The level and signed consistency of these two measures of fiscal deficits is equally reflected in the correlation between fiscal performance and economic growth across the sample. For all but three countries (Botswana, Gambia and Senegal), the correlation between income growth and fiscal balance is positive, both when fiscal performance is measured by operational and structural balances. However, the correlation coefficient associated with these positively correlated variables is not systematically significant. Despite this lack of significance, the positive association between operational balance and growth in a number of countries may suggest that a strong fiscal stance is growth-enhancing.

However, correlation does not necessarily imply causation. In fact, the positive association derived from point estimates is not consistent over the entire support of the distribution. An assessment of the relationship over the entire support of the distribution produces a more ambiguous result. In effect, a long-term trend of operational balance and growth suggests that sharp deteriorations of fiscal balances are likewise associated with higher and lower rates of economic growth. This ambiguous result is illustrated by Figure 1, which depicts operational balances and economic growth rates in Nigeria and Senegal. This outcome suggests that the relationship between fiscal adjustment and growth in the region warrants a further investigation.<sup>15</sup>

# **III. Analytical Framework**

A review of empirical research that models the effects of fiscal adjustments on growth suggests that fiscal austerity affects economic growth through a nonlinear pattern [Giavazzi, Jappelli and Pagano (2000)]. The inherent nonlinearity reflects varying and event divergent responses to fiscal adjustment by economic agents. Analytically, the alternative linearity hypothesis would require a uniform distribution of expected benefits of growth across the different economic agents following a fiscal impulse, irrespective of the determinants of growth and consumer behaviors.

In practice, there are a host of growth determinants which affect output in different ways. Although private and public investments are often singled out as key determinants of growth, there are other factors which may just as well play a significant role in the accumulation process. Most notable among these factors are human capital formation, research and development, openness and a set of initial conditions [Jovanovic and Nyarko (1996), Pattillo et al. (2005)]. While the transmission channels of fiscal adjustments may use indirect paths, the welfare effects of fiscal adjustments are more direct, especially when the reduction of deficits entail expenditure switching, and particularly cuts in public expenditures and wages [World Bank (2003), Sachs and Warner (1995), Gupta et al. (2005)].

Analytically the resilience effects associated with initial conditions, which are critical for long-run growth and output expansion, are illustrated by the nature and quality of physical infrastructures and level of economic development. At the same time, the growth effects of fiscal adjustments differ significantly over time. Fiscal adjustments that may first appear contractionary may become expansionary in the medium to long term. This can happen as a result of delayed response to the implementation of expansionary fiscal policies or out of concerns regarding the financing of inherent growing deficits.

> 15 Further information on trend of operational balance and growth is provided in Annex Table 1 for other countries.

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