Research background
1.1.1.An overview of the status of global economies in the period 1996–
During this period, the global economy witnessed the financial crisis that arose when the real estate bubble exploded in the US in 2007, driving the
US financial crisis and influencing production and exports in numerous developing countries However, the World Bank’s report said that in 2016, the economy’s growth recovery has rebounded (see table 1.1).
Table 1.1: the global economic growth rebound
Small States 5.50 2.40 1.60 2.30 1.40 2.80 merging market and developing untries
Emerging and developing Asia 8.40 8.00 7.00 6.80 6.50 6.40 Emerging and developing urope 4.60 2.10 2.90 2.80 3.00 3.00
Middle East, North Africa, ghanistan, and Pakistan 5.40 4.10 2.30 2.70 2.50 3.90 Latin American and the ribbean 3.60 3.20 2.90 1.30 -0.30 0.80
Figure 1.1: The line trend of global per capita income growth and ratio of tax revenue and government spending in 1996 and 2016 in 38 developedcountries.
Source: World bank’s database – WDI and IMF’s database – GFS.
Between 1996 and 2016, the disparity in income per capita among developed countries significantly decreased, with the maximum income per capita reducing from 13.8 times the minimum in 1996 to just 6.5 times in 2016 In 1996, Norway led with the highest income per capita at over $73,626, while Latvia had the lowest at approximately $5,321 By 2016, Norway maintained its position with a GDP per capita of around $90,344, whereas the Seychelles recorded the lowest at $13,963 Furthermore, most developed nations demonstrated a trend of higher tax collection coupled with lower spending.
In 1996, Norway's tax revenue accounted for approximately 53.5% of its GDP, with expenditures at 47.5% In contrast, Latvia, despite having the lowest income per capita, collected only 36.38% in taxes while spending slightly more at 37.03% By 2016, Norway sustained its tax revenue proportion above 53% of GDP.
Figure 1.2: the line trend of global per capita income growth and ratio of tax revenue and government spending in 1996 and 2016 in 44 developingcountries
Source: World bank’s database – WDI and IMF’s database – GFS.
In 1996, the disparity in GDP per capita among developing countries was significant, with a gap of 152.43 times; the Islamic Republic of Iran led with approximately $30,333.74, while Ethiopia lagged at just $199.00 Iran's tax revenue was 20.165% of GDP, with expenditures exceeding 21.08%, whereas Ethiopia collected only 14.86% in taxes and spent 18.79% of GDP By 2016, this gap had decreased to 26.68 times, with Russia at the forefront, boasting a per capita income of $11,099.17, compared to Madagascar's $416.00 Notably, Russia's tax revenue increased by over 1.02% since 1996, although its spending decreased during the same period.
1.1.2 The differences of public finance and growth between developed and developing countries a) Growth rate and stability in economies
High-income countries have experienced economic stability over the years, as illustrated in Figure 1.3 In contrast, middle-income and low-income countries have not demonstrated the same level of economic consistency.
Figure 1.3: the shrink frequency rate b)
Source: World Bank group (2017) Tax revenue, government expenditure, and control of corruption
Tax revenue plays a crucial role in government finances, with developing countries typically collecting less in taxes compared to their developed counterparts Despite this lower tax collection, these nations have tended to spend more, resulting in faster economic growth from 1996 to 2016.
Figure 1.4: Line trend of tax revenue – government expenditure – GDP per capita 2 for whole sample (82 countries) in 1996-2016
Source: World bank’s database – WDI and IMF’s database - GFS.
Figure 1.4 shows the trend of spending more and fast trend of economic growth in whole 82 countries.
Figure 1.5: Line trend of tax revenue – government expenditure – GDP per capita for 44 developing cuntries in 1996-2016
Source: World bank’s database – WDI and IMF’s database - WEO.
Through figure 1.5, we can observe that the rapid economic growth trend in developing economies is the same as that of the whole sample.
GDP per capita is calculated by dividing the gross domestic product by the midyear population According to the World Bank, GDP represents the total gross value added by all resident producers in an economy, including product taxes and excluding subsidies not factored into product values This GDP calculation does not account for depreciation of manufactured assets or the depletion and degradation of natural resources, and the data is expressed in constant 2010 U.S dollars.
However, beginning in 2010 these countries have attempted to spend more and collect fewer taxes for rapid growth
Figure 1.6 : Line trend of tax revenue – government expenditure – GDP per capita for 38 developed cuntries in 1996-2016.
Source: World bank’s database – WDI and IMF’s database - GFS.
Developed countries tend to collect higher taxes and spend less, resulting in a slower economic growth rate, as highlighted by the World Bank's report, which reveals significant disparities in economic growth and tax revenue between developed and developing nations Policymakers face challenges in understanding the underlying causes of these differences From 1996 to 2016, the global economy exhibited year-to-year variations, with a notable income per capita gap between rich and poor countries Spence (2011) noted that high-income countries accounted for 60% of global GDP growth in 2014, despite representing less than 15% of the global population Additionally, the World Bank projected that income per capita growth during this period may surpass future increases, while stark contrasts in tax revenue, government expenditure effectiveness, and corruption persist between affluent and impoverished nations.
Control of corruption (1996) in 38 developed countries
Control of corruption (2016) in 38 developed countries
In 2016, per capita control of corruption can exceed the minimum by a staggering 490 times, highlighting significant disparities in governance The most considerable difference between the highest and lowest rates of tax revenue or expenditure is sevenfold Notably, the highest control of corruption score recorded is 2.47, while the lowest stands at -1.53, as illustrated in Table 4.1.
Figure 1.7: The control of corruption indicators in 38 developed countries in 1996 and 2016
Source: World bank’s database –WGI.
Control of corruption (1996) in 44 developing countries
Control of corruption (2016) in 44 developing countries
Figure 1.8: The control of corruption indicators in 44 developing countries in 1996 and 2016
Source: World bank’s database –WGI.
In 2016, as illustrated in Figure 1.7, Greece was the only developed country with a negative control of corruption index, while most other developed nations exhibited positive indices Conversely, Figure 1.8 reveals that the majority of developing countries faced a negative control of corruption index.
Benin, Côte d'Ivoire, Ethiopia, Madagascar, and Mauritius face challenges related to corruption and exhibit varying levels of human development, with indices ranging from approximately 0.26 to 0.7 In 1996, Bulgaria had the highest human development index among developing countries, while Mali recorded the lowest Over time, these indices have shown improvement.
In 2016, Russia recorded the highest corruption control index at 0.8, while Mali had the lowest at 0.44 Georgia showed significant improvement, rising from a low of -1.53 in 1996 to a score of 0.67 in 2016, making it the top performer in corruption control that year Conversely, Cambodia faced challenges, ending up at the bottom with a score of -1.3 This situation prompts critical questions regarding the relationship between public finance and long-term economic growth, including how total tax revenue and government expenditure influence one another and how governance affects this relationship across different economic groups.
Research motivation
Public finance plays a crucial role in shaping government budgets and has complex effects on the economy According to Holley (2011), changes in public policy can significantly influence economic activities Despite this, there has been limited research on the relationship between economic growth and public finance, specifically in terms of total tax revenue and general expenditure Government expenditure remains a primary source for public goods, and it is suggested that lump-sum taxes for individuals should direct government spending In contrast, Barro's theories provide additional insights into this dynamic.
The argument presented in 1990 oversimplifies the relationship between public finance and economic growth by focusing solely on income taxes, neglecting the broader implications of tax revenue and government expenditure Effective governance is demonstrated through the strategic use of tax revenue to enhance the labor force, infrastructure, and technological investments, all of which are crucial for societal safety and production Changes in tax rates can significantly influence investor and household behavior, impacting overall economic activity and capital stock, key components of economic growth While previous studies have primarily analyzed specific tax subcomponents and their growth effects, the correlation between public finance and economic performance remains ambiguous This study aims to address this gap by measuring public finance through the ratio of total tax revenue to GDP and total government expenditure per GDP, thereby examining their relationship with economic growth.
In the past twenty years, public choice theory and cost-benefit theory have prompted researchers to explore the long-term relationship between economic growth and public finance Additionally, the short-term impacts of tax changes may differ from their long-term effects due to the elasticity of the demand curve To effectively plan future economic activities, it is essential for researchers to clarify these distinctions (Stiglitz, 2000; Holley, 2011).
Understanding the long-term economic relationship between tax revenue and expenditure is crucial for global policymakers to formulate effective tax and spending policies while preventing deficits Despite ongoing research, findings have been inconsistent, highlighting the complexity of these components in government budgeting A deficit occurs when government spending exceeds tax revenue, making it vital to explore the interplay between these factors and economic growth This study aims to clarify the long-term relationship among tax revenue, expenditure, and economic growth, providing insights that can help policymakers create sound fiscal strategies and address future deficits.
In order to assist the government in addressing the deficit, it is crucial for policymakers to comprehend the relationship between tax revenue and expenditure This research aims to clarify the connection between these two fundamental components of public finance.
The impact of corruption on economic activities and outcomes remains complex and varied, with literature revealing mixed results over recent decades Each economy consists of both private and public sectors, where the quality of governance significantly influences public finance and its effects on economic activities Governance theory highlights the intricate relationship between corruption, government, and economic growth, sparking ongoing debates Some researchers argue that corruption can act as both a "greasing" and "salting" force in different countries, with Méon and Weill (2010) suggesting that corruption serves as "efficient grease" in highly inefficient nations While Bird et al (2008) and Belkaoui (2008) found that controlling corruption enhances tax revenue and compliance, they did not explore its impact on expenditure and growth Dzhumashev (2014) posited that corruption could lead to more effective government spending, potentially boosting growth in less developed countries but harming it in developed ones Additionally, d’Agostino et al (2012) and Ugur (2014) noted that corruption reflects weak institutional quality and negatively impacts economic growth, while d’Agostino et al (2016) revealed that corruption's interaction with investment and military spending adversely affects growth.
Countries with low corruption indices tend to achieve higher tax revenues, lower spending, and stable economic growth While previous research has highlighted the dual role of corruption in economic dynamics, known as "greasing or salting," there is limited literature on how corruption influences public finance before impacting economic activities Additionally, the relationship between anti-corruption efforts and macroeconomic variables is complex, with the effects of corruption being influenced by government size and governance quality, necessitating further clarification.
The ongoing inquiry into how governance in anti-corruption influences public finance and economic growth continues to challenge economists worldwide.
Research objectives and research questions
This dissertation attempts to obtain the three below research objectives:
This study explores the long-term connections between public finance and economic growth, highlighting the importance for policymakers to exercise greater caution in formulating policies related to these areas The persistent relationship between public finance and economic growth underscores the need for careful consideration in policy decisions.
This thesis explores the causal relationship between tax revenue and government expenditure, contributing to the "tax and spend" hypothesis The findings can assist governments in effectively balancing spending and tax collection to manage deficits Additionally, the research provides valuable insights for policymakers, helping them understand these linkages and mitigate potential risks in their planning processes.
This research enhances the understanding of governance theory and endogenous growth theory by assessing how governance impacts the effects of public finance on economic growth across various country groups The findings aim to guide policymakers in both developed and developing nations in recognizing the significance of corruption and public finance policies, enabling them to formulate effective future strategies.
This study endeavors to answer the following questions to meet these research objectives: run?
How closely does public finance correlate with the economy in the long
Do tax revenue and government expenditure cause each other?
How does governance modify the effects of public finance on economic growth differently according to different group countries?
As the research scope plays a crucial role in the research approach, the next section will introduce the research scope.
Research scope
The study investigates linkages among government expenditures, tax revenue, and economic growth for the whole sample (82 developed and developing countries) in 21-year period 1996-2016.
The reasons for choosing research objects and research period are:
First, government expenditures and tax revenue are the key factors to create and maintain a government budget They also help policy makers control deficits to maintain a stable economy.
Second, control of corruption plays a crucial role in governance, which says about cause of difference of rich and poor countries.
Between 1996 and 2016, the global economy experienced significant turmoil, starting with the Asian financial crisis that originated in Thailand in 1997 and subsequently impacted stock markets across various Asian nations, including Malaysia and Taiwan This period was further complicated by a second financial crisis triggered by the collapse of the real estate bubble in the United States.
In 2007, the US financial crisis significantly impacted production and exports in various developing countries To mitigate data bias from these crises, this study incorporated the annual inflation rate as a control variable in the estimation model Furthermore, to address the spillover effects of macroeconomic variables on economic growth and the deeper impacts of the two financial crises, the research utilized the Seemingly Unrelated Regression (SUR) model This approach enhances estimation efficiency compared to single-equation models while examining the effects of public finance and corruption control.
The disparities in tax collection, expenditure levels, GDP per capita, and governance highlight significant gaps between developed and developing economies This issue has garnered extensive scholarly attention and requires further clarification While developing countries account for over 60% of the global population, they contribute less than 30% to the world's GDP (Spence, 2011).
Research methods
This study utilizes a co-integration test to explore the long-run relationships among variables, addressing the first research question Co-integration tests are commonly used to analyze long-term associations between stationary variables (Ojede and Yamarik, 2012) Furthermore, identifying co-integration among nonstationary variables helps prevent spurious regression (Gujarati, 2004; Persyn and Westerlund).
2008) There are numerous researchers who have designed co-integration tests to prevent spurious regression, such as McCoskey and Kao (1999), Bai and Ng
In this study, we utilize the co-integration test developed by Persyn and Westerlund (2008) to examine the relationships among the variables This method is highly flexible, accommodating a nearly heterogeneous specification of the long-run components of the error correction model, which can be derived from the data itself To ensure the robustness of our co-integration findings, we also incorporate additional tests, including those by Kao, Pedroni, and Westerlund.
The Granger test results are instrumental in addressing the second research question of this thesis, as they enable the identification of the relationship's direction between tax revenue and expenditure.
To minimize bias from data collection during two financial crises and to enhance estimation accuracy from the system equations, this study utilizes a Seemingly Unrelated Regression (SUR) model and a two-step System Generalized Method of Moments (SGMM) approach to assess how governance influences the impact of public finance on economic growth.
This study analyzes a strongly balanced panel dataset comprising 82 developed and developing countries from 1996 to 2016, utilizing data on GDP per capita, inflation rates, and the ratio of foreign direct net inflow to GDP sourced from the World Bank's World Development Indicators (WDI) To assess governance, the research incorporates "control of corruption" indicators from the World Bank's World Governance Indicators (WGI) Public finance is represented by the ratios of total tax revenue and total government expenditure to GDP, obtained from the International Monetary Fund's Government Finance Statistics (GFS) database Additionally, the study investigates the impact of human capital on economic performance.
The Control of Corruption index measures how public power is misused for private gain, encompassing both minor and major corruption, along with the influence of elites and private interests over state functions This index provides a score that reflects the country's performance on a standard normal distribution scale, ranging from approximately -2.5 to 2.5 Additionally, data for the Human Development Index (HDI) is sourced from the United Nations Development Program (UNDP).
The control of corruption indicator reflects the perceptions of private elite governors and foreign investors regarding public authorities serving the interests of private firms To further validate the impact of governance, this study also examines the corruption perception index.
(CPI) 5 of business developed by Transparency International website (TI) The results may support this research’s contribution toward determining the role of governance in an economy.
Research contribution
Contribution to public choice and cost-benefit theories
This thesis explores the long-term relationship between public finance, governance, and economic growth in both developed and developing countries from 1996 to 2016 Additionally, it assesses how governance affects the impact of public finance on economic growth.
The primary objective of this research is to examine the enduring relationship between public finance and economic growth in both developed and developing countries The results confirm a significant long-term connection between these two variables By incorporating the ratio of total tax revenue to GDP and the rate of government expenditure to GDP into the economic growth model, this study broadens the understanding of how public finance influences economic growth Additionally, these findings provide valuable insights for policymakers, emphasizing the importance of focusing on the interplay between public finance and economic growth.
The Human Development Index (HDI) is a composite measure that evaluates a country's development based on four key indicators: life expectancy, adult literacy rates, and the gross enrollment ratios for primary, secondary, and tertiary education This index is derived from data provided by the United Nations Development Program (UNDP).
Transparency International focuses on measuring bribery and the perception of corruption across various countries Between 1996 and 2011, the maximum score on the Corruption Perceptions Index (CPI) was ten However, starting in 2012, the methodology changed, increasing the highest possible score to 100, indicating a corruption-free environment This shift highlights the importance of transparency in fostering finance and economic growth, particularly for developing nations as they formulate effective fiscal policies for the future.
The second research objective aims to validate the bi-directional causal relationship between total tax revenue and general government spending, reinforcing the fiscal synchronization hypothesis According to cost-benefit theory, deficits can negatively impact an economy's budgetary creation (McGee, 2008) Therefore, it is essential for policymakers in both developed and developing nations to consider the implications of various tax rates, tax bases, and overall government expenditure objectives to effectively promote economic growth and manage deficits.
This study contributes to the limited research on the long-term relationship between total tax revenue, general government expenditure, and economic growth, demonstrating how these factors reflect the government's capacity By comprehensively understanding this relationship, policymakers can develop effective fiscal strategies tailored to various economic groups, addressing deficits and fostering economic growth.
The third research objective focuses on evaluating how governance influences public finance and economic growth across various economic groups This study reveals that public finance impacts economic growth differently based on government taxation and spending levels Additionally, the interaction between corruption control and public finance indicates that government expenditure can positively contribute to economic growth in both developing and developed nations However, corruption remains a significant barrier to economic advancement globally Furthermore, while the interaction of corruption control with tax collection positively affects economic growth in developing countries, the same effect is not observed in developed countries These findings reinforce the theory that the quality of governance influences economic outcomes variably across different country groups.
Public choice theory and cost-benefit theory have presented significant challenges for researchers analyzing the impact of public finance and governance on economic growth Limited prior studies have explored the effects of specific tax revenue components and government expenditures on short-term economic growth This thesis addresses this gap by utilizing co-integration and Granger tests on panel data from 82 developed and developing countries between 1996 and 2015, a period marked by two financial crises The findings confirm a long-term relationship between public finance, governance, and economic growth, highlighting its persistence during critical economic times.
This dissertation assesses public finance through total tax revenue and general expenditure, aiming to clarify the impact of government size on long-term economic growth.
This thesis confirms that effective governance, particularly in controlling corruption, enhances the positive impact of public finance on economic growth in both developed and developing nations The findings highlight that combating corruption poses significant challenges for governments worldwide The research indicates that developing countries can achieve higher tax collections by addressing corruption, whereas this relationship is less pronounced in developed countries Consequently, it is essential for developing nations to prioritize anti-corruption efforts in tax collection, while such measures may not be as critical for their developed counterparts.
Structure of dissertation
This thesis is presented in the following structure After the abstract, the key sections are:
This chapter offers a comprehensive overview of the theoretical and empirical foundations concerning government expenditure, tax revenue, corruption, and economic growth It also outlines the research objectives and summarizes the study's structure Additionally, the chapter highlights existing research gaps, providing a clear direction for future investigations.
Chapter 2: Literature review, and hypotheses development
This chapter provides a comprehensive literature review on the impact of government expenditure, tax revenue, and corruption control on economic growth It outlines the methodologies employed by previous researchers to analyze relevant data and examines how different regimes influence the relationship between these variables and economic growth.
Chapter 3: methods and research data
Chapter 3 introduces the methods that this research applies to achieve the research objectives; for instance, Granger causality, co-integration tests,SUR and two-step SGMM models Base on the characteristic of these methods, this chapter also presents the research data and sources from which the data were extracted, such as the WDI and WGI from the World Bank’s database, the WEO from the IMF’s database, and corruption perception index of business (CPI) from the Transparency International (TI)’s database.
Chapter 4: Public finance, governance and economic growth: A long-run analysis
Chapter 4 interprets the empirical research results that introduce the confirmation of a long-run economic relationship with two factors of public finance: tax revenue and government expenditure The research findings in this chapter also confirm the direction of the causal linkage between tax revenue and government expenditure, which supports the fiscal synchronization hypothesis and suggests that policy makers implement joint decision making for taxes and spending.
Chapter 4 also presents the means through which control of corruption affects the influences between public finance and economic growth depending on the economic group.
Chapter 5: Conclusions, implications, and limitations:
This chapter provides a comprehensive summary of the research findings and offers key recommendations for policymakers and governments to enhance economic development and address corruption Additionally, it highlights the limitations of the study and suggests avenues for future research.
Introduction
Public finance and governance are essential for shaping economic activities and outcomes Understanding their impact can guide governments in formulating effective policies that enhance societal and economic stability This chapter reviews existing literature on the long-term relationships between public finance and economic growth in both developed and developing nations Additionally, it examines the role of governance in combating corruption and fostering public finance to stimulate economic advancement By summarizing this literature, the chapter identifies research gaps and applies relevant theories to create an analytical framework connecting public finance, governance, and economic growth.
This thesis explores key concepts related to public finance and economic growth, highlighting theoretical arguments and the impact of corruption on these dynamics It reviews empirical research that examines the relationship between public finance and economic growth, emphasizing how corruption can alter these effects Additionally, the development of the analytical framework and research hypotheses is outlined, culminating in a summary of the chapter's findings.
Some key concepts
Public finance plays a crucial role in shaping economic activities through the interplay between government spending on public goods and tax collection capabilities According to Wagner (1883), understanding public finance involves examining the fiscal economy, which encompasses two key aspects of a state: government expenditure and tax revenue.
Public finance, as understood through traditional economic theories such as classical, neo-classical, and Keynesian economics, plays a crucial role in analyzing the impact of taxes and expenditures on the behavior of firms, families, and individuals Since individuals consistently strive to maximize their utility, any alterations in public policy or public finance can significantly influence the benefits experienced by all members of society (Buchanan, 1999).
According to Hillman (2009), the government has three primary responsibilities: ensuring microeconomic stability, minimizing unemployment and inflation, and safeguarding the stability of banking and financial systems through effective public finance and policy measures.
Gruber (2011) highlights the role of public finance in helping governments navigate economic crises To effectively manage these situations, governments must carefully determine the types of goods and services they can offer through public expenditure.
On the taxes side, governments should answer the question: “How much should a government tax its citizens?”
To grasp the concept of public finance, McGee (2013) emphasizes the importance of addressing the question: "What actions should the government take to deliver services effectively and encourage both private firms and individuals to willingly pay taxes?"
Su Dinh Thanh (2014) evaluated the Vietnamese public finance variable by analyzing government size, which encompasses two key components: government expenditure and government revenue.
Over the past two decades, public finance has been recognized by many authors as an essential instrument for governments to establish spending levels for public goods and services It plays a critical role in guiding tax decisions to enhance the future provision of these goods, while also serving as a mechanism for managing budget deficits Key elements of public finance include tax revenue and government expenditure, as highlighted by Buchanan (1999) and Wellisch.
(2004), Kaul and Conceiỗóo (2006), and McGee (2013).
Tax revenue, as highlighted by Hillman (2009), encompasses various types of taxes and serves as a crucial source for funding government expenditures Additionally, tax revenue can fluctuate with changes in tax rates Wellisch (2004) further emphasized that countries producing goods should be responsible for collecting tax revenue, thereby transferring the tax burden to the residents of the consuming countries.
Tax revenue serves as a crucial indicator of a country's ability to improve its taxation efforts, as highlighted by McGee (2008) Additionally, the ratio of tax revenue to GDP is a key measure of fiscal freedom Research by Rizvi, Bacha, and Mirakhor (2016) reveals that developing countries typically collect only two-thirds of the tax revenue compared to high-income nations.
Tax expenditure refers to government spending of tax revenue aimed at stimulating production and consumption (Holley, 2011) In less developed countries, the pressure for economic development compels governments to boost both expenditures and tax revenues, thereby generating additional funds to support growth (Philips, 1957).
In summary, we can apply the geometric shape shown in figure 2.1 to describe the flow of creating a government budget.
Figure 2.1: Public sector in the economy
In the analysis of private and public sector interactions, Figure 2.1 illustrates that solid lines depict private sector income and spending, while broken lines represent the public sector Initially, without a public sector, household income is generated from sales (line 1) and is subsequently allocated to spending (line 4) or savings (line 5) Households can utilize their savings to finance purchases in product markets (line 6), which, along with spending, reflects overall market activity When a government is present, it can allocate funds for public goods (line 2) or private products (line 7), with payments being transferred (line 8) Furthermore, governments generate revenue through tax collection (line 9) and borrowing (line 10).
Figure 2.1 illustrates the interaction between the public and private sectors within an economy, highlighting how government expenditure objectives influence all economic activities.
Governance serves five critical roles in society, including establishing institutions that facilitate social activities and managing the economy to ensure national security, as noted by Stoker (1998) Additionally, the government plays a key role in resource allocation within the economy According to Brunet and Aubry (2016), the principles outlined by the UNDP emphasize that legitimacy, efficiency, and accountability are essential criteria for assessing the quality of governance.
Governance involves the process of making collective decisions, as noted by Hague and Martin (2004) They emphasize that the legitimacy of a government's decisions is rooted in its authority—the recognized right to act—rather than merely the ability to exert power This authority generates its own power through the acceptance of the governed, highlighting the significant impact that the control of corruption can have on effective governance.
Dzhumashev (2014) posits that corruption reflects governance quality, affecting both private and public production by influencing government spending efficiency and production cost management In contrast, Ugur (2014) contends that corruption signifies institutional quality, resulting in varied impacts on a nation's per capita income.
Empirical literature on relationships among public finance, governance, and
2.4.1 Empirical literature on relationships between public finance, and economic growth
Barro's (1990) analysis highlights the interaction between government expenditure and taxes, suggesting that a simplistic view of social regimes exists where governments solely rely on income and property taxes However, this research falls short by not examining the correlation between total tax revenue and overall public spending, which is crucial for understanding government capacity.
In recent decades, two primary approaches have emerged to assess the relationship between public finance and economic growth The first approach involves scholars who utilized causality and co-integration tests to establish a correlation between economic growth and factors such as tax structure or government expenditure share (Ray, Pal, and Ray, 2012; Azam et al., 2015) Conversely, the second approach is characterized by researchers who employed the endogenous growth model to analyze the connection between specific components of tax revenue or government spending and economic growth Notable studies in this area include works by Landau (1983, 1985), Grier & Tullock (1989), Barro (1990, 1991), and many others, highlighting the complexity of the interplay between fiscal policies and economic performance.
(2016), Stoilova (2017), Ramírez, Díaz and Bedoya (2017).
Previous studies indicate that income, sales, and property taxes significantly impact economic outcomes in both developing and developed nations (Lee & Gordon, 2005; Ojede and Yamarik, 2012; Amir et al., 2013; Adkisson & Mohammed, 2014) Bujang et al (2013) utilized Kao’s co-integration test on a dataset comprising 24 developing and 24 developed countries over a decade, revealing that a long-term co-integrating relationship between tax structure and GDP exists only in developed nations Additionally, Easterly and Rebelo (1993) found that taxes on individual or organizational income can foster economic growth, whereas import and export taxes may hinder it.
Other earlier authors also confirmed the mixed growth effect of government expenditure and tax revenue By performing an empirical study of
Between 1960 and 1985, a study by Barro (1991) revealed a negative correlation between public spending and economic growth across 98 countries In contrast, Hitiris and Posnett (1992) examined data from 20 OECD nations over 28 years and discovered that government expenditure on healthcare can enhance per capita income Additionally, Kneller et al employed OLS, fixed effects (FE), and pooled OLS methodologies to further analyze these relationships.
(1999) performed an analysis of a dataset of 22 developed countries between
A study conducted between 1970 and 1995 revealed that government spending has a positive impact on income per capita, whereas taxation negatively affects this metric This raises important questions about how tax revenue and government expenditure influence economic growth, and whether their effects vary across different economic groups The following section of this thesis will address these inquiries.
Su Dinh Thanh (2011) conducted a Granger test using a VAR model on panel data from Vietnam spanning 1990 to 2010, revealing a one-way causal relationship between government expenditure and economic growth, indicating that increased government spending positively influences economic development Additionally, the study utilized the first difference GMM method on Vietnam's panel data over a 16-year period from 1997, further supporting these findings.
In 2012, research indicated that both government spending and revenue adversely impact economic growth, showing significance levels of 1% and 10% However, government spending on a per capita basis demonstrated a positive effect on economic development.
In a study conducted by Roşoiu (2015), data from Romania spanning from 1998 to 2014 was analyzed quarterly using the Granger test within a VAR model The findings revealed that both government expenditure and revenue positively influence GDP, with government expenditure having a more significant impact on economic growth than government revenue This contrasts with earlier research by Su Dinh Thanh (2014).
(2018) conducted an ECM model for a panel data of a 31-year period from
From 1981 to 2015, research in Nigeria indicated that government spending negatively impacts economic growth in both the short and long term Conversely, non-oil revenue positively contributes to economic advancement Additionally, the studies revealed that the effects of total government revenue and spending on economic growth can vary significantly depending on the specific country in question.
Barro (1990) posits that governments can increase revenue by raising tax rates or expanding the tax base; however, such tax increases may negatively impact private investment and hinder economic growth Current research on cluster data offers a limited perspective on the intricate relationship between public finance and the economy While previous studies have confirmed the influence of public factors on economic growth, there is a lack of comprehensive research examining the effects of total tax revenue and general government expenditure on the economy Therefore, conducting experimental research in this area could provide valuable insights into government capabilities and the overall economic landscape.
Since the nineteenth century, scholars have recognized the significant impact of tax revenue and government expenditure on budget creation and fiscal regulation in economic activities Research indicates that public finance can either positively or negatively affect the economy, influenced by the economic context and the types of taxes and spending involved While some studies confirm a causal relationship between tax revenue, government spending, and economic growth, there is a need to clarify how these dynamics differ between developed and developing countries Current literature often focuses on disaggregated components of taxes and spending, leaving a gap in understanding the overall effects of total tax revenue and general government expenditure Future research should explore the long-run relationship between these factors and economic growth, as they represent critical elements of public finance Understanding the government's capability in managing public finance necessitates a comprehensive analysis of total tax revenue and expenditure, which remains underexplored in existing studies.
(1989), Barro (1990), Hitiris and Posnett (1992), Aizenman and Glick (2006),
Numerous researchers have explored the relationship between tax structure and economic growth, highlighting its diverse roles Key studies include those by Cooray (2009), Baltagi and Moscone (2010), and Annabi et al (2011), alongside foundational works by Samuelson (1954) and Solow (1956) Additional contributions from Koster and Kormendi (1989), Bovenberg and van der Ploeg (1996), Bassanini and Scarpetta (2002), Lee and Gordon (2005), Arnold (2008), and Mercan et al further emphasize the complexity of this correlation.
A small group of scholars, including Barro (1991) and Engen and Skinner (1996), argue that the relationships among tax revenue, government expenditure, and economic growth vary across different country groups Research by Kneller et al (1999), Barro and Sala-i-Martin (2004), and Romero-Ávila and Strauch (2008) supports this perspective Additionally, Stoilova (2017) performed a regression analysis on pooled panel data covering EU-28 countries from 1996, contributing to the ongoing discussion about these interactions.
A study conducted in 2013 revealed that consumption, income, and property taxes contribute to economic growth in EU-28 countries However, these studies have a significant limitation: they do not assess the overall tax revenue and expenditure This gap presents a challenge for economic researchers seeking to fully understand the impact of comprehensive fiscal policies on government-driven economic development.
2.4.2 Relationship between tax revenue and government expenditures
The EC model fails to clarify the relationship direction between tax revenue and government expenditure While many studies have confirmed a long-term connection between these two variables, the findings are often complex and ambiguous, with much of the literature focusing solely on specific tax components or spending objectives Most researchers have utilized co-integration and Granger tests to analyze this relationship Some scholars advocate for the fiscal synchronization hypothesis, proposing that to effectively manage deficits, governments should simultaneously increase revenue and reduce spending (Chang et al., 2002; Chang and Chiang, 2009; Chowdhury, 2011; Mehrara et al., 2011; Paleologou, 2013).
Other researchers confirmed that to handle budget deficits, governments should reduce spending (Chang et al., 2002; Narayan, 2005; Saunoris and Payne, 2010; Chowdhury, 2011; Dalena and Magazzino, 2012; Paleologou,
Designing the analytical framework and building hypotheses
This research conducts a critical literature review on the intricate relationship between tax revenue, government expenditure, and economic growth, revealing the complex dynamics of public finance Su Dinh Thanh (2014) found that the share of government revenue and expenditure negatively impacts economic growth in both the short and long term The long-term interactions among these variables remain complicated and warrant further investigation Additionally, public choice and cost-benefit theories present challenges for researchers examining the connections between total tax revenue, government spending, and economic growth Previous empirical studies have highlighted the complex relationship between public finance and economic growth, underscoring the need for clarification These insights inform the development of the first hypothesis in this thesis.
The first hypothesis (1): There is a long run correlation between public finance and economic growth.
This dissertation aims to expand the long-term economic growth model by examining the role of public finance factors It posits that public finance can influence economic growth positively or negatively, depending on its various subcomponents, including tax revenue and public spending.
The World Bank (2017) emphasizes that governments aiming for high income must maintain economic stability, as deficits significantly impact economic status To effectively manage deficits, the "tax-spend, spend and tax" hypotheses serve as a foundational framework for researchers exploring the relationship between tax revenue and government expenditure This tax and spend theory, which encompasses three hypotheses, is applicable to both developed and developing nations in addressing deficits and formulating government budgets Furthermore, public choice theory presents two types of governments regarding their approach to trade-off theory, yet it remains unclear which type operates their economy more effectively This ambiguity necessitates further clarification, leading to the development of the second hypothesis: a positive causal link exists between tax revenue and government expenditure.
The second hypothesis (2): Tax revenue and government expenditure cause each other.
Corruption and governance theory highlight the significant impact of governance quality and corruption on economic performance While corruption is a complex issue that requires thorough examination, both governance and endogenous growth theories face challenges in assessing governance capabilities and their relationship with economic growth Corruption reflects governance quality, and indicators such as total tax revenue and government expenditure can indicate government capacity Despite numerous empirical studies exploring corruption's role in the economy, most focus on the behaviors of taxpayers, households, and government officials, with limited research verifying the quality and effectiveness of governance in driving economic success.
The literature highlights the significant impact of corruption on the interplay between tax revenue, government expenditure, and economic growth, illuminating the corruption theory that describes how corruption can both facilitate and hinder economic processes, often referred to as the "greasing and salting wheels" of corruption.
Corruption theory, particularly the concept of "greasing and salting wheels" of the economy, illustrates that corruption's impact varies across different countries, times, and contexts In recent decades, discussions surrounding the influence of corruption have become increasingly ambiguous Rent-seeking behaviors can distort public choice theory, as a small group of voters may seek personal benefits from elected authorities To address these demands, governments often resort to increasing taxes or cutting expenditures, which can negatively affect overall economic activities.
Lastly, endogenous growth theory alway is a mixed issue, which attracts more literature That’s why, this research following three above theories to develop third research hypothesis.
The third hypothesis (3): Governance modifies the effects of public finance on economic growth differently according to different group countries.
From these above hypotheses, this thesis develops the research analytical framework as seen as below.
Government expenditure Logarithm of GDP per capita
Figure 2.2: Analytical framework of correlation of public fiance, governance and economic growth
Figure 2.2 illustrates the relationship between the control of corruption indicator, which reflects governance, and the logarithm of GDP per capita, representing a country's economic growth It highlights the positive impact of effective governance on economic performance Moreover, the interactions between governance and various aspects of public finance can alter their effects on growth This figure also reveals a bi-directional causal relationship between tax revenue and government spending.
Summary
A literature review reveals the long-term relationship between public finance and economic growth, highlighting the complex interplay between tax revenue and government expenditure that has been studied since the nineteenth century Scholars have proposed four main hypotheses—fiscal synchronization, "spend and tax," "tax and spend," and neutral situational hypotheses—to analyze this relationship These theories can guide policymakers in managing deficits and crafting effective tax and spending regulations Additionally, economic activities are influenced not only by public finance but also by governance and macroeconomic factors, such as the inflation rate, which reflects economic stability and can significantly impact growth.
This study examines the relationship between public finance and economic growth through the lens of public choice theory and cost-benefit analysis of taxation It highlights the importance of foreign direct investment as a percentage of GDP, which reflects the investment climate, and the role of human capital, indicated by the human development index, in addressing the endogenous factors that influence economic stability and growth.
A critical review of existing literature highlights the essential role of governance in differentiating developed from developing countries, particularly through the "greasing and salting the wheels" hypothesis regarding corruption Findings indicate that governments must prioritize corruption control and adapt their strategies based on varying economic outcomes While much research has focused on the direct effects of corruption on economic growth, this study aims to explore both the direct and indirect influences of governance on economic growth, particularly through its interaction with public finance.
Finally, a summary of endogenous growth theory helped in understanding and properly choosing the appropriate analytical estimation to reduce bias from an endogenous phenomenon.
Introduction
This chapter outlines the methodology for designing the dissertation study, beginning with an explanation of the applied research philosophy and model for collecting secondary data It then discusses the research approach, detailing suitable methods, applied theories, and the overall research design Finally, the chapter concludes with a summary of the research philosophy, data collection, and methodologies employed.
Research models
3.2.1 Long-term linkages between public finance, and economic growth
Landau (1985) shed light on that real GDP per capita depends on total government expenditure; he also argued that cost of deflation, consumption and investment may impact on expenditure.
Barro (1990) assumed that government expenditure is financed by income tax rate:
Barro's argument posits that government expenditure (g) and revenue (T) are equal and reliant on total tax revenue, influenced by the income tax rate (τ) and capital resources, ultimately affecting economic outcomes (�) However, a limitation of Barro's study is its focus on a simple tax model To address this, Romero-Ávila and Strauch (2008) enhanced the model by incorporating lump-sum taxation, varying tax rates (T), productive government expenditure (g), and additional government spending (G).
Barro (1991) assessed economic growth through the annual growth rate of GDP per capita, highlighting the impact of human capital on this growth He identified two key ways in which human capital influences economic development: through the school enrollment rates at both the primary and secondary education levels.
Barro and Sala-i-Martin (1992), drawing on insights from Arrow (1962) and Rome (1986), argue that the productivity of each worker is influenced not only by their individual capital per worker (k) but also by the spillover effects of knowledge and ideas from other workers This leads to a revised production function that incorporates these knowledge spillovers.
In addition, these authors followed Samuelson (1954) and revealed that total government purchase G can affect production function, so economic outcome can be explained by below equation:
From (3) and (4) the authors designed the model to evaluate economic growth as seen as below:
Barro and Sala-i-Martin (1992) showed that the long-run growth rate in this model ∅ can be expressed as:
∅ = (1 − �)(1 − �)� ⁄(1−�) (�/�) �/(1−�) − �, (6) where and � are constants that reflect parameters in the utility function, the growth rate is decreasing in the rate of distortionary taxes �, increasing in government productive expenditure g.
Mankiw, Romer and Weil (1992) defined the way to explain economic growth with following equation:
The economic outcome at time t, denoted as Y(t), is influenced by physical capital (K(t)), human capital (H(t)), and the labor force (L(t)) It is important to note that the product A(t)L(t) does not remain constant; instead, its growth rate is defined as (n+g) Additionally, capital depreciation is represented by the symbol δ, while the fraction of income allocated for investment in physical capital is indicated by s.
� ℎ is faction invested in human capital, so they designed the equation for assessment of steady state of income per capita as seen as below:
Aparicio, Urbano and Audretsch (2016) applied production function to determine economic growth as following equation:
�� �� �� �� �� where � �� is the economic output of a country i at time t, measured as the gross
� �� domestic product (GDP); � �� denotes the total labor force
Labor productivity serves as a key indicator of economic growth, while opportunity entrepreneurship reflects the potential for innovation and business development Additionally, a country's capital endowment plays a crucial role in its economic performance, alongside exports that contribute to its trade balance Life expectancy is another important factor, indicating the overall health and well-being of the population, and final government consumption represents the government's role in the economy.
The relationship between informal and formal factors, including control of corruption, is represented by the equation II it = f(II it, FI it, xit), where II it and FI it are vectors that capture these influences Additionally, xit denotes the controlling vector that affects entrepreneurial opportunities in country i at time t.
Previous research has largely utilized Cobb-Douglas production functions, often expanding them with additional control variables These studies can be categorized into two main groups: the first group supports neo-classical or exogenous growth models, employing simple OLS and GLS methods to estimate growth effects, while the second group advocates for endogenous growth models, utilizing FE, 2SLS, and GMM approaches Most researchers recognize the importance of human and physical capital, as well as government consumption, in driving growth However, there is a noticeable gap in the literature regarding the role of public finance in growth models Public finance significantly influences production inputs, and tax revenue impacts the investment climate of countries Therefore, it is essential to explore the relationship between total tax revenue, general government expenditure, and long-term economic growth.
3.2 2 Tax revenue and expenditure relationship
As we may know that, ECM model as seen below, represents the long- run relationship between public finance and economic growth.
Hendry and Richard (1982), Kremer et al (1992), and Banerjee et al.
(1996, 1998) developed the ECM model to verify the linkage between tax revenue and expenditure:
Kao and Chiang (2000) Expanded the panel equation as following: ′
�,� �,�, where {� �,� } are 1x1, � is a k x1 vector of the slope parameters, zi,t is the deterministic component and {� �,� } are the stationary disturbance terms,
{� �,� } are k x1 intergrated process of order one for all i, where � �,� � �,�−1 +
To ensure a stable economy, it is essential for the government to manage deficits through careful regulation of tax and spending Researchers have employed Granger tests on panel data to explore the relationship between tax revenue and government expenditure This analysis is grounded in three distinct perspectives regarding the correlation between tax revenue and public spending.
The fiscal synchronization hypothesis establishes a bidirectional causal relationship between two key variables, as demonstrated by various scholars (Musgrave, 1966; Meltzer and Richard, 1981; Bohn, 1991; Chang & Chiang, 2009) In their study, Chang and Chiang (2009) utilized a unit root test based on the methodology of Phillips and Perron (1988) and performed a co-integration test following Kao's (1999) approach They further implemented the Granger causality test across 15 OECD countries over a 15-year span from 1992.
In a study conducted by Mehrara et al (2011) on a dataset of 40 Asian countries from 1995 to 2008, the findings reinforced the fiscal synchronization hypothesis, which posits that policymakers should make revenue and expenditure decisions in tandem This aligns with earlier research from 2006 that similarly supported the notion of joint decision-making in fiscal policy.
The "spend-tax" hypothesis suggests that government spending can significantly influence tax revenue (Friedman, 1978; Darrat, 1998; Blackley, 1986) A study by Saunoris and Payne (2010) analyzed UK data over a 55-year period (1955–2009) and found evidence supporting this hypothesis, indicating an asymmetric adjustment in the long-term equilibrium between government revenues and expenditures.
The "tax-spend" hypothesis highlights how tax revenue empowers governments to manage their expenditures effectively (Mahdavi & Westerlund, 2008; Hansan et al., 2012) In a study by Al-Khulaifi (2012), unit root, co-integration, and Granger tests were applied to analyze data from Qatar over a 32-year period, spanning from 1980 to 2011.
Several studies, including those by Chang et al (2002), Narayan (2005), Dalena and Magazzino (2012), Chowdhury (2011), and Paleologou (2013), utilized three specific tests to confirm the mixed hypothesis regarding the relationship between tax revenue and expenditure However, the majority of these studies focused on panel or cross-sectional data from high-income countries or a single nation, leading to conclusions that predominantly supported one of the three hypotheses This raises important questions for policymakers in both developed and developing nations about the existence of a bidirectional causality link between tax revenue and expenditure.
3.2.3 Relationship among governance, tax revenue, government expenditure, and economic growth
Acemoglu et al (2003) tried to explain the different outcome between high income countries and low income countries by adding institution variable in their model:
�,�−1,� where � � ,�−1,� says about macroeconomic outcome for country c between times t and t-1, the outcome measured by deviation of GDP per capita � ′ indicates a vector of macroeconomic policies for country c between times t
′ and t-1, � � , �=0 denotes the institution of the beginning of the sample,
� � ,�−1,� is control variables, ��� �,�−1 is logarithm of initial income per capita.
Bird, Martinez-Vazquez and Torgler (2008) designed the equation for evaluating level effect of corruption on tax effort as following equation.
� �, (15) where i is a country i, �� � says the tax effort of country i, Y i denotes the
GDPper capita, POP i is population growth, XM i is ratio between export and import,
NAGR i presents the non-agricultural products, GOVQ i stands for indicator of corruption and accountbility of country i.
Furthermore, Cooray (2009) shed light on role of quality of governance for interpretation of economic gorwth, he followed and expanded the Mankiw,Romer and Weil (1992) as following:
The output per worker, denoted as y(t), is influenced by the stock of private capital per worker, k(t), and the stock of human capital per worker, h(t) Additionally, the size of government, represented by g(t), is assessed through the stock of government capital per worker, while the quality of government is measured by the variable θ.
Beekman, Bulte and Nillesen (2013) argued that corruption affects economic behavious according to following equation:
� 3 � �� + � ��, (17) where subscript I indexes household I =1,….N and subscript j indexes community j =1,…44, � 1 stands for coefficient of interest, and � � denotes the fixed effect of province with k=1,2, and 3.
Research data and its source
3.3.1 Determining appropriate variables and its sources
This study aims to identify suitable variables for research model design, focusing on public finance, which is measured through two key components: the ratio of total tax revenue to GDP, referred to as “TAXgdp,” and the ratio of total government expenditure to GDP, known as “GEXgdp.” Data for these variables is sourced from the IMF's Government Finance Statistics (GFS) database In line with the methodologies of previous researchers, including d'Agostino et al (2016) and Acemoglu et al (2003, 2008), we assess economic growth through these established public finance indicators.
GDP per capita, measured in constant US dollars with 2010 as the base year, provides more reliable insights than overall GDP or average growth rates It is calculated by dividing the gross domestic product by the midyear population According to the World Bank, GDP encompasses the total gross value added by all resident producers, along with product taxes, while excluding subsidies not reflected in product value This GDP calculation does not account for depreciation of manufactured assets or the depletion and degradation of natural resources, ensuring that the data remains in constant 2010 U.S dollars.
To achieve the third research objective, this study utilizes the "control of corruption" score from Kaufman et al (2011) to assess the governance variable (CCI), which reflects perceptions of corruption defined as the misuse of public power for private gain The scoring system ranges from -2.5 to 2.5, where higher values indicate lower corruption and better governance outcomes Data for this variable were sourced from the World Bank’s World Governance Indicators (WGI) and averaged for the years 1997, 1999, and 2001, as the analysis has been conducted annually since 2002 (Torgler and Schneider, 2009; Law et al., 2013) This variable is relevant for understanding tax systems and public spending Additionally, for robustness, the study incorporates the corruption perception index (CPI) from Transparency International, which was evaluated from 1996 to 2011, noting a methodological change in 2012 that adjusted the maximum index from ten to 100, indicating a corruption-free environment Due to the absence of CPI data for many developing countries in 1996 and 1997, this research assumes the score for these years is equivalent to that of 1998, using the nearest available index to address these gaps.
Furthermore, we extract the annual data for whole sample, which includes 38 developed and 44 developing countries over a 21-year period (1996-2016.) (See Appendix A1- List of studied countries).
Economic instability significantly impacts economic activities, prompting the use of the annual inflation index (INFL) to assess economic status In this research, the ratio of foreign direct investment (FDI) to GDP serves as an indicator of the investment climate The data for this study is sourced from the World Bank's World Development Indicators (WDI) database.
The Human Development Index (HDI) is a key indicator that reflects the quality of human capital within a society This index is sourced from the United Nations Development Program (UNDP), providing valuable insights into human development.
Variables ‘meaning Code of Variables
Gross domestic per capita (US dollars) rgdp
Total tax revenue (% of GDP) TAXgdp
Total government expenditure (% of GDP)
Inflation(Consumer annual Price index) INFL
Inflow of foreign direct investment value (% of GDP) FDI
Human development index (index) HDI
Control of corruption indicator CCI
Corruption perception index (CPI) of business CPI
Source: World Bank’s database – WDI and WGI, IMF’s database –GFS and WEO, UNDP’s database – HDI, TI’s database – CPI.
This study utilizes secondary data from reputable sources such as the World Bank, the International Monetary Fund (IMF), and the United Nations Development Programme (UNDP), aligning with the positivism philosophy that is effective for analyzing large volumes of numeric data The use of secondary data is advantageous due to its convenience and credibility, having been validated by prior research and thorough analytical processes.
Public finance, governance, and economic growth are interrelated subjects that explore the relationship between tax revenue and expenditure This discussion includes an examination of how public finance and governance impact economic development in both developed and developing countries.
To effectively address a research topic, it is essential for researchers to examine relevant theories that underpin the analytical framework and support their hypotheses Furthermore, researchers should present their perspective on how changes in government policies or the introduction of new laws and regulations impact tax revenue and government expenditure.
To engage readers and address their strong beliefs while minimizing bias, researchers should gather extensive data from both developed and developing countries Following this, conducting an experimental study will help validate their theories with concrete evidence.
According to Creswell (2009), researchers initiate the scientific method with a theory, subsequently gathering data to support or challenge that theory, followed by necessary revisions before conducting tests Data is collected through instruments measuring attitudes, and analyzed using statistical methods and hypothesis testing The quantitative method is deemed the most effective for testing theories or explanations, which is why this research utilizes secondary data from three key sources outlined in section 3.3.1.
3 4 Check balance and essential test
This study emphasizes the importance of checking the balance of large, longitudinal, and cross-sectional panel data using statistical software, as imbalanced data can negatively impact overall performance and challenge statistical robustness (Wang and Yao, 2012) To address research questions one and two, it is essential to verify the stationarity of the research variables to justify the use of Granger tests, long-run tests, and appropriate regression methods for dynamic panel data Furthermore, the study highlights that non-stationary variables can lead to spurious correlations, resulting in unreliable and invalid empirical results.
This thesis employs the unit root test following Harris-Tzavalis (HT)
The Im-Pesaran-Shin (IPS) test, introduced in 2003, improves upon the Harris-Tzavalis (HT) test from 1999 by relaxing the assumption of a common autoregressive parameter and allowing for unbalanced panels, which reduces bias from spurious regression While the HT test assumes that all panels share the same autoregressive parameter and that rho is less than 1 with fixed periods, the IPS test only requires that the time dimension (T) is sufficiently large, making it more flexible for co-integration testing.
5 if the dataset is strongly balanced for the asymptotic normal distribution of Z
Holley (2011) highlighted that short-term tax changes may differ significantly from long-run effects due to the high elasticity of the demand curve Over the past few decades, researchers have conducted extensive analyses to assist policymakers in crafting effective fiscal policies, addressing the potential biases arising from non-stationary variables in regression analyses To mitigate issues of spurious regression, numerous studies have utilized co-integration tests (e.g., McCoskey and Kao, 1999; Bai and Ng, 2004; Pedroni, 2004; Breitung and Pesaran, 2005; Westerlund and Edgerton, 2008; Persyn and Westerlund, 2008).
To address the initial research question, this study employs a co-integration test because the error-correction (EC) model is commonly used to explore long-term relationships between stationary and cointegrated variables (Ojede and Yamarik, 2012) The Westerlund error-correction based panel cointegration tests offer significant flexibility, accommodating a highly heterogeneous specification for both the long- and short-run components of the error-correction model, with the latter derived from the data Additionally, the series can vary in length, and if cross-sectional units are suspected to be correlated, robust critical values can be obtained through bootstrapping techniques.
Assuming that i represents a country and t is time period, the long-run relationship can be represented as below:
����� �,� = � 0,� + � �,� � �,� + � �,� , (1) where ����� �,� is logarithm of GDP per capita (dependent variable),
� �,� denotes country-characteristic slope coefficients, � �,� indicates the vector of public finance, and � �,� is an error term of country i at time t.
This study enhances the understanding of the relationship between public finance and economic growth by analyzing total tax revenue as a percentage of GDP and the ratio of general government expenditure to GDP It highlights that changes in tax rates or tax bases can significantly influence private investor behavior, ultimately affecting economic growth Additionally, government expenditure plays a crucial role in supporting essential production inputs, such as the labor force and infrastructure By examining public finance as a whole, policymakers gain a clearer insight into the economy, rather than focusing on individual taxes or specific public spending components.
Research data
The strong balanced panel data used for analysis (see Table 4.1 – Description of variables).
Meaning Variable Obs Mean Std Dev Min Max
Gross domestic per capita (US dollars) rgdp 1721 16593.04 19304.80 186.66 91617.28 Inflow of foreign direct investment value (% of GDP) FDI 1714 5.52 18.99 -43.46 451.72
Inflation(Consumer annual Price index) INFL 1721 6.85 28.08 -27.63 1058.37 Human development index
Control of corruption indicator CCI 1721 0.29 1.06 -1.53 2.47
Source: World bank’s database - WDI and WGI, IMF’s databsae - GFS , and UNDP’s databse - HDI.
Table 4.1 highlights significant disparities in income per capita between developing and developed nations, with the maximum GDP per capita exceeding the minimum by a staggering 490 times Additionally, the variance in tax revenue or expenditure reveals a gap of up to 7 times The control of corruption indicators further illustrate this divide, showing a peak of 2.47 against a low of -1.53 These striking differences underscore the importance of exploring the interrelationships among these variables across both developed and developing countries.
Correlation matrix rgdp FDI INFL HDI TAXgdp GEXgdp CCI CPI rgdp
***, ***, * stand for significance at 1%, 5% and 10% respectively
Source: World bank’s database - WDI and WGI, IMF’s databsae - GFS , and UNDP’s databse - HDI.
Table 4.2 reveals a strong and significant correlation between public finance, corruption, and economic growth, highlighting the close relationship between tax revenue and expenditure Additionally, the data demonstrates a robust connection between the control of corruption indicator and the corruption perception index, confirming that the latter can effectively validate the reliability of the former in future analyses.
For the less bias from spurious regression as well as co-integration test running, this paper employs the unit root test following Harris-Tzavalis (HT)
(1999) test and Im-Pesaran-Shin (IPS) (2003) (see explanations in the point 3.4).
Results of unit root test for a panel with normal data for the whole sample in 1996-2016
Ho: Panels contain unit roots
Normal HT test IPS test z p-value Statistic p-value AIC chosen lags average rgdp 0.85 -0.85 0.20 8.91 1.00 0.71 lrgdp 0.87 0.36 0.64 2.98 1.00 0.74
***, ***, * stand for significance at 1%, 5% and 10% respectively
Source: World bank’s database - WDI and WGI, IMF’s databsae - GFS , and UNDP’s databse - HDI.
Table 4.3 reveals that the "GDP per capita" variable is the only one that remains non-stationary This observation is corroborated by Bujang et al (2013), highlighting the necessity to identify co-integration relationships among non-stationary and stationary variables.
Results of unit root test for a panel with data of first different values for the variable, which does not stay.
This study performs a unit root test on the first differences of the specified variable, revealing that all variables do not exhibit significant results in relation to both the HT and IPS tests.
First different HT test IPS test rho
Statistic z p- value Statistic p- value AIC chosen lags average
***, ***, * stand for significance at 1%, 5% and 10% respectively
Source: World bank’s database - WDI
Tables 4.3 and 4.4 provide evidence of stationarity for all variables;these results indicate that there is no unit root in the error term of the panel dataset.
Long-run relationship between public finance and economic growth
Performing co-integration test helps this study to meet the part of first objective and the first research question as seen as below: run?
How closely does public finance correlate with the economy in the long
Westerlund long-run cointegration test results
Dependent variable: lrgdp (Average AIC selected lag length: