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Annex 1. List of Developing Countries in the Sample by Income Level Group
Annex 2. Raw Correlations
Annex 3. Econometric Approach: Additional Notes
Annex 4. Cyclicality of Total, Education, and Health Public Expenditures: Fixed Effects and IV-Fixed effects
Annex 5. Cyclicality of Recurrent Expenditures
The authors are grateful for helpful comments and suggestions received from Emanuele Baldacci, Ugo Panizza, Fidel Jaramillo, Abdoul Wane, and Benedict J. Clements. They are also grateful to Ezequiel R. Cabezon and John Piotrowski for excellent assistance in the collection of data. Responsibility for remaining errors and omission lies with the authors.
For example, see Gavin and Perotti (1997), Tornell and Lane (1999), Agénor et al. (1999), Kaminsky, Reinhart, and Végh (2004), Alesina and Tabellini (2005), Akitoby et al. (2006), Stein et al. (1999), Talvi and Végh (2000), and Ilzetzki and Vegh (2008).
Alternatively, the output gap could be used. We explored this option; however, this specification did not pass the Hansen tests for S-GMM nor the Durbin-Wu-Hausman tests of exogeneity for an Instrumental Variables Fixed Effects model (IV-FE). Both, the fiscal variables and GDP growth could also be expressed as deviations from a long-run trend by using the Hodrik-Prescott filter. Yet there are well-known problems associated with detrending series in developing countries which could add substantial measurement error to our estimation. Both of the econometric methodologies employed in this paper control for country-specific effects, either by time-demeaning the variables or by first differencing, which helps to overcome this problem.
Education and health spending were converted into constant prices in domestic currency using the GDP deflator. The conclusions of the paper do not change if CPI is used instead of GDP deflator. In any case, the GDP deflator is preferable since it also captures changes in prices of intermediate inputs.
Data classified along the UN’s COFOG functional classification of expenditure are also available in the Government Financial Statistics (GFS) database. However, country coverage therein is too spotty, and not suitable for the econometric analysis performed in this study.
Potential output for each country is computed with a Hodrick-Prescott filter.
Countries are divided according to 2008 GNI per capita, calculated using the World Bank Atlas method. The groups are: low-income, $975 or less; lower-middle income, $976 - $3,855; upper-middle income, $3,856-$11,905. See Annex 1 for a list of the countries included in each group.
All models discussed in this paper included time period dummies to control for global shocks.
Following Lane (2003) and Jaimovich and Panizza (2007), we instrumented the domestic output growth rate with two variables: one measuring external shocks equal to the real output growth of trading countries, weighted by their share of exports, and the other by the lagged real domestic output growth.
The sample size corresponds to the number of countries for which data on total expenditures are available for univariate regressions. The sample size varies for multivariate as well as for education and health regressions.
Hallerberg and Strauch (2002) find primary expenditures in EU member states to be countercyclical while Lane (2003) finds different degrees of cyclicality in OECD countries based on country-specific estimates of fiscal cyclicality.
It should be noted that Table 4 reports results from S-GMM, whereas Jaimovich and Panizza use instrumental variables. This, together with our larger sample size, could explain the difference in results.
Table 5 reports results from S-GMM. We also explored the IV-FE methodology on two sub-samples: one for good times and another for bad times (following Jaimovich and Panizza, 2007). We find procyclicality for total expenditures in both good and bad times, but these specifications fail to reject the Durbin-Wu-Hausman test null when the dependent variables are education and health expenditures suggesting that the instrument is not valid.
Using the output gap, Clements Faircloth and Verhoeven (2007) also find that primary expenditures are procyclical only during bad times in Latin America.
This result is broadly robust to the use of an alternative definition of good and bad times. The latter are defined as periods of positive and negative real GDP growth, respectively. These results are available from the authors upon request.
Time dummies are not included in these specifications to preserve degrees of freedom because the number of observations is substantially lower when the sample is divided in groups by income level.