A potential problem with rules that call for surpluses during good times is what to do with the surpluses to limit pressures for spending them. One option is to force the government to use the surplus for debt reduction. Another popular alternative is to place surpluses in a fiscal stabilization fund (see, for example, the provisions in the fiscal responsibility laws of Argentina and Peru). This brings us to the second class of proposals. Stabilization funds are often championed as an option for accumulating savings during good times. In many cases, these funds are associated with revenues linked to commodities, such as Chile’s Copper Stabilization Fund. However, in countries with strong pressures to spend, and high levels of poverty and inequality, the surpluses in these funds might be difficult to sustain politically during good times. Furthermore, recent evidence regarding commodity stabilization funds shows that they present several potential problems. Davis, Ossowski, Daniel et al. (2001) argue that, among other problems, oil funds are not effective in stabilizing oil revenue, because the international price of oil does not appear to have a constant average. Therefore, it is difficult to distinguish between permanent and temporary changes in prices, and thus difficult to establish a sustainable rule for accumulating and spending the resources in the oil fund. They found evidence for a sample of 12 countries producing nonrenewable resources, of which five had stabilization funds, that public spending both in countries with and without funds usually followed commodity export earnings. A deeper problem with fiscal rules and stabilization funds discussed in Braun and Tommasi (2002) is that it is not obvious ex ante why a rule or a fund will change political incentives to overspend in countries accustomed to not complying with laws and abruptly changing policy regimes. Perry (2002) argues that fiscal rules can contribute to saving during good times by increasing the marginal political cost of higher saving, and by giving more power to a prudent finance minister vis-à-vis spending ministers. Milesi-Ferretti, (2000) however, argues that in countries with lower levels of budget transparency, fiscal rules can actually lead to more creative accounting instead of better outcomes. Governments may find it easier to fudge the numbers than to actually limit spending. He cites examples of creative accounting in France, Italy and Greece in the run-up to EMU in which fiscal outcomes were “improved” by up to 1 percent of GDP. The evidence presented in Braun and Tommasi (2002) and the cases of rule non-compliance we cite in Box 1 and Appendix C should warn us against being overly optimistic regarding the effectiveness of rules to limit procyclicality.
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