Fiscal policy, public expenditure composition and growth. theory and empirics

Willi, Semmlero and Alfred, Greiner and Bobo, Diallo and Anand, Rajaram and Armon, Rezai (2011): Fiscal policy, public expenditure composition and growth. theory and empirics. Published in: Aestimatio. The IEB International Journal of Finance No. 2 (July 2011): pp. 1-42.

Abstract

This paper responds to the development policy debate involving the World Bank and the IMF on the use of fiscal policy not only for economic stabilization but also to promote economic growth and increase per capita income. A key issue in this debate relates to the effect of the composition of public expenditure on economic growth. Policy makers and some researchers have argued that expenditure on growth-enhancing functions could enhance future revenue and justify the provision of "fiscal space" in the budget. But there are no simple ways to identify the growth-maximizing composition of public expenditure. The current paper lays out a research strategy to explore the effects of fiscal policy, including the composition of public expenditure, on economic growth, using a time series approach. Based on the modeling strategy of Greiner, Semmler and Gong (2005) we develop a general model that features a government that undertakes public expenditure on (a) education and health facilities which enhance human capital, (b) public infrastructure such as roads and bridges necessary for market activity, (c) public administration to support government functions, (d) transfers and public consumption facilities, and (e) debt service. The proposed model is numerically solved, calibrated and the impact of the composition of public expenditure on the long-run per capita income explored for low-, lower-middle- and uppermiddle-income countries. Policy implications and practical policy rules are spelled out, the extension to an estimable model indicated, a debt sustainability test proposed, and the out-of-steady-state dynamics studied.

• Item Type: MPRA Paper
• Language: English
• Keywords: Infrastructure investment, Economic growth, Compostion of the public budget, Financing public expenditures, Public deficit, Public debt
• Subjects: H - Public Economics > H4 - Publicly Provided Goods; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy; H - Public Economics > H1 - Structure and Scope of Government; H - Public Economics > H5 - National Government Expenditures and Related Policies; H - Public Economics > H2 - Taxation, Subsidies, and Revenue; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook; H - Public Economics > H3 - Fiscal Policies and Behavior of Economic Agents

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Glomm, G. and Ravikumar, R. (1997). Productive government expenditures and long-run growth. Journal of Economic Dynamics and Control, 21(1), pp. 183-204.

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Gruene, L. and Semmler, W. (2004). Using dynamic programming with adaptive grid scheme for optimal control problems in economics. Journal of Economic Dynamics and Control, 28, 2427-2456.

Hamilton, J. and Flavin, M. (1984). On the limitations of government borrowing: A framework for empirical testing. The American Economic Review, 76, pp. 808-819.

Kremers, J. (1988). US federal indebtedness and the conduct of fiscal policy. Journal of Monetary Economics, 23, pp. 219-238.

Lucas, R. (1988). On the mechanics of economic development. Journal of Monetary Economics, 22 (1), pp. 3-42.

Reddy, S. and Minoiu, C. (2006). Development, aid, and economic growth: A positive long-run relation. DESA Working Papers, 29, United Nations, Department of Economics and Social Affairs.

Rodrik, D. (2005). Why we learn nothing from regressing economic growth on policies. Mimeo, Kennedy School of Government.

Suescun, R. (2005). Fiscal space for investment in infrastructure in Colombia. [WP3629], World Bank.

Tanzi, V. and Zee, H. (1997). Fiscal policy and long run growth. IMF Staff Papers.

Temple, J. (2003). The long-run implications of growth theories. Journal of Economic Surveys, 17 (3), pp. 497-510.

Trehan, B. and Walsh, C. (1991). Testing inter-temporal budget constraints: theory and applications to us federal budget and current account deficits. Journal of Money, Credit and Banking, 23, pp. 206-223.

W.D.I. (2005). World development indicators. The World Bank.