CHAPTER 4 PUBLIC FINANCE, GOVERNANCE, AND ECONOMIC
4.4. Results of examining role of governance in modifying effect between public finance and economic growthpublic finance and economic growth
4.4.1 The role of governance in modifying effect between public finance and economic growth in developing countries
To fix the endogeneity phenomenon, this study applies the SUR model to estimate the effect of governance on economic growth and the way it affects the economy through its interaction with public finance. Nevertheless, the SGMM estimation helps reduce the regression bias compared to a fixed effects model (Baltagi, 2005). This thesis applied the “xtabond2”, which also reports tests of over-identifying restrictions, that is, of whether the instruments, as a group, appear exogenous. Here the Hansen test coincides with the Sargan (1958) test, but if nonsphericity is suspected in the errors, as in robust one-step GMM, the Sargan statistic (1/N)( ′ ̂ )′( ′ )−1 ′ ̂ is inconsistent, some software packages, including ivreg2 and xtabond2, therefore quietly perform the second GMM step to obtain and report a consistent Hansen statistic (Roodman, 2009). He also noted that SGMM estimation typically includes more instruments, which may, therefore, increase the efficiency of the regression. Additionally, to define the solution for the third research question, this study follows Bassanini and Scarpetta (2002), who find that dynamic models are appropriate for large N and large T. However, dynamic panel data always face autocorrelation problems, and thus, we employ the Arellano– Bond test to identify the autocorrelation of the various error terms;
in other words, E (∆ , ∆ −2 = 0) (Arellano & Bond 1991).
Table 4.8
Before running estimation, this study tries to divide the panel data into two groups: developed and developing countries following the classification of countries by World Bank on July 1, 2015.
The results of verification of the influence of governance on economic growth in 44 developing countries
(SUR) lrgdp
FDI INFL HDI TAXgdp GEXgdp CCI
CCI_TAX CCI_GEX
_cons Obs.
N. of groups N. of instruments AR2 Test Hansen test
Note * p < 0.1, ** p < 0.05, *** p < 0.01
Source: World bank’s database - WDI and WGI, IMF’s databsae - GFS, and UNDP’s databse - HDI.
Table 4.8 indicates that governance, tax revenue, and interaction between them positively affect economic growth, but government expenditure has a significantly negative effect on economic growth when it stays alone.
However, the interaction between governance and government expenditure becomes the beneficial factor for growth. These findings support the “salting”
role of corruption in the wheels of an economy (Méon and Weill, 2010; Ugur, 2014; Dzhumashev, 2014). The result also supports D’Agostino, Dunne and Pieroni (2016), who confirmed the direct positive effect of control of corruption on economic growth. Furthermore, we considered the endogenous variables in our SGMM model as “economic growth,” because the lag of this variable can affect on itself. We then used instrumental variables of
“governance” to correct the endogeneity phenomenon (Mauro, 1995;
Acemoglue et al., 1998; Aizenman & Glick, 2006; d’Agostino et al., 2016).
Additionally, to gain the effective results from SUR model, we choose the option “corr” to test the correlation between dependent variables in the system regression and all the test results confirm that among dependent variables such as “economic growth”, “tax revenue” and “government expenditure” are correlated (see table appendix A8). Through table 4.8, this study also confirms that foreign direct investment rate to GDP (FDI) is a beneficial factor for growth, while the unstable situation of an economy could be harmful to increase economic outcome.
4.4.2 The role of governance in modifying effect between public finance and economic growth in developed countries
Table 4.9
The results of verification of the influence of governance on economic growth in 38 developed countries
FDI INFL HDI TAXgdp GEXgdp CCI
CCI_TAX
CCI_GEX
_cons Obs.
N. Groups N.
Instruments AR.2 test Hansen test
Note * p < 0.1, ** p < 0.05, *** p < 0.01
Source: World bank’s database - WDI and WGI, IMF’s databsae - GFS , and UNDP’s databse - HDI.
Unlike developing countries, the interaction between governance and tax revenue in developed countries has negative effect on economic growth without any significance. This finding suggests that policymakers in developed countries should focus on fiscal policy more than anti-corruption policy in taxation to remain their growth. The other remain variables have the same influence with developing countries. Both table 4.8 and 4.9 presented in this chapter prove the third hypothesis (3): Governance modifies the effects of public finance on economic growth differently according to different group countries. Unlike Imam and Jacobs (2007), this study verifies the role of governance in modifying the link between public finance and economic growth. The findings denote the crucial role of governance in anti-corruption as well as in promoting the economy. The good governance with the high score of control of corruption indicator could increase the efficiency of government expenditure and encourage their economy.
To ensure the robustness of the model, we continue using other data, which measures the corruption perception index (CPI) of businesses by the Transparency International organization. The results were consistent with the
results of the control of corruption indicator from The World Bank website (see table 4.10 and 4.11).
Table 4.10
Robustness check of the governance role in 44 developing countries
FDI INFL HDI TAXgdp GEXgdp CPI
CPI_TAX CPI_GEX
_cons Obs.
N. of groups N. of instruments AR2 Test Hansen test
Note * p < 0.1, ** p < 0.05, *** p < 0.01
Source: World bank’s database - WDI and WGI, IMF’s databsae - GFS , and UNDP’s databse - HDI.
Table 4.11
Robustness check of the governance role in 38 developed countries
(SUR) lrgdp
main FDI INFL HDI TAXgdp GEXgdp CPI CPI_TAX CPI_GEX _cons Obs.
N. of groups N. of instruments AR2 Test Hansen test
Note * p < 0.1, ** p < 0.05, *** p < 0.01
Source: World bank’s database - WDI and WGI, IMF’s databsae - GFS , and UNDP’s databse - HDI.
We used the corruption perception index (CPI) developed by Transparency International (TI). The maximum index is 100 and indicates that countries, which receive the maximum index, are free of corruption. Table 4.8 and 4.9 show the consistent results of the control of corruption indicator (CCI) compared to the corruption perception index (CPI) in tables 4.10 and 4.11.
Tables 4.10 and 4.11 provide a robustness check of the role of governance in modifying the relationship between public finance and economic growth.
Chapter 4 debates the long-run relationship between public finance and economic growth. Applying ECM model we found that tax revenue and government expenditure have a strong relationship with economic growth in
long-term in both developed and developing countries. Furthermore, conducting Ganger test helps this research to identify the bi-directional linkage between tax revenue and government expenditure. The finding also supports the fiscal synchronization hypothesis, which recommends government in both developed and developing countries for controlling deficit, they should focus on assignment of taxes as well as on public spending.
This chapter also discusses the relationships among governance, public finance, and economic growth. Running a seemingly unrelated regression (SUR) and SGMM models, this chapter confirms that governance has a positive role in economies. The findings support the “salting of wheels” effects of corruption in an economy. Additionally, the interaction between governance and public finance has a diverse effect on economic growth depending on different groups of countries and kind of part of public finance such as tax revenue or government expenditure.
Furthermore, the corruption perception of business data, which is evaluated by Transparency International, was applied; this research provides evidence of a robustness check for the SUR and SGMM models. This result suggests that analysis of the governance effect through seemingly unrelated regression should provide robust results.
CHAPTER 5:
CONCLUSION, IMPLICATION AND LIMITATION