Government 'strength' and budget deficits in advanced democracies

Abstract. Roubini and Sachs provided the first systematic test of the idea that political structure the size, composition, diversity, and/or stability of a governing cabinet - is related to budget deficits. In this paper, we take issue with several of Roubini and Sachs' choices concerning data and operationalization, and argue that their approach cannot offer clear conclusions about the relationship between national political structure and budget deficits. We test the 'strength of government' hypothesis using central government finance data on 16 countries, 1959–1990. We measure deficits in a way that maximizes comparability across countries but avoids the potential problems of standardizing by GDP. We examine carefully the definition and measurement of 'strength of government', in light of recent theoretical and empirical work in comparative politics. We perform pooled time-series regression analysis of deficit change in 16 OECD countries for the period 1959–1990. We argue that while structural differences between governments may have little impact on deficits during good economic times, they may become especially noticeable and influential during periods when governments struggle to cope with severe economic problems.     

Inflation drag or taxation in drag: Responsible for the rising share of government in Australian GDP?

I am sure that these results will be by no means the last word. Possible many other influences have been neglected. Nonetheless, they are quite striking, and appear to indicate that price-level effects (inflation) have been a major if not the major influence in terms of raising the shares of government revenue and expenditure in GDP over the period 1949–50 to 1987–88 in Australia. This inflation drag which is really taxation in drag has only been able to operate because of a combination of a highly progressive personal-taxation system and the absence for most of this period of any inflation indexation of the tax system.I postulate that the primary cause is a high demand from certain segments of the community and special interest groups for greater government outlays and transfer payments. However, these demands may not in themselves be enough to achieve the objectives of these groups unless combined with (rational) voter ignorance about the real price to be paid for these activities in terms of higher taxes (and future taxes to pay the accumulated deficits).     

The Distributional Politics of Fiscal Adjustment: A Case Study of Four Northeastern States

The federal Tax Reform Act of 1986 and an unexpected economic downturn soon thereafter resulted in a divergence between actual and anticipated revenues at the state level. To cope with the resulting budget deficits, states increased taxes, decreased expenditures, or both. This paper looks at the decisions made in four Northeastern States-New York, Connecticut, New Jersey, and Massachusetts.     

Expenditures and receipts in state and local government finances: Comment

The aim of this note has been to show that Marlow and Manage's (1987) paper suffers from serious methodological problems due to the non-stationary data series used and the arbitrary lag lengths employed. Use of appropriate stationarity tests and optimal lag lengths of the variables change some of the basic conclusions of their paper. Contrary to their suggestion, the presence of a feedback between local tax receipts and expenditures imply that local governments should be concerned with the implication of their spending and revenue-enhancing decisions on their budget. Decisions to increase current expenditures may lead to higher future taxes. Similarly, efforts to impose higher taxes to reduce budget deficits at the local government level may be futile due to a subsequent increase in spending.     

Inflation,recession and the federal budget deficit (or,blaming economic problems on a statistical mirage)

Policy proposals to balance the budget and to limit government spending assume that budget deficits cause substantial harm, either increasing inflation or crowding out private borrowing from credit markets. These assertions have the support of policymakers across the breadth of the political spectrum, and dominate current political debate on macroeconomic policy. However, macroeconomic theory fails to provide a clearcut causal connection between budget deficits and larger economic problems such as inflation and recession. Thus, policies could be enacted that attack the symptoms instead of the causes of the deficit.We use the Granger causality test to find the causal relationships between budget deficits and inflation, GNP, and private investment respectively, for seventeen OECD countries for the period 1949–1981. Deficits do not cause changes in these variables; rather there is weak evidence that inflation and recession cause deficits. This implies that deficits are a symptom rather than a cause of inflation and reduced national output. So, if our goal is to reduce inflation and increase output, we should look to more direct policies than reducing deficits.An earlier version of this article was presented at the Annual Meeting of the American Society for Public Administration, New York, April 16–19, 1983.     

Politischer Opportunismus und Haushaltsdefizite in den westdeutschen Bundesländern

This article analyzes fiscal political business cycles in the West-German Länder. By linking the theory of political business cycles with the insights of the theory of economic voting, I argue that the German Länder governments do not have an incentive to raise the budget deficit in order to signal economic competence to the electorate. Despite having an incentive to spend more before an election in order to provide public goods to the voters, governments cannot finance the supply of public goods with higher deficits because voters prefer healthy fiscal policies. An empirical analysis of the West-German Länder between 1970 and 2003 bolsters the theoretical claims. A government that expands the deficit before an election thus experiences a loss in voter support. Consequently, governments tend to reduce the budget deficit in pre-election years.     

Fiscal variables and growth: A cross-sectional analysis

This paper examines the impact of the key fiscal variables — taxes, expenditures, and deficits — on economic growth performance, using a reduced-form model and cross-sectional data for a sample of 76 developed and developing countries for the period 1972–81. Its simultaneous consideration of fiscal variables overturns the results of some existing studies. While taxes seem negatively associated with GDP growth, they are concommitant with a higher rate of growth when their benefits in terms of reducing deficits are taken into account. The positive association of government expenditures with GDP growth is rendered negative when their impact on deficits are factored in. Deficits are contractionary, and deficit-reducing tax increases and expenditure cuts are positively associated with growth. A balanced budget expansion of taxes and expenditures is negatively associated with growth. When separating the sample into low-, middle- and high-income countries, these results hold only for the second group indicating that the level of development influences the linkages between fiscal variables and GDP growth.The views expressed herein are those of the authors and should not be attributed to the World Bank or its affiliated organizations.     

Democracy and countries with Muslim majorities: a reply and update

My empirical results in Potrafke (2012) confirm past conclusions that Muslim-majority countries are less likely to be democratic. Hanusch takes issue with my results—and by inference with all past empirical results on the relation between Islam and democracy. In his comment on my study, Hanusch indicates that he believes I was using the POLITY IV index. He has not realized, as I made most clear, that the purpose of my study was to show results based on new data from Cheibub et al. (2010). Hanusch claims to have reversed the conclusion that having a Muslim majority is associated with having autocratic government. He establishes his conclusion by excluding the heartland of Islam from the estimation sample. For his estimates, Hanusch moreover uses data that do not appear to exist, at least in the claimed sources. I update my estimates to address issues that Hanusch raises. My new results confirm the conclusion that countries with Muslim majorities are less likely to be democracies. In deriving this result, I do not follow the strategy proposed by Hanusch of excluding from the data sample the countries in the heartland of Islam.     

FROM DONORSHIP TO OWNERSHIP? BUDGET SUPPORT AND DONOR INFLUENCE IN RWANDA AND TANZANIA

In this article, I analyze the relationship between budget support and ownership, or recipient‐country control over policy outcomes, by exploring how budget support donors in Rwanda and Tanzania attempt to exert influence over domestic policy processes. In contrast to the conventional rhetoric about budget support, my empirical analysis finds little evidence that budget support decreases the influence that donors try to exert over recipient‐country governments. Instead, semi‐structured interviews with donor and government representatives in each country suggest that the aid modality is often used as a tool by which donors attempt to increase their leverage over domestic decision‐making. In particular, I identify three mechanisms frequently used by budget support donors to influence domestic policy processes: voice amplification, a seat at the table, and a license to ask questions. Copyright © 2013 John Wiley & Sons, Ltd.     

Fragmented Government Effects on Fiscal Policy: New Evidence

Using a panel of 22 OECD countries over the 1971–1996period, this paper extends previous literature on the effectsof fragmented government on fiscal policy outcomes in variousdirections. First, we focus on data relating to centralgovernment as alltheories refer to central government. Second, we also examinegovernment's position vis-à-vis parliament andgovernment's political fragmentation. We find evidence thatmore fragmented governmentshave higher deficits, while governments that have a largemajority in parliament have lower deficits. Right-winggovernments appear to have been fiscally more responsible inthe seventies. Political fragmentation does not affect agovernment's budget deficit.     

Towards more flexibility of government expenditure: Some recent developments in The Netherlands

As government revenues diminish, budgetary discretions or flexibilities have similarly decreased. A pressing question is therefore how to minimize the inflexible elements or components of a budget. This article distinguishes between technical and political inflexibilities as they are reflected in the budgetary process and argues that the latter are much more difficult to correct. After drawing some examples from studies of the Dutch national budget, the article proposes the use of reconsideration reports as a means to alleviate the politically inflexible components of the budget, as well as a way to assess government programs.I am grateful to Dr. L. J. C. M. Le Blanc, former Director General of the Budget in the Dutch Ministry of Finance for his valuable critical remarks and suggestions to earlier drafts of this article.     

Tax policies in a globalized world: Is it politics after all?

In a panel dataset of 17 OECD countries over 1970–1997, we provide empirical support for the joint existence of the efficiency and the compensation effects of globalization. Our regression analysis shows that higher economic integration—and the associated external risk—lead to a need for social security policies that require higher taxes. The latter take the form of larger social security contributions that are part of taxes on the immobile factors (labor). The tax burden on the relatively mobile factor (capital) is affected negatively by increased economic integration.     

Budget institutions and taxation

While a number of different studies have explored the effects of budgetary procedures and the centralization of the budget process on government debt, deficits and spending, few of them have explored whether such fiscal institutions matter for public revenue. This article argues that centralizing the budget process raises the levels of taxation by limiting the ability of individual government officials to veto tax increases in line with common-pool-problem arguments regarding public finances. Using detailed data on budgetary procedures from 15 EU countries, the empirical analysis shows that greater centralization of the budget process increases taxation as a share of GDP and that both the type of budget centralization and level of government fractionalization matter for the size of this effect. The results suggest that further centralizing the budget process limits government debt and deficits by increasing public revenues as well as constraining public spending.     

Independent central banks, regime type, and fiscal performance: the case of post-communist countries

This article analyzes the effect of central bank independence on fiscal deficits. Previous literature finds a negative relationship between bank independence and deficits in OECD countries. No such relationship is found for developing countries. We argue that independent and conservative central bankers prefer budget discipline due to the long run connection between deficits and inflation and can enforce their preference through interest rate hikes and refusal to lend to the government. The claim, however, is that the legislated independent status of the central bank is cheap talk in the absence of democratic institutions. We test empirically the conditional effect of central bank independence on a sample of 23 democratic and undemocratic post-communist countries from 1990 to 2002. Results show that independent central banks restrain budget deficits only in democracies. Also, democracies that have not granted independence to their central banks have the worst fiscal discipline.     

Do budgetary institutions mitigate the common pool problem? New empirical evidence for the EU

We analyze how budgetary institutions affect government budget deficits in member states of the European Union during 1984–2003 employing new indicators provided by Hallerberg et al. (2009). Using panel fixed effects models, we examine whether the impact of budgetary institutions on budget deficits is conditioned by political fragmentation (i.e., ideological differences among parties in government) and size fragmentation (i.e., the effective number of parties in government or the number of spending ministers). Our results suggest that strong budgetary institutions, no matter whether they are based on delegation to a strong minister of finance or on fiscal contracts, reduce the deficit bias in case of strong ideological fragmentation. In contrast, the impact of budgetary institutions is not conditioned by size fragmentation.     

Political cycles and economic performance in OECD countries: empirical evidence from 1951–2006

This paper examines whether electoral motives and government ideology influence short-term economic performance. I employ data on annual GDP growth in 21 OECD countries over the 1951–2006 period and provide a battery of empirical tests. In countries with two-party systems GDP growth is boosted before elections and, under leftwing governments, in the first two years of a legislative period. These findings indicate that political cycles are more prevalent in two-party systems because voters can clearly punish or reward political parties for governmental performance. My findings imply that we need more elaborate theories of how government ideology and electoral motives influence short-term economic performance.     

Crisis and Response: Treasury Cash Balance Crisis in Thailand 1980-1982

The author traces the treasury cash balance crisis in Thailand from 1980-1982 and finds that the crisis was a result of economic, political and technical factors. The world recession had a significant impact on revenues, as did the inability of the government to accurately project revenues. Politically, budget participants evaded prescribed procedures and resorted to emergency spending, which resulted in expenditures beyond budget planning. The Thai government resorted to borrowing, spending cuts, adjusting corporate tax payments and increasing taxes to cope with the crisis. The author calls for legal reforms to limit discretionary spending.     

Economic performance of 'weak' governments and their interaction with central banks and labour: Deficits, economic growth, unemployment and inflation, 1961–1998

Abstract.   Comparative political economists have conventionally claimed that the strength and stability of governments affect policy making and performance, and that what they call 'weak governments'– multiparty, minority and short-lived governments – show poorer economic performance. This article tests this and related hypotheses on deficits, economic growth, unemployment and inflation by examining data from 17 OECD countries. I find that there is generally little evidence to indicate that so-called 'weak governments', when considered independently, produce poorer performance than strong ones. However, the effects of different government types are partly contingent on central bank independence and labour organization. When central banks are independent, coalition governments exhibit better inflation and economic growth performance than one-party governments, but the opposite happens when central banks are dependent. I attempt an explanation for these relationships. I also find that independent central banks, under certain conditions, lead to lower growth and higher inflation. Thus, some of the benefits of central bank independence are context-specific, depending on other political-economic factors.     

Which among twin deficits hypothesis,twin divergence,and Ricardian's equivalence hold in a developing country?

South Africa witnesses the perpetual increase in budget deficit that hampers its ability for inclusive economic growth while on the other hand facing trade balance instability. To realise stability in the economy and sustainable yet inclusive economic growth, the two deficits, namely, budget and trade deficits, should be closely monitored. The study examined the empirical relationship between budget deficit and trade deficit in South Africa in the postapartheid era, employing time series data from 1994 to 2016. The autoregressive distribution lag approach was employed to examine the existence of a cointegration between the set of variables, both in the short‐ and the long‐run relationships and together with the error correction model. It was found that there is a significant and positive relationship between budget deficit and trade deficit in the short run. However, in the long run, the Ricardian's equivalence holds in South Africa. The study recommends that policies aimed at reducing budget and trade deficits should take into account inflation and aim to increase some macroeconomic variables such as fixed investment to ultimately achieve sustainable economic growth.