Does economic complexity reduce the probability of a fiscal crisis?

Abstract

Fiscal crises are costly but are not rare. It is crucial to prioritize preventing such crises. While several studies have explored the impact of macroeconomic variables and international factors on fiscal outcomes, little attention has been given to the role of a country’s productive structure sophistication. Does a country’s ability to export diversified and less ubiquitous goods significantly reduce the likelihood of a fiscal crisis? To answer this question, we use hazard duration analysis and a comprehensive dataset of 172 countries (spanning over 200 fiscal crisis episodes) between 1995 and 2020. We show that economic complexity has a significant impact on a country’s likelihood of experiencing a fiscal crisis. A one-point increase in the Economic Complexity Index reduces the probability of a fiscal crisis by half. This effect is robust across low-income, emerging, and advanced economies. Institutional factors also play an essential role in reducing the risk of a fiscal crisis, whereas variables such as debt-to-output ratio, real rate of growth, inflation, terms of trade, and fiscal balance have little to no impact. Our results indicate that a country’s development strategy should prioritize increasing economic complexity to reduce fiscal vulnerability. By reducing the risk of fiscal crises, economic complexity contributes to macroeconomic stability, which is a fundamental condition for economic development.