Estimating Conditional Functional Multipliers

Abstract

Spending based fiscal adjustment requires decisions on when? and how much to cut public spending to minimise adveræ effects on economic growth. This requires precise estimates of the response of output to changes in the functional components of public spending. I call this the functional multiplier.I disaggregate government spending in 36 low-income countries over the Period 1984-2013 into its functional components. Using a GMM-IV model with fuel subsidies as the instrument for government spending I exploit difference in the length of exposure to statehood as a proxy for current absorptive capacity to estimate functional multipliers conditional on absorptive capacity.The estimated functional multipliers vary from -1.11 for economic ærvices to 1.82 for social protection. I find that a one standard deviation change in absorptive capacity yields a 18 percent larger multiplier compared to the average level of absorptive capacity. A similar exercise for contestability shows that a one standard deviation change in contestability yields a 14 percent larger multiplier compared to the average level of absorptive capacity. I subject the GMM-IV estimates to a rigorous test to determine whether the estimated relationships an causal and not simply spurious correlation. Post-double LASSO estimates show that that the conditional functional multipliers are precisely estimated and of the same order of magnitude (though slightly larger) than the GMM-IV estimates. To obtain multipliers for individual countries (and not averages) I use a Bayesian iterative shrinkage estimators. The shrinkage estimates show that countries with higher than average absorptive capacity have multipliers that are 15 percent larger than thoæ below the average.