OCTOBER 2010
ABSTRACT: Public spending and investments in various sectors of the economy may behave differently over the business cycle, yet these dynamics are still poorly understood. The present paper analyzes the cyclicality of public spending on key social and economic sectors, including agriculture, education, health, social protection and military spending using data for about 38 developing countries spanning the period from 1980 to 2004. As a potential innovation in the literature, we turn to regressions involving dummy variables for growth acceleration and deceleration episodes to try and tease out possible patterns of public spending over these pronounced episodes in the business cycle. An over-all assessment of the results would suggest that public spending patterns in these sectors tend to be acyclical. The exception is public spending on education which seems to display some evidence of procyclicality. On the other hand, military spending seems to increase during growth accelerations. However, in countries with stronger governance, this increase also tends to be tempered. Growth decelerations do not tend to affect military spending, with the exception of countries with stronger governance where military spending tends to shrink during growth decelerations. With better governance, public finance allocations may reflect adjustments that tend to mitigate the build-up in military spending, particularly during downturns when social priorities may take precedence.
JEL Code: E-62; H-50; O-23
Key Words: business cycle; governance; social spending; fiscal space; countercyclical fiscal policy