Fiscal Policy, Governance, and the Growth Performance in Resource Abundant Economies

Evidence on whether fiscal policy affects growth is so far inconclusive. However, the recent view that differences in institutional and governance qualities could explain the differences in growth performance among countries is better established. Weak governance and institutional infrastructure could have a direct negative effect on growth by lowering the productivity of the economy. In more shock-prone economies, such as oil exporters, bad institutions can have an indirect effect by undermining the economy's ability to properly respond to external shocks. In particular, institutions affect the quality of fiscal policy management. This indirect effect is yet under-investigated, especially for oil-rich countries. A pro-cyclical fiscal policy, relatively high public debt ratios, or (and) a disproportionate increase in government spending during an oil boom can all be a manifestation of week institutions that lead to some form of fiscal policy failure. To the extent that this "voracity" effect is large, weak institutions and governance in oil-exporting countries can severely be detrimental to growth. Our central argument is that the quality of institutions and governance in such countries can affect the outcomes of fiscal policy, resulting in a second-round indirect effects on growth.

It is well documented that resource-rich countries, on average, have experienced poor growth performance compared to non-resource economies in the past few decades. The so called ''resource curse" phenomenon has intrigued many researchers to probe into the different potential channels. This study contributes to this literature by posing the following question. Could the interaction between different institutional qualities and fiscal policy mechanisms, such as expenditure composition and size, the financing decision, and the reaction to an external shock, explain the differences in growth performance among oil-exporters? The findings of this research can be of high relevance to the several resource abundant economies which have been striving recently to spur governance and best practices, and sustain growth.

The empirical investigation utilizes data for a panel of oil-rich countries for the period 1984-2007. In order to disentangle the direct effect of institutions on growth from that indirect effect through fiscal policy, the study applies a treatment effect model. In this empirical framework, the growth loss due to a greater frequency of fiscal policy management failure as a result of weak institutional and governance qualities can be compared to the direct effect of institutions on growth. IV methods are used to address endogeneity issues stemming from dual causality, measurement error, and other sources of potential bias in the results that could prevent robust inference.

The findings of this study should point into the direction of the necessary fiscal policy and institutional capacity that would enable sustainable growth in resource abundant economies. The results should clearly identify i) the effect of institutional quality on growth, ii) the indirect effect of institutions on fiscal policy and iii) the impact of fiscal policy on growth. The expected sign of these results is that i) bad institutions deteriorate growth, ii) bad institutions deteriorate fiscal performance and iii) procyclicality of fiscal policy has a negative effect on economic growth.