Corruption and determinants of fiscal deficits in asia pacific countries

Ministry of Education and Training
University of Economics Ho Chi Minh City
********

Research Topic

CORRUPTION AND DETERMINANTS OF FISCAL DEFICITS IN
ASIA PACIFIC COUNTRIES

Contributor
Nguyen Phuc Canh

Ho Chi Minh City, Aug/2017

i


Ministry of Education and Training
University of Economics Ho Chi Minh City
********

Research Topic

CORRUPTION AND DETERMINANTS OF FISCAL DEFICITS IN
ASIA PACIFIC COUNTRIES

Ref code: CS – 2017 - 17

Contributor
Nguyen Phuc Canh

Ho Chi Minh City, Aug/2017

ii


Table of content
Abstract ................................................................................................................................................. v
Chapter 1: INTRODUCTION .............................................................................................................. 1
1.1.

The motivations of the study .................................................................................................. 1

1.2.

The scope of the study ............................................................................................................ 3

1.3.

The contributions of the study ............................................................................................... 5

1.4.

The methodology .................................................................................................................... 6

Chapter 2: LITERATURE REVIEW ................................................................................................... 8
2.1. The fiscal deficits and determinants ........................................................................................... 8
2.2. The external debt and fiscal deficits ......................................................................................... 10
2.3. The government size and fiscal deficits .................................................................................... 12
2.4. The corruption controlling and fiscal deficits .......................................................................... 13
2.5. The effects of corruption controlling under the constraints of external debt and government

size .................................................................................................................................................... 15
Chapter 3: METHODOLOGY AND DATA ...................................................................................... 18
3.1. Methodology .............................................................................................................................. 18
3.2. Data ........................................................................................................................................... 20
Chapter 4: RESULTS AND DISCUSSIONS ...................................................................................... 23
4.1. The corruption controlling and fiscal deficits .......................................................................... 23
4.2. The effects of corruption controlling under the constraints of external debt and government
size .................................................................................................................................................... 26
4.3. Robustness check ...................................................................................................................... 28
Chapter 5: SOME REMARKING CONCLUSIONS ......................................................................... 31
Acknowledgement ............................................................................................................................... 32
References ............................................................................................................................................ 33

iii


Lists of Tables and Figures
Tables
Table 1. Data definitions and sources............................................................................. 19
Table 2. Data descriptions.............................................................................................. 20
Table 3. Correlation matrix ............................................................................................ 22
Table 4. The effect of Control of corruption and fiscal deficits ...................................... 24
Table 5. The effects of Control of corruption and its interactions with government
expenditure and external debt on fiscal deficits .............................................................. 26
Table 6. The effects of Control of corruption and its interactions with government
revenue and external debt on fiscal deficits .................................................................... 27
Table 7. The effects of Control of corruption on fiscal deficits in pre and post 2008 global
financial crisis ............................................................................................................... 28
Table 8. The effects of Control of corruption and its interactions with government
expenditure and external debt on fiscal deficits in pre and post 2008 global financial crisis

...................................................................................................................................... 29

Figures
Figure 1. Economic growth of areas ................................................................................ 4
Figure 2. Government expenditure growth rates in Asia Pacific areas .............................. 4
Figure 3. Primary fiscal balance in Asia Pacific countries (%/GDP) ................................ 5

iv


Abstract
The fiscal policy conducting with the aim of sustainable development is under strong
debate from both scholar and practice, in which the institution-based solutions for the
fiscal consolidation are suggested as essential measures to complement for the ineffective
of market-based solutions. The study contributes to the literature and practice by
emphasizing the roles of corruption controlling on fiscal deficits in the context of 26 Asia
Pacific countries for the period 2002 – 2015. By recruiting the system-GMM estimators
for unbalance panel data, the study finds the significant evidences that the better
corruption controlling eliminates fiscal deficits. Notably, the corruption controlling
measures have stronger effects in low indebted countries with small government size.
The result has significant implications for policymakers in fiscal consolidation and
sustainable policy setting.

Keywords: corruption, fiscal deficit, external debt, government size.
JEL classifications: E62, H11, H62, H63.

v


Chapter 1:

INTRODUCTION

1.1.

The motivations of the study

The excessive fiscal deficits in a long-run period are considered as the fundamental
problem and the cause of recent severe debt crisis such as crisis in Mexico and Argentina
in 1990s, crisis in European in 2000s (Cole & Kehoe, 1996; Featherstone, 2011;
Ruščáková & Semančíková, 2016). For instance, Ruščáková and Semančíková (2016)
summarize that worsening values of macro fundamental variables including the fiscal
deficits had predominantly significant effect on the origin of the European debt crisis
beside other drivers such as high international risk, the negative impact of rescue
activities, news about sovereign rating downgrades, etc.. However, the one of most
important factor is the crisis of confidence due to the long lasting deficits in the fiscal
budgets. Therefore, the measures to handle the budget deficits with the aim at sustainable
development are under strong attention from both scholars and policymakers.
In the theoretical and empirical literature of fiscal consolidation, the market-based and
institution-based solutions are both examined by researchers to find the efficiency way of
fighting excessive budget deficits. Whereas, the market-based solutions from internal
measures such as cut government spending, tax increases, stimulate economic growth to
external measures of international organizations (e.g., IMF, World Bank) such as increase
the borrowing interest rate, limit the ability to borrow, decrease the credit worthy
ranking) are under consideration and implementation. Unfortunately, the market-based
solutions such as setting high interest rates for high deficit government in getting new
debt to stimulate them lower the deficits are not effective. Maltritz and Wüste (2015)
document that European large governments such as Germany or France agreed to provide
funds for troubled countries at comparably low interest rates for during the crisis with the
aim at helping them out of default; thus, the market-based solution basing on the setting
1

high interest rate is not effective in recent European debt crisis. The institution-based
solutions are, in turn, implied with more significant in the literature (Maltritz & Wüste,
2015), in which corruption controlling not only reduces the wasted government spending,
but also stimulates the economic activities that enhances the government revenues.
In addition, Martinez-Vazquez et al. (2007) notice that the corruption has been
downplayed by many governments since it was considered as a cultural and political
issues and measuring corruption was nearly impossible so that corruption controlling was
hardly seen as an economic objective for development reforms. However, the negative
damages of corruption on the economic development, especially in poor countries, are
evidenced in studies recent decade. Dal Bó and Rossi (2007), for instance, find that
besides other factors such as public ownership, inflation, and lack of law and order,
corruption appears to play a separate and more robust role in damaging the efficiency of
firms in 13 Latin American countries over the period 1994-2001. Dimakou (2015) notices
that corruption constrains the fiscal capacity to tax and increases the reliance on inflation.
Moreover, the new dataset of institutional framework (World Governance Indicators –
World Bank), which include the indicator of controlling corruption, is provided with
more reliable information and better measuring method in evaluating the corruption
situation (Kaufmann et al., 2007). Thus, the question about the roles of corruption in
tackling the fiscal deficits has re-emphasized.
Apparently, Arestis (2011) notices that recent developments of “New Consensus in
Macroeconomics” in macroeconomic policy have downgraded the roles of fiscal policy,
but researchers and authorizers must careful consider other determinants of fiscal policy
such as the institutional frameworks, debt burden, and also government size. This rehighlights the interests in examining the associations of corruption controlling with other
economic drivers of fiscal deficits. Therefore, this study sheds lights on the effects of
corruption controlling and its interactions with other aspects of fiscal policy including
government size and external debt burden on fiscal deficits.

2

1.2.

The scope of the study

The study goes to examine the effects of corruption controlling on fiscal deficits and
its interactions with external debt and government size in the context of 26 Asia Pacific
countries 1. In which, the better corruption controlling is in line with the less corruption.
Therefore, in the understanding we can see the corruption and the corruption controlling
have opposite meanings.
The 26 Asia Pacific countries, which are mainly developing and emerging countries
that we exclude the advanced countries, are the fruitful sample to examine the roles of
corruption controlling on fiscal deficits due to their high economic development in along
with the variety of corruption situation and the structural changes in the economic
development. In fact, the Asia Pacific area is the one of most dynamic and highest
economic growth in the period of 2000-2015 (see Fig. 1). The real GDP growth rate of
this area is average higher than US, OECD, and European countries. While, its growth
rate is less impacted in the 2008 global financial crisis.

1

26 Asia Pacific countries in this study including: Afghanistan, Armenia, Azerbaijan, Bangladesh, Bhutan,
China, Fiji, Georgia, India, Indonesia, Kyrgyz Republic, Lao People's Democratic Republic, Malaysia,
Maldives, Mongolia, Nepal, Philippines, Papua New Guinea, Samoa, Solomon Islands, Sri Lanka,
Tajikistan, Thailand, Tonga, Vanuatu, Vietnam.
3


Economic growth (annual, %)

14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

East Asia & Pacific

Euro area

Europe & Central Asia

Latin America & Caribbean

Middle East & North Africa

OECD members

Sub-Saharan Africa

United States

2015

Figure 1. Economic growth of areas
Source: World Development Indicators (Worldbank)
On the aspect of government operation, the general government expenditure increased
in the pre-2008 global financial crisis, and they expended the government spending

higher in the crisis that presents the government policies to tackle with the crisis through
the stimulus packages and expansionary fiscal policy (see Fig.2). This fact shows the
important role of fiscal policy in macroeconomic policies of governments in this area.

General government final consumption expenditure (annual %
growth)
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2002

2003

2004

2005

2006

2007

2008

East Asia & Pacific

2009

2010

2011

2012

2013

Europe & Central Asia

Figure 2. Government expenditure growth rates in Asia Pacific areas
4

2014

2015


Source: World Development Indicators (Worldbank)
Furthermore, the fiscal budgets were usually under the deficit situations across
countries in the whole period (see Fig.3), except some small countries such as Georgia,
Mongolia, and Tonga in some short period of years. This fact provides a suitable sample
for us to examine the determinants of fiscal deficits

Primary fiscal balance (%/GDP)
10.0

0.0
-5.0

-10.0
-15.0

AFGHANISTAN
AFGHANISTAN
ARMENIA
ARMENIA
AZERBAIJAN
BANGLADESH
BANGLADESH
BHUTAN
Fiji
Fiji
GEORGIA
INDIA
INDIA
INDONESIA
KYRGYZ REPUBLIC
KYRGYZ REPUBLIC
LAO PEOPLE'S…
LAO PEOPLE'S…
MALAYSIA
MALDIVES
MALDIVES
MONGOLIA
Nepal
Nepal
PHILIPPINES
PAPUA NEW GUINEA
PAPUA NEW GUINEA

China
SAMOA
SAMOA
SOLOMON ISLANDS
SOLOMON ISLANDS
SRI LANKA
TAJIKISTAN
TAJIKISTAN
Thailand
TONGA
TONGA
VANUATU
Vietnam
Vietnam

5.0

-20.0
-25.0
-30.0

Figure 3. Primary fiscal balance in Asia Pacific countries 2002-2015 (%/GDP)
Source: Key economic indicators (ADB)
As a result, the developing countries in Asia Pacific area are the fruitful sample for
examining the effects of corruption and its interactions with other drivers on fiscal
deficits. Whereas, we examine the effects of corruption controlling and its interactions
with the external debt and government size on fiscal deficits in the period of 2002 – 2015.
This period of time is recruited due to the availability of data from the World Governance
Indicators of World Bank that provides the yearly data from 2002 and the lasted data in
2015.

1.3.

The contributions of the study
5


We believe that this study has significant contributions to scholar and practice in three
fronts. By using the Control of corruption indicator from the World Governance Indicator
dataset to examine the effects of corruption controlling on fiscal deficits, the result
contributes to the literature of institutional economies under the effects of institution on
macroeconomic policies. The study also contributes significant implications for the
practice by finding that better corruption controlling has significant positive effects on
fiscal balance.
Notably, the study analyzes the impacts of corruption controlling on fiscal deficits
under the constraints of government size and external debt burden. The results show that
the large government size and high indebted countries impedes positive effects of
corruption controlling on fiscal balance. Finally, the study contributes by examining the
government size under both aspects of revenue and expenditure and dividing sample into
pre and post the 2008 global financial crisis to investigate effects of corruption
controlling. The study finds that corruption controlling is more effective in tackling fiscal
deficits in pre-crisis period.
1.4.

The methodology

In order to achieve these objectives, the study is done as following strategy:
First, we recruit the basic determinants of fiscal deficits from the work of Maltritz and
Wüste (2015) including economic growth, inflation, real interest rate, changes in
unemployment and then incorporate the corruption controlling factor as suggesting in
Martinez-Vazquez et al. (2007) to examine its impacts on fiscal deficits.

Next, we use the interaction terms between control of corruption with ratio of total
expenditures to GDP and ratio of total external debt to GNI to investigate the effects of
corruption controlling on fiscal deficits under the constraints of government size and debt
burden.
Third, we recruit the ratio of total revenue to GDP to replace for the ratio of total
expenditure to GDP as the proxy for the government size in the robustness check. At last,
6


we divide our sample to two sub-samples including the period of 2002-2008 and the
period of 2009-2015 to examine the effects of corruption controlling on fiscal deficits in
pre and post the 2008 global financial crisis.
The remainder of this study is organized as follows. The Chapter 2 reviews the
literature in detail. Chapter 3 provides our empirical methodology and data. The results
and our discussions are presented in Chapter 4. Chapter 5 goes to some remarking
conclusions.

7


Chapter 2:
LITERATURE REVIEW
2.1. The fiscal deficits and determinants
The rise and persistence of large fiscal deficits in many developed and developing
countries from 1980s is one of the most striking macroeconomic debate in both literature
and practice (Woo, 2003). The cause of excessive fiscal deficits in the European debt
crisis renews interests in the question what are the determinants of fiscal deficits (Maltritz
& Wüste, 2015). According to Roubini and Sachs (1989), the traditional macroeconomic
literature, as Keynesian theory, assumes that government policy is exogenous variable, in
which the governments should take a fiscal stimulus to response to a recession as a

standard “Keynesian” suggestion. In the recession, governments either by tax cuts or
increased government spending can increase total demand to promote output and
employment. Whereas, the Keynesian theory does not mention to the fiscal deficits or the
source for the government spending. However, the changes in macroeconomic context
and development of macroeconomic literature have changed the views about fiscal
policy, whereas structural macroeconomic models combined with simply objective
functions for government lead to the normative rules for government’s behavior in their
fiscal policy (Roubini & Sachs, 1989).
In this line of literature, the neo-classical economic theory argues that fiscal policy,
inflation rates, and fiscal deficits are the outcomes of the optimal decisions from
policymakers for the preferences of private agents and welfare-maximizing functions
(Roubini, 1991). In particular, Barro (1979) proposes the tax-smoothing model in the
neoclassical of debt, whereas the policymakers try to choose policies to minor the excess
tax burdens in the frame of a long-run intertemporal optimization, which then reflect to
actual tax, inflation rates, and budget deficits. The fiscal budget is expected to raise when
the output is temporarily high and the government expenditure is temporarily low, in
which the fiscal policy plays as the counter-cyclical policy. This counters the economic
cycles by expanding in the low growth period and contracting in the high growth one, and
8


government, of course, has to accept the deficit or higher deficit in low growth periods.
Fiscal policy has, in turn, surplus or lower fiscal deficit in high growth periods to longrun balancing. Thus, the literature points out some main economic determinants of fiscal
deficits as economic growth, unemployment.
In fact, the economic growth and unemployment are used as main economic
determinants of fiscal deficits in many empirical studies. The fiscal policy is argued that
they have to play as the counter-cyclical policy in macroeconomic policies so that higher
economic growth increases revenue on one hand, while economic growth on the other
hand reduces the demand for government spending such as transfer and unemployment
aid. As the result, the higher economic growth improves the budget balance of

governments (Adam & Bevan, 2005; Altunc & Aydın, 2013; Attari & Javed, 2013).
However, governments do not implement the counter-cyclical fiscal policy all the time.
Aghion et al. (2014) find that more the more counter-cyclical fiscal policies are harmful
for industries with the sample of 15 OECD countries over the period 1980–2005. So,
Bauducco and Caprioli (2014) find that fiscal policy is pro-cyclical in emerging
economies, and they may transform to countercyclical policies in the long run. In the
same idea, Schalck (2014) documents that most EMU countries are characterized by an acyclical or pro-cyclical fiscal policy in the period of 1998-2012, but they pursued a
counter-cyclical policy after 2008.
Meanwhile, the unemployment is the crucial factor of fiscal policy conducting, where
the government tries to keep unemployment at low level as natural unemployment
(Degiannakis et al., 2016; Jha et al., 2014; Nishiyama, 2015). This means that the
increasing of unemployment requires the expanding of fiscal policy to counter, while it
limits the revenue bases of fiscal policy so that budget balance is worsen. Andersen and
Sørensen (1995) notice that balanced budget demand management policies in EMU
countries are shown to affect employment. Recently, DeLong and Summers (2012)
emphasize that fiscal policy has the stabilization policy mission to supplement for the

9


incapable of monetary policy due to the low – zero interest rate in the depressed economy
with ample cyclical unemployment.
Apparently, the development of literature also determines other economic drivers of
fiscal deficits such as real interest rate, inflation (Maltritz & Wüste, 2015). As reviewed
in Catão and Terrones (2005), macroeconomic views postulate that budget deficits cause
inflation from the point of view in Sargent and Wallace (1981), where governments have
sooner or later to finance the persistent deficits by money creation thus leads to the
inflation. However, Sargent and Wallace (1981) also argue that the deficit-inflation
relationship is dynamic. In this direction, Makin (1983) argues that the behaviors of fiscal
policy have relationships with real interest rate, money surprises, and inflation. Precisely,

higher inflation puts pressures on government to prudential controls of fiscal policy. The
higher inflation, on the other side, means lower real interest rate in borrowing debt to
finance the deficit that may stimulate policymakers to expand the fiscal policy. As the
argument of borrowing cost, higher real interest rate means higher borrowing cost for
government in getting fund for fiscal deficits, thus it stimulates policymakers to reduce
the fiscal deficits.

2.2. The external debt and fiscal deficits
Beside above determinants, the economics literature documents the roles of external
debt in fiscal policy (Ardagna et al., 2007; Demirgüç-Kunt & Detragiache, 1994; Engen
& Hubbard, 2005; Fosu, 1999; Galiński, 2015). Beginning with the Keynesian theory, the
fiscal policy is explained with positive effects on economic growth under the assumptions
as sticky price and excess capacity (Coddington, 1976). The government intervention,
therefore, is suggested and government expenditure is incorporated into the aggregate
demand function with the assumption that government activities are exogenous so that
fiscal policy is not impacted by the debt burden.

10


In the stream of literature development, the neo-classical economics address the
shortcomings of Keynesian economics such as lacking of considering institutional
environment, debt burden, and

microeconomic foundations (see Gaffney (1994),

Goodland and Ledec (1987), Davis (2006)). Today’s individuals in neo-classical views
think that the expansionary fiscal policy to increase the consumption creates existing
budget deficits, which have to pay back through taxes for future generations. While, the
government spending is less effective than private investment thus the increased output as

a result of the debt financed government expenditure does not fully offset the negative
effect due to the crowding-out effects to private investment on output (see Buiter (1977),
Arestis (1979), Mundell (1963), Fleming (1962)). Therefore, the policymakers are
constrained by the debt burden in implementing fiscal policy.
For instance, Aizenman et al. (2013) argue the impacts of fiscal management on the
sovereign risk of European area by documenting the significant evidence over the period
2005-2010 in Greece, Ireland, Italy, Portugal and Spain. Aguiar and Amador (2016)
argue that government should consider the zero labor tax as an optimal long run outcome
if the economy is subject to sovereign debt constraints. Alt and Lassen (2006) find that
the higher transparency of fiscal policy is associated with lower public debt and deficits
in 19-country OECD countries. Notably, Baharumshah et al. (2017) find that the
Malaysian government should cut the deficits only if public debt exceed a certain level.
Whereas, if the public debt exceeds a certain threshold level (above 55% of the gross
domestic product in the Malaysia case), it is negatively correlated with economic activity.
Baldacci et al. (2015) study 107 countries and 79 episodes of public debt reduction
during the 1980-2012 period, they find that fiscal adjustments are gradual and rely on a
mix of revenue and spending measures can support output expansion, while reducing
public debt. Previous, Bohn (1998) find evidence of corrective action in the US fiscal
policy, where the primary surplus is an increasing function of the debt-GDP ratio.
Çufadar and Özatay (2017) emphasize that fiscal contractionary is conducive to real
economic activity when initial government debt is high.
11


As the review in Hemming et al. (2002), the future government is limited in fiscal
capability by a strategic instrument from the debt, while governments in developing
countries have to tackle more constraints due to the availability and cost of domestic and
external borrowings. As a result, developing countries with highly indebted level have to
determine the size of fiscal deficit in facing with difficulties in assessing to international
capital market and less effectiveness of fiscal policy. As a result, they suffer more severe

fiscal deficits. The low indebted countries, in contrast, have higher fiscal room with more
favorable terms of debt-financing and more effective fiscal policy so that they are argued
with a better fiscal balance.

2.3. The government size and fiscal deficits
In fact, the literature and empirical works also proposes mixed conclusions about the
relationship between government size and economic growth (see Thanh (2014)). Altunc
and Aydın (2013) find that the optimal level of public spending should be between 15%
and 50% in the sample of Turkey, Romania and Bulgaria for the period 1995-2011.
Asimakopoulos and Karavias (2016) also find that government size has an asymmetric
impact on economic growth in both developed and developing countries. Thus, we can
expect the difference effects of government size on the fiscal deficits.
According to Andersen and Sørensen (1995), optimal fiscal policies require
constraints on the size of the public sector. The government size, which can be
represented by government spending as share of GDP (Garrett & Rhine, 2006), or tax
revenue as share of GDP (Altunc & Aydın, 2013), is investigated in previous studies
about its relationships with other economic factors such as economic growth,
macroeconomic stability, and effectiveness of fiscal policy (e.g., see Vedder and
Gallaway (1998), Benarroch and Pandey (2012), Asimakopoulos and Karavias (2016),
Bournakis and Tsoukis (2016)), but its roles in fiscal consolidation are likely ignored.

12


In the views of endogenous theory, the economic growth increases in line with
government services and taxation when government size is relative small (see Romer
(1986), Lucas (1988), Barro (1990), Rebelo (1990)). However, if the government size
goes beyond specific point that requires increasing in taxation to finance for additional
public services, the government size will diminish the return to investment and economic
growth. Afonso and Furceri (2010), for example, notice that the government size has

negative effects on growth in OECD and EU countries.
In fact, the country with small government has the greater advantage to increase in
efficiencies such as the total factor productivity growth and the capital productivity from
reducing tax burden and distortion. In addition, government with small size can exploit
the greater market disciplines to improve efficiency of resource distribution; they are also
more effective in providing the legal, administrative, and infrastructure critical for
growth, as well as for offsetting market failures (Dar & AmirKhalkhali, 2002). For
instance, Dar and AmirKhalkhali (2002) find that the country with larger government
size presents lower total factor productivity growth as well as the productivity of capital
on average. They notice that the advantage of a small government sector are the greater
efficiencies resulting from fewer policy-induced distortions and the greater discipline of
market forces. While, the government with large size or too large that goes beyond some
specific point may hamper capital accumulation and present the crowding-out effects on
economic growth (Wahab, 2011; Yamamura, 2011).
Therefore, we hypothesize a negative impact of large government size on the fiscal
balance due to the less effective of fiscal policy and the harder in management of
policymaker in implementing fiscal policy.

2.4. The corruption controlling and fiscal deficits
Despites that many macroeconomists have tried to make important effects in
formulating a positive theory of government behavior from the theoretical and empirical
13


views. The works of Kydland and Prescott (1977), Barro and Gordon (1983a), Barro and
Gordon (1983b) emphasize that optimal policies are time inconsistent so that actual
government policies may deviate from the optimal stance if policymakers can not commit
their works. Therefore, the institutional drivers of fiscal deficits are considered in the
literature from the framework of neoclassical approach beside the economic
determinants. As an early review in Alesina and Perotti (1995) and Persson and Tabellini

(1999), the economic literature focuses on some institutional aspects such as political
uncertainty, the conflicts between difference parties, the political regime, electoral law
approach (see Woo (2003)).
In this line of literature, there are some works considered the roles of corruption in the
fiscal policy’s effectiveness (see De Haan and Sturm (1994), De Haan and Sturm (1997),
Martinez-Vazquez et al. (2007), Dimakou (2015)). For instance, Martinez-Vazquez et al.
(2007) emphasize that the measures to eliminating corruption were not usually an
economic objective for the development of governments. But, they notice that the views
of corruption controlling are changed in recent decades due to the frustration with the
lack of effectiveness of traditional economic theories and the recognition of the important
roles of institutions and good governance practices. Moreover, Lockwood et al. (2001)
find that the fiscal policy in Greece in the period 1960-1972 did not follow a long-term
efficiency due to the political pressures, which determined the path of government
spending, taxations and borrowing. In addition, Dimakou (2015) finds that the fiscal
capacity in taxations is constrained by corruption and it may increase the inflationary
reliance.
In fact, corruption causes many consequences for the economy. Mo (2001) finds that
corruption reduces the level of human capital and the share of private investment.
Antunes and Cavalcanti (2003) notice that the country will be roughly 1/3 to 1/2 as rich
as the United States if debt contracts are not enforced and corruption corresponds to 10%
of business income. Lash (2004) summarizes that corruption causes a reduction in
economic efficiency, a diminution of capital formation and ultimately a slowdown in
14


economic growth. Dal Bó and Rossi (2007) point out that more corruption is strongly
associated with more inefficient firms in the sense that less output from inputs.
Fredriksson et al. (2004) present the evidences in 12 OECD countries over the period of
1982–1996 that the higher corruption reduces energy policy stringency, while increases
the coordination costs. Recently, Kunieda et al. (2014) find that highly corrupt countries

impose higher tax rates, then magnifying the negative impact of government corruption
on economic growth.
Therefore, we argue that the better corruption controlling will have positive effects on
fiscal balance under three strands. First, the better corruption controlling limits the
negative impacts of corruption on the effectiveness of fiscal policy (see Olawunmi and
Ayinla (2007)), which enhances the fiscal balance as the end. Second, the better
corruption controlling keeps government away from the wasted public expenditures,
while it enhances the effectiveness of fiscal policy (see Wu et al. (2010)), thus in turn
boosts the budget balance. Third, the better corruption controlling is positive effects on
economic growth in overall due to the lower implied cost for economic activities (see Mo
(2001)), therefore it helps improve the fiscal balance.

2.5. The effects of corruption controlling under the constraints of external debt and
government size
Goel and Nelson (1998) find that government size has a strong positive influence on
corruption since there are more chances and more things for policy-man taking
corruption. Kotera et al. (2012) indicate that an increase in government size can lead to a
decrease in corruption in the countries with high democracy level, it, in contrast, can lead
to an increase in corruption in low democracy level. Therefore, the positive effects of
corruption controlling on fiscal balance may be impeded by the government size and the
external debt burden.

15


In fact, the larger government has more incentives to taking corruption since
governments with large size have a variety of public services with a more complicated
system that create more opportunities with easier context for corruption (see Goel and
Nelson (1998)). Therefore, the measures for corruption controlling in countries with large
government sizes are agued with less effective. In addition, the more complicated system

with a variety of public services and more political connections between public
organizations in government with large size make the corruption controlling measures
harder to prudential conducting and taking effects.
As stated, the external debt is the burden for fiscal policy that makes the fiscal deficits
more severe. Due to less fiscal room and less favorable terms in new-debt borrowing,
individuals in high indebted countries are stronger stimulated to cut back their current
consumption in following the framework of neo-classical views, which then makes
crowding-out effects more stronger. In this case, the corruption controlling measures may
be less effective due to the less effectiveness of fiscal policy. Furthermore, the high
indebted countries are usually under strictly supervisions of lenders such as IMF or Work
bank, who of course provided funds with the requirements of improvement in institutions
including corruptions. This means that the measures for corruption controlling have
already implemented as a requirement so that the improvement in corruption controlling
as new measures do not have much space to improve and take effects. As a result, it
limits the effects of corruption controlling on fiscal balance.
According to DeLong and Summers (2012), governments are strongly suggested to be
cautioned regarding the pace of fiscal consolidation when they use the fiscal policy to
counter the depression. Previously, Alesina et al. (1999) document that `hierarchical' and
transparent procedures have been associated with more fiscal discipline in Latin America
in the 1980s and early 1990s. Therefore, there is the need to examine the determinants of
fiscal deficits under the new factors such as corruption controlling. In order to testing
these hypothesizes, the study examines the impacts of corruption controlling and its
effects under the constraints of government size and external debt burden on fiscal
16


deficits in the context of 26 Asia Pacific countries over the period 2002-2015. Next
section presents the methodology and data.

17

Chapter 3:
METHODOLOGY AND DATA
3.1. Methodology
In fact, it is difficult to measure the institutional quality of a country, especially the
corruption situation, it then becomes one of the major challenge in studying institutional
economics. In addition to some methods from difference organizations, the World
Governance Indicators (WGIs) that is recently provided by the methodologies of
Kaufmann et al. (2011) as a coordinated work with World Bank.
The indicators from WGIs including Voice and Accountability, Political Stability and
Absence of Violence/Terrorism, Government Effectiveness, Regulatory Quality, Rule of
Law, and Control of Corruption are facing a few critics about their bias or lack of
comparability and the utility (Thomas, 2010). However, they are used in many previous
studies to proxy for institutions as the most reliable indicators (see Kaufmann and Kraay
(2002), Neumayer (2002), Neumayer (2003), Dollar and Kraay (2003), Naudé (2004),
Lash (2004), Llamazares (2005), Neumayer (2005), Andrés (2006), SCHUDEL and
Schudel (2008), Clist (2011), Park (2012), In’airat (2014), Herrera-Echeverri et al.
(2014), Barry and Tacneng (2014), Zhang (2016)).
Control of corruption as defined in WGIs reflects “perceptions of the extent to which
public power is exercised for private gain, including both petty and grand forms of
corruption, as well as "capture" of the state by elites and private interests” is, of course, a
reliable proxy of corruption controlling. In which, the higher value of indicator is in line
with better corruption controlling.
This study recruits the literature models in studies of Edin and Ohlsson (1991),
Roubini (1991), De Haan and Sturm (1994), De Haan and Sturm (1997) and the empirical
model from the studies of Woo (2003) and Maltritz and Wüste (2015) as following:
𝐹𝑖𝑠𝑏𝑎𝑖𝑡 = 𝛼𝐹𝑖𝑠𝑏𝑎𝑖𝑡−1 + 𝛽1 𝐺𝐷𝑃𝑔𝑖𝑡 + 𝛽2 𝐼𝑛𝑓𝑖𝑡 + 𝛽3 𝐼𝑛𝑡𝑖𝑡 + 𝛽4 𝑈𝑛𝑒𝑚𝑖𝑡 + 𝛽5 𝐸𝑥𝑝𝑖𝑡 +

𝛽6 𝐷𝑒𝑏𝑡𝑖𝑡 + 𝛽7 𝐶𝑜𝑛𝑐𝑜𝑟𝑖𝑡 + 𝜀𝑖𝑡

(1)

18


In which: i, t are country i at year t; fisba is the primary fiscal balance; GDPg, Inf, Int,
Unem are the control variables including the real GDP growth rate, inflation rate, real
interest rate, and change in unemployment rate; Exp, Debt, Concor are the explanatory
variables including total government expenditure to GDP that proxies for government
size, total external debt to GNI that proxies for debt burden, and control of corruption
indicator. All detailed definitions and source of data are presented in Table 1.
Table 1. Data definitions and sources
Variables
Dependent
variable

Control
variables

Explanatory
variables

Gdpg
Inf
Int

Definitions
Fiscal balance =
(Total government revenue - Total

government expenditure)/GDP (%)
Real GDP growth (%)
Inflation, GDP deflator (annual %)
Real interest rate (%)

Unem

The change in unemployment rate (%)

Exp

Total government expenditure/GDP (%)

Rev

Total government revenue/GDP (%)

Debt
Conc
or

External debt/GNI (%)

Sources
Calculation from ADB
database (Key economic
indicators of each country)
WDI (Worldbank)
WDI (Worldbank)
WDI (Worldbank)

Calculation from WDI
(Worldbank)
Key economic indicator
(ADB)
Key economic indicator
(ADB)
Key economic indicator
(ADB) and WDI
(Worldbank)

Control of corruption index

WGI (Worldbank)

Fisba

The Eq. (1) helps us to examine the impacts of corruption controlling on fiscal
balance while controlling for main economic determinants such as economic growth,
inflation, real interest rate, unemployment, government size, and external debt burden as
the first step. In the second step, the study incorporates the interaction terms between
Control of corruption with government size (total government expenditure to GDP) and
external debt ratio, respectively, into Eq.(1) to investigate the effects of corruption
controlling under the constraints of government size and external debt burden. The study
focuses on this step as the main contributions to the literature and practice. Next, the
19


study uses the ratio of total government revenue to GDP to proxy for government size by
replacing the ratio of total government expenditure to GDP and then replicates the
process with the aim at checking robustness. At last step, we divide our sample into two

sub-samples following the break of the 2008 global financial crisis and examine these
relationships through two periods of 2002-2008 and 2009-2015.

3.2.

Data

The data is mainly collected from World Development Indicator, World Governance
Indicator dataset of World Bank, and the Key economic indicators from Asia
Development Bank. Due to the availability of World Governance Indicators from 2002 to
2015, our data covers from 2002 to 2015 period. The data description is presented in
Table 2, which shows that the fiscal balance in Asia Pacific area is usually under the
deficit situations.
Table 2. Data descriptions
Variables

Obs

Fisba
Gdpg
Inf
Int
Unem
Exp
Rev
Debt
Concor

359
362

362
349
337
359
359
357
364

Fisba
Gdpg
Inf
Int
Unem
Exp
Rev

182
181
181
178
156
182
182

Mean
2002-2015
-4.4296
5.8239
6.9077
6.8158

-0.0682
24.4236
19.9941
47.3225
-0.5351
2002-2008
-3.953
6.710
8.105
6.273
-0.125
22.990
19.037
20

Std. Dev.

Min

Max

4.3100
4.5013
6.2797
6.8724
1.5738
7.2030
6.8927
31.8351
0.5428

-27.3500
-14.1500
-18.9297
-13.7302
-12.7320
7.6601
2.8954
8.2879
-1.6410

4.9088
34.5000
39.1782
48.0557
7.9490
47.1144
43.7232
201.7092
1.2748

4.643
4.861
6.056
6.507
1.860
6.859
6.377

-27.350

-8.125
-1.992
-8.588
-12.732
7.660
2.895

4.909
34.500
28.164
27.402
7.949
44.128
37.495