Empirics of Fiscal Policy: A Primer for Success

In every economy, there are a variety of economic agents. These agents fall into five (5) broad classifications:

A. Individuals

B. Households

C. Firms

D. Governments

E. Institutions

Each economic agent makes decisions and engages in a variety of activities in pursuit of a core objective. Individuals are assumed to seek utility maximization while households work to attain a desired living standard. Firms tend to have a range of objectives as they adapt to their dynamic business environment, but it is traditional for for-profit firms to seek to maximise profit.

Governments exist to maximise their social welfare functions while institutions are established to entrench justice and peace in all human relationships. Governments retain the priviledge to create and maintain institutions that sustain socio-economic life within  territorial boundaries across the planet.

In other to maximise social welfare, governments make decisions and take actions to grow and sustain economic health and wealth. A consensus of modern macroeconomic policy objectives would include:

■ Steady and sustainable rates of economic growth and economic development

■ Stable general price levels

■ Full employment of productive resources

■ Balance of payments equilibrium 

■ Environmental protection

■ Equitable distribution of income

■ Economic freedom

The inevitable role of government in an economy, against the Classical laissez faire stance, is occasioned by the reality of market failure and externalities. Also, in order to promote social safety and security governments provide incentives for business while bridging gaps between haves, have nots, and everyone in between, so that no one is left behind.  

Fiscal policy involves the use of stabilisation tools in the purview of government (that is, taxation, public expenditure including public debt) to influence the economy. Suffice to say that many developing countries with low revenue generation capacities run perpetual budget deficits to maintain their wheels of economic progress. Typologies of a government's fiscal policy stance may include: neutral, contractionary and expansionary fiscal policy; discretionary and automatic fiscal policy. 

Given their recognition of economic cycles of booms and busts, Keynesians favour the use of stabilizers in macroeconomic management. Otherwise, free market models are not suited to real world phenomena.

Many developing countries are characterised by inequities in natural resource management, low capacity utilisation, inadequate human capital development systems, low enabling and connective infrastructure and high poverty rates. All of these signal the need for fiscal actions that bridge gaps created by market failure and provide public goods and merit goods sustainably.

Empirical literature is replete with evidence on the effects of fiscal policy on macroeconomic objectives and socio-economic outcomes. Within developing country contexts, empirical questions may include: 

■ What is the effect of fiscal policy on long-run economic growth?

■ What is impact of fiscal policy on human capital development?

■ To what extent is government expenditure crowding out domestic private investment? 

■ What is the effect of fiscal policy on inclusive growth?

■ How does fiscal policy impact on environmental sustainability? 

■ What are the determinants of fiscal policy effectiveness?

■ What is the relationship between institutional quality and fiscal policy effectiveness?

■ How effective is foreign aid flows in a developing country context?

■ What is the nature of relationship between government expenditure and unemployment rate?

■ What is relationship between fiscal policy and industrial productivity?

■ What is the impact of fiscal policy on inflation?

■ How does the size of the informal sector influence public revenue? 

■ How does population growth influence fiscal policy effectiveness?

■ What is effect of government expenditure on health on economic growth?

■ How does debt-to-GDP ratio affect exchange rate stability?

■ What is the effect of taxation on export promotion?

■ What is the impact of fiscal policy on domestic innovation?

■ What is the effect of fiscal policy on income inequality?

■ What is the impact of corruption on fiscal policy effectiveness? 

■ What is the relationship between fiscal policy and economic diversification?

■ How does the structure of an economy impact on its socio-economic outcomes?

While developing country governments seek to generate revenue, woo development aid and expend same, economic analysts and evaluators standby to assess the impact of public spending on the pace and rate of development.

Please consult existing literature to establish research gaps worthy of investigation in your area of interest.