Academic journal article Economia

When Do Governments Improve Fiscal Institutions? Lessons from Financial Crisis and Fiscal Reform in Latin America

Academic journal article Economia

When Do Governments Improve Fiscal Institutions? Lessons from Financial Crisis and Fiscal Reform in Latin America

Article excerpt

As countries recover from the worldwide financial crisis, much of the industrialized world has been facing pressure to initiate fiscal consolidation. The pressure is not only for policy reform (that is, expenditure cuts and revenue increases), but also for fundamental institutional reform. A variety of actors, including heads of international economic organizations, presidents of central banks, and prime ministers of countries, have called for fiscal institutional reforms. The European Union, in particular, strengthened its fiscal framework in 2011 and 2012, and some countries are now under joint European Union and International Monetary Fund (IMF) programs.

This paper examines the connection between financial crisis and fiscal institutional reforms in a region of the world that has experienced plenty of both-namely, Latin America. Fiscal institutional reforms are those that reduce the size of the common pool resource problem that is endemic in fiscal decisionmaking. Latin America is interesting in the context of the current crisis. Unlike other regions, such as eastern Europe or the United States, it seems to have done well economically relative to the rest of the world in the last few years and to have avoided major financial crises. This is a reversal of previous world shocks, such as the East Asian crisis in the late 1990s, when Latin America was susceptible to contagion. Latin American politicians have expressed exuberance, claiming that their policies have worked.1 Many analysts concur that better fiscal management before the crises allowed these countries to respond swiftly to the negative shock, so that the effects of the crisis in the developed world were minor in Latin America.2 Were these apparently successful reforms the result of learning from previous crises?

Three major financial crises hit the region in the past twenty years: the Mexican (or tequila) crisis, the Brazilian (or caipirinha) crisis, and the Argentine (or tango) crisis. While each of these hit one or more of the largest countries especially hard, they affected the entire region. In addition to regional crises, there were also a number of financial crises that were concentrated in specific countries. Latin American governments introduced several fiscal institutional reforms in the same period. Fiscal responsibility laws, which usually combine numerical spending or budget balance targets with measures to increase transparency, were particularly common in the late 1990s and early 2000s. After these reforms, countries in Latin America have, in general, fared much better in terms of their fiscal results than before the reforms. Several authors contend that the improved fiscal institutional frameworks directly contributed to higher levels of fiscal discipline.3

In this paper, we explore why countries implemented fiscal institutional reforms in the first place. In particular, when a financial crisis hits a country, under what conditions does the government initiate fiscal reforms? What are the political conditions that make reforms more or less likely?

The paper begins with the conceptualization of our dependent variable, which is whether there is fiscal institutional reform, and how to operationalize it. The second part considers how financial crises may be connected to reforms and explains how we measure crises. We then look at additional catalysts for reform before providing our empirical analysis, including robustness tests. We find that financial crises initially retard fiscal reforms so much that they simply do not occur. As the crisis continues, however, governments need credibility with markets, so they introduce fiscal reforms in later years. Moreover, if the crisis transforms into a true sovereign debt crisis, fiscal reforms become much more likely.

Fiscal Institutional Reforms in Latin America

Conceptually, we are interested in changes in rules and institutions. The core theoretical model on why fiscal institutional reforms that centralize the budget process are important assumes that all policymakers face a common pool resource (CPR) problem. …

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