Academic journal article International Journal of Business and Society

An Empirical Analysis of Fiscal Composition and Economic Growth: The Case of Malaysia

Academic journal article International Journal of Business and Society

An Empirical Analysis of Fiscal Composition and Economic Growth: The Case of Malaysia

Article excerpt

ABSTRACT

The paper analyzes the long-run relations between components of fiscal composition and output per labor for Malaysia using annual data spanning 1970-2002. Applying the DOLS estimation method, we find evidence that development (current) public expenditure is positively (negatively) related to real output per labor. We also document evidence for the negative effect of indirect taxes on real activity. For the case of direct taxes (corporate and income taxes), the finding is puzzling in that its estimated coefficient in the output equation is positive. From these results, we tend to state that proportionately changing all components of public expenditures and taxes for stabilization or fiscal consolidation purposes may not be appropriate. In other words, the government should pay close attention to which fiscal components are changed in its budget plan.

Keywords: Government Expenditure, Economic Growth, Malaysia.

I. INTRODUCTION

The relationship between government expenditure and economic growth is a subject that has attracted wide attention. Theoretically, existing views on the subject admit both negative and positive output effects of the government expenditure. According to the Classical view, an increase in government expenditure leads to higher interest rate which, then, discourages private investment. With presumably more productive private investment, the crowding-out effect of government spending is detrimental to a nation's long run growth. However, there is an alternative Keynesian view that raises the possibility of growth-enhancing government expenditure. Namely, public expenditure in especially infrastructure, education, health, and research and development may exert a positive effect on growth through the enhancement of private capital productivity. Moreover, the resulting increase in the economy's aggregate demand may influence private sector's future profit and sale expectations. Both mechanisms, i.e. enhancement of private capital productivity and favorable expectations, tend to boost or crowd-in private investment. Subsequently, with higher capital formation, the potential for the economy to grow is enhanced.

Not surprisingly, given these contrasting views and yet their important implications on stabilization policies and long-run growth, the empirical literature on the subject is voluminous. While early regression analyses based on cross-national data tend to support growth-impeding effects of government spending (see Barro, 1991), Levine and Renelt (1992) provide evidence indicating fragility of the results. Namely, using extreme bound analysis, they show that the relation between government size and economic growth depends crucially on the conditioning variables specified in the regressions. However, some recent studies that utilize time series data and focus specifically on the role of public investments in the growth process yield quite promising results. Namely, in more cases, public investments are found to be growth enhancing (Aschauer, 1989; Munnell, 1990; and Batina, 1998; Everaert and Heylen, 2001). While these studies have provided further insights on the issue, they have also hinted that certain types of public expenditure can be favorable to growth. Indeed, recent refinements in the growth literature have acknowledged the importance of distinguishing between various components of public spending and, additionally, incorporating methods of financing in the analysis. Some notable examples are Miller and Russek (1997), Kneller, et al (1999), and Gupta, et al. (2005).

Miller and Russek (1997) employ a sample of 39 developed and developing countries from 1975 to 1984 to examine the effects of components as well as financing sources of government expenditure on growth. They document evidence suggesting not only different growth effects of various components of public spending but also significant roles of methods of financing in determining the effect of a particular expenditure on growth. …

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