Procyclicality of fiscal policy in oil-rich countries: Roles of resource funds and institutional quality

Abstract

Fiscal policy management in natural resource-rich countries, particularly the ones struggling with inadequate institutional quality, faces significant challenges because of the dependence of government expenditures on highly volatile revenues of their natural resources. To resolve this issue, most of them have set up natural resource funds; however, the effectiveness of these funds is under debate. Large government expenditures financed by transfers from these funds are not highly likely sustainable and may entail long-term severe economic risks. That brings the necessity of detailed analyses of resource-rich countries' fiscal policy management by integrating the effects of the natural resource funds. This study puts a step forward in this direction; it takes 32 oil-rich countries for the period 1984–2015. Then it analyzes their fiscal policies regarding their government expenditures by unravelling the effects of the presence of the natural resource funds and the adequacy levels of their institutional qualities, categorized with the clustering algorithms. It uses dynamic panel data analysis and elaborates on the proper estimation techniques by considering cross-sectional dependence among data of these countries, heterogeneity of slope coefficients and endogeneity issues. The study reveals that even after controlling the effects of the volatility of the oil price changes and the share of oil rents in total income, resource-rich countries' fiscal policy goes with the flow. In favourable economic conditions, government expenditures are soaring, but when economic downturns happen, their growth levels also turn down. That means high fiscal procyclicality even in the presence of natural resource funds. As expected, the presence of these funds is not sufficient. For the desired countercyclical policy, adequately high enough institutional quality is needed to manage those funds and fiscal policy effectively.