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The twin deficits hypothesis holds if government’s fiscal deficit, through its impact on national saving and consumption, leads to a deterioration of the current account. The fiscal and current account deficits of most countries in Sub-Saharan Africa (SSA) appear relatively large or have been widening over the past several years in the face of positive output growth and steady decline in inflation. Using data for 41 countries from 2000 to 2012, we test the twin deficits hypothesis for SSA. Applying the system Generalised Method of Moments (GMM) estimation technique, the major conclusion drawn from the results indicates that fiscal deficits tend to improve the current account and vice versa, thereby rejecting the twin deficits hypothesis in favor of the twin divergence proposition. The findings, nonetheless, have policy relevance for the region.

The twin deficits hypothesis holds if government’s budget deficit, through its impact on national saving and consumption, leads to a deterioration of the current account [

The aftermath of recent developments in the global economy such as the global financial crisis of 2008 and 2009 and the debt crisis in the Eurozone in 2011 has re-ignited debates mostly among policy makers and economists in the developed economies particularly, about the twin-deficits hypothesis. Public sector profligacy in some economies, for example, in the post 2001 era in the United States is argued to have accounted for the accumulation of colossal global external imbalances, which possibly contributed to the genesis and severity of the financial and economic crisis of 2008-2009. Similarly, entering a hard-hitting economic downturn with a precarious budget balance obviously confines the scope for fiscal stimulus and can possibly lead to a Greek-like sovereign debt crisis [

The fiscal and current account deficits of most countries in Sub-Saharan Africa (SSA) appear relatively large or have been widening over the past several years in the face of positive output growth and steady decline in inflation [

The region’s persistent negative fiscal and current account balances over the past few years which contrasts the positive outlook of other macroeconomic indicators such as real output growth and inflation rates over the same period require further scrutiny to ascertain whether or not there is a link between SSA’s internal and external balances.

There are several studies on the twin deficits hypothesis using large panels of countries in the literature, the focus have been predominantly on developed economies (see for instance, [

Description | 2004-2008 | 2010 | 2011 | 2012 | 2013 | 2014 |
---|---|---|---|---|---|---|

(Percent change) (Projection) | ||||||

Real GDP growth | 6.4 | 5.4 | 5.3 | 5.1 | 5.4 | 5.7 |

Inflation, end of period | 8.8 | 7.2 | 10.1 | 7.9 | 6.9 | 5.8 |

(Percent of Regional GDP) | ||||||

Fiscal balance | 1.9 | −3.9 | −1.3 | −1.7 | −2.7 | −2.8 |

Current account balance | 0.6 | −1.3 | −1.7 | −2.8 | −3.5 | −4.1 |

Source: IMF-World Economic Outlook database, 2013.

the world. Just a selected number of SSA countries are captured in such studies (see [

The empirical and theoretical literature does not have a common position on the twin-deficits hypothesis. [

Fiscal profligacy has been adduced as responsible for the current account problems of many developed economies according to some economists. The results of some empirical studies give credence to this position and thus prescribe fiscal consolidation as remedy for the external imbalances [

The rest of the paper is organized as follows. The next section provides a survey of the literature, followed by a discussion of the methodology in Section 3. The results and discussion are presented in Section 4. Section 5 concludes with policy recommendations.

The unmatched increases in the deficits of the U.S. in both current (trade) account balance and fiscal balance, particularly, in the 1980s engineered the theoretical formulation and empirical scrutiny of the twin-deficits hypothesis [

Evidence in both the theoretical and empirical literature although not unanimous, essentially points to a unidirectional causal relationship from the budget balance to the current account balance [

In the empirical literature, the focus of most studies have been to establish the direction of causality as well as the magnitude or significance of the causal relationship between the fiscal and current account balances. Such studies normally involve panel regressions for a large number of countries as well as time series regressions for individual country analysis. These studies have in the main found statistically significant impact of expansionary fiscal policy actions on external imbalances. Quite recent studies such as [

The literature highlights the importance of country specific features in the determination of long-run causality and significance of the relationship between fiscal and external imbalances. Country-specific characteristics in some cases may account for the lack of unanimity in defining the causal relationship between the two deficits as well as the significance of the long-run causality between the budget deficits and current account deficits. [_{1}-2012Q_{1.}

Some empirical outcomes, however, have out rightly rejected the twin-deficits hypothesis, implying no long- run causal relationship between the budget deficits and the current account deficits. For instance, [

The obvious ambiguity in the empirical literature regarding the relationship between budget deficits and current account deficits require further investigation. This paper aims at providing further evidence on the relationship between budget deficits and current account deficits, particularly in the context of SSA.

In order to analyze the effect of fiscal balance on the current account balance, a dynamic panel regression model is estimated. The study uses the dynamic panel model in order to account for temporal autocorrelation, reduce the level of potential spurious regression which may lead to inaccurate inferences and inconsistent estimates. Besides, a suitable estimation technique should account for the likelihood of country-specific characteristics that are significant for explaining the current account balance but omitted by the model. Hence, the Fixed Effects model ought to be preferred to the Pooled OLS (POLS) and Random Effects [

The presence of econometric problems such as endogeneity and persistence ensure that some panel data estimators (POLS, Fixed Effects, and Random Effects) yield inconsistent estimates. The Generalized Method of Moments (GMM-Sys) dynamic panel model accounts for these problems and addresses potential model mis- specification to obtain consistent estimates in the presence of endogenous regressors. Even so, the instruments used must be valid in order for the system GMM estimator to give consistent and reliable estimates. Two main tests are therefore conducted to determine the validity of the instruments. Firstly, a Sargan test of over- identifying restrictions which tests the null hypothesis that the over-identifying restrictions are valid would be conducted. Secondly, Arellano-Bond test is used to scrutinize the hypothesis that there exists no serial correlation between the error terms.

Panel regressions (with individual country fixed effects) using annual data from 2000 to 2012 would be used to test the twin-deficits hypothesis (i.e. whether or not there is any significant and robust association between fiscal balances and current account balances) pertaining to SSA. This study employs the Generalized Method of Moments (GMM-Sys) estimation technique and similar model specification employed by [

where CA_{it} measures the external balance for country i (i = 1, ・・・, n) at time t (t = 1, ・・・, T), Deficit_{it} is the government budget deficit, Govexp_{it} is government expenditure, YG_{it} is the real per capita income growth, Debt_{it} is government’s debt stock, PopG_{it} is annual population growth rate and V_{it} is the error term.

The empirical approach in equation (1) captures both the Ricardian and Keynesian views. The primary distinction between the Ricardian and the Keynesian theories concerns the sign and significance of α_{1} which is the response of the current account balance to a unit variation in fiscal deficit, ceteris paribus. The conventional Keynesian view suggests that a rise in fiscal deficits tends to deteriorate current account (i.e. α_{1} < 0), whilst private consumption should increase in response to an increase in the fiscal deficit. The Ricardian view suggests that α_{1} = 0, implying that a unit variation in fiscal deficit does not impact the current account.

Data for the study is sourced from the IMF’s World Economic Outlook (CA_{it}, Deficit_{it}, Govexp_{it} and Debt_{it}) and the World Bank’s World Development Indicators (YG_{it} and PopG_{it}) online databases. The description of the variables are provided in

The descriptive statistics in

The dynamic panel estimates of the current account model are presented in

Variable | Description | Source |
---|---|---|

CA | Current Account to GDP ratio | IMF |

Deficit | Net borrowing (−) or net lending (+) of central government as % of GDP | IMF |

Govexp | General government total expenditure as % of GDP | IMF |

YG | GDP per capita growth (annual %) | World Bank |

Debt | Gross government debt as % of GDP | IMF |

PopG | Population growth annual as % of GDP | World Bank |

Variable | Mean | Standard deviation | Minimum | Maximum |
---|---|---|---|---|

Current Account % of GDP | −5.51 | 10.35 | −83.66 | 25.63 |

Fiscal Deficit % of GDP | −1.54 | 6.71 | −30.42 | 40.34 |

Gov. expenditure % of GDP | 25.66 | 9.75 | 5.62 | 74.16 |

Real GDP per capita growth | 2.23 | 5.86 | −33.98 | 58.36 |

Public Debt % of GDP | 76.24 | 100.46 | 0.78 | 931.66 |

Population growth rate | 2.52 | 0.86 | 0.11 | 6.68 |

Source: Authors’ computation (based on data from the IMF’s WEO and the World Bank’s WDI online databases) using STATA 13.

The coefficient of fiscal deficits in both the static panel and system GMM estimations is positive, indicating that a 1 unit increase in fiscal deficit improves the current account to GDP ratio by 0.39 and 0.35 units respectively. Moreover, the first lag of budget deficit (Deficit_{i}_{,t−1}) also improves the current account in the system GMM estimation by 0.14 units. This significant positive relationship between the current account and fiscal balance at 1 percent level of significance, implies a rejection of both the twin-deficits hypothesis as well as the Ricardian equivalence arguments, as the former posits widening fiscal deficits is inimical to the current account (a coefficient less than zero) whereas the latter suggests no effect on the current account (a coefficient equal to zero). Our results contradict the outcomes of some very recent cross-country and panel studies on the subject matter in the literature which have variously sought to affirm the twin-deficits hypothesis. For instance, [

In line with the a priori expectations, the coefficient of government expenditure is negative and significant only in the System GMM estimation. Similarly, the first lag of government spending (Govexp_{i,t}_{−1}) deteriorates the current account by 0.12 units. This outcome therefore suggests that a unit increase in government’s expenditure worsens the trade balance by 0.11 units and with a lag of 0.12 units, respectively. This result underscores the relevance of the size of government or public spending for trade equilibrium. The system GMM estimates of earlier studies by, for instance, [

Our findings regarding public debt are mixed. The coefficient of public debt in the static panel estimation is positive and significant, while in the system GMM estimation it is negative and significant with a two-period lag. The latter outcome is in tune with the a priori expectations and confirms findings from some recent studies (see for instance, [

Variables | Static Panel | System GMM |
---|---|---|

Constant CA_{t}_{−1 } _{ } CA_{t}_{−2 } Deficit_{t}_{ } Deficit_{i}_{,t−1 } Deficit_{i}_{,t−2 } Govexp_{t } Govexp_{i,t−}_{1 } Govexp_{i,t−}_{2 } YG_{t} YG_{i,t−}_{1} YG_{i,t−}_{2} Debt_{t} Debt_{i,t−}_{1} Debt_{i,t−}_{2} Popg_{t } _{ } Popg_{i,t−}_{1 } Popg_{i,t−}_{2 } | −2.7037 (2.6471) 0.3879^{***} (0.0702) 0.0120 (0.0649) −0.1623^{**} (0.0662) 0.0176^{***} (0.0053) −1.4204^{*} (0.7375) | −2.6569 (4.4555) 0.2134^{***} (0.0168) −0.1175^{***} (0.0091) 0.3538^{***} (0.06080) 0.1425^{***} (0.0209) 0.00126 (0.0248) −0.1111^{*} (0.0591) −0.1205^{***} (0.0244) −0.0054 (0.0330) −0.0100 (0.0259) −0.1871^{***} (0.0327) −0.2761^{***} (0.0291) 0.0044 (0.0066) −0.0011 (0.0051) −0.0238^{***} (0.0044) 0.6358 (6.8263) −4.8017 (9.3516) 6.8567 (4.3872) |

Wald chi−squared (Prob > chi-squared) Arellano?Bond (AR (2), Prob > Z) Sargan test (Prob > Chi-squared) No. of observation | 0.0000 520 | 0.0000 0.2407 0.6583 520 |

Note: The dependent variable is Current Account to GDP ratio. Figures in parenthesis are the standard errors of the estimates whereas ^{***}, ^{**} and ^{*} denote the statistical significance of the estimates at 1%, 5% and 10% respectively. Source: Authors’ Computation Using STATA 13.

rising debt burden that will ultimately constrain borrowing capacity. The effect of population growth on the current account balance is negative and significant in the static panel estimate; indicating that 1 unit increase in population growth worsens the current account by 1.42 units. This finding is also consistent with Magazzino [

This paper sought to test the twin deficits hypothesis―the relationship between the fiscal balance and the current account balance―based on SSA data. The twin deficits hypothesis posits that fiscal deficits reflect in current account deficits. The conclusion drawn from the estimation results indicate, however, that fiscal deficits of governments in SSA improve the current account and vice versa, thereby rejecting the twin-deficits hypothesis in favor of the twin divergence proposition. This finding rather paradoxically suggests rising budget deficits could aid the reduction of SSA’s external deficits. Such situation could arise during economic downturns, where output falls and the fiscal balance worsens. The current account will most likely improve at the same time if the fall in output leads to a greater fall in investment than the fall in national saving. In relatively open economies such as those of SSA, a fiscal expansion could thus result in an increase in the real interest rate which may in turn crowd out private investment but stimulate private saving. Sticky prices could account for a real exchange rate depreciation resulting from a government deficit shock, since nominal exchange rate depreciation (as opposed to a change in the relative price level) may well explain the real exchange rate depreciation [

The implication of our findings for policy is that fiscal deficit can be relied upon to improve the current account perhaps only during slumps and interest rate would have to go up to crowd out private investment but stimulate private saving along with a real depreciation of the exchange rate. Since several other factors determine the direction of change of these variables (interest rate and exchange rate, etc.), it will be in the interest of the governments of the region to work at reducing their budget deficits instead since the conditions necessary for the deficits to improve the current account are clearly not under their control. Moreover, fiscal profligacy through unguarded public spending could hurt the external stance of SSA countries. On the contrary, and as our results show, fiscal consolidation could be one of the measures to reduce Sub-Saharan Africa’s large current account deficits.

A shortcoming of this paper, however, is the exclusion of variables such as real effective exchange rate, real interest rate, and trade openness (which influence the current account), due to unavailability of consistent data for countries in the study. In addition, net government lending/borrowing as percent of GDP was used as proxy in the absence of data for actual budget deficit to GDP ratio as was similarly employed by [

Godson Korbla Aloryito,Bernardin Senadza,Edward Nketiah-Amponsah, (2016) Testing the Twin Deficits Hypothesis: Effect of Fiscal Balance on Current Account Balance—A Panel Analysis of Sub-Saharan Africa. Modern Economy,07,945-954. doi: 10.4236/me.2016.79097

East Africa | Middle Africa | Southern Africa | West Africa |
---|---|---|---|

Burundi | Angola | Botswana | Benin |

Ethiopia | Cameroon | Lesotho | Burkina Faso |

Eritrea | Chad | Namibia | Cote d’Ivoire |

Kenya | Central African Rep | South Africa | Gambia, The |

Madagascar | Comoros | Swaziland | Ghana |

Malawi | Congo, Dem. Rep. | Zambia | Guinea |

Mauritius | Congo, Rep. | Guinea-Bissau | |

Mozambique | Equatorial Guinea | Liberia | |

Rwanda | Gabon | Mali | |

Tanzania | Niger | ||

Uganda | Nigeria | ||

Zimbabwe | Senegal | ||

Sierra Leone | |||

Togo |

Source: Based on United Nation’s classification of countries.

Ho: Constant variance |
---|

Chi2 (1) = 8.09 |

Prob > chi2 = 0.0541 |

Source: Authors’ computation using Stata 13.

Ho: Difference in coefficients not systematic (there is random effect) |
---|

Chi2(6) = (b-B)’[(V_b-V_B)^(1)] (b-B) |

= 34.25 |

Prob > Chi2 = 0.0000 |

Source: Authors’ computation using Stata 13.

Null Hypothesis | P-value (Prob > Chi2) |
---|---|

Deficits uncorrelated with error term | 0.0541 |

Government expenditure uncorrelated with error term | 0.0541 |

Income growth uncorrelated with error term | 0.0541 |

Public debt uncorrelated with error term | 0.0541 |

Note: The residuals of the variables are predicted and tested for significance after regressing them on all the other exogenous variables. Source: Authors’ computation using Stata 13.