Mehmood, Rashid; Sadiq, Sa a
A icle
The ela ionship be ween go e nmen expendi u e and
po e y: A coin eg a ion analysis
Romanian Jou nal o Fiscal Policy (RJFP)
P o ided in Coope a ion wi h:
Romanian Jou nal o Fiscal Policy (RJFP)
Sugges ed Ci a ion: Mehmood, Rashid; Sadiq, Sa a (2010) : The ela ionship be ween go e nmen
expendi u e and po e y: A coin eg a ion analysis, Romanian Jou nal o Fiscal Policy (RJFP), ISSN
2069-0983, Edi u a ASE, Bucha es , Vol. 1, Iss. 1, pp. 29-37
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Romanian Jou nal o Fiscal Policy
Volume 1, Issue 1, July-Decembe 2010, Pages 29-37
The Rela ionship be ween Go e nmen Expendi u e and Po e y:
A Coin eg a ion Analysis
Rashid MEHMOOD
Applied Economics Resea ch Cen e , Uni e si y o Ka achi
Sa a SADIQ
Applied Economics Resea ch Cen e , Uni e si y o Ka achi
ABSTRACT
The s udy examines he long un as well as sho un ela ionship be ween he iscal de ici s,
which is ou come o high go e nmen expendi u e o e he le el o ax e enue collec ion, and
po e y. The esul s e eal a nega i e ela ionship be ween go e nmen expendi u e and
po e y based on ime se ies da a om 1976 o 2010. The sho un and long un ela ionships
be ween po e y and o he a iables a e iden i ied by ECM model and Johnson Coin eg a ion
es espec i ely. The esul s show ha he e exis sho un as well as long un ela ion
be ween he po e y and go e nmen expendi u e.
Keywo ds:
Go e nmen expendi u e, po e y
JEL code:
H50, I30
1. In oduc ion
Go e nmen expendi u e plays an impo an ole in po e y educ ion. Acco ding o Keynesian
app oach, public spending may inc ease he agg ega e demand which u he s imula es he
economic g ow h and employmen . Many s udies show ha go e nmen spending is posi i ely
ela ed wi h economic g ow h. While inc ease in go e nmen spending may leads o iscal
de ici . Bu i go e nmen educes hei expendi u e i may ad e sely a ec he economy. Bu
he excess o go e nmen expendi u e due o he cu en expenses o unp oduc i e use o e
he axes collec ion capaci y o economy c ea es iscal de ici . Many economis s belie e ha
iscal de ici is he oo cause o e e y illness in he economy. Fiscal de ici can be ha m ul o
wel a e o se e al easons, such as: i can lead o ine icien alloca ion o esou ces and can
c owd ou he p i a e in es men . Fu he mo e inc eases in deb o GDP a io may ha e a
nega i e impac on coun y’s long un iscal sus ainabili y; i migh a ec he wel a e o nex
30
gene a ions. Many s udies ha e ound ou ha he e exis s a signi ican s a is ical ela ionship
be ween iscal de ici and many mac oeconomic a iables. Con inuous inc ease in iscal de ici
c ea es dis o iona y e ec s in he economy. I may cause high in la ion, low g ow h and
c owding ou o he p i a e in es men and consump ion in he long un. The a o e-men ioned
a iables u he cause he po e y and dec ease he wel a e in he economy. The inancing o
iscal de ici c ea es se e e p oblem o po e y educ ion. In mos o he de eloping coun ies,
iscal de ici is inanced h ough in e nal and ex e nal bo owing. The in e nal bo owing a ec s
he in e es a e and i c owds ou he p i a e in es men in he long un. While ex e nal
bo owing leads o cu en accoun de ici and app ecia ion o exchange a e which u he
dec eases he ne expo o he coun y. Al hough high iscal de ici is inju ious o he economy
and i inc eases po e y bu i i inc eases due o de elopmen expendi u e i can help educe
po e y in he long un h ough inc ease in p oduc i i y and employmen . In Pakis an
go e nmen dec ease he go e nmen expendi u e o educing he iscal de ici a e joining
S uc u al Adjus men P og am o IMF which causes o inc ease po e y due o educ ion in
subsidies and de elopmen expendi u es.
Zaidi (2005) s a ed ha du ing he eigh ies, po e y in Pakis an dec eased due o high economic
g ow h a es along wi h high emi ances, and an ac i e spend h i public sec o . In he
nine ies, po e y s a ed inc easing a e joining he IMF’s S uc u al Adjus men P og amme
which emphasized on he educ ion o iscal de ici h ough ax inc ease, cu in de elopmen
expendi u e and educ ion o emo al o subsidies which a e mos ly on impo an inpu s o daily
li e. On he o he hand p i a e in es men and public sec o in es men a e complemen a y as
he la e pe ain o in as uc u es; he implica ions o he decline in public in es men on
g ow h a e se ious. Bu an inc ease in iscal de ici dec eases he de elopmen expendi u e.
Kemal (1989)
This s udy examines he ela ionship be ween go e nmen expendi u e and po e y along wi h
p i a e in es men , emi ances and seconda y school en ollmen using as a human capi al. The
ela ionship be ween iscal policy and po e y educ ion in Pakis an is in es iga ed by using
E o Co ec ion Model and Jhonson Coin eg a ion Technique. The pape is o ganized as ollows:
Sec ion 2 comp ises Li e a u e e iew, sec ion 3 discusses he model speci ica ion and
me hodology, sec ion 4 con ains empi ical e idences and hei in e p e a ions, and inally
sec ion 5 gi es conclusion.
2. Li e a u e e iew
Many s udies show ha go e nmen expendi u e is posi i ely ela ed wi h economic g ow h
and po e y educ ion bu due o high expendi u e mos o he de eloping coun ies a e acing
he p oblem o iscal de ici . Fiscal de ici leads o in la ion in he economy. In many de eloping
coun ies high iscal de ici c owding ou he p i a e in es men in he long un and dec eases
he employmen and ou pu which ad e sely a ec s he po e y.
31
Za a and Mus a a (1998) analyze ela ionship be ween mac oeconomic a iables and economic
g ow h in Pakis an. They ha e concluded ha budge de ici is nega i ely co ela ed wi h he
economic g ow h and ou pu as i conside ed as a sign o mac oeconomic ins abili y. They
u he concluded ha iscal de ici educes he ou pu h ough axes and cu en expendi u e
(ci il se an sala ies e c) ha nega i ely a ec he p i a e sec o p oduc i i y and i also c owd
ou he p i a e sec o in es men as weak c edi ma ke pe o mance. Yaya (2010) in es iga ed
he causal ela ionship be ween budge de ici and economic g ow h in six coun ies and ound
mixed esul s. In h ee cases he did no ind any casual ela ionship be ween budge de ici and
g ow h while in emaining h ee cases e idence shows ha budge de ici ad e sely e ec ed he
g ow h. Chaudha y and Ahmed (1995) examined he money supply, de ici and in la ion ela ion
in case o Pakis an. They concluded ha in la ion c ea es po e y h ough income edis ibu ion.
They u he s a ed ha he long un ela ionship be ween budge de ici and money supply
exis s. Financing o budge de ici h ough banking sys em causes in la ion which can be kep
unde con ol by educing he size o budge de ici and s ep should be aken o boos p i a e
in es men .
Agha and Khan (2006) ha e done empi ical analysis o iscal imbalances and in la ion in Pakis an.
They ound ou sho un as well as long un ela ionship among money supply, budge de ici
and in la ion and concluded ha he bank bo owing is mo e in la iona y han non bank
bo owing. They u he concluded ha he expansiona y iscal policy inc eases in e es a e and
may c owd ou p i a e in es men and inc eases in la iona y p essu e.
Me in (1991) analyzes he empi ical ela ionship be ween in la ion and budge de ici o
Tu kish economy h ough mul i a ia e co in eg a ion analysis. He ound ha he scaled budge
de ici signi ican ly e ec s he in la ion in Tu key. Ca ao and Te ones (2003) examined he
ela ionship be ween iscal de ici and in la ion. A s ong posi i e ela ionship be ween iscal
de ici and in la ion among high-in la ion and de eloping coun y g oup we e s udied. Soloman
and We (2004) examined he e ec o budge de ici on in la ion in Tanzania and ound ha
economy expe ienced a high in la ion a e accompanied by high iscal de ici .
Benne h (2007) examined he ole o iscal policy in alle ia ing po e y in case o Nige ia. He
used he gene al equilib ium model o he s udy and concluded ha he go e nmen e enue
also posi i ely edis ibu es income bu go e nmen expendi u es a e he impo an and
e ec i e ool o income edis ibu e and educ ion in po e y. He u he concluded ha he
iscal policy should be o mula ed in such a way ha i edis ibu es he income om he ich
people o he socie y o poo ones.
Fu he mo e pe sis en high in la ion a e can a ec he sus ainabili y o iscal de ici . Angelo
and Sousa (2009) ound associa ion among high in la ion a e and la ge de ici o GDP a io and
de ici ins abili y. As economic g ow h may inc eases h ough go e nmen spending. Jamshaid
e al (2010) examined he ela ionship be ween economic g ow h and go e nmen expendi u e,
32
bo h a bi a ia e (agg ega e) and mul i a ia e (disagg ega e) sys ems and concluded ha
economic g ow h causes go e nmen expendi u e a bi a ia e le el and also suppo ed ha
inc ease in GDP causes g ow h in go e nmen expendi u e - Wagne ’s hypo hesis.
Inequali y is also an impo an ac o in inc easing po e y in de eloping coun ies as i
ad e sely e ec s he economic g ow h. Many s udies ound high economic g ow h accompanied
wi h inc easing po e y while some o hem also show ha in pe iod o low g ow h po e y
educes. Volke (2005) ha e done s udy on Tanzania’s g ow h p ocess and educ ion in po e y
ha how he la ge scale p i a iza ion, libe aliza ion and mone a y and iscal policy a ec he
po e y h ough di e en channel, like p i a e in es men and exchange ma ke . He a gues ha
economic e o ms and mac oeconomic s abiliza ion, esul ing in s ong g ow h and low in la ion
which signi ican ly impac po e y.
Rashid and Amjad (1997) s udies he mac oeconomic policies and hei impac on po e y
educ ion, ounds ha he g ow h abo e a h eshold le el o abou 5 pe cen , inc ease in
employmen and emi ances a e he mos impo an a iables explaining he change in po e y
o e ime. They also examine hose policies unde S uc u al Adjus men P og am by IMF
inc eases po e y. Kaldo (1957) and Bou guignon (1981) sugges ed ha g ea e inequali y
migh lead o g ow h h ough capi al accumula ion. While in con as mode n app oaches
emphasizes ha poo people a e unable o in es in human and physical capi al wi h ad e se
consequences o long un g ow h on he o he hand Fo bes (2000) ound posi i e e ec s o
income inequali y on g ow h.
Rizwan and Kemal (2006) s udied he ela ionship be ween emi ances, ade libe aliza ion and
po e y in Pakis an in gene al equilib ium amewo k. They ha e used he decomposi ion
app oach ( u al and u ban) and ound ha all po e y measu e in u al and u ban shows ha
decline in emi ances inc eases po e y. They ha e concluded ha he emi ances educ ion
g ea ly con ibu e in he po e y o Pakis an. He u he concluded ha educ ion in he
emi ances and ade libe aliza ion inc eases he income inequali y ha inc eases po e y.
3. Model speci ica ion
The aim o his pape is o analyze he long un ela ionship be ween he go e nmen
expendi u e and po e y in he p esence o con olled a iables (P i a e in es men , Seconda y
school en ollmen and Remi ances).
Po = ( GE, Pin , Sse, Rem) (1)
The empi ical equa ion is
Po
= β
o
+ β
1
GE
+ β
2
Pin
+ β
3
Sse
+ β
4
Rem
+ ξ
(2)
33
Whe e:
Po = Po e y ( Po e y head coun a io, Head coun a io o Po e y is used he e. P = Q/N whe e Q= no
o poo s and N deno es he o al popula ion.
GE = Go e nmen expendi u e as a pe cen age o GDP (using as a p oxy o Budge de ici )
Pin = P i a e in es men as a pe cen age o GDP
Sse = Seconda y school en ollmen (pe cen age o popula ion)
Rem = Remi ances (in log o m)
The long un ela ionship be ween go e nmen expendi u e and economic g ow h will explain
how economic g ow h educes po e y. Many s udies show ha emi ances plays i al ole in
educ ion in po e y. Seconda y school en olmen inc eases he human capi al which educes
he unemploymen and less p oduc i i y.
Me hodology:
In o de o a oid he p oblem c ea ed by he uni oo , in his pape i is used Augmen ed Dickey
Fulle es s o e i y i he a iables a e s a iona y. As he da a is no s a iona y we will ake he
i s di e ence o make i s a iona y. We u he examine he Sho un and Long un
ela ionship among a iable so we will use ECM and Johnson Coin eg a ion es espec i ely.
A e applying uni oo es o each a iable i is in es iga ed ha all he a iables a e
s a iona y a i s di e ence so we will apply Johnson co in eg a ing es o ind ou he Long un
ela ionship be ween he a iables. The null hypo hesis o he ADF is ha se ies has uni oo .
∆Y
= Ψ
o
+ δ
+ Ψ
1
Y
-1
+ βΣ ∆Y
-1
(3)
The abo e equa ion indica es he ADF wi h end and d i .
Long un co in eg a ion es :
Fo long un ela ionship we ha e applied he likelihood a io es ha is based on he maximum
eigen alue and ace s a is ics o he s ochas ic ma ix o he Johansen (1988) p ocedu e. The
necessa y condi ion o Johnson co in eg a ion is ha all a iables should be s a iona y a same
le el.
E o Co ec ion Model:
E o co ec ion model is applied o check he sho un ela ionship among he a iables. So we
will apply he ECM app oach o ind ou he sho un ela ionship be ween po e y and o he
a iables. So he alue o coe icien o µ should be signi ican and nega i e ha will ell you
how a we a e om he long un equilib ium ha will show he sho un equilib ium among
he a iables.
∆Po
= β
o
+ β
1
∆GE
+ β
2
∆Pin
+ β
3
∆Sse
+ β
4
∆Rem
+ β
5
µ
-1
+ ξ
(4)
Whe e ∆ indica es he i s di e ence o all he a iables.
34
4. Da a and empi ical e idence
The annual da a se ies be ween 1976 and 2010 a e collec ed om a ious issues o Pakis an
Economic su ey, SBP bulle in and Wo ld De elopmen indica o s and SPDC epo s. Time se ies
ha e uni oo p oblem. The Augmen ed Dickey Fulle es (ADF) esul s in Table 1 sugges ed
ha all a iables a e in eg a ed a i s di e ence.
Table 1 Tes o Uni - Roo : (ADF wi h D i and T end)
Va iables Le el Fi s Di e ence
GE -2.4 -5.9*
POV -2.238 -8.986*
SSE 0.47 -4.52*
PINV -1.8 -4.7*
REMT -0.036 -4.159**
(* ) Signi ican a 1% Le el (**) signi ican a 5% le el
All he en i e h ee a iables a e Non S a iona y a le el bu ound S a iona y a 1
s
Di e ence.
No e: Schwa z in o ma ion c i e ion is used o selec he op imum lag leng h
Once he se ies may be made s a iona y by using i s di e ence, hey can be used in eg ession
analysis by applying he coin eg a ion echnique, which shows he long un ela ionship among
he a iables. Table 2 sugges ed ha he e exis log un ela ion among a iables. Bo h
Maximum eigen alue and T ace s a is ics shows i e coin eg a ion equa ion a 5 % le el o
signi icance. Table 3 sugges ed ha go e nmen expendi u e, emi ances and seconda y school
en olmen a e signi ican and ha ing nega i e signs. While he P i a e in es men ha e nega i e
sign bu i is s a is ically insigni ican . Nega i e sign o Go e nmen expendi u e means ha
he e is an in e se ela ion be ween go e nmen expendi u e and po e y. I is sugges ed ha
public spend h i inc ease he economic ac i i ies and ou pu which educes he po e y. Table
4 shows he esul s o E o Co ec ion Model (ECM).The nega i e sign and signi icance o E o
Co ec ion e m (EC) indica ed ha he e exis sho un ela ionship be ween po e y and
Go e nmen expendi u e and akes mo e han wo yea s o a ain equilib ium.
The De i ed equa ion (5) s a es he long un ela ionship be ween po e y and go e nmen
expendi u e along wi h con ol a iables:
Po
= -.893GE
- .039Pin
– 4.472Sse
- .002Rem
(5)
35
Table 2 Johnson Un es ic ed Co-in eg a ion Rank Tes
Hypo hesized Hypo hesis T ace Max Eigen S a is ic
No. o CE(s) S a is ic C i ical alue S a is ic C i ical alue
None * Ho; =0,
H1; ≥1 171.57 69.81 58.56 33.87
A mos 1 * Ho; =1,
H1; ≥2 113.01 47.85 51.06 27.58
A mos 2 * Ho; =2,
H1; ≥3 61.95 29.79 32.15 21.13
A mos 3 * Ho; =3,
H1; ≥4 29.79 15.49 19.15 14.26
A mos 4 * Ho; =4,
H1; ≥5 10.64 3.84 10.64 3.84
* deno es ejec ion o he hypo hesis a he 0.05 le el
Table 3 No malized Coin eg a ing coe icien s
Dependen Va iable: POV
GE - 0.893
SSE -4.472
REMT -0.002
PINV -0.039
Table 4 E o Co ec ion Model
Va iables Coe icien S. E o -S a is ic P ob.
D (GE) -0.3044 0.1406 -2.1648 0.0394
EC(-1) -0.3551 0.1636 -2.1706 0.0389
5. Conclusion
Po e y educes due o inc ease in public spend h i and inc ease in emi ances. Go e nmen
expendi u es s imula e he economy in long un h ough inc ease in agg ega e demand. In his
s udy i is checked ha he e exis s ela ionship be ween po e y and go e nmen expendi u e
along wi h emi ances and human capi al. Ou esul s sugges ed ha he e exis long un
ela ionship among a iables. Go e nmen expendi u e and po e y ha e in e se ela ion. The
sha p decline in po e y obse ed a e 2002 which may be due o inc ease in emi ances a e
9/11 om all o e he wo ld. Go e nmen expendi u e o spending is posi i ely ela ed o
economic g ow h in long un bu un o una ely in case o de eloping coun ies like Pakis an
iscal o budge balance is achie ed h ough cu bing he de elopmen expendi u es which
nega i ely a ec he p oduc i i y and economic e iciency o a sys em.
While on he o he hand go e nmen expendi u e o spending and app op ia e sou ce o
inancing, pa icula subsidies o speci ic ime pe iod a e p oduc i e and e icien . I can
inc ease he p i a e in es men , job oppo uni ies, human capi al h ough educa ion and heal h
36
expendi u e educes po e y. Resul oo showed a nega i e ela ionship be ween go e nmen
expendi u e and po e y as i expendi u es a e on he de elopmen side like de elopmen o
social acili ies, public u ili ies, in as uc u e, o e head capi al gene a ion, heal h and educa ion
so i can educe po e y in long un. So he eal ma e o conce ned is he composi ion o
go e nmen expendi u e. Bu usually he inc ease in public expendi u e causes iscal de ici
which dis o economy. Go e nmen s ake di e en measu e o educe iscal imbalances like cu
in de elopmen expendi u e, subsidies and social expendi u es e c which a ec s he wel a e. I
he educ ion in iscal de ici is a ma e o conce n hen Go e nmen can be educed iscal
de ici by inc easing p oduc i i y and g ow h a he educing expendi u e.
Acknowledgemen s
I am g ea ly hank ul o e e ees o he suppo s and cons uc i e commen s hey ha e
p o ided du ing he w i ing o his pape . I also acknowledge he suppo and use ul sugges ions
o And eea Ma ia S oian, he edi o o RJFP.
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