Oil volatility and government spending behaviour in oil-exporting countries.

Abstract

This thesis principally seeks to provide an empirical examination of the contribution of the dynamic relationship between oil volatility, including revenue, price and rent in relation to government spending behaviour in OPEC and non-OPEC oil exporting countries. A research gap has been identified in three areas, firstly, there is a paucity of comparative literature between OPEC and non-OPEC countries. Secondly, there exists a limited number of studies of oil volatility and the effect on government expenditure. Thirdly, there is little research on the impact of volatility in relation to the quality of political institutions and the influence of extant democratic processes. The thesis, therefore, seeks to contribute to closing these gaps. In particular, the study, firstly, investigates the impact of oil volatility on aggregated government spending. Secondly, it investigates the effect of oil volatility on disaggregated government spending, namely, on health, education and military expenditure. Thirdly, it analyses the effects in periods of high and low oil volatility regimes. Fourthly, it studies the impact of the quality of political institutions on the relationship. Put it differently, the thesis evaluates whether the response to oil volatility differs between democracies and non-democratic states. To achieve this aim, a panel Vector Auto- Regressive (PVAR) model along with panel impulse response functions over the period 1983- 2015 are applied. We find that oil price volatility does not exert any significant effect on aggregated government spending of OPEC countries whereas oil revenue volatility precipitates a decline in economic growth, an increase in inflation and, the maintenance of government expenditure leading to a greater share of the percentage of GDP. Oil rent volatility exercises both a direct and indirect impact on government expenditure via the exchange rate and inflation channels. In contrast, non- OPEC countries are susceptible to oil price uncertainty but are unaffected by higher oil revenue volatility. Oil rent volatility affects government expenditure directly and has an indirect effect through GDP channel. When the focus turns to specific areas of government expenditure, the influence of oil volatility on health expenditure appears to have no effect on that of education in both OPEC and non-OPEC countries. However, it leads to a rise in health and a reduction in military expenditure in OPEC countries and an increase in the share of military spending in non-OPEC states. However, an increase in oil revenue volatility leads to a rise in military expenditure in OPEC countries with no effect in non-OPEC countries. On the other hand, oil rent volatility increases health and military expenditures. Overall, oil volatility leads to higher military expenditure. Turning to the quality of political institutions, it is observed that in democratic countries an increase in oil volatility leads to an increase in government expenditure. In contrast, in non- democratic countries, governments’ response to oil volatility fluctuating between the positive and negative depends on the quality of political institutions; the more some attributes of democracy are seen, the greater the expenditure. This difference in response between them can be attributed to a variation in institutional quality. When the individual components of government expenditure are analysed, we find that in democratic countries, an increase in oil volatility is accompanied by an increase in education and health expenditure, whilst military expenditure remains unchanged. In contrast, in non-democratic countries, oil volatility leads to a reduction in the share of education and health expenditure and an increase in military expenditure. When the degree of democratic attributes is controlled the rate of reduction of health and education expenditure slows, but rising military expenditure is unaffected. Therefore, the behaviour of governments in relation to different component of expenditure are dependent on the quality of the institutions they control; the more the tendency towards a degree of democracy, the less the effect of volatility on health and education whereas the less democracy the greater the emphasis on military spending. There are a number of policy implications that arise. The destructive nature of oil revenue volatility in oil exporting countries indicates a need for some defensive strategies. These could be in the form of the creation of a sovereign wealth fund invested in exogenous non-oil business vehicles providing an alternative form of revenue. Regulatory controls could be adapted to include the use of alternative financial instruments such as the futures and bond markets and the encouragement of FDI inflows would provide a platform for technology transfer encouraging upstream and downstream oil related industries. Structural changes could be introduced to allow an expansion into oil price derivatives, the expansion of oil market value chains and deregulation which would serve to eliminate monopolies. An improvement in strategic risk planning together greater government transparency could lead to institutional quality improvement and the development of health and educational facilities which would both improve national welfare and increase absorptive capacity to provide a platform for industrial expansion.