_Procyclicality_ is a measure of the extent to which government spending responds to business-cycle variation in GDP. Formally Git=θiGDP<sup>cycl</sup> it. The parameter θ captures the pro-cyclicality of government spending. I.e. if θ is positive, then government spending increases when the cyclical component of GDP is positive (meaning, when GDP is above trend). We obtain data on θ from Frankel et al. (2013). Frankel et al. (2013) provide values of θ for a sample of 93 countries; we will use this data in the estimation of equation (1). In order to maximize coverage of countries when estimating equation (1), we will apply the methodology of Frankel et al. to generate values of θ for countries not covered by Frankel et al. (2013).

The econometric model includes country fixed effects, ai. These fixed effects capture time-invariant country characteristics that affect economic growth, i.e. variables related to history and geography. Note that the country fixed effects account for the linear effect that _FDi_ and _Procyclicalityi_ have on economic growth. The time fixed effects, bt, capture common shocks that affect countries' GDP per capita growth in a given time period.

Differentiating equation (1) with respect to volatility yields: (2) d(Growth)/d(Volatility) = α + β*FDi + γ*Procyclicalityi Hypotheses (i)-(iii) imply that α<0, β<0, γ<0.

In order to examine whether the coefficients α, β, and γ differ for the Eastern Caribbean, we augment the econometric model: (3) Growthit = ai + bt + α1Volatilityit + β1(Volatilityit*FDi) + γ1(Volatilityit*Procyclicalityi) + (α2Volatilityit + β2(Volatilityit*FDi) + γ2(Volatilityit*Procyclicalityi))*OECSi + φ1lnGDPit-1 + e1it where _OECS_ is an indicator variable that is unity if countries are part of the Organization of Eastern Caribbean States. Note that α2, β2, and γ2 capture the differences in effects that the variables of interest have on economic growth in OECS countries. This can be seen from differentiating equation (3) with respect to volatility: (4) d(Growth)/d(Volatility) = α1 + β1*FDi + γ1*Procyclicalityi + (α2 + β2*FDi + γ2*Procyclicalityi)*OECSi

- (5) d(d(Growth)/d(Volatility))/dOECSi= α2 + β2*FDi + γ2*Procyclicalityi

Although small-island countries have greater terms of trade and output volatility (see Easterly and Kraay, 2000; Tumbarello, 2013), it is unclear whether this implies heterogeneity in the coefficients specified in equation (1). In fact, Easterly and Kraay (2000) conclude that small states are no different from large states, and so should receive the same policy advice that large states do.

We note that standard errors are Huber robust and clustered at the country level. Clustering standard errors at the country level ensures that residuals are appropriately adjusted for arbitrary within-country serial correlation (Wooldridge, 2002).

Table 1 provides a list of the variables used in the econometric analysis and their data sources. Table 2 shows bi-variate correlations. Summary statistics of the variables' first and second

> of the financial sector. La Porta et al. document for a cross-section of countries that financial development is significantly higher in countries with common law.

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