The Distributional Effects of Government Spending Shocks in Developing Economies

IMF Working Papers, March 14, 2018

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Constructed unanticipated government spending shocks for 103 developing countries from 1990 to 2015.
Main finding: unanticipated fiscal consolidations lead to a long-lasting increase in income inequality, while fiscal expansions lower inequality.
Additional finding: (unanticipated) fiscal consolidations lead to an increase in poverty.

Sample: 103 developing countries, 1990–2015.
Identification: unanticipated government spending shocks (details in underlying paper).
Distributional measures: several measures of income distribution and size of fiscal shocks were used; results robust across these measures.
Comparisons: effects examined across expansions and recessions and across country groups (low-income countries versus emerging markets).
Decompositions: effects estimated separately for total government expenditure, public investment, and public consumption.

Directional effects:
- Fiscal consolidations → long-lasting increase in income inequality.
- Fiscal expansions → decrease in income inequality.
Robustness:
- Results robust to several measures of income distribution and size of the fiscal shocks.
- Results robust to an alternative identification strategy.
- Results hold across expansions and recessions and across country groups (low-income countries versus emerging markets).
Component effects:
- The inequality effect is larger for total government expenditure than for public investment and consumption.
- Likely channel: the redistributive role of transfers in total government expenditure.

Computed a medium-term inequality multiplier.
On average about 1 in the sample.
Interpretation: a cumulative decrease in government spending of 1 percent of GDP over 5 years is associated with a cumulative increase in the Gini coefficient over the same period of about 1 percentage point.

Fiscal consolidations (unanticipated) are associated with an increase in poverty (finding reported in the paper).

Reductions in total government expenditure can have meaningful distributional consequences, increasing inequality and poverty in developing economies.
The redistributive components of government spending (transfers) appear important in mitigating inequality; cuts to total expenditure may be more harmful for distribution than cuts focused on public investment or consumption alone.
Policymakers should weigh distributional and poverty effects when designing fiscal consolidations and consider protecting redistributive spending to limit adverse distributional outcomes.

Source: IMF Working Paper by Davide Furceri, Jun Ge, Prakash Loungani, and Giovanni Melina, March 14, 2018.