title: Fiscal Policy, Public Debt and Economic Performance in Developing Countries: An Empirical Analysis
Creators: name: Gunarsa, Singgih
Publisher: name: Griffith University
Year: 2020
Subjects: subject: fiscal policy
subject: macroeconomic time-series data
subject: developing countries

description: Since the Global Financial Crisis, interest in the use of fiscal policy by governments to stabilise economic activity, boost economic growth and achieve development objectives has grown. Consequently, however, governments run budget deficits which, in many countries, result in increased government debt. Since many governments in developing economies run budget deficits, the macroeconomic impact of fiscal policy and public debt sustainability remain a serious concern. This thesis is an empirical study of four sub-topics of fiscal policy using macroeconomic time-series data from developing countries. The first chapter explores the decomposition of government expenditure in developing countries. It examines the impact of government expenditure composition based on function to economic growth using datasets from developing countries from 1973 to 2015. We applied a dynamic panel model approach, using system GMM, to study which component of government expenditure has a significant impact on growth. The results indicate that government expenditure in developing Asian countries has no significant association with growth. In terms of composition, public capital spending is positively associated with economic growth abstracting from possible offsetting effects that arise from how spending is financed (taxes or borrowing). Government interest payments show a negative relationship with growth in developing economies. Using a similar baseline model, the study also estimates sectoral government composition. The results show that public spending on education sector is negative and significant to growth. The negative coefficient on spending in the education sector implies that there is inefficient spending in this sector of both allocation and outcome. On the other hand, in line with the existing theory, public health spending indicates positive association with economic growth in developing economies whereas defence spending is insignificant to growth. The second chapter discusses the impact of fiscal policy namely, public debt and budget deficit on the real interest rate in developing countries from 1990 to 2015. The proposed model for this study is based on the Barro and Modigliani interest rate determination model, with several control variables based on the latest reviews. We employ a semiparametric approach to examine the non-linearity condition of fiscal policy and interest rates, and a dynamic panel model using a system GMM approach for linear estimation. The results show that all semiparametric estimates indicate little relationship between fiscal policy (public debt and budget deficit) and interest rates. Furthermore, the dynamic panel model, using linear regression estimates, finds that, by controlling related variables, both public debt and fiscal deficit correspond to a positive effect on interest rates in developing and emerging countries. The findings imply that higher interest rates may crowd out private consumption and, therefore, dampen the initial positive effect of government expenditure on growth. Moreover, the effect varies if the interaction model is applied when the dataset is split into subsamples. For instance, the impact of rising public debt on interest rates is more significant under a high budget deficit and low financial depth condition. Similarly, a budget deficit also raises interest rates under a high budget deficit but not significant in low financial depth condition. Overall, the results are theoretically plausible and in line with previous studies. The third chapter estimates the relationship between public debt and economic growth and tries to identify the effect of the economic crisis using an econometric model based on 25 developing Asian countries from 1970 to 2015. This model is developed from growth accounting relationships, with the inclusion of control variables based on the latest literature. The regression technique in this chapter employs dynamic panel models that have some well-known advantages over typical cross-sectional or time-series approaches. After highlighting key theoretical linkages and previous findings on the public debt-growth nexus, the study found a relatively weak negative relationship from a dynamic panel model. The results imply that a 10% increase in public debt is associated with growth reduction from 0.2% to 0.4%, which is macroeconomically significant. The fourth and final empirical study in this thesis uses the latest fiscal and macroeconomic data from ten ASEAN countries to investigate their fiscal sustainability. This chapter examines whether Asian countries have satisfied their fiscal sustainability with the application of an intertemporal budget constraint (IBC) model. We also incorporate the impact of an ageing population on the intertemporal budget constraint model and study its effects on fiscal sustainability. The results show that ASEAN countries require substantial effort to stabilise current debt levels. Using the debt reduction scenario from the IBC model to reduce debt to 25%, Indonesia needs a 1% primary surplus within ten years, whereas Vietnam and Malaysia would need around 3% to 4% primary surplus over GDP. Furthermore, this study also reveals that an ageing population in ASEAN countries has created pressure on fiscal policy through a consequent decrease in labour force growth. Despite relatively strong economic growth in ASEAN economies, our results suggest that substantially larger primary budget balances will be required to ensure future public debt sustainability. Overall, this thesis lists and investigates a number of issues regarding the macroeconomic impact of fiscal policy in developing economies. The thesis suggests three main policy implications that are relevant to the empirical results of the above studies. One is the importance of increasing the quality of public spending, especially in choosing sectors that will benefit from long-term growth. Secondly—in order to minimise future fiscal risk arising from higher world interest rates or the realisation of contingent liabilities—the governments of developing countries must ensure that additional public debt is matched by high quality public spending. This should be done while strengthening budgetary institutions and practice, particularly in managing deficit and public debt. Prudent debt management includes managing the debt portfolio by calculating risk and cost that may increase sovereign credibility and maintain fiscal sustainability. The third main policy implication is developing a deep and liquid domestic market which can make a domestic financial market more resilient to external volatility and also be a potential source of funding.