metadata: authors: 0: author: Bogetic,Zeljko
1: author: Naeher,Dominik
count: Middle East and North Africa,Poland
docna: 0: docna: Is Escaping the Fiscal Pro-Cyclicality Trap
            Possible ? Evidence from the Middle East and North Africa
docty: Policy Research Working Paper
abstracts: cdata!: This paper analyzes fiscal policy
            cyclicality, with a specific focus on the Middle East and
            North Africa region, which is known for its significant
            output volatility. The paper provides new and more granular
            evidence on the direction, intensity, and specific fiscal
            sources of cyclicality. Based on annual data covering 184
            countries from 2000 to 2022, the findings suggest that there
            are important differences in the assessment of
            countercyclical fiscal policy achievements among different
            fiscal policy variables, across world regions, and also
            within the Middle East and North Africa region. While the
            global associations between fiscal cyclicality and income
            levels have remained relatively stable, countries in the
            Middle East and North Africa have exhibited diverse
            performances, some transitioning toward countercyclicality
            and others moving away from it. The paper also identifies
            several countries in the Middle East and North Africa that
            have successfully shifted from procyclical to
            countercyclical fiscal policy, breaking free from the
            &#x201c;fiscal pro-cyclicality trap.&#x201d; To
            understand more specific fiscal sources of cyclicality, the
            paper examines subcomponents of revenues and expenditure. It
            shows that nontax revenues exhibit a greater degree of
            procyclicality than tax revenues, and subsidy expenditures
            tend to be less countercyclical than other fiscal
            expenditures. This has policy implications and adds a
            dimension of assessment to subsidies that is not addressed
            in the literature: subsidies, being less countercyclical
            than other expenditures in the Middle East and North Africa,
            do not contribute to macroeconomic stability and long-term
            growth through this channel, independent of their adverse
            efficiency, distributional, and fiscal space effects. The
            paper concludes with a discussion of the implications of
            these findings, aimed at improving countercyclicality in
            fiscal policy.
display_title: Is Escaping the Fiscal
            Pro-Cyclicality Trap Possible ? Evidence from the Middle
            East and North Africa
listing_relative_url: /research/2024/10/34412617/escaping-fiscal-pro-cyclicality-trap-possible-evidence-middle-east-north-africa
topicv3: Fiscal Consolidation m1326651 1116,Macro-Vulnerability m1326711 1148,Fiscal Policy and Growth m1326899 1072,Fuel Subsidies m1327095 1628,Fiscal Counter-Cyclicality m1327617 1117
publishtoextweb_dt: 2024-10-28T00:00:00Z
dois: 10.1596/1813-9450-10959
origu: Off of Sr VP Dev Econ/Chief Econ (DECVP)
no_of_pages: 19
author_keys: 0: author_key: 94115
1: author_key: 1499381
model_extractions: Policy Research Working Paper 10959 Is Escaping the Fiscal Pro-Cyclicality Trap Possible? Evidence from the Middle East and North Africa _Željko Bogetić Dominik Naeher_ Prosperity Practice Group October 2024 A verified reproducibility package for this paper is available at http://reproducibility.worldbank.org, click **here** for direct access.
Policy Research Working Paper 10959

# **Abstract**

This paper analyzes fiscal policy cyclicality, with a specific focus on the Middle East and North Africa region, which is known for its significant output volatility. The paper provides new and more granular evidence on the direction, intensity, and specific fiscal sources of cyclicality. Based on annual data covering 184 countries from 2000 to 2022, the findings suggest that there are important differences in the assessment of countercyclical fiscal policy achievements among different fiscal policy variables, across world regions, and also within the Middle East and North Africa region. While the global associations between fiscal cyclicality and income levels have remained relatively stable, countries in the Middle East and North Africa have exhibited diverse performances, some transitioning toward countercyclicality and others moving away from it. The paper also identifies several countries in the Middle East and North Africa that have successfully shifted from procyclical to countercyclical fiscal policy, breaking free from the “fiscal pro-cyclicality trap.” To understand more specific fiscal sources of cyclicality, the paper examines subcomponents of revenues and expenditure. It shows that nontax revenues exhibit a greater degree of procyclicality than tax revenues, and subsidy expenditures tend to be less countercyclical than other fiscal expenditures. This has policy implications and adds a dimension of assessment to subsidies that is not addressed in the literature: subsidies, being less countercyclical than other expenditures in the Middle East and North Africa, do not contribute to macroeconomic stability and longterm growth through this channel, independent of their adverse efficiency, distributional, and fiscal space effects. The paper concludes with a discussion of the implications of these findings, aimed at improving countercyclicality in fiscal policy.

This paper is a product of the Prosperity Practice Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at zbogetic@worldbank.org and dnaeher@uni-goettingen.de. A verified reproducibility package for this paper is available at http://reproducibility. worldbank.org, click **here** for direct access.

<!-- Start of picture text --> TRANSPARENT<br>ANALYSIS<br>G<br>R E<br>N<br>S<br>I P<br>Y E<br>K A<br>C A<br>R P<br>LI R<br>O E<br>O C<br>W R<br>H<br>S<br>P<br><!-- End of picture text --> _The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
Is Escaping the Fiscal Pro-Cyclicality Trap Possible? Evidence from the Middle East and North Africa by **Željko Bogetić**<sup>∗</sup> **and Dominik Naeher**<sup>+</sup> _Keywords:_ Fiscal policy, Business cycle, Procyclicality, Countercyclicality, MENA _JEL codes:_ E32, E62, H20, O23

> ∗ World Bank Group, Washington, DC, United States. E-mail: zbogetic@worldbank.org.

> + University of Goettingen, Goettingen, Germany. E-mail: dnaeher@uni-goettingen.de.
# **1. Introduction**

Fiscal policy can be a powerful tool to stabilize the economy, but it represents a double-edged sword. When it operates procyclically, that is, when public expenditure and the fiscal deficit expand during good times or when it cuts public expenditures and reduces the fiscal deficit in bad times (“austerity”), it amplifies the economy’s business cycle, intensifying both economic upswings and downturns. In this way, procyclical fiscal policy can undermine macroeconomic stability as well as long-term growth. Conversely, when fiscal policy runs counter to the business cycle, it helps smooth it, therefore, contributing to macroeconomic stability and long-term growth, which depends on macro stability. The key to implementing countercyclical fiscal policy, however, is understanding its past trends and precise sources of cyclicality so that effective policy reform can be implemented towards greater countercyclicality which contributes to macroeconomic stability and growth.

This paper makes thee contributions to the empirical literature on cyclicality of fiscal policy in general and, specifically, within the Middle East and North Africa (MENA) region. First, using the most recent and largest database covering 184 countries for the period 2000-2022, we reassess the overall direction, intensity, and sources of cyclicality of fiscal policy across the world, with particular focus on the MENA region; we provide a more granular view of subcomponents of expenditures and revenues that contribute to the overall cyclicality than has been the case in the previous literature, which often relied on a single variable of fiscal policy to measure its cyclicality. Second, we pay particular attention to identifying country cases that managed to escape the “fiscal procyclicality trap”, moving fiscal policy management in the desirable direction. Third, we draw implications of the analysis and thoughts on how governments can make their fiscal policies more countercyclical, contributing to macroeconomic stability and growth.

# **2. Related literature and contribution of this paper**

Based on both theoretical insights and empirical evidence, considerable economic policy research advocates for a countercyclical fiscal policy, urging policy makers to actively deploy government spending and taxation to counteract the natural fluctuations of the business cycle (Chari et al. 1994, Riera-Crichton et al. 2015, Aizenman et al. 2019). During recessions, when private sector spending decreases, governments can, indeed, boost economic activity by increasing fiscal expenditures and/or reducing taxes (provided that they have sufficient “fiscal space”), thereby preventing further declines in employment and income.

Conversely, during economic booms when the private sector thrives and tax revenues rise, countercyclical fiscal policy entails scaling back expenditures and/or increasing taxes to prevent the economy from overheating and potentially contributing to accelerated inflation. The countercyclical approach to fiscal policy aims to mitigate inflationary pressures and build fiscal reserves or “buffers” in good times that can be used in future economic downturns. Put simply, the approach can be summarized as “save in good times, spend in bad times”. Empirical evidence, indeed, suggests that embracing fiscal policy countercyclicality not only stabilizes the economy, but also fosters economic growth, whereas procyclicality can impede growth (Woo 2009; World Bank 2024).

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The empirically observed cyclicality of fiscal policy differs widely across countries, including by income group. Most industrial countries have successfully pursued countercyclical fiscal policy (Frankel et al. 2013). This is typically facilitated through automatic stabilizer processes, whereby tax revenues tend to decrease and transfer payments increase during recessions even without the implementation of discretionary policy measures (Bashar et al. 2017).

At the same time, it has been argued that developing and emerging economies can be caught in a fiscal pro-cyclicality trap, whereby fiscal policy is persistently procyclical, reinforcing the business cycle and adding further instability to the economy, thereby making attaining a countercyclical fiscal policy even more challenging (Vegh & Vuletin 2015, Herrera et al. 2019). Explanations for this behavior in the literature center around imperfect access to international credit markets, lack of financial depth, and political distortions (Tornell & Lane 1999, Talvi & Vegh 2005, Alesina et al. 2008, Frankel et al. 2013, Bogetić & Naeher 2024). Nevertheless, recent work has also documented countries successfully escaping the fiscal pro-cyclicality trap (Herrera et al. 2019).

This paper updates and expands the existing evidence on countries that managed to switch from procyclical to countercyclical fiscal policy. Our empirical analysis is conducted at a global scale, but in interpreting the results we mostly focus on the Middle East and North Africa (MENA) region. This region is home to countries with the highest output volatility in the world (Abdih et al. 2010) and thus is particularly interesting to study in this context. Various fiscal policy variables have been analyzed in the existing literature, including government spending, revenue, tax rates, and fiscal balance (or deficit). For example, a recent study by Nguyen and Lotfi (2024) shows that public expenditure policy has been largely procyclical in MENA countries. However, this and many previous studies focus either on the spending or the financing side, often choosing a single indicator as their main fiscal policy variable of interest. In contrast, we build a dataset that allows us to analyze multiple fiscal policy variables side-by-side in order to shed light on how some countries managed to escape the fiscal pro-cyclicality trap, providing a much more nuanced view of cyclicality and its sources within the components of the budget revenues and expenditures. In addition, we make use of more comprehensive data on fiscal policy variables than most previous studies were able to exploit, which allows us to zoom in on specific subcomponents of government spending (subsidies, grants, and other social benefits) and of government revenue (tax vs. non-tax revenue).

Our findings suggest that there are important differences in the assessment of countercyclical fiscal policy achievements among different fiscal policy variables. Specifically, we find that, over the past two decades, many countries in the world featured countercyclical fiscal policy in revenue and fiscal balance, but not in expenditures. This suggests that automatic stabilizer processes may be stronger on the revenue (financing) side than on the spending side, or that many countries implemented discretionary policy measures more effectively for revenues than for expenditures.

We also find that, while the average relationship between fiscal policy cyclicality and income levels across countries remained relatively stable over the past two decades, individual countries exhibit diverse performances. This also applies to the MENA region, where some countries transitioned towards countercyclicality, and others moved away from it. There are also many countries where the direction of change differed across fiscal policy variables, which again highlights the importance of investigating different fiscal policy variables side-by-side. We identify several MENA countries (notably Jordan, Oman, ~ 3 ~
and Qatar) that managed to switch from fiscal procyclicality to countercyclicality over the past two decades. This confirms previous findings in the literature suggesting that escaping the fiscal pro-cyclicality trap is possible and demonstrates that this is feasible even for countries in a region like MENA with very high output volatility.

When looking at different subcomponents of government revenue, we find that tax revenue and non-tax revenue in MENA countries featured similar cyclicality patterns but of different magnitudes, with non-tax revenue typically moving more strongly with the business cycle than tax revenues (which is a desirable outcome for revenues under countercyclical fiscal policy). On the spending side, we find that subsidy expenditures in MENA countries tend to be less countercyclical (more procyclical) than other fiscal expenditures (an undesired outcome for revenue under countercyclical fiscal policy). Our findings give rise to implications for policies aimed at making fiscal policy more countercyclical, which we discuss in detail below.

# **3. Data and methods**

The existing literature uses various policy variables to analyze fiscal cyclicality, including government spending, revenue, and fiscal balance (or deficit). On the revenue side, it is often argued that (tax) revenues are endogenous to the business cycle and tend to support countercyclical fiscal policy simply as a result of the widened tax base during times of expansion (Vegh & Vuletin 2015, Bashar et al. 2017). This suggests that, in evaluating the performance of fiscal policy decisions on the financing side, tax rates rather than tax revenue should be considered. However, comparable cross-country data on tax rates are not readily available (Bashar et al. 2017).<sup>1</sup> To ensure the robustness and greater granularity of our conclusions, and to shed light on how some countries managed to escape the fiscal pro-cyclicality trap, our study analyzes multiple fiscal policy variables side-by-side. Specifically, the main fiscal policy variables considered in our empirical analysis are government total expenditure, government revenue, and overall fiscal balance. We also consider revenue as a share of GDP as an alternative to tax rates, as an increase in both indicators during economic expansions and a decline during recessions points towards countercyclical fiscal policy measures. In addition, we zoom in on particular subcomponents of government spending (subsidies, grants, and other social benefits) and of government revenue (tax vs. non-tax revenue).

The data used in this study are publicly available from the following sources (we subjected the data to consistency checks). Annual data for general government revenue (percent of GDP) and general government total expenditure (percent of GDP) come from the International Monetary Fund’s World Economic Outlook database (IMF 2023). Annual data for tax revenue (percent of GDP) come from the IMF’s World Revenue Longitudinal Dataset (IMF 2022). Annual data for subsidies including grants and other social benefits (percent of GDP),<sup>2</sup> real GDP (constant local currency unit, LCU), and real GDP per capita

> 1 Building their own dataset on tax rates for 62 countries for the period 1960-2013, Vegh & Vuletin (2015) find tax policy to be acyclical in industrial countries but mostly procyclical in developing countries. However, their dataset covers very few low-income countries, which are of particular interest in our study.

> 2 More precisely, the subsidy variable includes all unrequited, nonrepayable transfers on current account to private and public enterprises; grants to foreign governments, international organizations, and other government units; and social security, social

~ 4 ~
(constant 2015 US$) come from the World Bank’s World Development Indicators database (World Bank 2023).

The data on revenue (percent of GDP), tax revenue (percent of GDP), expenditure (percent of GDP), and subsidies (percent of GDP) are multiplied with real GDP (constant LCU) to derive the respective total values measured in LCU. Following the previous literature (Talvi & Vegh 2005; Frankel et al. 2013), the cyclicality of each of these variables is estimated as the correlation between the cyclical component of the respective variable ( ) and the cyclical component of GDP ( ): XX YY C i i i i )], (1) Cyclicality(XX) = C [(XX −XX<sup>�</sup> ) −(YY −YY<sup>�</sup> where i i ) is the Hodrick-Prescott (HP)-filtered cyclical component of the logarithm of the fiscal policy variable , and i i ) is the HP-filtered cyclical component of the logarithm of real GDP (XX −XX<sup>�</sup> (following Ravn & Uhlig 2002 and Belhaj et al. 2022, we use a smoothing parameter of ). The XX (YY −YY<sup>�</sup> cyclicality of revenue as a share of GDP is computed in the same way but without taking logs. The cyclicality λλ= 6.25 of the overall fiscal balance is computed as the difference between the cyclical component of government revenue and the cyclical component of government expenditure (IMF 2016).

For each fiscal policy variable, a positive correlation indicates procyclical behavior and a negative correlation indicates countercyclical behavior relative to the business cycle. It is important to note that countercyclical fiscal policy requires expenditures to move countercyclically to the business cycle, whereas revenues and fiscal balance should move procyclically to the business cycle; that is, revenues should _increase_ during economic booms (when GDP increases), dampening the cycle, and _decrease_ during recessions, softening the economic downturn (when GDP decreases). Therefore, we will interpret the derived correlation coefficients as being in line with the goal of countercyclical fiscal policy if they are negative for expenditures and positive for revenues and fiscal balance.

The sample covers 184 countries in the period 2000-2022, including 17 MENA countries: Algeria, Bahrain, the Arab Republic of Egypt, Iraq, the Islamic Republic of Iran, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Qatar, Saudi Arabia, Tunisia, the United Arab Emirates, the West Bank and Gaza, and the Republic of Yemen (other countries in the MENA region are excluded for lack of consistent data).

# **4. Empirical results**

**Over the past two decades, fiscal policy tended to be more countercyclical in richer economies.** Figure 1 shows the correlation between the cyclicality of several fiscal policy variables and countries’ income levels. Most low- and middle-income countries feature procyclical or cyclically neutral expenditures, whereas most high-income countries feature countercyclical expenditures. At the same time, high-income countries also saw their revenues and fiscal balances move more strongly in line with the business cycle, corresponding to the desired outcome under countercyclical fiscal policy. This indicates that richer countries were generally more successful in achieving countercyclical fiscal policy than countries with

assistance benefits, and employer social benefits in cash and in kind (World Bank 2023). For the Arab Republic of Egypt, we amend this variable with data from World Bank internal sources as follows (for the years 2003-2023): 4.9%, 5.1%, 5.5%, 11.2%, 7.8%, 10.3%, 12.2%, 8.5%, 9.0%, 9.0%, 10.6%, 10.7%, 8.1%, 7.4%, 7.6%, 7.1%, 5.1%, 3.7%, 4.0%, 4.4%, 4.4%.

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lower income levels. This is consistent with the findings of previous studies (Vegh & Vuletin 2015, Herrera et al. 2019), although existing studies often focus exclusively on the expenditure side while we also provide evidence on the cyclicality of revenue and fiscal balance.<sup>3</sup> When revenues are measured as a share of GDP, then there is no clear relationship with income levels (i.e., the slope of the bivariate regression line is close to zero). This suggests that the observed differences in the cyclicality of revenues (as a share of GDP) across countries are likely driven by factors other than those directly determined by countries’ per capita income levels.

**Most countries in the world feature countercyclical fiscal policy in revenue and fiscal balance, but** **_not_ in expenditures.** As the results in Figure 1 show, cyclicality in total government revenue and fiscal balance was in line with countercyclical fiscal policy in almost all countries. Specifically, apart from a few exceptions, most countries are located above the zero-horizontal line (recall that for fiscal policy to be countercyclical, it is desirable to have countercyclical expenditures and procyclical revenues and fiscal balance).  This is consistent with previous findings in the literature that fiscal revenue is usually procyclical in both developing and industrial countries (Talvi & Vegh 2005, Aizenman et al. 2019). In contrast, less than half of the included countries feature countercyclical expenditures (i.e., those below the zerohorizontal line for expenditure). This suggests that automatic stabilizer processes may be stronger on the revenue side than on the spending side. For instance, tax revenues are endogenous to the business cycle and tend to support countercyclical fiscal policy simply as a result of the widened tax base and higher revenue collection during times of expansion (Vegh & Vuletin 2015, Bashar et al. 2017). Additionally, our findings are also in line with the view that many countries implemented discretionary policy measures more effectively for revenue collection than for expenditures. Politically, it may be easier to cut taxes during a downturn than to increase expenditures, which may be subject to fiscal space, financing, and other constraints. Indeed, especially in low-income countries, it may be difficult for policy makers to increase government spending during recessions (and reduce spending during economic booms) due to imperfect access to international credit markets, lack of financial depth, or political distortions (see the studies cited in the Introduction).

**Over the past two decades, most MENA countries featured revenues and fiscal balances in line with countercyclical fiscal policy, but expenditures were procyclical in several countries.** Figure 2 reports the cyclicality of different fiscal policy variables in MENA countries over the period 2000-2022. While revenues and fiscal balances moved in line with the business cycle in almost all these countries (corresponding to the desired outcome under countercyclical fiscal policy), there are several MENA countries with procyclical expenditures (i.e., Egypt, Qatar, Iraq, the Islamic Republic of Iran, Lebanon, Yemen, Libya). It may be noted that most of these countries (notably Iraq, Lebanon, Yemen, and Libya) are post-conflict countries with comparatively weaker fiscal institutions and capacity to implement effective countercyclical policy. For revenue as a share of GDP, several countries (Morocco, the West Bank and Gaza, Qatar, Oman) show negative cyclicality, suggesting that discretionary policy measures or automatic stabilizers on the revenue

> 3 Various explanations have been proposed for this finding. For instance, Alesina et al. (2008) argue that procyclicality in developing countries may be driven by a political economy channel whereby citizens “seek to starve the Leviathan” to reduce political rent. When they observe the economy booming, they demand more public goods and/or lower taxes, which causes a procyclical bias in fiscal policy. Indeed, there is ample empirical evidence that corruption reduces government revenue (Tanzi & Davoodi 1997, Méon & Sekkat 2005), and does so more in settings where political rent seeking is more likely to remain unpunished, such as in fragile states or countries with autocratic governments (Bogetić & Naeher 2023).

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side (e.g., progressive taxes) are not as effective in these countries as they should be to attain fiscal countercyclicality. In all other MENA countries, revenue as a share of GDP was either procyclical or cyclically neutral.

**Tax revenues and non-tax revenues in MENA countries feature similar cyclicality patterns but of different magnitudes, with non-tax revenues typically moving more strongly with the business cycle than tax revenues.** Figure 2 reports the cyclicality of revenues obtained from taxes (Libya is excluded due to insufficient data coverage).<sup>4</sup> The average correlation coefficient capturing cyclicality among the included MENA countries equals 0.35 for tax revenues and 0.48 for revenues overall. This implies that nontax revenues tend to move more strongly with the business cycle than tax revenues in these countries; that is, non-tax revenues tended to act more of a stabilizer than tax revenues. One possible explanation of this finding may be that non-tax revenues (e.g., natural resource royalties) are more strongly affected by automatic stabilizer processes than tax revenues (e.g., income and wealth taxes, which are limited in the region); that is, even in the absence of discretionary policy measures, the dominant sources of nontax revenues in MENA countries tended to decrease during recessions and increase during economic booms.

**Subsidy expenditures tend to be less countercyclical than other fiscal expenditures in MENA countries.** As shown in Figure 2, more than half of the 17 MENA countries featured countercyclical fiscal expenditures over the period 2000-2022, but only one of these countries (Morocco) also had countercyclical subsidy expenditures (note that data on subsidy expenditures are only available for six countries). Fiscal expenditure in Saudi Arabia, the West Bank and Gaza, and Jordan was countercyclical overall, but procyclical (or cyclically neutral) for subsidies (including grants and other social benefits), indicating that other (non-subsidy) expenditures were relatively strongly countercyclical in these countries. Egypt and Lebanon had both procyclical subsidies and procyclical overall expenditures. Systematic underpricing of fossil fuels in domestic economies in view of volatility world prices of fossil fuels have likely contributed to the observed pattern of cyclicality of subsidies.

**While the average relationship between fiscal cyclicality and income levels across countries remained relatively stable over the past two decades, there were considerable dynamics in individual country performances.** Figure 3 shows the cyclicality of different fiscal policy variables when the sample is split into two periods, 2000-2011 and 2012-2022. For fiscal balance, revenue, and expenditure, the direction of the association with countries’ per capita GDP (as indicated by the slope of the bivariate regression line) is consistent with the respective results for the overall period 2000-2022 shown in Figure 1. For revenue as a share of GDP, the average relationship changed from being slightly positive in 2000-2011 to slightly negative in 2012-2022 (i.e., the slope of the regression line changed from a positive to a negative value). However, in both cases the slope is close to zero and the fit (e.g., measured by the R-squared) is very small.

**Despite the stable relationship between fiscal cyclicality and income levels across countries, many MENA countries experienced significant changes in the cyclicality of their fiscal policy variables over the past two decades.** Figure 4 shows the cyclicality of different fiscal policy variables in MENA countries when

> 4 Since data on tax revenue and subsidies are missing for some countries and years, we report the results for these two indicators only for MENA countries and only when there is sufficient data coverage (i.e., no gaps in the respective time series).

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the sample is split into two periods, 2000-2011 and 2012-2022. Country experiences in this region are very mixed, with some countries transitioning toward countercyclicality, and others moving away from it. There are also many countries where the direction of change differed across fiscal policy variables. For instance, Egypt’s expenditures switched from being procyclical in 2000-2011 to countercyclical in 2012-2022, representing a desirable outcome for fiscal countercyclicality. However, at the same time Egypt’s revenues and fiscal balance became less aligned with the business cycle, corresponding to a deterioration in countercyclicality.

**Over the past two decades, several MENA countries managed to switch from fiscal procyclicality to countercyclicality.** There are a few noteworthy instances of countries that had mostly procyclical fiscal policy over the first decade of the 21st century (and possibly before that) but managed to re-align both their expenditures and revenues in ways consistent with fiscal countercyclicality. This applies particularly to Jordan, Oman, and Qatar. While the fiscal balances of these three countries were negatively related to the business cycle in the period 2000-2011, they had shifted to the desirable procyclicality for fiscal balances in 2012-2022. The same applies to revenue as a share of GDP in these countries as well as to total revenue in Jordan (in Oman and Qatar, total revenues were already in line with countercyclical fiscal policy in 2000-2011). In addition, expenditures were countercyclical in Jordan and Oman in 2012-2022, and Qatar saw its expenditures become significantly less procyclical over time (almost reaching cyclical neutrality). This confirms previous findings in the literature suggesting that escaping the fiscal pro-cyclicality trap is possible (Herrera et al. 2019), and demonstrates that this is feasible, even for countries in a region like MENA with very high output volatility and relatively narrow tax base (Abdih et al. 2010).

**There is no one-size-fits-all solution for achieving countercyclical fiscal policy, and sometimes crises can**

**act as catalysts for transformation** . While there are several broad principles suggested in the literature to guide the development and implementation of countercyclical fiscal policy (see our discussion in Section 5), no one-size-fits-all solution exists, as the effectiveness and appropriateness of each measure depends on the unique circumstances of each country, including economic context, institutional capacity, and government priorities. For instance, in Oman, a country in which fluctuations in exports and government revenue are to a large extent driven by oil prices, recent efforts focused on increasing fiscal discipline and diversifying the economy away from the hydrocarbon sector (Oweis 2023), both of which tend to facilitate countercyclical fiscal policy especially in commodity-exporting countries like Oman (Céspedes & Velasco 2014, Marioli & Vegh 2023). Conversely, the transition to countercyclical fiscal policy in Jordan, a country historically characterized by limited fiscal space and procyclicality, has been attributed to the government's robust response to address the substantial economic downturn triggered by the COVID-19 pandemic (World Bank 2021). This shift, though effective in mitigating the impact on economic activity, came at the cost of a significant increase in public debt.

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# **5. Conclusion and policy implications**

Using an expanded and updated dataset for 184 countries in the period 2000-2022, this paper contributes to the existing evidence on fiscal policy cyclicality across the world. A more granular assessment of the direction, intensity, and sources of cyclicality of fiscal policy is provided, with particular focus on countries in the MENA region, including those that managed to switch from procyclical to countercyclical fiscal policy during the past two decades. High-income countries are found to generally have led countercyclical fiscal policy compared to low- and middle-income countries where it is found to be predominantly procyclical or neutral.

In a novelty to the literature, breaking down revenues to tax and non-tax revenues and expenditures into subsidies (including grants and other social benefits) and other fiscal expenditures, we show that non-tax revenues tend to be more in line with countercyclical fiscal policy than tax revenues. This is likely the result of relatively weak automatic stabilizers within the tax system (e.g., progressive income taxes, unemployment insurance, capital income taxes) and this seems to be especially the case in low- and middle-income countries, including those in the MENA region. On the expenditure side, countercyclical fiscal policy in MENA countries is less supported by subsidies, grants and other social benefits (which exhibit weak countercyclicality) than by other spending categories. This may also be a result that subsidies in many countries operate more as a fixed entitlement, fairly independent of the business cycle rather than discretionary expenditures that respond to the cyclical changes in output.

Within the MENA region, we find that many countries show procyclical fiscal policy, consistent with the literature. At the same time, we also identify several countries (notably Jordan, Oman, Qatar) which recently managed to shift from procyclical to countercyclical fiscal policy. Nevertheless, many low- and middle-income countries, in MENA and the rest of the world, continue to follow procyclical behavior, potentially being caught in a fiscal pro-cyclicality trap whereby fiscal policy is _persistently_ procyclical, thereby reinforcing the business cycle and adding further instability and uncertainty to the economy (Vegh & Vuletin 2015, Herrera et al. 2019).

Achieving strong countercyclical fiscal policy faces many challenges, including tax system structure, timing of policy decisions, fiscal space, financing constraints, and other political or external economic influences (Alesina et al. 2008, Frankel et al. 2013, Bogetić & Naeher 2024b). However, there are a number of policy measures proposed in the literature that policy makers can adopt to enhance countercyclicality. We review these here and add to them in view of the new evidence in this paper.

First, governments can design policies supporting greater use of **automatic stabilizers** such as progressive income taxes and unemployment benefits, helping limit economic overheating in good times and reducing slumps in bad times (Bashar et al. 2017, Aizenman et al. 2019). Increased use of ad-valorem rather than specific excises, where possible, might also increase responsiveness of the tax base of excised goods to the business cycle. Moreover, greater use of real estate taxes, which are typically a minor source of government revenues in low- and middle-income countries, especially in the MENA region, may increase the revenue contribution to the overall countercyclicality of fiscal policy. Combined, these measures may tilt the observed balance from non-tax to tax revenues as the key contributor to the countercyclical fiscal ~ 14 ~
policy. This would be desirable because non-tax revenue tends to be a tax bases that is smaller, less stable, and potentially subject to major changes (e.g., royalties, state-owned enterprises).

Second, **structural policies** like exchange rate flexibility, currency convertibility, and lifting restrictions on international financial flows can mitigate fiscal procyclicality, especially when supported by fiscal discipline and well-designed institutions ensuring the conservation of fiscal space (World Bank 2024). For example, **fiscal rules** that ensure that current expenditures are financed by revenues (‘the golden rule”) can help reduce fiscal policy volatility and allow governments to respond to adverse shocks countercyclically by conserving fiscal space (Marioli et al. 2023). To build buffers today in preparation of expansionary fiscal policies during future recessions, governments need to **mobilize revenues** to a sufficient extent that they can finance basic functions of the state on a sustainable basis. However, many low-income countries feature revenue-to-GDP ratios so low (often below 15 percent of GDP) that even the financing of basic elements of the state is a challenge (IMF 2018), and the potential to improve revenue mobilization is often limited by unfavorable demographic or economic structures (Bogetić et al. 2023) as well as corruption and rent seeking (Bogetić & Naeher 2023). Therefore, strengthening tax collection **administrations** , eliminating **tax exemptions** , and attracting private investments are crucial for revenue improvement (Djankov et al. 2010, Naeher & Narayanan 2023, World Bank 2024). In addition, **expenditure measures** such as eliminating distortionary **subsidies** (especially for fossil fuels) and investing in productive infrastructure and human capital can enhance fiscal balances and stimulate both macroeconomic stability and overall economic development (Ansar et al. 2016).

Finally, recent evidence suggests that fiscal policy tends to be more procyclical in commodity-exporting countries (Céspedes & Velasco 2014, Marioli & Vegh 2023), and the projected deceleration in China’s demand for raw materials is poised to further intensify challenges for these economies (Bova et al. 2016, World Bank 2024). Given that many countries in the MENA region are significant commodity exporters (especially in terms of oil and natural gas), breaking free from the fiscal pro-cyclicality trap will likely become more challenging in the future—unless they also develop **broader and more diversified tax bases** , beyond oil and gas. To navigate these complexities in country contexts, a comprehensive understanding of the specific sources of procyclicality in each country’s fiscal policy is key. This study contributes to such comprehension by examining global, regional, and country patterns in cyclicality across various fiscal policy variables and subcomponents of government revenues and expenditures. More work in this direction at the country level is critical for facilitating evidence-based decision making aimed at fostering greater countercyclicality in fiscal policy towards macroeconomic stability and sustainable growth.

# **Declaration of Conflicting Interests and Funding**

Dominik Naeher declares that, in addition to his position at the University of Goettingen, he has worked as a consultant to the World Bank.

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