Corruption And Determinants Of Fiscal Deficits In Asia Pacific Countries.pdf

i Ministry of Education and Training University of Economics Ho Chi Minh City ******** Research Topic CORRUPTION AND DETERMINANTS OF FISCAL DEFICITS IN ASIA PACIFIC COUNTRIES Contributor Nguyen Phuc C[.]

Ministry of Education and Training University of Economics Ho Chi Minh City ******** Research Topic CORRUPTION AND DETERMINANTS OF FISCAL DEFICITS IN ASIA PACIFIC COUNTRIES Contributor Nguyen Phuc Canh Ho Chi Minh City, Aug/2017 i Ministry of Education and Training University of Economics Ho Chi Minh City ******** Research Topic CORRUPTION AND DETERMINANTS OF FISCAL DEFICITS IN ASIA PACIFIC COUNTRIES Ref code: CS – 2017 - 17 Contributor Nguyen Phuc Canh Ho Chi Minh City, Aug/2017 ii Table of content Abstract v Chapter 1: INTRODUCTION 1.1 The motivations of the study 1.2 The scope of the study 1.3 The contributions of the study 1.4 The methodology Chapter 2: LITERATURE REVIEW 2.1 The fiscal deficits and determinants 2.2 The external debt and fiscal deficits 10 2.3 The government size and fiscal deficits 12 2.4 The corruption controlling and fiscal deficits 13 2.5 The effects of corruption controlling under the constraints of external debt and government size 15 Chapter 3: METHODOLOGY AND DATA 18 3.1 Methodology 18 3.2 Data 20 Chapter 4: RESULTS AND DISCUSSIONS 23 4.1 The corruption controlling and fiscal deficits 23 4.2 The effects of corruption controlling under the constraints of external debt and government size 26 4.3 Robustness check 28 Chapter 5: SOME REMARKING CONCLUSIONS 31 Acknowledgement 32 References 33 iii Lists of Tables and Figures Tables Table Data definitions and sources 19 Table Data descriptions 20 Table Correlation matrix 22 Table The effect of Control of corruption and fiscal deficits 24 Table The effects of Control of corruption and its interactions with government expenditure and external debt on fiscal deficits 26 Table The effects of Control of corruption and its interactions with government revenue and external debt on fiscal deficits 27 Table The effects of Control of corruption on fiscal deficits in pre and post 2008 global financial crisis 28 Table The effects of Control of corruption and its interactions with government expenditure and external debt on fiscal deficits in pre and post 2008 global financial crisis 29 Figures Figure Economic growth of areas Figure Government expenditure growth rates in Asia Pacific areas Figure Primary fiscal balance in Asia Pacific countries (%/GDP) iv Abstract The fiscal policy conducting with the aim of sustainable development is under strong debate from both scholar and practice, in which the institution-based solutions for the fiscal consolidation are suggested as essential measures to complement for the ineffective of market-based solutions The study contributes to the literature and practice by emphasizing the roles of corruption controlling on fiscal deficits in the context of 26 Asia Pacific countries for the period 2002 – 2015 By recruiting the system-GMM estimators for unbalance panel data, the study finds the significant evidences that the better corruption controlling eliminates fiscal deficits Notably, the corruption controlling measures have stronger effects in low indebted countries with small government size The result has significant implications for policymakers in fiscal consolidation and sustainable policy setting Keywords: corruption, fiscal deficit, external debt, government size JEL classifications: E62, H11, H62, H63 v Chapter 1: INTRODUCTION 1.1 The motivations of the study The excessive fiscal deficits in a long-run period are considered as the fundamental problem and the cause of recent severe debt crisis such as crisis in Mexico and Argentina in 1990s, crisis in European in 2000s (Cole & Kehoe, 1996; Featherstone, 2011; Ruščáková & Semančíková, 2016) For instance, Ruščáková and Semančíková (2016) summarize that worsening values of macro fundamental variables including the fiscal deficits had predominantly significant effect on the origin of the European debt crisis beside other drivers such as high international risk, the negative impact of rescue activities, news about sovereign rating downgrades, etc However, the one of most important factor is the crisis of confidence due to the long lasting deficits in the fiscal budgets Therefore, the measures to handle the budget deficits with the aim at sustainable development are under strong attention from both scholars and policymakers In the theoretical and empirical literature of fiscal consolidation, the market-based and institution-based solutions are both examined by researchers to find the efficiency way of fighting excessive budget deficits Whereas, the market-based solutions from internal measures such as cut government spending, tax increases, stimulate economic growth to external measures of international organizations (e.g., IMF, World Bank) such as increase the borrowing interest rate, limit the ability to borrow, decrease the credit worthy ranking) are under consideration and implementation Unfortunately, the market-based solutions such as setting high interest rates for high deficit government in getting new debt to stimulate them lower the deficits are not effective Maltritz and Wüste (2015) document that European large governments such as Germany or France agreed to provide funds for troubled countries at comparably low interest rates for during the crisis with the aim at helping them out of default; thus, the market-based solution basing on the setting high interest rate is not effective in recent European debt crisis The institution-based solutions are, in turn, implied with more significant in the literature (Maltritz & Wüste, 2015), in which corruption controlling not only reduces the wasted government spending, but also stimulates the economic activities that enhances the government revenues In addition, Martinez-Vazquez et al (2007) notice that the corruption has been downplayed by many governments since it was considered as a cultural and political issues and measuring corruption was nearly impossible so that corruption controlling was hardly seen as an economic objective for development reforms However, the negative damages of corruption on the economic development, especially in poor countries, are evidenced in studies recent decade Dal Bó and Rossi (2007), for instance, find that besides other factors such as public ownership, inflation, and lack of law and order, corruption appears to play a separate and more robust role in damaging the efficiency of firms in 13 Latin American countries over the period 1994-2001 Dimakou (2015) notices that corruption constrains the fiscal capacity to tax and increases the reliance on inflation Moreover, the new dataset of institutional framework (World Governance Indicators – World Bank), which include the indicator of controlling corruption, is provided with more reliable information and better measuring method in evaluating the corruption situation (Kaufmann et al., 2007) Thus, the question about the roles of corruption in tackling the fiscal deficits has re-emphasized Apparently, Arestis (2011) notices that recent developments of “New Consensus in Macroeconomics” in macroeconomic policy have downgraded the roles of fiscal policy, but researchers and authorizers must careful consider other determinants of fiscal policy such as the institutional frameworks, debt burden, and also government size This rehighlights the interests in examining the associations of corruption controlling with other economic drivers of fiscal deficits Therefore, this study sheds lights on the effects of corruption controlling and its interactions with other aspects of fiscal policy including government size and external debt burden on fiscal deficits 1.2 The scope of the study The study goes to examine the effects of corruption controlling on fiscal deficits and its interactions with external debt and government size in the context of 26 Asia Pacific countries In which, the better corruption controlling is in line with the less corruption Therefore, in the understanding we can see the corruption and the corruption controlling have opposite meanings The 26 Asia Pacific countries, which are mainly developing and emerging countries that we exclude the advanced countries, are the fruitful sample to examine the roles of corruption controlling on fiscal deficits due to their high economic development in along with the variety of corruption situation and the structural changes in the economic development In fact, the Asia Pacific area is the one of most dynamic and highest economic growth in the period of 2000-2015 (see Fig 1) The real GDP growth rate of this area is average higher than US, OECD, and European countries While, its growth rate is less impacted in the 2008 global financial crisis 26 Asia Pacific countries in this study including: Afghanistan, Armenia, Azerbaijan, Bangladesh, Bhutan, China, Fiji, Georgia, India, Indonesia, Kyrgyz Republic, Lao People's Democratic Republic, Malaysia, Maldives, Mongolia, Nepal, Philippines, Papua New Guinea, Samoa, Solomon Islands, Sri Lanka, Tajikistan, Thailand, Tonga, Vanuatu, Vietnam Economic growth (annual, %) 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 East Asia & Pacific Euro area Europe & Central Asia Latin America & Caribbean Middle East & North Africa OECD members Sub-Saharan Africa United States 2015 Figure Economic growth of areas Source: World Development Indicators (Worldbank) On the aspect of government operation, the general government expenditure increased in the pre-2008 global financial crisis, and they expended the government spending higher in the crisis that presents the government policies to tackle with the crisis through the stimulus packages and expansionary fiscal policy (see Fig.2) This fact shows the important role of fiscal policy in macroeconomic policies of governments in this area General government final consumption expenditure (annual % growth) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2002 2003 2004 2005 2006 2007 2008 East Asia & Pacific 2009 2010 2011 2012 2013 Europe & Central Asia Figure Government expenditure growth rates in Asia Pacific areas 2014 2015 Source: World Development Indicators (Worldbank) Furthermore, the fiscal budgets were usually under the deficit situations across countries in the whole period (see Fig.3), except some small countries such as Georgia, Mongolia, and Tonga in some short period of years This fact provides a suitable sample for us to examine the determinants of fiscal deficits Primary fiscal balance (%/GDP) 10.0 0.0 -5.0 -10.0 -15.0 AFGHANISTAN AFGHANISTAN ARMENIA ARMENIA AZERBAIJAN BANGLADESH BANGLADESH BHUTAN Fiji Fiji GEORGIA INDIA INDIA INDONESIA KYRGYZ REPUBLIC KYRGYZ REPUBLIC LAO PEOPLE'S… LAO PEOPLE'S… MALAYSIA MALDIVES MALDIVES MONGOLIA Nepal Nepal PHILIPPINES PAPUA NEW GUINEA PAPUA NEW GUINEA China SAMOA SAMOA SOLOMON ISLANDS SOLOMON ISLANDS SRI LANKA TAJIKISTAN TAJIKISTAN Thailand TONGA TONGA VANUATU Vietnam Vietnam 5.0 -20.0 -25.0 -30.0 Figure Primary fiscal balance in Asia Pacific countries 2002-2015 (%/GDP) Source: Key economic indicators (ADB) As a result, the developing countries in Asia Pacific area are the fruitful sample for examining the effects of corruption and its interactions with other drivers on fiscal deficits Whereas, we examine the effects of corruption controlling and its interactions with the external debt and government size on fiscal deficits in the period of 2002 – 2015 This period of time is recruited due to the availability of data from the World Governance Indicators of World Bank that provides the yearly data from 2002 and the lasted data in 2015 1.3 The contributions of the study Chapter 2: LITERATURE REVIEW 2.1 The fiscal deficits and determinants The rise and persistence of large fiscal deficits in many developed and developing countries from 1980s is one of the most striking macroeconomic debate in both literature and practice (Woo, 2003) The cause of excessive fiscal deficits in the European debt crisis renews interests in the question what are the determinants of fiscal deficits (Maltritz & Wüste, 2015) According to Roubini and Sachs (1989), the traditional macroeconomic literature, as Keynesian theory, assumes that government policy is exogenous variable, in which the governments should take a fiscal stimulus to response to a recession as a standard “Keynesian” suggestion In the recession, governments either by tax cuts or increased government spending can increase total demand to promote output and employment Whereas, the Keynesian theory does not mention to the fiscal deficits or the source for the government spending However, the changes in macroeconomic context and development of macroeconomic literature have changed the views about fiscal policy, whereas structural macroeconomic models combined with simply objective functions for government lead to the normative rules for government’s behavior in their fiscal policy (Roubini & Sachs, 1989) In this line of literature, the neo-classical economic theory argues that fiscal policy, inflation rates, and fiscal deficits are the outcomes of the optimal decisions from policymakers for the preferences of private agents and welfare-maximizing functions (Roubini, 1991) In particular, Barro (1979) proposes the tax-smoothing model in the neoclassical of debt, whereas the policymakers try to choose policies to minor the excess tax burdens in the frame of a long-run intertemporal optimization, which then reflect to actual tax, inflation rates, and budget deficits The fiscal budget is expected to raise when the output is temporarily high and the government expenditure is temporarily low, in which the fiscal policy plays as the counter-cyclical policy This counters the economic cycles by expanding in the low growth period and contracting in the high growth one, and government, of course, has to accept the deficit or higher deficit in low growth periods Fiscal policy has, in turn, surplus or lower fiscal deficit in high growth periods to longrun balancing Thus, the literature points out some main economic determinants of fiscal deficits as economic growth, unemployment In fact, the economic growth and unemployment are used as main economic determinants of fiscal deficits in many empirical studies The fiscal policy is argued that they have to play as the counter-cyclical policy in macroeconomic policies so that higher economic growth increases revenue on one hand, while economic growth on the other hand reduces the demand for government spending such as transfer and unemployment aid As the result, the higher economic growth improves the budget balance of governments (Adam & Bevan, 2005; Altunc & Aydın, 2013; Attari & Javed, 2013) However, governments not implement the counter-cyclical fiscal policy all the time Aghion et al (2014) find that more the more counter-cyclical fiscal policies are harmful for industries with the sample of 15 OECD countries over the period 1980–2005 So, Bauducco and Caprioli (2014) find that fiscal policy is pro-cyclical in emerging economies, and they may transform to countercyclical policies in the long run In the same idea, Schalck (2014) documents that most EMU countries are characterized by an acyclical or pro-cyclical fiscal policy in the period of 1998-2012, but they pursued a counter-cyclical policy after 2008 Meanwhile, the unemployment is the crucial factor of fiscal policy conducting, where the government tries to keep unemployment at low level as natural unemployment (Degiannakis et al., 2016; Jha et al., 2014; Nishiyama, 2015) This means that the increasing of unemployment requires the expanding of fiscal policy to counter, while it limits the revenue bases of fiscal policy so that budget balance is worsen Andersen and Sørensen (1995) notice that balanced budget demand management policies in EMU countries are shown to affect employment Recently, DeLong and Summers (2012) emphasize that fiscal policy has the stabilization policy mission to supplement for the incapable of monetary policy due to the low – zero interest rate in the depressed economy with ample cyclical unemployment Apparently, the development of literature also determines other economic drivers of fiscal deficits such as real interest rate, inflation (Maltritz & Wüste, 2015) As reviewed in Catão and Terrones (2005), macroeconomic views postulate that budget deficits cause inflation from the point of view in Sargent and Wallace (1981), where governments have sooner or later to finance the persistent deficits by money creation thus leads to the inflation However, Sargent and Wallace (1981) also argue that the deficit-inflation relationship is dynamic In this direction, Makin (1983) argues that the behaviors of fiscal policy have relationships with real interest rate, money surprises, and inflation Precisely, higher inflation puts pressures on government to prudential controls of fiscal policy The higher inflation, on the other side, means lower real interest rate in borrowing debt to finance the deficit that may stimulate policymakers to expand the fiscal policy As the argument of borrowing cost, higher real interest rate means higher borrowing cost for government in getting fund for fiscal deficits, thus it stimulates policymakers to reduce the fiscal deficits 2.2 The external debt and fiscal deficits Beside above determinants, the economics literature documents the roles of external debt in fiscal policy (Ardagna et al., 2007; Demirgỹỗ-Kunt & Detragiache, 1994; Engen & Hubbard, 2005; Fosu, 1999; Galiński, 2015) Beginning with the Keynesian theory, the fiscal policy is explained with positive effects on economic growth under the assumptions as sticky price and excess capacity (Coddington, 1976) The government intervention, therefore, is suggested and government expenditure is incorporated into the aggregate demand function with the assumption that government activities are exogenous so that fiscal policy is not impacted by the debt burden 10 In the stream of literature development, the neo-classical economics address the shortcomings of Keynesian economics such as lacking of considering institutional environment, debt burden, and microeconomic foundations (see Gaffney (1994), Goodland and Ledec (1987), Davis (2006)) Today’s individuals in neo-classical views think that the expansionary fiscal policy to increase the consumption creates existing budget deficits, which have to pay back through taxes for future generations While, the government spending is less effective than private investment thus the increased output as a result of the debt financed government expenditure does not fully offset the negative effect due to the crowding-out effects to private investment on output (see Buiter (1977), Arestis (1979), Mundell (1963), Fleming (1962)) Therefore, the policymakers are constrained by the debt burden in implementing fiscal policy For instance, Aizenman et al (2013) argue the impacts of fiscal management on the sovereign risk of European area by documenting the significant evidence over the period 2005-2010 in Greece, Ireland, Italy, Portugal and Spain Aguiar and Amador (2016) argue that government should consider the zero labor tax as an optimal long run outcome if the economy is subject to sovereign debt constraints Alt and Lassen (2006) find that the higher transparency of fiscal policy is associated with lower public debt and deficits in 19-country OECD countries Notably, Baharumshah et al (2017) find that the Malaysian government should cut the deficits only if public debt exceed a certain level Whereas, if the public debt exceeds a certain threshold level (above 55% of the gross domestic product in the Malaysia case), it is negatively correlated with economic activity Baldacci et al (2015) study 107 countries and 79 episodes of public debt reduction during the 1980-2012 period, they find that fiscal adjustments are gradual and rely on a mix of revenue and spending measures can support output expansion, while reducing public debt Previous, Bohn (1998) find evidence of corrective action in the US fiscal policy, where the primary surplus is an increasing function of the debt-GDP ratio Çufadar and Özatay (2017) emphasize that fiscal contractionary is conducive to real economic activity when initial government debt is high 11 As the review in Hemming et al (2002), the future government is limited in fiscal capability by a strategic instrument from the debt, while governments in developing countries have to tackle more constraints due to the availability and cost of domestic and external borrowings As a result, developing countries with highly indebted level have to determine the size of fiscal deficit in facing with difficulties in assessing to international capital market and less effectiveness of fiscal policy As a result, they suffer more severe fiscal deficits The low indebted countries, in contrast, have higher fiscal room with more favorable terms of debt-financing and more effective fiscal policy so that they are argued with a better fiscal balance 2.3 The government size and fiscal deficits In fact, the literature and empirical works also proposes mixed conclusions about the relationship between government size and economic growth (see Thanh (2014)) Altunc and Aydın (2013) find that the optimal level of public spending should be between 15% and 50% in the sample of Turkey, Romania and Bulgaria for the period 1995-2011 Asimakopoulos and Karavias (2016) also find that government size has an asymmetric impact on economic growth in both developed and developing countries Thus, we can expect the difference effects of government size on the fiscal deficits According to Andersen and Sørensen (1995), optimal fiscal policies require constraints on the size of the public sector The government size, which can be represented by government spending as share of GDP (Garrett & Rhine, 2006), or tax revenue as share of GDP (Altunc & Aydın, 2013), is investigated in previous studies about its relationships with other economic factors such as economic growth, macroeconomic stability, and effectiveness of fiscal policy (e.g., see Vedder and Gallaway (1998), Benarroch and Pandey (2012), Asimakopoulos and Karavias (2016), Bournakis and Tsoukis (2016)), but its roles in fiscal consolidation are likely ignored 12 In the views of endogenous theory, the economic growth increases in line with government services and taxation when government size is relative small (see Romer (1986), Lucas (1988), Barro (1990), Rebelo (1990)) However, if the government size goes beyond specific point that requires increasing in taxation to finance for additional public services, the government size will diminish the return to investment and economic growth Afonso and Furceri (2010), for example, notice that the government size has negative effects on growth in OECD and EU countries In fact, the country with small government has the greater advantage to increase in efficiencies such as the total factor productivity growth and the capital productivity from reducing tax burden and distortion In addition, government with small size can exploit the greater market disciplines to improve efficiency of resource distribution; they are also more effective in providing the legal, administrative, and infrastructure critical for growth, as well as for offsetting market failures (Dar & AmirKhalkhali, 2002) For instance, Dar and AmirKhalkhali (2002) find that the country with larger government size presents lower total factor productivity growth as well as the productivity of capital on average They notice that the advantage of a small government sector are the greater efficiencies resulting from fewer policy-induced distortions and the greater discipline of market forces While, the government with large size or too large that goes beyond some specific point may hamper capital accumulation and present the crowding-out effects on economic growth (Wahab, 2011; Yamamura, 2011) Therefore, we hypothesize a negative impact of large government size on the fiscal balance due to the less effective of fiscal policy and the harder in management of policymaker in implementing fiscal policy 2.4 The corruption controlling and fiscal deficits Despites that many macroeconomists have tried to make important effects in formulating a positive theory of government behavior from the theoretical and empirical 13 views The works of Kydland and Prescott (1977), Barro and Gordon (1983a), Barro and Gordon (1983b) emphasize that optimal policies are time inconsistent so that actual government policies may deviate from the optimal stance if policymakers can not commit their works Therefore, the institutional drivers of fiscal deficits are considered in the literature from the framework of neoclassical approach beside the economic determinants As an early review in Alesina and Perotti (1995) and Persson and Tabellini (1999), the economic literature focuses on some institutional aspects such as political uncertainty, the conflicts between difference parties, the political regime, electoral law approach (see Woo (2003)) In this line of literature, there are some works considered the roles of corruption in the fiscal policy’s effectiveness (see De Haan and Sturm (1994), De Haan and Sturm (1997), Martinez-Vazquez et al (2007), Dimakou (2015)) For instance, Martinez-Vazquez et al (2007) emphasize that the measures to eliminating corruption were not usually an economic objective for the development of governments But, they notice that the views of corruption controlling are changed in recent decades due to the frustration with the lack of effectiveness of traditional economic theories and the recognition of the important roles of institutions and good governance practices Moreover, Lockwood et al (2001) find that the fiscal policy in Greece in the period 1960-1972 did not follow a long-term efficiency due to the political pressures, which determined the path of government spending, taxations and borrowing In addition, Dimakou (2015) finds that the fiscal capacity in taxations is constrained by corruption and it may increase the inflationary reliance In fact, corruption causes many consequences for the economy Mo (2001) finds that corruption reduces the level of human capital and the share of private investment Antunes and Cavalcanti (2003) notice that the country will be roughly 1/3 to 1/2 as rich as the United States if debt contracts are not enforced and corruption corresponds to 10% of business income Lash (2004) summarizes that corruption causes a reduction in economic efficiency, a diminution of capital formation and ultimately a slowdown in 14 economic growth Dal Bó and Rossi (2007) point out that more corruption is strongly associated with more inefficient firms in the sense that less output from inputs Fredriksson et al (2004) present the evidences in 12 OECD countries over the period of 1982–1996 that the higher corruption reduces energy policy stringency, while increases the coordination costs Recently, Kunieda et al (2014) find that highly corrupt countries impose higher tax rates, then magnifying the negative impact of government corruption on economic growth Therefore, we argue that the better corruption controlling will have positive effects on fiscal balance under three strands First, the better corruption controlling limits the negative impacts of corruption on the effectiveness of fiscal policy (see Olawunmi and Ayinla (2007)), which enhances the fiscal balance as the end Second, the better corruption controlling keeps government away from the wasted public expenditures, while it enhances the effectiveness of fiscal policy (see Wu et al (2010)), thus in turn boosts the budget balance Third, the better corruption controlling is positive effects on economic growth in overall due to the lower implied cost for economic activities (see Mo (2001)), therefore it helps improve the fiscal balance 2.5 The effects of corruption controlling under the constraints of external debt and government size Goel and Nelson (1998) find that government size has a strong positive influence on corruption since there are more chances and more things for policy-man taking corruption Kotera et al (2012) indicate that an increase in government size can lead to a decrease in corruption in the countries with high democracy level, it, in contrast, can lead to an increase in corruption in low democracy level Therefore, the positive effects of corruption controlling on fiscal balance may be impeded by the government size and the external debt burden 15 ...Ministry of Education and Training University of Economics Ho Chi Minh City ******** Research Topic CORRUPTION AND DETERMINANTS OF FISCAL DEFICITS IN ASIA PACIFIC COUNTRIES Ref... controlling on fiscal deficits and its interactions with external debt and government size in the context of 26 Asia Pacific countries In which, the better corruption controlling is in line with... The fiscal deficits and determinants The rise and persistence of large fiscal deficits in many developed and developing countries from 1980s is one of the most striking macroeconomic debate in