THE ACADEMY OF ECONOMIC STUDIES, BUCHARESTDOCTORAL SCHOOL OF FINANCE AND BANKING

DISSERTATION PAPER

Fiscal Policy and Economic Growth in European Union Countries

MSc Student: Zoescu Mihai

Supervisor: Professor Moisă Altăr

BUCHAREST, JULY 2003

1.Empirical Evidence

2.Theoretical Background

3.Methodology

4.Data

5.Estimation Results

6.Conclusions

Ram (1986)

115 countries - 1960-1980 (Summers-Heston database)

estimations for each country based on time-series

positive impact of government size in 100 cases

positive impact of marginal government size in 98 cases

1.Empirical Evidence

Barro (1991)

cross-country evidence on 98 countries, 1960-1985

(Summers-Heston database)

growth inversely related to the share of

government consumption in GDP

growth insignificantly related to the share of public investment

Folster and Henrekson (2000)

panel study on OECD sample, 1970–95 period

government consumption is significantly negatively related to growth

robust negative relationship between government expenditure and growth

Heitger (2001)

panel estimates for 21 OECD countries, 1960–2000

negative and statistically highly significant relation

government expenditures - economic growth

all subcategories of consumptive government expenditures:

significantly negative impact

2.Theoretical Background

0

)( dtecuU t

1

1)(

1ccu

endogenous growth

constant returns to a broad concept of capital

Y=Akconstant returns to scale in k and g together but diminishing returns in k separately

11

1

k

g

c

c

11

)/(

k

g

yg

Barro (1990)

0 20 40 60 80 100 Government (tax) share

Growth rate

11

1

k

ghgh

Panel data

Advantages:

double dimension

a better representation of the dynamic behavior of the individuals

takes into account individuals heterogeneity

data are numerous

the biases and the variance of estimation go to zero

are very precise

Inconveniences:

the existence of aberrant observations

missing observations

3.Methodology

4.The Dataannual data for the EU countries from 1977 till 1997

Source : World Bank, 2002, World Development Indicators

Symbol Variable name

GDP Real gross domestic product growth per capita

GCONS General government final consumption expenditure as percent of gross domestic product

TEXP Government total expenditure as percent of gross domestic product

REV Government tax revenues as percent of gross domestic product

CAPF Gross fixed capital formation as percent of gross domestic product

DGCONS GCONS change in percentage points

DTEXP TEXP change in percentage points

DREV REV change in percentage points

DCAPF CAPF change in percentage points

ntntntntnt DGCONSbDREVbDCAPFbcGDP 321

ntntntntnt DTEXPbDREVbDCAPFbcGDP 321

(1) (2)

Dep. var. GDP GDP

No. obs. 315 315

Const. 0.0235 (24.35) 0.0234 (23.12)

DGCONS -1.2133 (-8.17) -

DTEXP - -0.2848 (-5.49)

DREV -0.1607 (-2.14) -0.1235 (-1.48)

DCAPF 0.7271 (10.39) 0.6937 (8.99)

R2 0.42 0.36

0.0167 0.0175

5.Estimation Results

-.08

-.04

.00

.04

.08

.12

-.08 -.04 .00 .04 .08

DREV

GD

P

GDP vs. DREV

-.08

-.04

.00

.04

.08

.12

-.02 .00 .02 .04

DGCONS

GD

P

GDP vs. DGCONS

-.08

-.04

.00

.04

.08

.12

-.08 -.04 .00 .04

DCAPF

GD

P

GDP vs. DCAPF

-.08

-.04

.00

.04

.08

.12

-.2 -.1 .0 .1 .2

TEXP

GD

P

GDP vs. TEXP

(1) (2)

FE RE FE RE

Dep. var. GDP GDP GDP GDP

DGCONS -1.2286 (-9.01) -1.2264 (-9.05) - -

DTEXP - - -0.2657 (-5.56) -0.2702 (-5.64)

DREV -0.1832 (-2.68) -0.1802 (-2.65) -0.1547 (-2.01) -0.1472 (-1.90)

DCAPF 0.7254 (11.47) 0.7257 (11.53) 0.7005 (9.85) 0.6989 (9.79)

R2 0.55 0.54 0.49 0.46

0.0150 0.0149 0.0161 0.0162

Fixed Effects vs. Random Effects

Hausman Test

•test statistics are -0.025 respectively 0.021.

•critical value at 5% level 814.732

K

kntkntknnt wxbay

1itiitit uxy

Dependent Variable: GDP?  

Method: Pooled Least Squares  

Sample(adjusted): 1977 1997  

Included observations: 21 after adjusting endpoints  

Number of cross-sections used: 15  

Total panel (balanced) observations: 315  

Variable Coefficient Std. Error t-Statistic Prob.

D(CAPF?) 0.725486 0.063204 11.47842 0.0000

D(GCONS?) -1.228627 0.136293 -9.014569 0.0000

D(REV?) -0.183271 0.068199 -2.687308 0.0076

_AUT--C 0.022114 0.003285 6.731685 0.0000

_BEL--C 0.020368 0.003283 6.204628 0.0000

_DEN--C 0.017992 0.003285 5.477289 0.0000

_FIN--C 0.027167 0.003298 8.236291 0.0000

_FRA--C 0.021854 0.003293 6.635366 0.0000

_GER--C 0.018052 0.003280 5.503260 0.0000

_GRE--C 0.012265 0.003284 3.734947 0.0002

_IRE--C 0.040329 0.003293 12.24811 0.0000

_ITA--C 0.026152 0.003323 7.869903 0.0000

_LUX--C 0.036965 0.003280 11.26858 0.0000

_NED--C 0.014632 0.003284 4.455122 0.0000

_POR--C 0.033321 0.003303 10.08748 0.0000

_SPA--C 0.026909 0.003302 8.148580 0.0000

_SWE--C 0.015694 0.003286 4.775237 0.0000

_UK--C 0.019619 0.003292 5.960505 0.0000

R-squared 0.559056 Mean dependent var 0.021169

Adjusted R-squared 0.533816 S.D. dependent var 0.021994

S.E. of regression 0.015017 Sum squared resid 0.066979

Log likelihood 884.8459 F-statistic 22.15025

Durbin-Watson stat 1.587439 Prob(F-statistic) 0.000000

Dependent Variable: GDP?

Method: Pooled Least Squares

Sample(adjusted): 1977 1997

Included observations: 21 after adjusting endpoints

Number of cross-sections used: 15

Total panel (balanced) observations: 315

Variable Coefficient Std. Error t-Statistic Prob.

D(CAPF?) 0.700592 0.071070 9.857819 0.0000

D(TEXP?) -0.265734 0.047714 -5.569341 0.0000

D(REV?) -0.154769 0.076941 -2.011533 0.0452

_AUT--C 0.021731 0.003527 6.160615 0.0000

_BEL--C 0.020412 0.003526 5.789422 0.0000

_DEN--C 0.018164 0.003527 5.149435 0.0000

_FIN--C 0.025754 0.003537 7.280845 0.0000

_FRA--C 0.020542 0.003531 5.817209 0.0000

_GER--C 0.019291 0.003524 5.473797 0.0000

_GRE--C 0.011167 0.003523 3.169804 0.0017

_IRE--C 0.042033 0.003526 11.92139 0.0000

_ITA--C 0.026187 0.003568 7.338408 0.0000

_LUX--C 0.036666 0.003523 10.40782 0.0000

_NED--C 0.016592 0.003519 4.714858 0.0000

_POR--C 0.030810 0.003532 8.722262 0.0000

_SPA--C 0.025235 0.003537 7.133960 0.0000

_SWE--C 0.016546 0.003531 4.685862 0.0000

_UK--C 0.021612 0.003523 6.134115 0.0000

R-squared 0.491513 Mean dependent var 0.021169

Adjusted R-squared 0.462407 S.D. dependent var 0.021994

S.E. of regression 0.016126 Sum squared resid 0.077239

Log likelihood 862.3989 F-statistic 16.88738  

Durbin-Watson stat 1.784239 Prob(F-statistic) 0.000000  

(1) (2)

OLS GMM OLS GMM

Dep. var. GDP GDP GDP GDP

GDP(-1) 0.2180 (4.95) 0.1889 (2.52) 0.1383 (2.88) 0.1504 (1.19)

DGCONS -1.3301 (-10.01) -1.3189 (-9.13) - -

DTEXP - - -0.2597 (-5.50) -0.2750 (-3.55)

DREV -0.1976 (-3.00) -0.1933 (-2.98) -0.1741 (-2.28) -0.1818 (-1.77)

DCAPF 0.5723 (8.38) 0.5848 (6.35) 0.6126 (8.00) 0.6020 (5.02)

R2 0.59 0.59 0.50 0.50

0.0144 0.0144 0.0159 0.0159

Ahn and Schmidt (1993) - GMM estimatorBalestra and Nerlove (1966) 1,, XXDZ

OLS vs. GMM

Hausman Test •test statistics are 0.40 respectively 0.37•critical value 78.71.0,42

K

kntnkntktnnt wfxbayy

11,

-.06

-.04

-.02

.00

.02

.04

.06

-.08

-.04

.00

.04

.08

.12

50 100 150 200 250 300

Residual Actual Fitted

Model (1)

-.08

-.04

.00

.04

.08

-.08

-.04

.00

.04

.08

.12

50 100 150 200 250 300

Residual Actual Fitted

Model (2)

(1) (2)

Dep. var. GDP GDP

GDP(-1) 0.1937 (4.61) 0.1227 (2.82)

DGCONS -1.2013 (-9.90) -

DTEXP - -0.3085 (-4.41)

DREV -0.1901 (-3.37) -0.1748 (-2.42)

DCAPF 0.6503 (7.93) 0.6910 (7.78)

R2 0.60 0.53

0.0144 0.0158

Fixed Effects with Cross Section Weights

6.Conclusions

tax rates have a negative impact on economic growth

the level of tax rates is beyond the optimum point

the relation: government expenditures - economic growth is negative

and highly significant

government expenditures are situated above the point of

maximum economic growth

government consumption has a much greater negative impact

on output growth than total government expenditure

Shortcomings:

economic growth has many determinants

data with measurement errors

tax revenues as proxy for tax rates

government total expenditure separated on types

References

Barro, Robert (1990), “Government spending in a simple model of endogenous growth”, Journal of Political Economy, 98(5), S103-117.

Barro, Robert (1990), “Economic Growth in a Cross Section of Countries”, The Quaterly Journal of Economics, Volume 106, 407-443.

Barro, R. and Sala-i-Martin, X. (1992), “Public finance in models of economic growth”, Review of Economic Studies, 59, 645-61.

Barro, R. and Sala-i-Martin, X. (1995), “Economic Growth”, The MIT Press Cambridge, Massachusetts London, England, pp 153-161.

Blanchard, O. and Perotti R. (1998), “An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output”, NBER, WP 7269

Corsetti, G. and Roubini, N. (1996), “Optimal Government Spending and Taxation in Endogenous Growth Models”, NBER, WP 5851

Devereux, M. and Love, D. (1995), “The Dynamic Effects of Government Spending Policies in a Two Sector Endogenous growth Model”, Journal of Money, Credit and Banking, Volume 27, 232-256.

Fölster, Stefan, Henrekson, Magnus (2000), “Growth Effects of Government Expenditure and Taxation in Rich Countries”, The European Economic Review.

Gale, W. and Easterly, W. (1995), “What Do Cross-Country Studies Teach about Government Involvement, Prosperity and Economic growth? Comments and Discussion”, Brookings Papers on Economic Activity, Volume 1995, 416-431.

Gerson, Philip (1998), “The Impact of Fiscal Policy Variables on Output Growth”, IMF WP/98/1.Greene, William H. (2000), “Econometric Analysis”, Fourth Edition, Prentice Hall

International, Inc., New Jersey.Gupta, S., Clements B., Baldacci E. and Mulas-Granados, C., “Expenditure Composition, Fiscal Adjustment,

and Growth in Low-Income Countries”, IMF WP/02/77.Heitger, Bernhard (2001), “The Scope of Government and Its Impact on Economic

Growth in OECD Countries”, Kiel WP No. 1034.Islam, Nazrul (1995), “Growth Empirics: A Panel Data Aproach”, The Quarterly Journal of Economics,

Volume 110, 1127-1170.Jones, L., Manuelli, R. and Rossi P. (1993), “Optimal taxation in models of endogenous growth”,

Journal of Political Economy, 101(3), 485-519. King, R., and Rebelo, S. (1990), “Public Policy and economic growth: Developing

neoclassical implications”, Journal of Political Economy, 98(5), S126-51.Levine, Ross and Renelt, David (1992), “A Sensitivity Analysis of Cross-Country

Growth Regressions”, The American Economic Review, Volume 82, 942-963.Perotti, Roberto (2002), “Estimating the Effects of Fiscal Policy in OECD Countries”,

BCE WP no.168.Ram, R. (1986), “Government size and economic growth: A new framework and some evidence from

cross-section and time series data”, The American Economic Review, 76(1), 191-203.Sala-i-Martin, Xavier (1997), “I just run four million regressions”, NBER, WP 6252Sevestre, Patrick (2002), “Econometrie des donnees de panel”, Dunod, Paris. Stokey, N. and Rebelo, S. (1995), “Growth effects of flat-rate taxes”, Journal of Political Economy,

103(3), 510-50.***The World Bank, World Development Indicators (2002)