A study on fiscal policy and economic growth from an institutional perspective

This dissertation studies the interrelationship between fiscal policy and institutions (property right protection and economic freedom, in particular) in affecting economic growth. The vast literature on economic growth examines institutions and fiscal policy as separate determinants of economic growth, and has not established a theoretical basis or empirical link on the interaction between them. This dissertation takes a unique approach to the growth literature by studying a channel that institutions affect growth – the fiscal policy channel. Among the first ones who incorporate economic institutions into a growth model with fiscal policy, I construct a theoretical framework in Chapter 2 to illustrate the role of property rights protection in determining the growth impact of government spending. The analysis is based on the standard Solow growth model with some modifications where security of property rights is modeled to affect the so-called“effective aggregate capital level”, a new concept introduced in the dissertation. It is shown that the impact of government investment on the steady-state output level and the output growth rate depends on the level of property rights protection. Moreover,increase in security of property rights can either enhance or reduce the growth impact of government investment, depending on the relationship between private and public saving of a country. This theoretical framework provides a basis for testing the hypothesis about the determining role of institutions on the growth impact of fiscal policy. In Chapter 3, I test the hypothesis on the interrelationship between fiscal policy and institutions in affecting growth by employing the framework presented in Chapter 2 but extending the concept of institutions to a broader scope – economic freedom.Using a sample of 72 countries over the period of 1990 through 2015 in interactive growth regression models, and the economic freedom index of the Heritage Foundation, I find that is the level of economic freedom has a significant impact on the effectiveness of fiscal policy on economic growth. Public investment in infrastructure can enhance long-term growth better in countries with less degree of freedom. Meanwhile, public consumption does not benefit growth but its adverse impact is mitigated if a country enjoys greater economic freedom. Furthermore, the determining role of institutions in emerging countries is more prominent than that in advanced economies which are pretty homogenous in economic development and have already been at a high level of economic freedom. Chapter 4 extends the scope of this study by investigating institutional determinants of the short-term impact of fiscal policy – fiscal multipliers – with a three-step regression procedure for a sample of 72 countries from 1960 through 2015.I find significant and positive correlations between fiscal multipliers and economic institutions but weak evidence on the direct impact of political institutions on the multipliers. Countries with political stability, higher economic freedom, more efficiently regulatory system, and less corruption have greater government expenditure multipliers. The role of institutions is not the same to different components of fiscal stimulus. Institutional characteristics can explain variations in public consumption multipliers better than variations in public investment multiplier across countries. The size of fiscal multiplier across countries also depends on legal origin and level of economic development