The pursuit of countercyclical fiscal policy through discretionary increases to public spending, with the wage bill comprising the largest share of overall expenditure increases, resulted in South Africa’s budget structurally increasing to a higher level of expenditure to GDP. To the extent that the expansion of expenditure was based on a mirage of higher potential GDP, it is difficult to reverse past decisions and return to a budget size more in line with actual potential GDP. In South Africa, in light of high public debt, high expenditures but slowing revenue dynamics, this has only left the option to cut discretionary spending, notably on infrastructure. Yet, cutting investment eventually comes at the expense of raising future potential, to the levels where it was perhaps expected when the cycle became the trend.

## _4. Underestimated structural dynamics_

The commodity super cycle is one possible reason why potential GDP growth was overestimated. Another potential reason is that South Africa’s structural constraints—and the ability to resolve them— have been underestimated, resulting in an unanticipated slowdown in potential GDP growth. World Bank Group (2018) shows that total factor productivity growth has been decelerating significantly in South Africa, and declining in recent years. This can be due to multiple factors, including rigid factor markets that keep factors from being allocated more efficiently. It can also be due to South Africa losing global competitiveness due to labor ad factor market rigidities and the weakening of the performance of important state-owned enterprises, in electricity or transport. South Africa has also been attracting relatively limited investment (both physical and in innovation). The World Bank Group partly attributed this to policy uncertainty that is keeping investors wary. An underappreciation of the magnitude of South Africa’s challenges may also have resulted in overestimates of potential growth, in addition and beyond _the cycle is the trend_ .

# 5. Conclusion

Fiscal policy is an important stabilization tool. Adequate countercyclical fiscal policy may stabilize the economic cycle. Unfortunately, policy mis-steps such as the mistiming of fiscal policy can destabilize the cycle, or prolong recessions. This paper estimates the cyclical stance of EMDEs with a focus on South Africa by decomposing the budget into transitory and permanent components. To control for the variability in output, a _cycle is the trend_ variable is constructed, but cleaned of commodity price effects. This accounts for the possibility that the authorities might perceive long cycles as the trend – in which case they run the risk of enacting procyclical fiscal policy.

The results show that fiscal policy in EMDEs has been mostly procyclical. This result is robust regardless of different lengths of _the cycle is the trend_ or alternative measures of the cycle such as the output gap. This can be attributed to good intentions by the fiscal authorities, but missing either important turning points of the business cycle, perceiving long-cycles as the trend due to commodity price cycles, poor choices on spending which are difficult to reverse such as wages or weak policy coordination where funds are disbursed and allocated but not spent on time.

We study South Africa to understand the extent to which this may have played out in a case study. An interesting outcome of the analysis for South Africa is the relationship between the fiscal stance and a derived _intention_ measure which is calculated using texts from various Budget Reviews. The difference between outcomes and intentions yields a set of consistency measures. They show that meeting budget announcements and stabilizing the business cycle have been at odds at times and the outcomes related to intentions sometimes went in opposite directions. There exists thus a mismatch between what the government aimed to achieve (e.g. countercyclical fiscal policy) and the outcome. Imperfect knowledge regarding the length of the economic cycle (e.g. the commodity boom in the 2000s), and external shocks and other exogenous shocks may have contributed to this mismatch.

These results imply that forecasts of GDP and specifically the output gap have a large weight in policy errors. A clearer understanding of the duration of cycles, the impact of expenditure and revenue policies on the cycle and credibility of fiscal policy will go a long way in aligning fiscal policy with macroeconomic objectives of sustainable countercyclical fiscal policy.

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