Economic Growth and Fiscal Policy

University dissertation from Department of Economics

Abstract: This thesis deals with the two subjects economic growth and fiscal policy. The first three chapters after the introduction are theoretical approaches to the determination of long-run growth. In each of these chapters, the ability of fiscal policy to influence long-run growth is examined as well. The next chapter relates the development of GDP in the long run to the financial system. The final chapter examines the long-run behaviour of government debt. Chapter 2 explores whether the aggregate level of public consumption affects the long-run growth rate when public consumption is an imperfect substitute for private consumption. It is shown that a reduction in public consumption improves growth. Chapter 3 develops a model of growth where human capital, technological innovations and the provision of financial capital complement each other as the engine of growth. Long-run growth occurs when the three factors grow in constant proportions to each other. Contrary to a number of recent growth models, economic policy can affect economic growth in the long run. Subsidies to research and education have a positive effect on the growth rate, whereas capital and labour income taxation have a negative effect. Chapter 4 is an investigation into the effects on growth of a harmonization of capital tax rates across the world. The world consists of a large number of small, open economies in this model where capital flows freely across national borders. Labour, on the other hand, is assumed to internationally immobile. Technology is assumed to be the driving force of economic growth. We find that if some countries are more innovative than others, a complete harmonization of capital taxes reduces long-run growth. In order to prevent tax competition among innovative countries, an international agreement that prevents innovative countries from lowering taxes may be necessary. Chapter 5 is purely empirical. It examines the long-run relationship between financial lending and economic development in Sweden from the 1830s to the 1990s using the econometric technique of cointegration. A fairly unique set of long-run data is employed. To our knowledge, no tests of this kind have been reported previously, at least for the European experience. Our results suggest a pattern of interaction among the variables studied. The estimated contribution of the financial system to economic development depends crucially on the time period studied and the variables included in the analysis. Chapter 6 provides international evidence of the sustainability of the public debt. We test if the public debt-to-GDP ratio is stationary in six countries over the period 1885–1996. Standard unit root tests suggest that this is not the case, but when controlling for temporary government expenditure and temporary shortfall of taxes due to temporarily low GDP, we find that the debt-to-GDP ratio is stationary in four out of the six countries. If we allow for a structural break in 1973, the debt-to-GDP ratio is stationary in all six countries.

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