The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
This paper shows that high energy subsidies and low public social spending can emerge as an
equilibrium outcome of a political game between the elite and the middle-class when the provision
of public goods is subject to bottlenecks, reflecting weak domestic institutions. We test this and
other predictions of our model using a large cross-section of emerging markets and low-income
countries. The main empirical challenge is that subsidies and social spending could be jointly
determined (e.g., at the time of the budget), leading to a simultaneity bias in OLS estimates. To
address this concern, we adopt an identification strategy whereby subsidies in a given country are
instrumented by the level of subsidies in neighboring countries. Our Instrumental Variable (IV)
estimations suggest that public expenditures in education and health were on average lower by
0.6 percentage point of GDP in countries where energy subsidies were 1 percentage point of GDP
higher. Moreover, we find that the crowding-out was stronger in the presence of weak domestic
institutions, narrow fiscal space, and among the net oil importers.