Budget Deficits, Economic Freedom, and Economic Growth in OECD Nations: P2SLS Fixed-Effects Estimates, 2003-2008

By Cebula, Richard | Journal of Private Enterprise, April 1, 2013 | Go to article overview

Budget Deficits, Economic Freedom, and Economic Growth in OECD Nations: P2SLS Fixed-Effects Estimates, 2003-2008


Cebula, Richard, Journal of Private Enterprise


I. Introduction

Since the end of the Great Recession, economic growth in the United States has been anemic, and the unemployment rate in the United States has remained stubbornly high, the extraordinary policies of the Federal Reserve in purchasing massive quantities of toxic assets and U.S. Treasury issues notwithstanding. As this slow growth-high unemployment scenario has played out, two very interesting controversies have arisen. The first involves the massive size of U.S. federal budget deficits, whether measured in dollar terms, inflation-adjusted dollars, or as a percentage of GDP, and the argument that such deficits are both unsustainable and have contributed to the stubbornly poor performance of the U.S. economy (El-Shagi, 2010; Gartner, Griesbach, and Jung, 2011). The second controversy deals with economic freedom and findings that economic freedom in the United States has fallen and that the United States is now ranked only 19th among nations in the world in the overall level of its economic freedom (Gwartney, Lawson, and Hall, 2012). Arguably, this diminished economic freedom has also contributed to the stubbornly poor performance of the U.S. economy.

Given these two sets of circumstances, this study empirically investigates whether higher budget deficits and reduced economic freedom do in fact reduce economic growth and thereby raise unemployment. In particular, the fundamental purpose of this study is to investigate empirically not only the impact not only of central government budget deficits (as a percentage of GDP) on per capita real economic growth but also of the principal forms of economic freedom on per capita real economic growth. In the latter case, the focus is on the economic freedom measures developed by the Heritage Foundation (2013). The empirical findings in this study affirm that both controversies are well founded, namely, that large budget deficits and reduced economic freedom do in fact reduce economic growth.

Background for the empirical model is presented in the following section of this study. The model and data are described in Section III. The empirical analysis is provided in Section IV, where multiple estimates are undertaken. The first takes the form of a P2SLS (panel two stage least squares) estimation of the basic model using recent data from the OECD nations. Additional P2SLS estimates are then provided to test the robustness of the initial results. An overview is provided in the final section. The investigation is undertaken using a six-year panel data set for OECD nations covering the period 20032008.

The empirical evidence provided in this study shows that the pattern of massive budget deficits begun under the Bush Administration (2001-2009) but greatly expanded under the Obama Administration (since 2009) has created a persistent negative impact of per capita real GDP growth in the United States. This condition cannot be allowed to continue if economic freedom and growth are the desired outcomes of a healthy economy. Likewise, the pattern of declining economic freedom, which also began under the Bush Administration (2001-2009) but became greatly exacerbated under the Obama Administration (since 2009), must be quickly and significantly reversed. The stakes are high. This dual impact on U.S. prosperity, jobs, and living standards will be economically and indeed socially devastating if permitted to continue and will ultimately relegate the United States to the status of a second-class economic citizen in the global economy.

This study significantly extends the recent study in this journal (Cebula, 2011) in a number of ways, including emphasis on the impact of the central government budget deficit on per capita real GDP growth, a variable that was not considered in Cebula (2011), the addition of an additional year of data to the panel (which permits the inclusion of the full year 2008 of the Great Recession), estimation within the context of the Fixed Effects model, and omission of the net exports/GDP variable, which could be critiqued as presenting a specification issue because net exports are part of GDP. …

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