EFFECT OF FISCAL POLICY ON ECONOMIC GROWTH IN SUB-SAHARAN AFRICA

ABSTRACT

Studies on economic growth have provided insights into why States grow at different rates over time. Classical economics posits that economic growth is largely influenced by factors of production, particularly labour and capital. The proponents of the Classical school assert that the effect of government spending is temporary and not effective, particularly in the long-run, when prices adjust and output and employment are at their optimum levels. On the contrary, the Keynesian economics opine that public consumption has a positive effect on the economy. Most recently, endogenous growth economics asserts that government expenditure and taxation will have both temporary and permanent effects on economic growth. The debate on the effectiveness of fiscal policy as a tool for promoting growth and development remains inconclusive given the above positions as well as conflicting results of recent studies. Thus, the controversy is yet to be settled. Against this background, therefore, this study sought to determine: (i) the effect of government productive expenditure on the economic growth of sub -Saharan African countries, (ii) the effect of government unproductive expenditure on the economic growth of sub-Saharan African countries, (iii) the effect of distortionary tax on the economic growth of sub-Saharan African countries, (iv) ) the effect of non-distortionary tax on the economic growth of sub-Saharan African countries, and (v) the effect of budget surplus on the economic growth of sub-Saharan African Countries. The ex-post facto research design was adopted which enabled the study to make use of secondary data of sub-Saharan African Countries in panel least squares. The hypotheses were linearly modelled while adopting the panel data estimation under the fixed-effect assumptions. Findings reveal that Government productive and unproductive expenditures have a negative and significant effect on the economic growth of sub -Saharan African countries, while distortionary tax (a proportional tax on output at rate) and non-distortionary taxes has a positive and significant effect on the economic growth of sub-Saharan African countries. Findings also revealed the budget balances of sub- Saharan African countries have a positive and insignificant effect on the economic growth of sub-Saharan African countries. The study therefore recommends that Governments of sub -Saharan African countries should engage in more productive and unproductive expenditures while improving on the mechanisms for the collection of distortionary and non-distortionary taxes for enhanced economic growth.

CHAPTER ONE
INTRODUCTION
1.1 Background of the Study.
Economic growth studies has provided insights into why states grow at different rates over time and that influence of government in her choice of tax and expenditure determines that level at which a given economy will grow. Studies on economic growth and drivers have received attention among scholars but with differing evidences. Economic growth represents the expansion of a country’s potential Gross Domestic Product (GDP) or output (Abata, et al., 2012).

A number of Sub-Saharan African countries had relatively favourable development prospects and income levels at the time of independence. However, overtime, economic development in the region has been dependent on aid and debt due to mismanagement of fiscal policies. When the region is compared with those in Southeast Asian countries, it is obvious and glaring that economic development in Sub-Saharan Africa has been lagging behind. In the most recent times many Southeast Asian countries have far higher development and income levels with some been categorised as emerging economies. The Sub-Saharan African economy has been plagued with several challenges over the years. Notable among the challenges is the management and mismanagement of fiscal policies. In spite of many, and frequent changing of fiscal and other macro-economic policies, the sub-Saharan African countries are yet to tap her economic potentials for rapid economic development and growth. Fiscal policies are extremely linked in macro-economic management; growth in one sector of the economy directly affects growth in the other. Notably, fiscal policy is central to the health of any economy, as government’s has power to raise revenue (tax) and expend revenue. These actions affect the disposable income of citizens and corporations which in turn affects the general economy as well.

Fiscal policy has conventionally been associated with the use of taxation and public expenditure to influence the level of economic activities. The implementation of fiscal policy is essentially routed through government’s budget. Consequently, the most important aspect of a public budget is its use as a tool in the management of a nation’s economy (Omitogun & Ayinla, 2007). Fiscal policy is a deliberate action of government.


It involves the use of government spending, taxation and borrowing to influence the pattern of economic activities and also the level and growth of aggregate demand, output and employment. This includes sustainable economic growth, high employment creation and low inflation. Thus, fiscal policy aims at stabilizing the economy. Increases in government spending or a reduction in taxes tend to pull the economy out of a recession; while reduced spending or increased taxes slow down a boom (Dornbusch & Fischer, 1990). Fiscal policy entails government's management of the economy through the manipulation of its revenue and expenditure to achieve certain desired macroeconomic objectives amongst which is economic growth (Medee & Nembee, 2011). Olawunmi and Tajudeen (2007) opine that fiscal policy has conventionally been associated with the use of taxation and public expenditure to influence the level of economic activities. Furthermore, Olawunmi and Tajudeen (2007) argue that the implementation of fiscal policy is essentially routed through government's budget. Anyanwu (1993) notes that the objective of fiscal policy is to promote economic conditions conducive to business growth while ensuring that any such government actions are consistent with economic stability.

Over the last decade, the growth impact of fiscal policy has generated large volume of both theoretical and empirical literature. Economic growth has long been considered an important goal of economic policy with a substantial body of research dedicated to explaining how this goal can be achieved (Fadare, 2010). Scholars argue that increase in government expenditure on socio-economic and physical infrastructures encourage economic growth likewise expenditure in health and education raise the productivity of labour and increase the growth of national output (Barro & Sala-i-Matins, 1995). Similarly, expenditure on infrastructure such as roads, communications, power, etc, reduces production costs, increases private sector investment and profitability of firms, thus fostering economic growth. Supporting this view, scholars concluded that expansion of government expenditure contributes positively to economic growth (Barro & Sala-i-Matins, 1995). Conversely, other school of thought claim that increasing government expenditure deters economic growth, instead they assert that higher government expenditure might slowdown overall performance of the economy. Furthermore, in an attempt to finance rising expenditure, government may increase taxes and/or borrowing which might affect her spending behaviour. Thus, higher income tax discourages individual from working for long hours or even searching for jobs and this reduces income and aggregate demand. In the same vein, higher profit tax tends to increase production costs and reduces investment expenditure as well as profitability of firms (Oseni & Onakoya, 2012). Moreover, if government increases borrowing (especially from the banks) in order to finance its expenditure; it will compete away the private sector, thus reducing private investment.

Propositions exist on the effect of fiscal policy on economic performance outcomes. Khosravi & Karimi (2010) opine that classical studies estimate that economic growth is largely linked to factors of production particularly labour and capital. The proponents of the classical view assert that the effect of government spending is temporary and not effective particularly in the long-run when prices adjust and output and employment are at their optimum levels (Mathew, 2009). Furthermore, Mathew (2009) notes on the contrary the Keynesian view as represented in Blinder and Solow (2005) suggest that consumption has a positive effect on the economy. Most recently, there has been the emergence of the endogenous growth theory which predicts that government expenditure and taxation will have both temporary and permanent effects on economic growth. Bogdanov (2010) points out that the emergence of the endogenous growth theory has encouraged specialists to question the role of other factors in explaining the economic growth phenomenon.

Adeoye (2006) points out that the debate on the effectiveness of fiscal policy as a tool for promoting growth and development remains inconclusive given the conflicting results of current studies. On the theoretical front, there are two main strands of literature regarding the role fiscal policy play in fostering economic growth. One view is that government’s support for knowledge accumulation, research & development, productive investment, the maintenance of law and order and the provision of other public goods and services can stimulate growth in both the short-run and the long run (Easterly & Ribero, 1993; Mauro, 1995; Folster & Henrekson, 1999). On the other hand, there is also the view that governments are inherently bureaucratic and less efficient and as a result they tend to hinder rather than facilitate growth if they get involved in the productive sectors of the economy (Mathew, 2009). Thus government fiscal policy is thought to stifle economic growth by distorting the effect of tax and inefficient government spending.

In the neoclassical growth model of Solow (1956), together with its many subsequent extensions, the long-run growth rate is driven by population growth and the rate of technical progress. Distortionary taxation or productive government expenditures may affect the incentive to invest in human or physical capital, but in the long run this affects only the equilibrium factor ratios and not the growth rate, although there will in general be transitional growth effects (Mathew, 2009). Endogenous growth models such as those of Barro (1990), and King & Rebelo (1990), on the other hand, predict that distortionary taxation and productive expenditures will affect the long-run growth rate. The implications of endogenous growth models for fiscal policy have been particularly examined by Barro (1990), Jones et al. (1993), Stokey & Rebelo (1995) and Mendoza et al. (1997).

In the light of the above, this study contributed to the debate by investigating the effect of the two sides (structure) of fiscal policy on economic growth and for sub-Saharan Africa.

1.2 STATEMENT OF PROBLEM.
A major strand in literature regarding the role fiscal policy play in fostering economic growth is that government’s support for knowledge accumulation, research & development, productive investment, the maintenance of law and order and the provision of other public goods and services can stimulate growth in both the short-run and the long run (Easterly & Ribero, 1993; Mauro, 1995; Folster & Henrekson, 1999). This notwithstanding, the extent to which fiscal policy engender economic growth has continued to attract empirical debate especially in developing countries.

Fundamental to this problem statement is the representation of fiscal policy. Literature reveals that there are different opinions as to what coefficient best captures fiscal stance. Theoretically, three standard fiscal policy measures; spending/expenditure, taxation and deficits exist. Out of these three variables, literature does not single out any as the most representative of fiscal policy. While scholars such as (Rebelo, 1991; Xu, 1994; Stokely &  Rebelo, 1995; Engen & Skiner, 1996) have made use of tax rates as a proxy for fiscal policy others such as Martin and Fardmanesh (1990) and Easterly & Sergio (1993) have used deficits to account for fiscal policy in their estimations. Yet, scholars including Barro (1990), Aushauer (1989) used expenditure to account for fiscal policy stance. When expenditure is considered as a fiscal policy measure certain studies have considered aggregate government expenditure as a single variable while others are of the view that the variable ought to be decomposed into several categories.

Consequently, past empirical results differ greatly between various studies as (Levine and Renelt, 1992) emphasized the sensitivity of the findings to changes in the set of control variables. Levine and Renelt (1992) also argue that none of the three policy variables has a robust association with economic growth when examined individually. Fu, et al. (2003) suggest the inadequacy of any one of the identified fiscal policy indicators (as pointed by Levine & Renelt, 1992) but disputed the mainstream growth literature which could be due to the inability of any one policy factor to adequately account for a given fiscal policy position. Mathew (2009) consequently points out that a third-generation strand of the literature on fiscal policy and economic development has emerged which attempts to examine the structure of at least two fiscal policy variables simultaneously.

A significant problem with most of the past African countries studies is the inability of the studies to apply pair-wise combinations of the fiscal. This implies testing the effects of fiscal policy on economic growth taking into account the structure of fiscal policy i.e. both sides of taxation and expenditure. In other words, past African studies focused on the effect of government deliberate spending on economic growth while ignoring, at least partially, the other side (taxation/ income) of fiscal policy. Bleaney, et al (2000) opines that any fiscal policy growth study, which does not take both sides of the fiscal policy into account, suffers from substantial biases of the coefficient estimates. This study dealt with the above problems in the context of static panel regressions by showing the complete specification of the government budget constraint and careful attention to fiscal classifications to produce dramatically different results for the economic growth effects of fiscal policy.


1.3 RESEARCH OBJECTIVES
The objectives of this study are as follows:

1.     To determine if productive government expenditure positively and significantly affect the economic growth of sub-Saharan African Countries.
2.     To ascertain if non-productive government expenditure positively and significantly affect the economic growth of sub-Saharan African Countries.
3.     To determine if distortionary taxes negatively and significantly affect the economic growth of sub-Saharan African Countries.
4.     To ascertain if non-distortionary taxes negatively and significantly affect the economic growth of sub-Saharan African Countries.

5.     To find out if budget surplus positively and significantly affect economic growth of sub-Saharan African Countries.

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Item Type: Ph.D Material  |  Attribute: 170 pages  |  Chapters: 1-5
Format: MS Word  |  Price: N3,000  |  Delivery: Within 30Mins.
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