FISCAL STRUCTURES AND ECONOMIC GROWTH: INTERNATIONAL EVIDENCE

I. INTRODUCTION A large and growing body of literature searches for the determinants of economic growth employing cross-country regression analysis (e.g., Kormendi and Meguire [1985], Grier and Tullock [1989], Barro [1990; 1991; 1992], Romer [1989; 1990], Levine [1991], and Levine and Renelt [1992]).(1) The cross-country regression approach implicitly assumes that the growth process possesses similar structural properties across the countries in the sample. Structural differences, be they political, economic, social, or other, between countries, therefore, do not condition the growth process. Or if they do, then the effects are randomly distributed with zero mean. If structural differences between countries do matter significantly and non-randomly in the growth process, then the existing cross-country research is potentially flawed. Attempts are sometimes made to control for such differences by including dummy variables for different regions of the world (e.g., dummy variables for African, Latin American, and other groups of countries). Within the literature on the determinants of economic growth, some papers (e.g., Landau [1983; 1985; 1986], Kormendi and Meguire [1985], Ram [1986], Koester and Kormendi [1989], Barth, Keleher, and Russek [1990], Easterly and Rebelo [1993], and Fischer [1993]) consider the effects, if any, of government expenditure and revenue on economic growth. Overall, the findings of these studies paint a mixed picture; the relationship between growth and government is sometimes significant and positive, sometimes significant and negative, and sometimes not significant. Although these studies consider many different fiscal variables, they do not as a rule examine the effects of these fiscal variables in a systematic way that controls for the mode of financing. They generally overlook, for example, how an increase in government consumption expenditure is financed. Is it with higher taxes, and which taxes? Or is it with lower spending, and which spending? Finally, is it with a larger deficit? Controlling for these factors may lead to different findings about the effect of an increase in government consumption expenditure on economic growth. Borrowing from some work on the effect of fiscal structure on national economic growth within the United States in Helms [1985], Mofidi and Stone [1990], and Miller and Russek [1993], we introduce the government budget constraint into the regression equations that examine the determinants of economic growth. As a result, we directly address the three financing questions raised in the previous paragraph. In this framework, we consider the growth process using pooled times-series, cross-section data and comparing the results from fixed- and random-effects econometric techniques.(2) These techniques attempt to accommodate structural differences between countries and across time. We also compare the performance of the more-standard ordinary least squares regression approach with that of the fixed- and random-effect models. II. AN OVERVIEW OF INTERNATIONAL FISCAL STRUCTURES Before presenting our model and statistical findings, a brief overview of the growth and fiscal characteristics of the countries in our sample provides some additional information for those not familiar with the data, which otherwise would not be revealed by our analysis.(3) This information can contribute in a limited way to the debate about the effects of government on economic growth, although it is not a substitute for modeling the growth process. For the sample as a whole, the growth rate of real per capita gross domestic product (GDP) averaged 1.35% per year during 1975 to 1984, with a coefficient of variation of 3.52. By comparison, the average growth rate in the United States was 1.45%. The five fastest growth countries were Botswana (6.72), Indonesia (4.19), Korea (6.32), Sri Lanka (3.20), and Thailand (4.31). The five slowest growth countries were El Salvador (-1. …