Current Expenditure Upswings in Good Times and Capital Expenditure Downswings in Bad Times? New Evidence from Developing Countries

We study the cyclical properties of two key expenditure categories (current and public investment spending) during the different phases of the business cycle. Anecdotal evidence suggests that policymakers usually cannot... [ view full abstract ]

We study the cyclical properties of two key expenditure categories (current and public investment spending) during the different phases of the business cycle. Anecdotal evidence suggests that policymakers usually cannot resist the temptation of spending more on current expenditure in good times, but only pick capital expenditures to adjust during bad times. In this paper, we answer the following questions: do current and capital expenditures react to the business cycle? If so, by how much, and why? In a sample of more than 100 developing countries and 30 developed countries observed between 1980 and 2014, we identify a new empirical regularity specific to developing countries: upswings are associated with increases in current primary expenditures (e.g. wages, transfers) only; while public investment falls and current spending remains acyclical during downturns. We also present evidence that such asymmetrical response is consistent with a political economy mechanism: incumbent politicians have stronger incentives to increase (decrease) current (capital) spending in good (bad) times in the presence of short political time horizons. Weak institutions provide the conditions to advance this policy pattern. Other type of factors traditionally discussed in the literature (limited creditworthiness, fiscal rules, and tax base volatility) have limited explanatory power.