Adopting fiscal measures to face economic shocks

A topic which is rarely mentioned in economic reviews in Bangladesh is that of fiscal policy cyclicality. Leading researchers all around the world have spent years analysing cyclicality of fiscal policy in developed and emerging economies. The issue was recently stressed in the World Bank's latest 'Global Economic Prospect' report. It articulates the importance of running a counter-cyclical fiscal policy to boost growth amid economic slowdown, especially in the developing economies.   
A countercyclical policy, simply put, is a budgetary stance by the government that goes against the business cycle i.e., expansionary in bad times and conctractionary in good times. A government that follows countercyclical stance increases spending at the time of the downturn of the economy to spur aggregate demand while it cuts back in the upswing. The intuition behind such a stance is simple -- a countercyclical policy smoothes out inter-temporal consumption while the alternative, a pro-cyclical stance, leads to volatile investment cycles and erratic current account balances. According to the World Bank, counter-cyclicality has been very effective in providing necessary fiscal stimulus to a number of developing economies during the great recession in 2008-09.
While more and more countries are opting for counter-cyclicality, fiscal policy in Bangladesh remains woefully pro-cyclical. As illustrated in graph 1 below,

correlation between GDP (gross domestic poroduct) growth and government's expenditure growth in Bangladesh was 0.59 during the period 1960-1999. The figure for some of our regional peers is significantly lower, indicating comparatively less pro-cyclical tendencies.  
Fiscal pro-cyclicality was once considered a norm in emerging and frontier economies. But over the past decade, many of these countries have graduated from this sub-optimal regime. It is, therefore, immensely important that we understand the root causes of prolonged pro-cyclicality. Only then, can we start thinking of solutions.
 INTERPLAY OF TWO CULPRITS -- POLITICS AND FACTIONALISED INSTITUTIONS: During booms, the government earns more revenue which increases the pressure from factionalised stakeholders to increase spending in their favour. Now when it comes to our country, retaining popularity of the political party in power takes precedence over everything else. And to guard that popularity, the government cannot resist the urge to spend, regardless of the productivity of the expenditure. As the government does not use the revenue for building necessary fiscal space to face future economic shocks, it fails to raise expenditure to spur demand during crisis.
 Simple correlation tests (in addition to more sophisticated quantitative analysis) of the two variables shown above will reveal the degree of high pro-cyclicality in Bangladesh. Over the past decades, convergence between the peak and dip of our economic growth and government expenditure growth verifies the inefficiency in fiscal cyclicality of our country. And once we delve further to find out why we are pro-cyclical, the role played by deeply flawed institutional framework also comes into play. The public institutions, which were supposed to ensure inclusive, sustainable growth by developing prudent and time-effective policies, lack the ability to make unbiased judgment largely due to the deep-rooted practices of corruption and ill-politics within these institutions.
Transparency and accountability, the two basic pillars of efficient fiscal management, remain absent in our public institutions. Some of the recent cases paint the poor image of our institutions. In the latest 'Global Competitiveness Index 2014-15', Bangladesh ranked 131 out of 144 countries across the globe in terms of institutional quality. It is this inefficiency of institutions that create the incentive to fill one's own pocket out of the loopholes in the entire framework.

Consequently, the motivation to undertake empirically proven strategies like counter-cyclical policy takes the back seat and prevents us from optimising fiscal policy. Inevitably, during economic slumps, the government is left with no choice but to cut spending and raise taxes pushing the economy into deeper jeopardy. In such scenarios, normalisation of investment cycles and economic growth would take much longer compared to a scenario with a counter-cyclical policy.
INDEPENDENT ADVISORY PANEL AND SAVINGS FUND: While there are many sophisticated fiscal tools available to escape the trap of pro-cyclicality, we first need to undertake a number of reforms to improve our basic institutional quality. Effectiveness of public policies largely depends on the quality of the people executing those. A panel can be formed with members from preeminent think-tanks of the country who will be given the authority to make budgetary forecasts based on facts, research and economic intuition. This measure is expected to free the budget from political influence, making the projections realistic and achievable. The insulation of the panel from political influence can be further strengthened by framing appropriate rules or laws.
Once the quality of the budgetary institution improves, transitioning to counter-cyclicality can be initiated through a structured plan over an optimal timeline. This can be undertaken by allocating a certain portion of revenue surplus [earned during booms] to a savings fund. Subsequently, during economic downturns, the government can spend from this fund to revive aggregate demand.
Considering our current fiscal position, it is true that creating a fund would take a lot of time and efforts. But once created, such a fund can foster sustainable economic growth in the long run. For the near term, including such an idea in the upcoming 7th Five Year Plan can be a starter. Alternatively, a separate national policy aimed at optimising fiscal cyclicality can be created.   
Cyclicality of fiscal policy, when governed efficiently, can ensure low volatility in demand and consumption patterns over long periods of time. For a country with a significant portion of the population below the poverty line and widespread inequality in income distribution, a pro-cyclical fiscal stance only adds to the woes of millions of people during bad economic conditions. Therefore, this issue should not be taken lightly, and relevant stakeholders, economists and researchers need to collaborate to mainstream the notion of cyclicality of fiscal policy in our national strategies.  

Sabrina Afroz is an Investment Analyst at a Multinational Asset Management Firm in Bangladesh. [email protected].
Sharjil M. Haque is a graduate student in International Economics at John Hopkins University, Washington D.C. [email protected]