Revisiting the Growth Effects of Fiscal Policy: A Bayesian Model Averaging Approach

Motivated by the mixed evidence in previous literature, we reexamine the effects of various types of government spending and taxes, as well as overall budget surplus/deficit, on economic growth. To address the model uncertainty issue that may have plagued earlier studies we employ a Bayesian Model Averaging (BMA) approach. We use a panel data set for OECD countries for the 1990-2013 period, control for country and time specific effects, and allow for a wide range of other potential growth determinants. The results suggest a robust link between only some fiscal variables and economic growth. On the spending side, productive public spending has a robust positive effect on growth. On the revenue side, we document a robust negative effect for the top corporate tax rate, but, maybe surprisingly, not for any income tax variable. Finally, our results suggest that a budget surplus has a robust positive effect on economic performance. We also analyze the timing of effects and conclude that most effects occur with a lag of two years

Revisiting the Growth Effects of Fiscal Policy: A Bayesian Model Averaging Approach

© 2019 Elsevier Inc. Motivated by the mixed evidence in previous literature, we re-examine the effects of various types of government spending, taxes, and overall budget surplus/deficit, on economic growth. To address the model uncertainty issue that may have plagued earlier studies, we employ a Bayesian Model Averaging (BMA) approach. We use a panel data set for OECD countries for the 1990–2013 period, and allow for a wide range of other potential growth determinants. The results suggest a robust link between only some fiscal variables and economic growth in the short to medium run. On the spending side, productive public spending has a robust positive effect on growth. On the revenue side, we document a robust negative effect for the top corporate tax rate. Finally, our results suggest that a cyclically adjusted budget surplus has a robust positive effect on economic performance. Some, but limited, evidence points to effects of productive expenditure and of top income tax rates on medium-to-long-run growth. With regard to timing of short-to-medium run effects, our results show that most effects occur with a lag of two years

How do political and economic institutions affect each other?

This paper provides evidence for the mutually reinforcing relation of political and economic institutions. To overcome problems of endogeneity I utilize lag instruments within a GMM framework for dynamic panel data. Employing recently developed tests, I show that limiting the number of lag instruments and collapsing the instru- ment matrix eliminates many and weak instrument biases. My major findings are that (i) improving economic institutions has a large positive effect on future po- litical institutions, and (ii) political institutions have a positive but quantitatively smaller effect on current economic institutions. In addition, (iii) political instability positively affects future political institutions. In line with predictions from the in- stitutional literature, the timing of effects is such that political institutions depend on lags of explanatory variables, while economic institutions are contemporaneously determined. Moreover, results are driven by countries with initially low political institutions implying that in these countries, much is to be gained from institutional reform

Further Unbundling Institutions.

This paper analyzes the effects of institutions on economic development, and focuses on separating political institutions from contracting and economic institutions. For a sample of former European colonies, I find that differences in income levels are strongly affected by political institutions, which regulate political accountability and constrain political elites. There is some evidence for a positive effect of economic institutions, which protect property rights, but no evidence for positive effects of contracting institutions, which facilitate contracting among individuals. A decomposition of GDP reveals that political institutions work through the channel of physical and human capital accumulation. Economic institutions have a positive impact on total factor productivity. To identify and unbundle effects, I exploit exogenous variation in each of the three institutions using instrumental variables based on colonial history and geographic endowments. The application of a recently developed test for weak instruments in the multiple endogenous variables setting shows that the effects of institutions can be separated. The paper adds to the literature by identifying the fundamental importance of political institutions for economic development, and provides an inside into the channels through which specific institutions affect income levels

Further Unbundling Institutions

This paper analyzes the effects of institutions on economic development, and focuses on separating political institutions from contracting and economic institutions. For a sample of former European colonies, I find that differences in income levels are strongly affected by political institutions, which regulate political accountability and constrain political elites. There is some evidence for a positive effect of economic institutions, which protect property rights, but no evidence for positive effects of contracting institutions, which facilitate contracting among individuals. A decomposition of GDP reveals that political institutions work through the channel of physical and human capital accumulation. Economic institutions have a positive impact on total factor productivity. To identify and unbundle effects, I exploit exogenous variation in each of the three institutions using instrumental variables based on colonial history and geographic endowments. The application of a recently developed test for weak instruments in the multiple endogenous variables setting shows that the effects of institutions can be separated. The paper adds to the literature by identifying the fundamental importance of political institutions for economic development, and provides an inside into the channels through which specific institutions affect income levels