OIL PRICES AND ECONOMIC GROWTH IN OIL-EXPORTING COUNTRIES Amany El Anshasy, Collage of Business and Economics, UAE university, Phone: +971 05 6603536, E-mail: Aelanshasy@UAEU.ac.ae Overview Oil-exporting countries face large fluctuations in the prices of their oil. Such fluctuations are typically manifested in similar movements in the countries’ terms of trade. In addition, oil price shocks affect the fiscal balance because a large proportion of government revenues are derived from the oil sector. The resulting swings in government revenues and the often pro-cyclical government expenditures would contribute to higher output volatility and lower long-run growth rates. Therefore, the effects of oil price shocks on long run growth via the fiscal channel could be quite significant in oil-exporting countries. During the period 1960 to 2002, oil-exporters had an average savings rate higher than developing and other non-oil exporters, yet they experienced the lowest average annual growth rate. Moreover, those countries did exceptionally well and had the highest average growth in real per capita income during periods of stable or rising oil prices. To the contrary, the decline in oil prices in the 1980s and 1990s coincided with a huge collapse in oil-exporters’ growth rates compared to non-oil exporters. This paper is an attempt to study the impact of the highly volatile oil prices on economic growth, controlling for fiscal policy effects, in a panel of 15 oil-exporters, covering the period 1972-2003. In particular, it aims to shed some light on the following questions. (i) Do oil price shocks slow economic growth in oil-exporting countries? (ii) Does oil price volatility hamper long-run growth? (iii) Do the composition of government spending and the financing method matter for economic performance and long-run growth in shock-prone economies? The paper is organized as follows: Section II is a review of the role fiscal policy plays in growth in theoretical models and empirical literature. A special reference is made to the specific nature of fiscal policy in oil-exporting countries. In section III and IV present the empirical model and estimation methodology, respectively. Estimation results are interpreted in section V. Section VI concludes. Methods The study employs dynamic panel estimation techniques, namely, the Generalized-Method-of-Moment (GMM) system estimator suggested by Arellano and Bover (1995) and later developed by Blundell and Bond (1998), and Blundell, Bond, and Windmeijer (2000). This estimator has the potential advantages of minimizing the bias resulting from estimating dynamic panel models, exploiting the dynamic and time series properties of the data, controlling for the unobserved country-specific effects, and correcting for the bias resulting from the possible endogeneity of the explanatory variables. The use of annual observations allows exploiting the dynamic nature of the data and distinguishing between the long run and short run effects. Results The evidence suggests the following: (i)oil price shocks- rather than oil price volatility- could have long run growth effects. The unanticipated increases in oil prices trigger higher growth rates in the long as well as the short run. However, the magnitude of that direct effect is relatively small. Also, there is no evidence of asymmetric growth effects of oil price shocks. (ii) Fiscal policy does play an important role in transmitting oil revenue shocks to the economy. The study finds that accumulating budget surpluses resulting from oil booms has a depressive effect on growth. In that sense, government revenue windfalls are harmful for growth. In addition, the structure of public expenditures plays an important role in determining the net impact of the shock on long-run growth. Countries with a higher initial share of public investment in GDP can better cope with adverse oil shocks. However, those countries tend to reap a smaller benefit from positive oil price shocks due to low return on capital spending during booms. Conclusions The unanticipated increases in oil prices triggers higher growth rates in the long run as well as the short run. However, the magnitude of the direct effect cannot explain much of the collapse in growth in many oil exporters during the 1980s and 1990s. In addition, fiscal policy plays an important role in transmitting oil price shocks to the economy. The composition and structure of public expenditure seems to determine the net impact of the shock on long-run growth. In addition, the structure of the fiscal adjustments at times of booms or busts could also affect long-run growth. The main policy implications of the paper’s findings are: (i) reducing the fiscal dependency on oil and expanding the non-oil tax base is growth-improving, (ii) Adjusting to a negative shock by cutting capital expenditures deepens the negative effect of the shock and severely hurts growth, (iii) at times of plenty, the government should allocate more resources to productive expenditures such as infrastructure as well as improving the public services. 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