Government Consumption Volatility and the Size of Nations

Abstract

This paper provides empirical evidence showing that smaller countries tend to have more volatile government consumption for a sample of 160 countries from 1960 to 2000. It also shows that country size is negatively related to the discretionary part of government consumption and to the volatilities of most of government consumption items. We argue that the larger size of a country decreases the volatility of government consumption because it acts as an insurance against idiosyncratic shocks, and it leads to increasing returns to scale due to the higher ability of the government to spread its cost of financing over a larger pool of taxpayers. The results are robust to different time and country samples, different econometric techniques and to several sets of control variables.

The influence of decentralized taxes and intergovernmental grants on local spending volatility

“…The literature offers a few studies on the determinants of such volatility. For instance, Furceri and Poplawski-Ribeiro (2009) use data for 160 countries from 1960 to 2000 to prove that country size, proxied by total population, is associated with lower government consumption volatility. This suggests that smaller countries are characterized by more volatile public spending.…”

“…In addition to country size, the literature suggests that both demographic (Albuquerque, 2011;Furceri & Poplawski-Ribeiro, 2009) and macroeconomic (Afonso, Agnello, & Furceri, 2010;Brzozowski and Siwinska-Gorzelak, 2010) factors may potentially affect government consumption volatility, as well as political and institutional ones (Albuquerque, 2011). 3 In general, the level of development is thought crucially to affect public spending volatility, with low-income economies experiencing higher volatility than high-income ones (Furceri et al, 2014).…”

“…Sub-central spending volatility is worth studying in the light of its potential effects on the economy, as suggested by the literature on aggregate spending volatility. On the one hand, the latter may have detrimental effects on economic growth and welfare (Fatás & Mihov, 2003Furceri, 2007;Loayza, Ranciere, Servén, & Ventura, 2007) and, on the other hand, it may be beneficial to smooth out business cycle fluctuations (Furceri & Poplawski-Ribeiro, 2009). It is conceivable for local spending volatility to have similar effects as it constitutes a significant part of aggregate spending in most advanced countries (OECD, 2009b).…”

“…The existing contributions dealing with volatility only investigate that of aggregate expenditure measures, such as government consumption (Furceri & Poplawski-Ribeiro, 2009) or discretionary spending (Albuquerque, 2011). The main existing findings point towards spending volatility being negatively associated with the quality of institutions and country size/ population.…”

Deep Roots of Fiscal Behavior

“…Ramey and Ramey (1995) presented evidence that government spending volatility has a negative effect on real GDP per capita growth. Looking at the underlying determinants, Furceri and Poplawski-Riberio (2008) found that smaller countries tend to have more volatile government spending, while Agnello and Sousa (2009) observed significant linkages between deficit volatility and the level of economic development, political instability, and inflation, especially in countries with more trade openness. From a macro-fiscal point of view, Fatás and Mihov (2003) showed that numerical fiscal rules tend to lead to a lower degree of volatility in fiscal policy implementation.…”