy in developed countries is either acyclical or countercyclical, it has been generally procyclical in developing countries. There are two main explanations for this. On the one hand, limited access to financing prevents developing countries from borrowing in bad times, which often leaves governments with no other choice but to cut spending (especially public investment) and/or raise tax rates.^1,2 On the other hand, weak institutions may not be capable of containing political pressure to spend in good times, leading to fiscal profligacy and/or rent-seeking activities.³ Political pressures for additional spending in good times may be hard to resist, particularly when there is a genuine need for more government spending in critical social areas.⁴ Procyclical fiscal policies may have harmful implications in both the short and long run. When governments cut expenditure in response to a fall in oil revenue, for example, the most vulnerable groups are the hardest hit if safety nets are weak, and long-term growth could be hampered if governments withdraw resources from productive projects. 

We test whether fiscal policy in CEMAC countries has been procyclical. The tendency for fiscal policies in the CEMAC region to be procyclical is high.⁵ These countries’ low economic diversification and high share of revenues from commodities make government revenues vulnerable to large and unpredictable swings in commodity prices, limiting their ability to respond to negative shocks, especially in the absence of sufficient fiscal buffers accumulated during periods of high oil prices. During economic upturns, procyclical fiscal policy in CEMAC countries may be amplified by their weak institutional context, which does not allow governments to contain political pressures to spend.⁶ Indeed, in oil exporting countries, oil rents are often seen as the property of the nation, which may encourage rent-seeking and pressure to distribute rents.⁷ Moreover, less mature democracies, with weak political parties and low transparency, present higher challenges because they lack a sufficiently effective political system to create a consensus and the capacity to negotiate how rents are used in the long term.

We use data from 1990 to 2020 to compare the cyclicality of fiscal policy between CEMAC and other SSA countries. The governments’ fiscal response (focusing on expenditure) to changes in economic conditions was estimated using a standard econometric methodology (generalized method of moments, GMM) used in the literature. Such exercises face the usual problems of unclear causality (when the studied variables could mutually influence each other). The GMM methodology is designed to handle such problems.  In our case, an increase in fiscal spending has a potential impact on economic growth (i.e., the fiscal multiplier), while an increase in economic activity can have also an impact on spending (i.e., the fiscal reaction). The econometric estimation includes other variables that can have an impact on the fiscal response, including an institutional variable to test whether better institutions reduce the degree of fiscal procyclicality.⁸   

The results of the empirical exercise find strong evidence that the fiscal policy response has been more procyclical in CEMAC than in other SSA countries.⁹ While all SSA countries reveal procyclical fiscal policies during the time frame (consistent with the results of the existing literature), this effect is even stronger in CEMAC countries, as the coefficient is higher. 

Improvement in the quality of institutions could considerably decrease the degree of procyclicality. The quality of institutions, measured by an index composed by the Worldwide Governance Indicators, plays a significant role in reducing the degree of procyclicality among SSA countries, which is consistent with the literature on the role of institutions in fiscal cyclicality.¹⁰ A simulation of an improvement in the quality of institutions for CEMAC countries from its average ranking to match those, for example, of the best-performing CEMAC country and the best-performing SSA, we find that the degree of pro-cyclicality could be reduced by approximately 38 % and 81 %, respectively.¹¹ Although more data will be needed to formally test the relation, these results suggest that institutional reforms such as the New Convergence Rules (NCR) in CEMAC could lead to less procyclical fiscal policies. In particular, the new reference fiscal criterion, under the NCR, can be defined as the overall non-oil balance plus 80 % of the average oil revenue-to-GDP ratio over the three previous years. It is therefore fully disconnected from the current year’s oil revenue, and thereby does not allow governments to increase spending immediately when oil revenue increases.

Fiscal rules and better transparency could help. Research shows that a combination of top-down and bottom-up approaches may help countries escape the procyclicality bias.¹² Top-down solutions include the adoption of well-designed fiscal rules that have been associated with better fiscal/debt outcomes in the countries that have adopted them. Bottom-up solutions are complementary and consist of improving transparency in the implementation of the budget and the fiscal rule, providing lawmakers, markets, and citizens with the information they need to hold governments accountable.

_{¹ Caballero and Krishnamurthy 2004; Gavin et al. 1996.
² Countries are less likely to have countercyclical fiscal policies if there are no (or only limited) automatic stabilizers (e.g., unemployment benefits), which are often triggered during downturns in high-income countries. 
³ Diallo 2009; Sherrera et al. 2019. 
⁴ Végh 2011.
⁵ Herrera et al. 2019. 
⁶ Bradley et al. 2011; Erbil 2011. 
⁷ Eifert et al. 2002.
⁸ See CEMAC Quarterly Economic Barometar : Vol 2 - Q3
⁹  This result was also found for the countries of the West African Economic and Monetary Union (Dessus et al. 2014). 
¹⁰ See, for example, Végh (2014) and Herrera et al. (2019).
¹¹ A reduction of 100 % in the degree of procyclicality would mean that fiscal policy becomes acyclical, and a reduction of more than 100 % would imply that fiscal policy becomes countercyclical. 
¹² Herrera et al. (2019); Carneiro and Kouame (2020)}