Exogenous oil shocks, fiscal policies and sector reallocations in oil producing countries

Abstract

Previous literature has suggested that different mechanisms of transmission of exogenous oil shocks are responsible for the negative effects on the economic performances of oil exporting countries. This paper aims at providing further evidence on the role of sectoral reallocation between private and public sectors in explaining the impact of shocks to oil revenues on the economic growth rates of major oil producing countries (namely the GCC – Gulf Corporation Council – countries). The effects of oil shocks and expansionary fiscal policy on the business cycle of oil producing countries are examined. The possibility to distinguish between various components of public sector spending policy (that is, purchases of consumption goods, investments in productive activities and compensation for public employees) is, in particular, allowed for. A real business cycle (RBC) model is calibrated to fit the data on an “average” oil producing country. Results from the simulation of the theoretical model suggest that the possibility that the expansion of the size of the government (due, in particular, to the increase in the number of employees) can explain a large fraction of the negative effects of shocks to oil revenues on the private sector of the economy. However, since the growth in size of the public sector more than compensate for the reduction in size of the private sector, an increase in oil revenues has the effect to boost total output.