Institutional Quality and Fiscal Sustainability in Developing Countries: A Comparative Panel Analysis of Oil and Non-Oil Economies

Taherpoor, Javad; Arab Mazar Yazdi, Ali; Malekhosseini, Mahshid

doi:10.22054/joer.2025.86401.1280

Document Type : Research Paper

Authors

¹ Associate Professor in Economics, Department of Economics, Allameh Tabataba’i University, Tehran, Iran

² Assistant Professor in Economics, Department of Economics, Allameh Tabataba'i university, Tehran, Iran

³ Master's Student in Economics, Department of Economics, Allamah Tabataba'i University, Tehran, Iran

https://doi.org/10.22054/joer.2025.86401.1280

Abstract

Financial instability poses a challenge for developing countries, particularly oil-dependent developing nations, due to their reliance on windfall oil revenues. During periods of abundant oil income, governments tend to increase spending under political pressures, while during times of declining revenues, they struggle to reduce expenditures proportionally due to spending rigidities. In this context, institutional quality appears to influence fiscal sustainability by fostering fiscal discipline. Accordingly, this study examined the impact of institutional quality on fiscal sustainability in 11 oil-producing developing countries and 16 non-oil developing countries from 2010 to 2020, using panel regression models and the PCSE technique. To measure institutional quality, three indicators were used: control of corruption, rule of law, and regulatory quality, while fiscal sustainability was measured by budget deficit volatility. The estimation results indicate a negative relationship between budget deficit volatility and institutional quality indicators. Furthermore, a comparative analysis revealed that the effects of corruption control and regulatory quality are stronger in oil-producing developing countries, whereas the rule of law has a greater impact on budget deficit volatility in non-oil developing countries.
Introduction
The mismatch between the growth of government revenues and expenditures has turned fiscal instability into a serious challenge in developing countries, particularly in many oil-dependent developing nations. In these countries, governments control windfall oil revenues and, disregarding their finite and volatile nature, expand their expenditures—especially consumptive spending—to gain political support, thereby exacerbating fiscal instability. Iran, too, has faced fiscal instability due to its long-term reliance on windfall oil revenues, which the government has used to expand consumptive expenditures (through hiring, wage payments, subsidies, etc.), as well as to finance the legacy of the eight-year Iran-Iraq war. Therefore, this research aims to examine how institutional quality affects the fiscal sustainability of governments and how this effect differs between oil-rich and non-oil developing countries.
Method
The present study estimates the aforementioned model once for oil-rich developing countries and once for non-oil developing countries using panel data models and the PCSE technique, with Stata 17. After estimating the models, the results of the two models were compared using a Z-test.
Results
Since the Hausman test confirmed the fixed-effects model, the Wald test confirmed the presence of heteroskedasticity, and the Wooldridge test confirmed first-order autocorrelation in the error terms for both groups of countries, and given that the number of cross-sections (N) is larger than the time periods (T), the PCSE estimator is used for estimation. The results for oil-rich developing countries indicate a negative relationship between the rule of law, corruption control, regulatory quality, and budget deficit fluctuations. In non-oil developing countries, a negative relationship between institutional quality indicators and budget deficit fluctuations was confirmed. A comparison of the results between the two groups shows that the impact of corruption control and regulatory quality on budget deficit fluctuations is stronger in oil-rich developing countries.
Conclusion
According to the findings, the effects of corruption control and regulatory quality on budget deficit fluctuations are stronger in oil-rich developing countries, while the effect of the rule of law is stronger in non-oil developing countries.

Keywords

References

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Economics Research

Institutional Quality and Fiscal Sustainability in Developing Countries: A Comparative Panel Analysis of Oil and Non-Oil Economies

References

References

Volume 24, Issue 95 - Serial Number 4
January 2024
Pages 5-50

Institutional Quality and Fiscal Sustainability in Developing Countries: A Comparative Panel Analysis of Oil and Non-Oil Economies

References

References

Volume 24, Issue 95 - Serial Number 4January 2024Pages 5-50

Volume 24, Issue 95 - Serial Number 4
January 2024
Pages 5-50