Guest Contribution: The Fiscal Stimulus in 2009-11
Trade Openness, Fiscal Space and Exchange Rate Adjustment
This post draws upon Aizenman and Jinjarak (2011).
The dire outlook of the global economy in the second half of 2008 necessitated unprecedented fiscal expansions in most OECD and emerging-market countries. The resultant fiscal stimuli focused attention on the degree to which countries possessed "fiscal space" and on ways to apply it in a counter-cyclical manner. But what does "fiscal space" mean? In attempting to clarify this fuzzy concept, Heller (2005) defined it "as room in a government’s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy."
In our recent paper, we aim at defining a measurable "fiscal space" variable, and apply this concept in the context of the global crisis. A conventional metric, used by Maastricht criteria and frequently by scholars is the public debt/GDP. They question the degree to which normalizing public debt and fiscal deficit by the GDP is an efficient way of comparing fiscal space across countries and across time. A given ratio of public debt/GDP, say 60%, is consistent with ample fiscal space in countries where the average tax collection is about 45% of the GDP [Norway]. But, with a limited fiscal space, in countries where the average tax collection is about 10% [China, India].
A useful notion is the de facto tax base, measuring the realized tax collection as a fraction of the GDP, averaged across several years to smooth for business cycle fluctuations. The ratio of the outstanding public debt to the de facto tax base, or the tax-years needed to repay the public debt is measuring the de facto fiscal space. Figure 1 reports this measure of 123 countries, subject to data availability in 2006. It shows the wide variation in the tax-years needed to repay the public debt, from well below one year in Australia (indicating a high fiscal space), to about five years in Uruguay, and above 9 years in India and Argentina (indicating a very low fiscal space) (See Aizenman, Hutchison, Jinjarak, 2011). For most of the countries in our sample, the tax-years it would take to repay the public debt in 2006 were below three years. Figure 1 is consistent with the notion that, even without increasing the tax base, a fair share of countries had significant fiscal space in 2006.
Figure 1: De facto fiscal space measure based on public debt and tax revenue. Notes: This figure plots country’s fiscal space as measured by inverse of the tax-years needed to repay the public debt. De facto fiscal space measure based on public debt and tax revenue is defined by [2006 Debt/GDP] ÷ [2000-05 Average Tax Revenue/GDP.
They apply the de facto fiscal space in order to explain the cross-country variation in the fiscal stimulus during the aftermath of the global crisis. The pre-crisis tax revenue measures the de facto tax capacity in years of relative tranquility during the early 2000s -- the Great Moderation. The presumption is that a lower pre-crisis public debt and lower average fiscal deficits relative to the pre-crisis tax base imply greater fiscal capacity to fund stimuli using the existing tax capacity.
Figure 2 summarizes the averages of these measures for the low, lower-middle, upper middle, and high-income. The Figure suggests that in 2006, the middle income countries’ fiscal space was higher than the low income countries. While the debt overhangs [2006 public debt/GDP] of the low and lower middle income countries are slightly above the other groups, their ratio to the tax base is much higher than that of the upper middle income and the OECD countries. This in turn implies that the low- and lower-middle income countries may have more limited fiscal space than the upper-middle income and the OPEC countries. Consequently, the fiscal stimuli of the richer countries would have the side benefit of helping the poorer countries in invigorating the demands facing lower income countries.
Figure 2: De facto fiscal space by income classification.
The 2008-9 crisis led to a significant fiscal stimulus in the US, Japan, and Germany, the magnitude of which increased from 2009 to 2010, reflecting various lags associated with fiscal policy. In the US, Germany, and the UK, massive "bailout" transfers to the banking systems were put in place as an attempt to stabilize the financial panic. In Germany and the UK the size of these transfers to the financial systems exceeded the fiscal stimulus to the non-financial sector. Similar trends, though in varying intensity, were observed in emerging markets. China, South Korea, and Russia provided front-loaded fiscal stimulus at rates that were well above the one observed in the OECD countries. Notable is the greater agility of the emerging markets’ response relative to that of the OECD countries, reflecting possibly a faster policy response capacity of several emerging markets. This observation is remarkable considering the earlier evidence of the fiscal pro-cyclicality observed in emerging markets and developing countries during the 1980s-90s [see Kaminsky, Reinhart and Végh (2005)].
We perform a regression analysis, accounting for the cross-country variation in the fiscal stimulus during 2009-2011. We find that a greater de facto fiscal space, higher GDP per capita, higher financial exposure to the US, and lower trade openness were positively associated with fiscal stimulus/GDP during 2009-2011. The economic magnitude of these effects is large. Lowering the 2000-05 public debt/tax base from the average level of low-income countries (6) down to the average level of the Euro minus the periphery countries (2.3), was associated with a larger crisis stimulus in 2009-11 of 2.8 GDP percentage points. A decrease in the public debt/tax base revenue by one standard deviation (2.4) was associated with an increase of the fiscal stimulus during 2009-2011 of 2.2 percent of GDP.
Intriguingly, we found that higher trade openness had been associated with a lower fiscal stimulus, and higher exchange rate depreciations. A possible interpretation is that, as fiscal multipliers may be lower in more open economies, these countries opted for a smaller fiscal stimulus, putting greater weight on adjustment via exchange-rate depreciation ("exporting their way to prosperity"). The economic magnitude of these factors is sizable. An increase of trade openness ((Export+Import)/GDP) by 1 standard deviation (0.5) is associated with a higher cumulative depreciation during 2007-09 of 7 percentage points. The results validate the presence of gains associated with greater fiscal coordination among countries. A coordinated fiscal stimulus may generate positive spillover effects, mitigating the reliance on competitive depreciations. In a companion paper, we also study the usefulness of the de facto fiscal space measures by showing that they account better for sovereign spreads of countries than the more conventional public debt/GDP [Aizenman, Hutchison, and Jinjarak (2011)].
These results validate that the de facto fiscal space [tax revenue as a share of the GDP, averaged across the business cycle], provides a useful way of normalizing macro public finance Data, and account well for the patterns of fiscal stimuli and sovereign risk during and after the global crisis of 2008-9.
This post written by Joshua Aizenman and Yothin Jinjarak.