Comments and Discussion

Sanjeev Gupta:

Christopher Adam and David Bevan's paper makes an important contribution to fiscal adjustment literature. By analyzing fiscal adjustment in both Organization for Economic Cooperation and Development (OECD) and developing countries, the authors enrich our understanding of what sustains fiscal reforms and how the fiscal behavior differs across countries by income levels. Many studies have analyzed episodes of fiscal adjustment in industrial countries, but similar studies for developing countries, and in particular low-income countries, are rather limited. In this way Adam and Bevan's paper fills a void in the literature by building on the strengths of existing methodologies.

Adam and Bevan's paper confirms findings of Gupta and others, which are based on a sample of low-income countries but rely on a different measure of fiscal consolidation.¹ In particular for developing countries as a whole, they find that revenue increases and fiscal history, including the number of previous failures, are critical for sustaining fiscal adjustment, while expenditure reductions play a minor role. This contrasts with findings in the literature on industrial countries, where expenditure reductions dominate the sustainability of fiscal adjustment.

The policy implications stemming from these results are far reaching. While there will continue to be a need for improving efficiency of public expenditures in developing countries, the scope for raising additional revenue for sustaining fiscal adjustment cannot be overlooked. In general, the ratios of revenue to GDP in these countries are relatively low, in part because of weak administration and pervasive tax exemptions. This implies that revenue increases could be achieved without raising tax rates.

In order to explore different options for designing policies, however, Adam and Bevan's paper would need to find out more. For example, do wage cuts contribute to sustained fiscal consolidation? Does the composition of spending matter? The research on fiscal adjustment in low-income countries carried out by staff of the International Monetary Fund suggests that a reallocation of spending from current to capital outlays fosters growth² and is positively related to the persistence of adjustment. This may be due to the positive impact of capital spending on income growth, which in turn has a positive impact on the probability of sustaining fiscal consolidation. Additional work for a wider sample of developing countries would be needed to confirm this.

Further research is also needed to understand the channels through which initial fiscal and macroeconomic conditions impact on the persistence of fiscal adjustments in developing countries. Although the Adam-Bevan paper reports evidence on the impact of macroeconomic variables (such as inflation, growth, and exchange rates) on sustaining fiscal adjustment in these countries, the channels through which this happens—including whether the relationship is linear or nonlinear—are not clear.

The paper provides a useful typology of the definition of fiscal consolidation and persistence in applying survival analysis:

• mdash level approach (a specified threshold for the deficit);

• mdash gradient approach (reduction of the deficit at some specified minimum rate);

• mdash and composite approach.

Each approach has its own strengths and weaknesses. The work carried out by the IMF used what they refer to as the gradient approach, while Adam and Bevan prefer the level approach.

There are some difficulties in the use of the level approach. First, it imposes a common threshold on what is clearly a diverse group of countries facing different policy environments. The revised version of the paper rightly assesses the robustness of empirical results by taking into account disparity in circumstances facing middle- and low-income countries. But this approach does not fully capture diversity in effort required by countries for achieving fiscal sustainability as the overall fiscal deficit that is consistent with sustainable debt—expressed in nominal or net present value terms—varies from country to country. This is confirmed by work done by staff of the IMF on debt sustainability, which points to a variation in country-specific thresholds for a sustainable debt ratio.³ The latter is sensitive to such factors as export growth, current account balances, and commodity price developments. In addition, access and exposure to international capital markets are important determinants of fiscal...