(LUẬN văn THẠC sĩ) the effectiveness of fiscal policy, contributions from institutions and external debts 002

464 | ICUEH2017 The effectiveness of fiscal policy: Contributions from institutions and external debts NGUYEN PHUC CANH University of Economics HCMC – canhnguyen@ueh.edu.vn Abstract The effectiveness of fiscal policy is an interesting field in literature of macroeconomics In this paper, we use panel data from 2002 to 2014 from 20 emerging markets to investigate the effects of fiscal policy on economic growth under contributions from the differences in institutions and external debt levels By using GMM estimators for unbalanced panel data, our results show positive growth effects of fiscal policy across emerging markets in the examined periods Notably, the improvement in institutions promotes higher crowding-in effects of fiscal policy In addition, this paper finds interesting evidences that the external debt has non-linear effects on economic growth, whereas the heterogeneous effects of fiscal policy on economic growth as positive effects in low indebted level and negative effect in high indebted level may explain the mechanism of this non-linear relationship The results have significant contributions to the literature and useful implications for authorizers in promoting sustainability of the economy The authorizers are strongly recommended to focus on improving the institutional quality that not only boosts the effectiveness of fiscal policy in general, but also solves the dilemma of high indebted countries when the fiscal policy loses the effectiveness Keyword: external debt; effectiveness; fiscal policy; institutions Introduction Fiscal policy is conducted by government through taxation and public spending with the aims at sustainable development for the economy So, fiscal policy and its impacts on the economic growth tend to be at the center of macroeconomic and political debates The field of the effectiveness of fiscal policy has re-highlighted in light of the 2008 global financial crisis with the new contemporary drivers such as external debt (Ruščáková & Semančíková, 2016) Due to the complexity of the fiscal process by which it is not fully captured, that why different theories provide different answers regarding macroeconomic effects of fiscal policy and arguments about the suitability and real effects TIEU LUAN MOI download : skknchat@gmail.com Nguyen Phuc Canh | 465 of government expenditures on economic growth are still interesting field of study (Bouakez, Chihi, & Normandin, 2014) Whereas, the main question in the literature of the fiscal policy’s effectiveness is that whether fiscal policy presents crowding-out and/or crowding-in effects in a country and what its drivers In fact, many researchers try to find evidences with the parallel existence of both and mixed conclusions (see Ahmed and Miller (2000), Heutel (2014), Şen and Kaya (2014)) The studies of the effectiveness of fiscal policy have developed and conducted in long history through many economic growth models Many studies use versions of the Solow (1956) model to study the dynamic effects of taxation on economic growth, while other studies use neo-classical growth model (Easterly & Rebelo, 1993) In this regard, researchers argue that the effects of government expenditures on economic growth follow two different regimes including crowding-out effects and crowding-in effects The neoclassical theory states that government expenditure crowds out private investment then has negative impacts on economic growth While, Keynesian view, in contrast, states that government expenditure stimulates private investment in the case of un-fully employment, which then has positive impacts on economic growth, especially in developing countries (Ahmed & Miller, 2000) Moreover, the effects of fiscal policy on economic growth is driven by many factors such as the employment in the economy, the transparency of government, the composition of government expenditures, or even the government size (see Akanbi (2013), Arestis (2011), Kasselaki and Tagkalakis (2016), Hemming, Kell, and Mahfouz (2002)) In empirical literature about the determinants of fiscal policy’s effectiveness, there are, in fact, some studies that consider the role of institutional framework such as corruption situation, economic freedom, democracy (see Baldacci, Hillman, and Kojo (2004), Martinez-Vazquez, Boex, and Arze del Granado (2007), Nelson and Singh (1998)) Meanwhile, the burdens of external debt on the sustainability of fiscal policy are also concerned For instance, Amato and Tronzano (2000) find the evidence that the debt maturity and the share of foreign-denominated debt are crucial determinants of exchange rate stability in Italia Bal and Rath (2014) find that Indian economic growth is impacted by central government debt, total factor productivity growth, and debt-services in the short-run They also recommend that Indian government should follow the objective of inter-generational equity in fiscal management over the long term to stabilize debt level TIEU LUAN MOI download : skknchat@gmail.com 466 | ICUEH2017 Which means that the external debt may influence the effectiveness of fiscal policy Recent study, Doğan and Bilgili (2014) find that external borrowing has negative impact on growth both in regime at zero and regime at one, but the public debt has higher negative effects on economic growth and development, thus they conclude a non-linear relationship between economic development and borrowing variables In fact, there are very early studies about the effects fiscal policy such as Smith (1937), Bailey (1971), Buiter (1977), and Arestis (1979), and many recent studies try to investigate the impacts of both government expenditures on private investment and especially economic growth However, the debate with regard to the effectiveness of fiscal policy is still ongoing (Bouakez et al., 2014; Heutel, 2014; Kameda, 2014a; Şen & Kaya, 2014) Precisely, the literature of fiscal policy is lacking of the studies about the effectiveness of fiscal policy under the contributions from the institutions and external debts in a comprehensive work Therefore, this study is conducted under the motivations from the study of Doğan and Bilgili (2014) by investigating the effectiveness of fiscal policy on economic growth under the relationships with the changes in the institutions and the burdens of external debt in the context of 20 emerging markets including Argentina, Bangladesh, Brazil, Bulgaria, China, Colombia, Egypt, India, Indonesia, Malaysia, Mexico, Pakistan, Peru, Philippines, Romania, Russia, South Africa, Thailand, Turkey, and Vietnam In this paper, we achieve our objectives by implementing following strategy We firstly examine the impacts of fiscal policy on economic growth through the modified model of endogenous growth theory by incorporating government expenditure and controlling other common drivers of economic growth including capital, labor, financial development, technology, economic openness (trade and capital flows) Then, the institutional factors including government effectiveness, regulatory quality, and control of corruption are incorporated, respectively, to test the impacts of institutions on economic growth Next, we use the interaction terms between government expenditure and institutions to examine the effectiveness of fiscal policy under the associations of institutional framework We then estimate the growth model with the explanatory variables including both external debt level to GNI and its square to examine the nonlinear relationship between external debt and economic growth After that, we divide our data into two sub-samples (the low indebted countries and high indebted countries) to TIEU LUAN MOI download : skknchat@gmail.com (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 Nguyen Phuc Canh | 467 investigate the effectiveness of fiscal policy under two regimes At last, we use GDP per capita growth rate in replacing GDP growth rate to check robustness of results By doing this strategy, we believe that this study has significant contributions to both theory and practice Firstly, this study has contribution to the literature of fiscal policy effectiveness and fiscal indebtedness by adding the effects of government expenditures under the external debt level and the associations with institutional quality The results find significant evidences that the institutions enhance the effectiveness of fiscal policy Notable, the external debt level presents the non-linear relationship with economic growth through the mechanism that the fiscal policy has the heterogeneous effects on economic growth: the crowding-in effect in low indebted level and crowding-out effects in high indebted one Secondly, this study has significant implications for the authorizers in implementing the long-term sustainable fiscal policy in line with borrowing policy and the solutions for the high indebted countries that face to the dilemma of ineffective fiscal policy This paper is structured as following Section states our motivations of this study Section briefly presents literature reviews and then our arguments on the effectiveness of fiscal policy under the contributions from institutions and external debt Methodology and data are provided in Section Section presents the results and our discussions The concluding remarks are discussed in Section Literature reviews In the literature of fiscal policy effectiveness, it is natural place to start with the Keynesian theory In Keynesian model, the sticky price and excess capacity are assumed that contraries to the classical economics, so that aggregate demand determines output and government expenditures have a multiplier effect on aggregate demand and output (Coddington, 1976) Therefore, Keynesian economics call for the government intervention and incorporate government expenditure into the aggregate demand function The Keynesian views argue that there is very rare case for an fully employed economy, thus the sensitivity of investment to interest rates would be low and then an increase in interest rates due to expansionary fiscal policy would be minimal, the government expenditure, in turn, has positive impacts on economic growth (O’Hara, 2011; Şen & Kaya, 2014) This view is also called as the crowding-in effects of fiscal policy, where the government should TIEU LUAN MOI download : skknchat@gmail.com (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 468 | ICUEH2017 undertake the expenditure in the recession time to cover the lack of private consumption and investment (Jahan, Mahmud, & Papageorgiou, 2014) However, some of extensions in the line of Keynesian model allow for crowding-out effects of fiscal policy, which means the expansion of government expenditure crowds out the private demand and then influences negatively on output, through the changes in interest rates and exchange rate in the case of open economy With the assumption that the private investment is negative impacted by the increase in interest rate, the expansionary fiscal policy that backed by borrowing leads to the lower private investment due to higher interest rates Moreover, the higher interest rates due to the expansionary fiscal policy attract capital flows in the case of open economy that appreciate exchange rate and then results the deterioration in current account (see Mundell (1963), Fleming (1962)) The neo-classical economics address the shortcomings of Keynesian economics on its lack of microeconomic foundations The neo-classical views focus on the determination of goods, outputs, and income distributions in markets through both supply and demand sides by adding the assumption of utility maximization of income-constrained individuals and firms under the boundary of factors in production and available information (see Gaffney (1994), Goodland and Ledec (1987), Davis (2006)) In which, the neo-classical economics raise the rational expectations in comparing to the adaptive expectations in Keynesian economics This brings forward adjustments in economic factors that occur more progressively so that fiscal policy matters in not only long-term but also short-term period And the permanent fiscal changes can lead to the crowding-out effects since private sectors expect the persistent changes in interest rates and exchange rates in this case (see Buiter (1977), Arestis (1979), Mundell (1963), Fleming (1962)) In addition to neo-classical economics, the Ricardian view that is based on Ricardian equivalence theorem assumes that the individuals are forward-looking in the current activities, which is also in contrasting with the Keynesian economics view as individuals rely on current income (see Barro (1988), McCallum (1984)) In Ricardian view, individuals anticipate a present tax cut as higher government borrowing that turns into the higher taxes in the future so that there is no change in permanent income This condition in along with the assumptions of no liquidity constraints and perfect financial markets lead to no change in private consumption in general (Barro, 1974) Thus, TIEU LUAN MOI download : skknchat@gmail.com (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 Nguyen Phuc Canh | 469 Ricardian view suggests neither crowding-in nor crowding-out effects of fiscal policy (Arestis, 2011; Şen & Kaya, 2014) However, if governments change lump-sum taxes for the fiscal policy, the features of progressive taxes will have impacts on permanent income and then the aggregate demand and output As a result, the effectiveness of fiscal policy most likely depends on how it is paid in the future and the productivity of government expenditures (Hemming et al., 2002) As a brief summary, the government expenditure, as according to the Keynesian views, is needed to cover the lack of consumption in private sectors, which means the fiscal policy presents a positive effect on economic growth However, the Keynesian view is lacked of considering other factors such as institutional environment or debt burden on the effectiveness of fiscal policy The neo-classical economics views further explains the effectiveness of fiscal policy in the some manner relationship with the public debt In neoclassical views, today’s individuals think that the existing budget deficits due to the expansionary fiscal policy to increase the consumption level have to pay back through taxes for future generations In addition to the less effective of government expenditure in comparing to private investment so that the increased output as a result of the debt financed expenditure does not fully offset the negative effect due to the crowding-out effects to private investment on output Therefore, the fiscal policy presents crowdingout effects at the end Meanwhile, the Ricardian view suggests that fiscal policy presents neither crowding-in nor crowding-out effects due to the independently path of private investment and government spending Where, the increase in government spending is anticipated to be accompanied by a rise in taxes in the future, thus government expenditure financed by debts is expected to be repaid by revenue generated through taxes levied in the future As the result, interest rates and private investment remain unchanged All above economic views require assumptions to be presence such as no liquidity constraints, perfect financial markets in Ricardian equivalence However, these assumption are usually un-existed thus the significance of theories is questioned in both theory and practice (Haque & Montiel, 1989) Furthermore, there are some cases that the effectiveness of fiscal policy is explained by all of these views For instance, if government is restricted by the fiscal rules to balance the fiscal budget in the long run, thus individuals may partial adjust their behaviors if they have short-term horizon which presents the presence of both Ricardian and neo-classical views In the same idea, if the current path TIEU LUAN MOI download : skknchat@gmail.com (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 498 | ICUEH2017 Acknowledgement The author wish to thank the Editors, Professor Su Dinh Thanh, for their many helpful comments and suggestions which greatly enhance the brevity and quality of this study I am grateful for the financial support from the Project on “Promoting the Enhance Quality of the English-Language Version of Journal of Economic Development, Intended as a Scopus-Listed Journal” of Journal of Economic Development and University of Economics, Ho Chi Minh City, in conducting this research Any remaining errors are of course our own responsibility References Acemoglu, D., & Robinson, J (2008) The role of institutions in growth and development World Bank, Washington DC Adam, C S., & Bevan, D L (2005) Fiscal deficits and growth in developing countries Journal of public economics, 89(4), 571-597 doi:http://dx.doi.org/10.1016/j.jpubeco.2004.02.006 Afonso, A., & Strauch, R (2007) Fiscal policy events and interest rate swap spreads: Evidence from the EU Journal of International Financial Markets, Institutions and Money, 17(3), 261-276 doi:http://dx.doi.org/10.1016/j.intfin.2005.12.002 Agenor, P.-R., & Montiel, P J (1996) Development macroeconomics: Princeton, New 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contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy 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Analyzing the effects of government spending on private investment in Turkey Panoeconomicus, 61(6), 631-651 TIEU LUAN MOI download : skknchat@gmail.com (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002 (LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002(LUAN.van.THAC.si).the.effectiveness.of.fiscal.policy contributions.from.institutions.and.external.debts.002