url
31
Jan
2014

FISCAL ADJUSTMENT AND DYNAMIC ECONOMICS PERFORMANCE: LITERATURE REVIEW

A large number of studies have focused their discussion on fiscal adjustment, debt and foreign deficit sustainability with theoretical econometrics modeling. Hojman investigated a basic investment equation and production function application on the external debt contribution to output, employment, productivity and consumption in Chile between 1960 and 1982. The theoretical framework derived the contribution of external indebtedness to the stock of capital and the effects of foreign capital movement as net of debt service to the capital formation. More specifically, in order to identify the external debt contribution, the author used a foreign-capital-dependent investment equation to generate a capital stock series, towards estimating a non-homogeneous variable elasticity of substitution production function. The empirical results show a significant negative relationship between net foreign capital movements and domestic savings. A low marginal product of capital is estimated that represent minimal external debt contributions to output, employment and productivity. However, factor price distortions, capacity under-utilization, preferences for current consumption, short planning horizons combined with huge debt, unrealistically rigid assumptions of previous work and model limitations, all suggest substantial direct consumption costs of default or repudiation and through them, indirect output and income costs.
In term of economic performance indicator, Hameed et al. has analyzed the long-run and short-run relationships between external debt and economic growth of Pakistan. They have examined the dynamic effect of GDP, debt service, capital stock and labor force on the economic growth by fitting the production function using annual data for the entire period of 1970-2003. The basic model is derived from the neoclassical production function by incorporating the external debt service variable as suggested by Cunningham. The results show that debt servicing has a negative effect on the productivity of labor and capital; and debt service ratio tends to affect negatively GDP and thereby the rate of economic growth in the long run, which in turn, reduces the ability of the country to service its debt. The estimated error correction term shows the existence of a significant long-run causal relationship among the specified variables. While in the short run, unidirectional causality is reported from debt service to GDP. These suggested that debt as an important factor in overall debt scenario in Pakistan. Economic theory also postulates that reasonable levels of borrowing promote economic growth through factor accumulation and productivity growth. Therefore, it is important to the government in sustaining the debt level. Economic sustainability has three important elements; firstly, the government needs enough resources to ensure its ability to carry out its functions; secondly, the implications for other macroeconomic variables; and thirdly, relates to the issue of affordability.
Koo has test the fiscal sustainability for Korea and examines the discernible change in the behavior of government debt following the Asian financial crisis. The empirical analysis indicates that the levels of government debt are not sustainable in Korea and it is also shows that the crisis contributes significantly to push the government debt in excess of its sustainable level. Hamilton and Flavin has also examined whether the present value borrowing constraints holds for the United States and their found that the stationary of discounted debt would indicate towards a sustainable fiscal policy. On the other hand, Wilcox have used Hamilton and Flavin’s data and examined the sustainability in the presence of a structural break and found that for the period prior to 1974 there is no evidence of the violation of the budget constraint but the stationary of the deficit process did not hold for the period after 1974 and hence concludes that the recent structure of fiscal policy is not sustainable.
Meltzer and Richard indicate bidirectional causality between government spending and taxation. Through this study, government revenue and spending are decided simultaneously in relation to other economic considerations. Olekalns and Cashin, has examined the issue of sustainability of budgetary deficits at the level of centre government in India over the period of 1951-1998. Their study seeks to examine if the budget constraint is breached for India using real revenues and expenditures and does not find any cointegration indication either with Engle-Granger test or Gregory-Hansen procedure. These unexpected results show that India’s fiscal policy is not sustainable though the size of the fiscal deficit as a proportion of gross domestic product has fallen in 1991.
Meanwhile, Gounder et al. has found a strong evidence of fiscal adjustment for Fiji in the long-run and implying that expenditure decision are actually not made in isolation from revenue decision. This study attempts to analyze the long run relationship between fiscal adjustment and economic performances of Malaysia using Gregory-Hansen cointegration technique. The plan of this study is as follows. Section 3 will present the model specification and empirical findings and section 4, we briefly discussed conclusion remarks.

A large number of studies have focused their discussion on fiscal adjustment, debt and foreign deficit sustainability with theoretical econometrics modeling. Hojman investigated a basic investment equation and production function application on the external debt contribution to output, employment, productivity and consumption in Chile between 1960 and 1982. The theoretical framework derived the contribution of external indebtedness to the stock of capital and the effects of foreign capital movement as net of debt service to the capital formation. More specifically, in order to identify the external debt contribution, the author used a foreign-capital-dependent investment equation to generate a capital stock series, towards estimating a non-homogeneous variable elasticity of substitution production function. The empirical results show a significant negative relationship between

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Kevin J. Brandon

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