Is Escaping the Fiscal Pro-Cyclicality Trap Possible? Evidence from the Middle East and North Africa

Is Escaping the Fiscal Pro-Cyclicality Trap Possible? Evidence from the Middle East and North Africa

Introduction

Fiscal policy can serve as a powerful tool to stabilize the economy. However, when it operates procyclically—expanding public expenditure and fiscal deficits during good times and cutting expenditures and reducing deficits during bad times—it amplifies economic cycles, potentially undermining macroeconomic stability and long-term growth. Conversely, countercyclical fiscal policy helps smooth these cycles, contributing to stability and growth. Understanding the sources of fiscal cyclicality is crucial for effective policy reform aimed at greater countercyclicality.

Key Contributions

1. Empirical Reassessment: Using the most recent and largest dataset covering 184 countries from 2000 to 2022, the paper reassesses the overall direction, intensity, and sources of fiscal cyclicality globally, with a particular focus on the Middle East and North Africa (MENA) region.
2. Identification of Successful Cases: The study identifies countries in the MENA region that have successfully shifted from procyclical to countercyclical fiscal policies, breaking free from the "fiscal pro-cyclicality trap."
3. Policy Implications: The analysis draws implications for governments to implement more countercyclical fiscal policies, contributing to macroeconomic stability and growth.

Background and Literature Review

• Theoretical Insights and Empirical Evidence: Economic policy research advocates for countercyclical fiscal policy, urging policymakers to use government spending and taxation to counteract business cycle fluctuations.
• Cyclical Behavior Across Countries: Empirical evidence shows that most industrial countries have successfully pursued countercyclical fiscal policies, often facilitated by automatic stabilizers. Developing and emerging economies, however, can be trapped in a fiscal pro-cyclicality trap, where fiscal policy remains persistently procyclical, reinforcing economic instability.
• Explanations for Pro-Cyclicality: The literature attributes this behavior to imperfect access to international credit markets, lack of financial depth, and political distortions.

Findings

• Global Trends: The global associations between fiscal cyclicality and income levels have remained relatively stable, but countries in the MENA region have exhibited diverse performances, with some transitioning toward countercyclicality and others moving away from it.
• Specific Fiscal Sources: Non-tax revenues exhibit a greater degree of procyclicality than tax revenues, while subsidy expenditures tend to be less countercyclical than other fiscal expenditures. Subsidies do not contribute to macroeconomic stability and long-term growth through this channel, independent of their adverse effects.
• Successful Case Studies: Several countries in the MENA region have successfully shifted from procyclical to countercyclical fiscal policies, breaking free from the fiscal pro-cyclicality trap.

Policy Implications

• Governments should focus on reducing procyclicality by adjusting non-tax revenues and subsidies.
• Effective policy reforms can help achieve greater countercyclicality, contributing to macroeconomic stability and growth.

Conclusion

Understanding the sources and trends of fiscal cyclicality is essential for implementing effective fiscal policies. The paper highlights the importance of addressing procyclicality in the MENA region and provides insights into successful strategies for achieving countercyclicality.