Essays on fiscal sustainability in the Caribbean

Mitchell, Travis Klaus

Abstract

The PhD thesis sets out to improve fiscal sustainability assessment in the Englishspeaking Caribbean and to provide the tools for more robust dialogue on the topic. It also seeks to influence Caribbean governments’ fiscal policy actions by providing evidence on debt sustainability issues, and appropriate fiscal responses. The guiding questions of the thesis are whether Caribbean fiscal policy is conducive to debt sustainability now and into the future, and what is the region’s debt limit, important enquiries considering the islands’ comparatively high vulnerability and prolonged debt challenges. The thesis makes several original contributions, including bridging the wide gap in Caribbean research; original empirical testing; some new recommendations for policy action; methodological innovation; and lays new foundations for future research. The literature on fiscal sustainability, particularly from the perspective of the Caribbean, is extremely shallow in comparison to that of other indebted regions, including Latin America and Europe. This paucity of research on the region is startling owing to the region’s high and established rank within the halls of the globally indebted, crystallised by the region’s omission in the most recent and prominent survey on global debt issues. The lack of focus on the region and accompanying implications is the primary gap which the thesis aims to fill, as is unearthed in a critical literature review that also helps to determine the most appropriate methods for responding to the thesis’ research questions, as well as assists with establishing the status quo as pertains the state of fiscal sustainability in the Caribbean. Moreover, from the perspective of fiscal policy limits, to establish the current perspectives on the Caribbean’s debt threshold, which is important for guiding the region’s debt reduction. In search of answers on the region’s fiscal sustainability, an innovative empirical test for cointegration between the Caribbean’s revenue and expenditure outlays is undertaken using an adapted sustainability cointegration approach. From this the thesis confirms the presence of sustainable fiscal policy in 6 of the 9 Caribbean countries tested, but with a debt ratio that is seemingly unbounded. In this regard, it is recommended that governments consider implementation of expenditure rules, enshrined in the constitution, to strengthen the region’s sustainability position. Further, motivated by two recent empirical studies on debt sustainability in the region, with the use of panel data, the thesis employs fiscal reaction functions but with an estimator selected by way of Monte-Carlo simulations to determine the least biased approach for assessing fiscal sustainability in the Caribbean, noting an incongruence between recent methods employed and the Caribbean’s data structure. Through this novel approach, and with the addition of institutional variables as controls to the Caribbean fiscal response function – another original contribution, the thesis again confirms the region’s weak fiscal sustainability and finds that diversifying trade in services, reducing election spending, and improving on the perception of corruption in the region are key policy initiatives for improving the primary balance and the region’s fiscal sustainability going forward. On the question of the region’s debt capacity, the rise in Caribbean debt post COVID-19 stemming from large fiscal stimulus and positive interest-growth rate differentials, evidences the thesis’ concern on the matter. A debt threshold is an important anchor for fiscal policy generally, and more so in the Caribbean where fiscal policy is the primary policy tool. A clearly established debt threshold provides the basis for debt reduction targeting and for assessing risks around the debt trajectory. A very wide margin of thresholds has been the feature of research in this area in the Caribbean, leaving much at bay as regards the region’s debt limit. In a fresh bid to answer the related question, the thesis employs Gosh et al. (2013) fiscal fatigue theory, which postulates a positive response of fiscal policy to debt as debt rises, but a negative fiscal response at ever higher levels of debt owing to a government’s eventual fiscal fatigue. Despite this theory’s intuitive appeal and in contrast to the findings of Cevik and Nanda (2020), the thesis concludes that there is no evidence of a cubic fiscal reaction function for the Caribbean, and therefore it does not appear that a debt threshold for the region exists as defined by the theory. Instead, the thesis finds that the Caribbean’s debt threshold is defined by way of a dynamic threshold model at 106.2 percent, nearly double the IMF rule of thumb and the thresholds estimated via the debt-growth nexus. Several policy approaches are proposed to enhance and strengthen Caribbean governments’ fiscal sustainability based on the results unearthed in the thesis. These include: the introduction of fiscal rules for better expenditure management; establishing a debt threshold assessment method and undertaking regular assessments; strategic fiscal adjustment to avoid default; diversification of trade in services; containment of election spending; and improving the Caribbean’s ranking in the perception of corruption index. Collectively, the thesis’ findings imply a renewed relevance of cointegration approaches to fiscal sustainability and the applicability of the revenue-expenditure method for fiscal sustainability assessment to the Caribbean, where data is severely limited. It raises questions on the suitability of the fiscal fatigue theory for assessing debt thresholds in developing countries, given the theory’s developed country origins and due to the contrasting composition of developed countries versus Caribbean countries’ debt portfolios. The thesis warns of making policy decisions based on regional assessments that could mislead owing to the heterogeneity at country level, which could readily be missed due to the necessity of panel data to overcome serious data issues, especially as regards fiscal data. The thesis provides an excellent foundation for future research, much of which surrounds old theoretical questions on the long run, and on the limits to fiscal sustainability.

Citation

Mitchell, T. K. Essays on fiscal sustainability in the Caribbean. (Thesis). Keele University. https://keele-repository.worktribe.com/output/1015617

• Thesis Type: Thesis
• Deposit Date: Dec 13, 2024
• Publicly Available Date: Dec 19, 2024
• Public URL: https://keele-repository.worktribe.com/output/1015617
• Award Date: 2024-12