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Research on fiscal policy has recently re-emerged after the subprime crisis in 2007. This paper contributes to the literature by examining the impact of institutional quality on the conduct of fiscal policy across Asia Pacific countries from 2002 to 2013. This study is among the first attempts unveiling the important roles of institutional quality on fiscal policy conducting. The study finds that better institutional quality tends to slow down the growth rates of tax revenue and government expenditure. This has strong implications to not only policymakers but also international financial organizations such as International Monetary Fund and World Bank on their funding agreements
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The Empirical Economics Letters, 16(9): (September 2017) ISSN 1681 8997
Institutional Quality and Fiscal Policy: An Empirical
Investigation in Asia Pacific Countries
Canh Phuc Nguyen
University of Economics, Ho Chi Minh City, Vietnam
Thai Vu Hong Nguyen
RMIT University, Vietnam
Thong Trung Nguyen
University of Economics, Ho Chi Minh City, Vietnam
Abstract: Research on fiscal policy has recently re-emerged after the subprime crisis in
2007. This paper contributes to the literature by examining the impact of institutional
quality on the conduct of fiscal policy across Asia Pacific countries from 2002 to 2013.
This study is among the first attempts unveiling the important roles of institutional
quality on fiscal policy conduct. Results show that better institutional quality tends to
slow down the growth rates of tax revenue and government expenditure. This has strong
implications to not only policymakers but also international financial organizations such
as International Monetary Fund and World Bank on their funding agreements.
Keywords: Institution, external debt, fiscal policy, Asia Pacific.
JEL Classification Number: E02, E62, H63.
1. Introduction
Institutional quality has recently got increasing attention from researchers in explaining
the differences in economic developments and macroeconomic performance across
countries (Chen et al. 2014; Helland and Sørensen 2015). Institution is defined as the
society‟s “rule of game” reflecting the quality of governance measured by World Bank
and adjusting the behaviors of all agencies in the economies, including government
departments and public bodies (North, 1990). Although research on the impact of
institutional quality on macroeconomic performance such as economic growth (Dollar and
Kraay 2003) is growing, the role of institutional quality on the conduct of fiscal policy is
largely ignored. As better institutional quality improves transparency, accountability and
responsibility of policy decision making (Acemoglu and Robinson, 2010), we argue that
better institutional quality enforces deliberate conduct of fiscal policy measured
alternatively by tax revenue and government expenditure. We further argue that better
institutional quality tends to support economic growth (Butkiewicz and Yanikkaya, 2006;
Easterly and Rebelo, 1993; Engen and Skinner, 1992), making the economies less rely on
The Empirical Economics Letters, 16(9): (September 2017) 874
economic stimulating expenditure from the government, and instead, the government
reduce tax to support economic growth. Nevertheless, after the subprime crisis in 2007,
fiscal policy in the form of government spending has been employed intensively as an
economic stimulation tool (Candelon and Lieb, 2013; Hemming et al., 2002), while its
effectiveness is still under debate (Ahmed and Miller, 2000; Buiter, 1977; Congdon, 2009;
Heutel, 2014; Padoa Schioppa, 1983; Şen and Kaya, 2014; van de Klundert, 1993), the
determinants affecting fiscal policy remain a big gap in the literature. It is, therefore, an
imperative need to investigate the impact of institutional quality on fiscal policy conduct.
Asia Pacific countries provide a fruitful context for the research as these countries are
undergoing different stages of institutional quality development with varying degrees of
fiscal policy employment. The study contributes to the literature on two fronts. First, the
study extends institutional economics theories into the conduct of fiscal policy. We argue
that better institutional quality enhances transparency, accountability and responsibility to
fiscal policy makers, and hence, induces deliberate conduct of fiscal policy. Second, the
study sheds lights on the impacts of institutional quality on government tax revenue and
government expenditure. The study finds that better institutional quality tends to reduce
tax revenue and government expenditure. These findings imply that governments in
countries with better institutional quality tend to spend more deliberately and to be less
dependent on public spending to stimulate the economies. These findings suggest that
international financial organizations i.e. IMF and World Bank, should impose institutional
quality improvement as conditions for their funding decisions to ensure sound fiscal policy
conduct.
The remaining of the study is organized as followings. Section 2 reviews literature and
develops hypotheses. Section 3 presents data and regression models. Data analysis and
discussion are provided in section 4 and the last section concludes the study.
2. Literature and Hypotheses
According to North (1990), the institutions are the social rules of game that set
“constraints” on human behaviors which subsequently stimulate economic incentives.
Better institutional quality is argued to advance transparency, accountability and
responsibility of policy decision making (Acemoglu and Robinson, 2010). We argue that
better institutions associated with lessened information asymmetry makes fiscal policy
conduct more transparent, deliberate, and hence, less wasteful. Therefore, we hypothesize
that better institutions reduce government expenditure growth rate.
In addition, the improvement in institutions which results in better rules of game and lower
asymmetric information problem is able to arguably reduce risk, cut down transaction
cost, enforce property rights, and enhance economic allocation efficiency (Cohen et al.,
The Empirical Economics Letters, 16(9): (September 2017) 875
1983; Ho and Michaely, 1988; Williamson, 1981). For these reasons, the literature
generally supports that better institutional quality leads to better economic performance
(see Djankov et al., 2002; Dal Bó and Rossi, 2007; Park, 2012; Young and Sheehan, 2014;
Herrera-Echeverri et al., 2014; Farhadi et al., 2015; Zhang, 2016). We further argue that
better economic performance releases the pressure on government expenditure for
economic stimulation, and instead, governments who encourage economic development
by reducing business uncertainty tend to shift to non-preferential taxation regime to
sustain economic growth (Araujo and Arvate, 2016). We argue that as better institutional
quality encourages economic growth and governments would further support this through
tax reduction and shift to non-tax income from providing services to the public,
government tax revenue falls. We hypothesize that better institutional quality reduces tax
revenue growth rate.
3. Regression Models and Data
3.1. Regression models
To examine the determinants of fiscal policy conduct, we follow the models in Koczan
(2015):
Taxgit = Debtit-1 + GDPgit-1 + Govquat + ɛit (1)
Expengit = Debtit-1 + GDPgit-1 + Govquat + vit (2)
We measure fiscal policy by total tax revenue growth rate (Taxgit), and total government
expenditure growth rate (Expengit), respectively. We apply World Governance Index
(WGI) from World Bank to measure institutional quality (Govquat), the higher the index,
the better the quality. Five aspects of WGI are alternatively employed, namely, Corruption
(the efficiency of corruption control), govereffect (the efficiency of government in
economic management), political (the political stability), reguquality (the efficiency of
regulation) and law (the efficiency of law system). We also include external debts which
has been argued to reflect the probability of government default, and hence, fiscal policy
conduct (Alt and Lassen, 2006; Antelo and Peón, 2014). The government external debt
ratios to gross national income (Debtit-1) are used, where external debts are measured
alternatively as total external debts (totaldebt), long-term external debts (longdebt) and
short-term external debts (shortdebt). We also use the growth rate of real gross domestic
product (GDPgit-1) to control for the economic performance. ɛ and v are well behaved
residuals.
3.2. Data
The governance quality indicators are collected from the World Bank Worldwide
Governance Indicators. Other variables are collected from Key indicators reports of Asia
The Empirical Economics Letters, 16(9): (September 2017) 876
Development Bank (ADB). We collect the data for 28 Asia Pacific countries1 over the
period of 2002-2013, for the sample of 308 observations. The data description from Table
1 shows that tax growth rate and government expenditure growth rate average around
5.8%. In addition, the means of all institution indicators are negative while the index of 0
is deemed the median of the standard scale.
Table 1: Data Description
Variables
Obs
Mean
Std.
Min
Max
Taxg
308
5.881
5.253
-11.800
23.900
Expeng
308
5.879
5.274
-10.000
29.400
Gdpg
308
5.644
4.167
-5.500
34.500
Totaldebt
308
46.892
29.266
0.000
153.900
Longdebt
308
36.550
23.419
0.000
150.800
Shortdebt
308
10.344
11.806
0.000
69.100
Corruption
308
-0.311
0.932
-1.490
2.460
Goveffect
308
-0.096
0.819
-1.260
2.040
Political
307
-0.375
1.008
-2.810
1.470
Reguquality
308
-0.210
0.780
-1.640
1.970
Law
308
-0.213
0.857
-1.440
1.940
4. Regression Results and Discussions
The panel data estimations from Fixed effects (FEM) and Random effects (REM) are
recruited to control for heteroskadesticity and potential endogeneity (Kiviet, 1995; Ahn
and Schmidt, 1995). For control variables, the regression results show that real GDP
growth rate consistently has a positive impact on government tax revenue and expenditure.
When the economy grows the government can collect more tax and subsequently spend
more. Total debts and long-term debts significantly increase tax revenue and decrease
government expenditure. However, short-term debts have no statistical impact on fiscal
policy conduct. These results indicate that governments in Asian Pacific countries tend to
raise tax revenue to pay-off debts and spend less when the debts are high, yet, they do not
pay much attention to short term debts.
1The sample includes Australia, Azerbaijan, Bangladesh, Bhutan, Cambodia, China, Fiji, Georgia,
India, Indonesia, Japan, Kazakhstan, Korea, Kyrgyz, Malaysia, Mongolia, Nepal, New Zealand,
Pakistan, Papua New Guinea, Philippines, Sri Lanka, Tajikistan, Thailand, Tonga, Uzbekistan,
Vanuatu and Vietnam.
The Empirical Economics Letters, 16(9): (September 2017) 877
Institutional quality indicators including corruption, government efficiency, political
stability, regulation and law consistently reduce government expenditure growth rates
(Table 2, 3 and 4). The significant impacts of institutional quality on government
expenditure are higher when short term debts are used in the model to control for external
debts. These results support the first hypothesis that better institutional quality improves
transparency, accountability and responsibility of policy makers, and this leads to more
deliberate, efficient and less wasteful government spending. The results from Table 5, 6
and 7 demonstrate that institutional quality indexes have very significant negative impacts
on government tax revenue growth rate. These support our hypothesis that better
institutional quality reduces risk, information asymmetry, transaction cost, and hence
advance economic growth, and the governments further support this growth by reducing
tax. This findings support the study of Araujo and Arvate (2016) that governments in
countries with less uncertainty tend to choose non-preferential taxation regime.
Table 2: Institutional Quality, Total External Debt and Total Government
Expenditure
Expeng
2
3
4
5
(FEM)
(FEM)
(FEM)
(FEM)
Gdpg(-1)
0.492***
0.514***
0.498***
0.493***
Debt(-1)
-0.057***
-0.062***
-0.056***
-0.053***
Corruption
Govereffect
-4.188**
Political
-2.376**
Reguquality
-2.372*
Law
-1.976
Constant
5.487***
5.036***
5.285***
5.251***
R2/R2-within
0.189
0.189
0.178
0.173
R2-ad/R2-between
0.431
0.240
0.353
0.426
R2-overall
0.238
0.170
0.219
0.249
F-test/Wall-chi2
19.33***
19.34***
18.00***
17.41***
N
280
280
280
280
No. of countries
28
28
28
28
Hausman test
18.42***
18.01***
16.60***
13.16***
Note: *, ** and *** are significance levels at 10%, 5% and 1% respectively.
The Empirical Economics Letters, 16(9): (September 2017) 878
Table 3: Institutional Quality, Long-Term External Debt and Total Government
Expenditure
Expeng
7
8
9
10
(FEM)
(FEM)
(FEM)
(FEM)
Gdpg(-1)
0.488***
0.509***
0.494***
0.489***
LongDebt(-1)
-0.072***
-0.076***
-0.070***
-0.068***
Corruption
Govereffect
-4.079**
Political
-2.244**
Reguquality
-2.205
Law
-1.782
Constant
5.473***
4.992***
5.300***
5.321***
R2/R2-within
0.193
0.192
0.182
0.177
R2-ad/R2-between
0.434
0.208
0.335
0.399
R2-overall
0.248
0.165
0.221
0.247
F-test/Wall-chi2
19.79***
19.67***
18.42***
17.88***
Hausman test
17.53***
20.29***
15.73***
12.88***
Note: *, ** and *** are significance levels at 10%, 5% and 1% respectively.
Table 4. Institutional quality, short-term external debt and total government
expenditure
Expeng
12
13
14
15
(FEM)
(REM)
(FEM)
(REM)
Gdpg(-1)
0.510***
0.571***
0.517***
0.550***
ShortDebt(-1)
-0.061
-0.011
-0.061
0.058*
Corruption
Govereffect
-4.284**
Political
-0.873**
Reguquality
-2.654*
Law
-2.138***
Constant
3.330***
2.520***
3.149***
1.815***
R2/R2-within
0.165
0.153
0.156
0.144
R2-ad/R2-between
0.539
0.570
0.508
0.743
R2-overall
0.270
0.296
0.268
0.351
F-test/Wall-chi2
16.39***
78.61***
15.29***
113.99***
Hausman test
8.02**
5.81
8.08**
4.49
Note: *, ** and *** are significance levels at 10%, 5% and 1% respectively.
The Empirical Economics Letters, 16(9): (September 2017) 879
Table 5: Institutional Quality, Total External Debt and Tax Revenue
Taxg
16
17
18
19
20
(REM)
(REM)
(REM)
(REM)
(REM)
Gdpg(-1)
0.423***
0.428***
0.453***
0.430***
0.405***
Debt(-1)
0.026**
0.021**
0.015
0.027***
0.019*
Corruption
-1.782***
Govereffect
-2.108***
Political
-1.195***
Reguquality
-2.338***
Law
-2.051***
Constant
1.790**
2.360***
2.195***
1.793***
2.310***
R2/R2-within
0.052
0.052
0.057
0.061
0.049
R2-ad/R2-between
0.745
0.795
0.633
0.787
0.799
R2-overall
0.250
0.263
0.216
0.270
0.265
F-test/Wall-chi2
85.24***
98.66***
56.38***
101.97***
99.40***
Hausman test
3.15
3.86
5.72
3.70
2.97
Note: *, ** and *** are significance levels at 10%, 5% and 1% respectively.
Table 6: Institutional Quality, Long-Term External Debt and Tax Revenue
Taxg
21
22
23
24
25
(REM)
(REM)
(REM)
(REM)
(REM)
Gdpg(-1)
0.421***
0.425***
0.457***
0.425***
0.403***
LongDebt(-1)
0.030**
0.024**
0.029**
0.029**
0.023*
Corruption
-1.557***
Govereffect
-1.916***
Political
-1.143***
Reguquality
-2.051***
Law
-1.878***
Constant
1.976***
2.470***
1.868**
2.072***
2.421***
R2/R2-within
0.051
0.051
0.055
0.060
0.049
R2-ad/R2-between
0.746
0.792
0.672
0.777
0.797
R2-overall
0.250
0.263
0.225
0.266
0.264
F-test/Wall-chi2
85.22***
98.23***
63.19***
100.16***
98.98***
Hausman test
3.15
3.75
6.35
3.82
2.94
Note: *, ** and *** are significance levels at 10%, 5% and 1% respectively.
The Empirical Economics Letters, 16(9): (September 2017) 880
Table 7: Institutional Quality, Short-Term External Debt and Tax Revenue
Taxg
26
27
28
29
30
(REM)
(REM)
EM)
(REM)
(REM)
Gdpg(-1)
0.414***
0.428***
0.429***
0.434***
0.402***
ShortDebt(-1)
0.051
0.045
-0.022
0.080**
0.043
Corruption
-1.967***
Govereffect
-2.347***
Political
-0.997***
Reguquality
-2.887***
Law
-2.282***
Constant
2.459***
2.835***
3.344***
2.077***
2.734***
R2/R2-within
0.054
0.053
0.055
0.064
0.050
R2-ad/R2-between
0.701
0.772
0.609
0.772
0.782
R2-overall
0.239
0.257
0.210
0.265
0.260
F-test/Wall-chi2
71.71***
95.65***
52.35***
99.73***
96.84***
Hausman test
2.92
4.15
5.10
3.93
3.43
Note: *, ** and *** are significance levels at 10%, 5% and 1% respectively.
5. Conclusions
This study examines the impact of institutional quality on fiscal policy through the taxation
and government expenditures from 28 Asia Pacific countries in the period from 2002-
2013. Using the panel data estimation methods, results show that better institutional
quality tends to reduce government expenditures and government tax revenue growth
rates. Countries with better institutional quality conduct fiscal policy more deliberately
and support economic growth better. This puts less pressure on government spending as
the economic stimulation tool, and instead, governments tend to reduce tax revenue to
sustain economic growth. This paper has implications for international financial
organizations such as World Bank on institutional quality improvement as the condition
for funding agreements.
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... In the literature dealing with institutions, several studies investigated the relationship between the latter and the economic growth (Nguyen et al., 2018a, Phuc Nguyen et al., 2018, Thong & Canh, 2016. Other studies focused on the link between institutional quality and several macroeconomic factors such as trade, firm growth, productivity, market efficiency and competitiveness of firms (Araujo et al., 2016, Canh et al., 2018bLuo & Schinckus 2015). ...
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... As such, regulators or the government and public agencies play an essential role in promoting entrepreneurship (Kwapisz 2019;Yoon et al. 2018). Specifically, the new institutional economics proposes that institutional settings can shape economic incentives, thereby steering economic activities toward some specific direction (Canh 2018;Nguyen et al. 2017;Phuc Nguyen et al. 2018;Su et al. 2019). In this theory, a set of well-designed, efficient and conducive institutional arrangements including legislation frameworks and constitutional laws can facilitate productive economic incentives and boost entrepreneurial activities (Anokhin and Schulze 2009;Simón-Moya et al. 2014). ...
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