Public finance, governance and economic growth

1

MINISTRY OF EDUCATIONAL & TRAINING
UNIVERSITY OF ECONOMICS HO CHI MINH CITY
_________

NGUYEN PHUONG LIEN

PUBLIC FINANCE, GOVERNANCE AND
ECONOMIC GROWTH

DOCTORAL DISSERTATION

Ho Chi Minh City - 2018


2

MINISTRY OF EDUCATIONAL & TRAINING
UNIVERSITY OF ECONOMICS HO CHI MINH CITY
_________

NGUYEN PHUONG LIEN

PUBLIC FINANCE, GOVERNANCE AND
ECONOMIC GROWTH
Specialization: Finance-Banking(Public Finance)
Specialization code: 9340201

DOCTORAL DISSERTATION
SUPERVISOR:

Prof. SU DINH THANH

Ho Chi Minh City - 2018


i

COMMITMENT

I commit that, throughout the whole process, I did this research based on
ethical rules and laws for academic scientific research, including creating research
ideas, conducting the literature review, collecting data, as well as the data analysis
and research interpretation. In addition, I commit that I conducted this study by
myself. The dissertation uses the data and analysis that I did by myself.

Committed by

PhD student


ii

ACKNOWLEDGEMENTS

First, I would like to express my deepest appreciation to my supervisor,
Professor Sử Đình Thành, for his lectures as well as coaching me while I performed
this research. Without his instructions and persistent support, this dissertation would
not have been possible.
Second, I would like to thank all UEH’s lecturers who instructed me in my
research methods courses during my time as a Ph. D. student in the University of

Economics, Ho Chi Minh City. Dr. Trần Thị Tuấn Anh’s expert guidance was
especially valuable for completing my research with clear and logical
interpretations of the methodology.
Third, I am also grateful to my parents, my young sisters, and my sons for
their encouragement in my life. I also wish to express my endless thanks to my love
for his sacrifice and daily care of me.
Finally, last but by no means least, thank you to all my colleagues who
shared with me their useful comments to help complete my publication.


iii

TABLE OF CONTENT

Table of Contents
COMMITMENT ...........................................................................................................i
ACKNOWLEDGEMENTS ........................................................................................ ii
TABLE OF CONTENT ............................................................................................. iii
ABBREVIATIONS ................................................................................................... vii
LIST OF TABLES ..................................................................................................... ix
LIST OF FIGURES ......................................................................................................x
Abstract: ...................................................................................................................... xi
CHAPTER 1 .................................................................................................................1
INTRODUCTION ........................................................................................................1
1.1.

Research background ......................................................................................1

1.1.1. An overview of the status of global economies in the period 1996–2016 .1
1.1.2. The differences of public finance and growth between developed and

developing countries ..............................................................................................5
1.2.

Research motivation .....................................................................................10

1.3.

Research objectives and research questions.................................................14

1.4.

Research scope ..............................................................................................15

1.5.

Research methods .........................................................................................16

1.6.

Research contribution ...................................................................................18

1.7.

Structure of dissertation ................................................................................20

CHAPTER 2: ..............................................................................................................23
LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT .......................23
2.1. Introduction ......................................................................................................23
2.2. Some key concepts ...........................................................................................24
2.2.1. Public finance ............................................................................................24

a) Tax revenue ...................................................................................................25
b) Government expenditure...............................................................................26


iv

2.2.2. Governance and corruption ......................................................................27
2.3 Theoretical literature on the relationship between public finance and
economic growth .....................................................................................................33
2.3.1 Public choice theory ...................................................................................33
2.3.2. Cost-benefit theory of taxation ..................................................................35
2.3.3. Governance theory ....................................................................................37
2.3.4. Economic growth theory: Exogenous and endogenous growth theory ....39
2.4 Empirical literature on relationships among public finance, governance, and
economic growth .....................................................................................................41
2.4.1 Empirical literature on relationships between public finance, and economic
growth......................................................................................................................41
2.4.2. Relationship between tax revenue and government expenditures ............45
2.5 Designing the analytical framework and building hypotheses ........................52
2.6. Summary ..........................................................................................................56
CHAPTER 3 ...............................................................................................................58
METHODS AND RESEARCH DATA.....................................................................58
3.1 Introduction .......................................................................................................58
3.2. Research models ..............................................................................................58
3.2.1 Long-term linkages between public finance, and economic growth .........58
3.2. 2 Tax revenue and expenditure relationship................................................61
3.3 Research data and its source .............................................................................64
3.3.1. Determining appropriate variables and its sources .................................64
3.3.2 Collecting secondary data ..........................................................................67
3. 4 Check balance and essential test ......................................................................68

3. 5 Choose appropriate analytical methods ...........................................................68
3.7. Summary..............................................................................................................77
CHAPTER 4 ...............................................................................................................79
PUBLIC FINANCE, GOVERNANCE, AND ECONOMIC GROWTH: A LONG
RUN ANALYSIS .......................................................................................................79
4.1. Research data ...................................................................................................79


v

4.2. Long-run relationship between public finance and economic growth ............83
4.3.

Linkage between tax revenue and government expenditure........................85

4.4. Results of examining role of governance in modifying effect between public
finance and economic growth .................................................................................86
4.4.1 The role of governance in modifying effect between public finance and
economic growth in developing countries ..........................................................86
4.4.2 The role of governance in modifying effect between public finance and
economic growth in developed countries ............................................................88
CHAPTER 5: ..............................................................................................................93
CONCLUSION, IMPLICATION AND LIMITATION ...........................................93
5.1. Conclusion .......................................................................................................93
5.2. Suggestion to policy makers ............................................................................95
5.3. Research limitation and future research ..........................................................96
LIST OF AUTHOR’S PUBLICATION ....................................................................96
REFERENCES ...........................................................................................................99
APPENDICIES .............................................................................................................1
Table Appendix A1 ...................................................................................................1

List of studied countries ............................................................................................1
Table Appendix A2 ...................................................................................................4
Table Appendix A3 ...................................................................................................8
Table Appendix A4 .................................................................................................14
Table Appendix A5 .................................................................................................17
Table Appendix A6 .................................................................................................18
Table Appendix A7 .................................................................................................19
Table Appendix A8 .................................................................................................20
1. Description of variables ...............................................................................21
2. Correlation matrix ........................................................................................21
3. HT and IPS unit root test results (normal variables) ..................................22
4. Results of co-integration test ........................................................................29
5. Granger test results ......................................................................................30


vi

7. Results of verification of governance role in modifying economic growth by
SUR model ...........................................................................................................31
8. Results of verification of governance role in modifying economic growth by
SGMM ..................................................................................................................38
9. Robustness check with CPI ...........................................................................43


vii

ABBREVIATIONS

Words
GDP

Meanings
Gross Domestic Products

OECD

Organization for Economic Co-operation and
Development.

RGDP

Real GDP per capita

LRGD

Logarithm of Real GDP per capita

Gexp

Government expenditure

Taxrev

Total Tax revenue

RE

Random-Effects

FE

Fixed Effects

OLS

Ordinary Least Square

SGMM

System Generalized Method of Moments

GMM

Generalized Method of Moments

SUR

Seemingly Unrelated Regression

EC

Error Correction

GLS

Generalized Least Square

2SLS

Two-stage Least Square

HT

Harris-Tzavalis (1999) test

IPS

Im-Pesaran-Shin (2003) test

UEH

University of Economics Ho Chi minh City

USA

United States of America

US

United States

UK

United Kingdom

BI

Business International Corporation

ICRG

International Countries Risk Guide

WB

World Bank

IMF

International Moneytary Fund


viii

UNDP

United Nations Development Programme

WDI

World Development Indicators

WGI

World Governance Indicator

WEO

World Economic Outlook

HDI

Human Development Index

CCI

Control of corruption indicator

CPI

Corruption perception index

ECM

Error correction mechanism model

TI

Transparency International


ix

LIST OF TABLES

1. Table 1.1: the global economic growth rebound ..............................................1
2. Table 4.1: Description of variables ………………………………………. 78
3. Table 4.2: Correlation matrix ………………………………………………82
4. Table 4.3: Results of unit root test for a panel with normal data for the whole
sample in 1996-2016………………………………………………………….. 83

5. Table: 4.4: Results of unit root test for a panel with data of first different
values for the whole sample in 1996-2016…………………………………… 84
6. Table 4.5: Westerlund long-run cointegration test results (lrgdp)………… 85
7. table 4.6: Westerlund long-run cointegration test results (tax – exp)……... 87
8. table 4.7: Pairwise Granger test results……………………………………...88
9. Table 4.8: Westerlund long-run cointegration test results (lrgdp; Taxrev, and
Gexp)…………………………………………………………………………...89
10. Table 4.9: The results of verification influence of corruption on public
finance and economic growth in completely 82 developed and developing
countries……………………………………………………………………… 91
11. Table 4.10: The results of verification of the influence of corruption on
public finance and economic growth in 44 developing countries……………. 94
12. Table 4.11: The results of verification of the influence of corruption on
public finance and economic growth in 38 developed countries……………. 95
13. Table 4.12: Robustness check of the corruption role in all 82 countries, 44
developing countries, and 38 developed countries ……………………………97


x

LIST OF FIGURES

1. Figure 1.1: The line trend of global per capita income growth and ratio of tax
revenue and government spending in 1996 and 2016 in 38 developed
countries. ...........................................................................................................2
2. Figure 1.2: the line trend of global per capita income growth and ratio of tax
revenue and government spending in 1996 and 2016 in 44 developing
countries ............................................................................................................4
3. Figure 1.3: the shrink frequency rate ................................................................5
4. Figure 1.4: Line trend of tax revenue – government expenditure – GDP per

capita for whole sample in 1996-2016..............................................................6
5. Figure 1.5: Line trend of tax revenue – government expenditure – GDP per
capita for 44 developing cuntries in 1996-2016 ...............................................6
6. Figure 1.6 : Line trend of tax revenue – government expenditure – GDP per
capita for 38 developed cuntries in 1996-2016. ...............................................7
7. Figure 1.7: The control of corruption indicators in 38 developed countries in
1996 and 2016 ...................................................................................................8
8. Figure 1.8: The control of corruption indicators in 44 developing countries in
1996 and 2016 ...................................................................................................9
9. Figure 2.1: Public sector in the economy………………………………… 26
10. Figure 2.2: Analytical framework of correlation of public fiance, corruption
and economic growth. …………………………………………………

54


xi

Abstract:
This study runs a co-integration and Granger causality tests that corroborate
the existence of long-run co-integration linkages of public finance and economic
growth and a bi-directional causal correlation between tax revenue and government
expenditure. This finding suggests that to control deficits, a government’s decisions
on collecting taxes and government expenditure should be simultaneous. To verify
the effects of governance represented by control of corruption on modifying the
relationship between public finance and economic growth, this study applies a
seemingly unrelated regressions model for the dataset, followed by a robustness
check using a corruption perception index developed by the Transparency
International organization. Measuring public finance by two factors: total tax
revenue and general government expenditure helps this study to confirm the results,

which reveal that the governance has a positive role in the economy. Additionally,
the interaction between governance and tax revenue or government expenditure
affects economy diversely depending on the different economic groups of
developing and developed countries1. For instance, in developing countries, the
interaction between public finance and governance always becomes a beneficial
factor for growth. While in developed countries, this interaction does not have any
meaning with taxation. Therefore, it may increase the efficiency of government
expenditure only. On the first side, the findings also suggest that developing
countries should focus on governance in anti-corruption to increase the
effectiveness of public finance and promote their economic growth. On the other
hand, developed countries should make the decision on public finance separately
with control of corruption.

In this study we call the “developed countries” are high-income countries, which were classified by World
bank and determined as those with a GNI per capita, computed using the World Bank Atlas method. On 1
July 2015, high-income countries gained more than $12,736. This study also calls the “developing countries”
are those countries were classified by World bank as seen as below. Low-income economies are determined
as those with a GNI per capita of $1,045 or less in 2014; Lower-middle-income economies are those with a
GNI per capita of more than $1,045 but less than $4, 125; and upper-middle-income economies are more
than $4,125 but less than $12,736.
1


xii

Keywords: long-term economic growth, co-integration test, governance,
government expenditure, total tax revenue.
JEL Classifications: O40, C52, D73, H20

1

CHAPTER 1
INTRODUCTION
1.1.

Research background

1.1.1. An overview of the status of global economies in the period 1996–
2016
During this period, the global economy witnessed the financial crisis
that arose when the real estate bubble exploded in the US in 2007, driving the
US financial crisis and influencing production and exports in numerous
developing countries. However, the World Bank’s report said that in 2016, the
economy’s growth recovery has rebounded (see table 1.1).
Table 1.1: the global economic growth rebound

World
Advanced economies
Emerging market and developing
countries
Commonwealth of independent
States
Emerging and developing Asia
Emerging and developing
Europe
Middle East, North Africa,
Afghanistan, and Pakistan
Latin American and the
Caribbean

Sub-Saharan Africa
Low-income developing
countries
Emerging market countries
Fragile States
Small States
Source: World Bank Group (2016)

200108
4.20
2.20

Actual
2009- 201 201
12
3
4
3.30
3.30 3.40
0.60
1.10 1.80

6.50

5.50

5.00 4.60

7.20

2015

2016

3.10
2.00

3.60
2.20

4.00

4.50

1.70

2.20 1.00 -2.70

0.50

8.40

8.00

7.00 6.80

6.50

6.40

4.60

2.10

2.90 2.80

3.00

3.00

5.40

4.10

2.30 2.70

2.50

3.90

3.60

3.20

2.90 1.30 -0.30

0.80

6.10

5.00

5.20 5.00

3.80

4.30

6.40

5.90

6.10 6.00

4.80

5.80

6.50
5.00
5.50

5.50
6.60
2.40

4.90 4.50
4.90 1.30
1.60 2.30

3.90
1.40
1.40

4.40
6.30
2.80


2

Figure 1.1: The line trend of global per capita income growth and ratio of
tax revenue and government spending in 1996 and 2016 in 38
developedcountries.
Source: World bank’s database – WDI and IMF’s database – GFS.


3

From figure 1.1, we can see that there is a difference in income per
capita between 1996 and 2016 in developed countries. The maximum income
per capita is more than 13.8 times the minimum in 1996. By 2016, this gap has
declined to only 6.5 times. In 1996, Norway had the highest income per capita
at more than 73,626.16 US dollars. In contrast, Latvia had the lowest at almost
5,321.397 US dollars. In 2016, Norway still had the highest GDP per capita,
which was about 90,344.41 US dollars. However, the Seychelles had the
lowest income per capita (only 13,963.59 US dollars of GDP per capita).
Additionally, most developed countries collected more tax and spent less. In
1996, Norway’s tax revenue as a proportion of GDP was nearly 53.5 percent,
while its expenditure was only 47.5 percent. An interesting point is that

Latvia, with the lowest income per capita, also collected less tax (36.38%) and
spent more (37.03%). Norway continued to maintain its tax revenue
proportion at more than 53 percent of GDP in 2016.


4

Figure 1.2: the line trend of global per capita income growth and ratio of
tax revenue and government spending in 1996 and 2016 in 44
developingcountries
Source: World bank’s database – WDI and IMF’s database – GFS.
There is a large gap (152.43 times) between the highest and lowest
GDP per capita in developing countries in 1996. At about 30,333.74 US
dollars, Islamic Republic of Iran had the highest income per capita, while
Ethiopia remained at the bottom with only about 199.005 US Dollars. Islamic
Republic of Iran collected tax revenue of 20.165 percent of GDP and spent
more than 21.08 percent of GDP. In contrast, Ethiopia collected only 14.86
percent of GDP in tax revenue and spent 18.79 percent of GDP. In 2016, the
gap between the highest and lowest GDP per capita in developing countries is
lower than in 1996 at about 26.68 times. Russia remained at the top with about
11,099.17 US dollars per capita, while Madagascar had only 416.0027 US
dollars per capita. Russia increased their tax revenue proportion more than
1.02 percent compared with 1996, however this country spent lower than 1996
(see figure 1.2).


5

1.1.2. The differences of public finance and growth between developed
and developing countries

a)

Growth rate and stability in economies
Figure 1.3 indicates that developed countries maintain stability in their

economies better than developing countries.

Figure 1.3: the shrink frequency rate
Source: World Bank group (2017)
b)

Tax revenue, government expenditure, and control of corruption
Tax revenue is an important component of revenue for most

governments. While most developing countries collected less in taxes than
developed countries, they spent more, and their economies grew more rapidly
from 1996 to 2016 (see figure 1.5 ).


6

Figure 1.4: Line trend of tax revenue – government expenditure – GDP
per capita2 for whole sample (82 countries) in 1996-2016
Source: World bank’s database – WDI and IMF’s database - GFS.
Figure 1.4 shows the trend of spending more and fast trend of economic
growth in whole 82 countries.

Figure 1.5: Line trend of tax revenue – government expenditure – GDP
per capita for 44 developing cuntries in 1996-2016
Source: World bank’s database – WDI and IMF’s database - WEO.

Through figure 1.5, we can observe that the rapid economic growth
trend in developing economies is the same as that of the whole sample.

2

GDP per capita is gross domestic product divided by midyear population. The World Bank
considered that GDP is the sum of gross value added by all resident producers in the economy plus
any product taxes and minus any subsidies not included in the value of the products. This calculation
of GDP is without making deductions for depreciation of fabricated assets or for depletion and
degradation of natural resources. Data are in constant 2010 U.S. dollars.


7

However, beginning in 2010 these countries have attempted to spend more and
collect fewer taxes for rapid growth

Figure 1.6 : Line trend of tax revenue – government expenditure – GDP
per capita for 38 developed cuntries in 1996-2016.
Source: World bank’s database – WDI and IMF’s database - GFS.
In contrast, developed countries prefer to collect more taxes and spend
less to maintain a slow rate of growth in their economies (see figure 1.6). The
World Bank’s report shows that a large gap exists between developed and
developing countries in economic growth, as well as tax revenue. What is the
cause of the differences between two these groups of countries? Policy makers
around the world have been challenged in dealing with this question. In
summary, the global economy from 1996 to 2016 varies from year to year.
There is a large gap in income per capita between developed countries and
developing countries. There is also a large gap in the ratio of contribution to
global GDP growth. As mentioned by Spence (2011), the global monitoring

report 2015/2016 confirms that high-income countries contributed 60% to
global GDP growth in 2014, but their population was less than 15%.
Moreover, the World Bank estimated that income per capita in this period
might have increased more than it will in future periods. There are also large
differences between poor and rich countries in tax revenue, effectiveness of
government expenditure, and corruption, in this period. The maximum of real


8

GDP per capita can be bigger than the minimum by 490 times. The largest gap
between the highest rate of tax revenue or expenditure and its lowest is 7
times. The highest indicator of control of corruption is 2.47, while the lowest
is only -1.53 (see table 4.1).

Control of corruption (1996) in 38
developed countries
2.5
2
1.5
1
0.5
0
-0.5
-1

Control of corruption (1996)

Control of corruption (2016) in 38
developed countries

2.5
2
1.5
1
0.5
0
-0.5

Control of corruption (2016)

Figure 1.7: The control of corruption indicators in 38 developed countries
in 1996 and 2016
Source: World bank’s database –WGI.


9

Control of corruption (1996) in 44
developing countries
1

0
-0.5
-1
-1.5

Benin
Cote…
Ethiopia
Islamic…

Madagas…
Mauritius
South…
Tunisia
Armenia
Cambodia
Indonesia
Malaysia
Nepal
Philippines
VN
Belize
Brazil
Colombia
Georgia
Jamaica
Peru
Russia

0.5

-2
Control of corruption (1996)

Control of corruption (2016) in 44
developing countries
1

0
-0.5

-1

Benin
Cote d'Ivoire
Ethiopia
Islamic…
Madagascar
Mauritius
South Africa
Tunisia
Armenia
Cambodia
Indonesia
Malaysia
Nepal
Philippines
VN
Belize
Brazil
Colombia
Georgia
Jamaica
Peru
Russia

0.5

-1.5
Control of corruption (2016)

Figure 1.8: The control of corruption indicators in 44 developing
countries in 1996 and 2016
Source: World bank’s database –WGI.
Through figure 1.7, we find that in 2016, with exception of Greece,
which maintained a negative index of control of corruption, most other
developed countries had a positive index of control of corruption. However,
figure 1.8 indicates that most developing countries showed a negative index of


10

control of corruption, and a lower index of human development of around 0.26
to 0.7. In 1996, the developing country with the highest index of human
development is Bulgaria, and the lowest was Mali. This index improved; in
2016, the highest index is 0.8 and belongs to Russia, while Mali remained the
lowest (0.44). Georgia is a country that improved its corruption status too
rapidly. In 1996, this country had the lowest indicator of control of corruption
(-1.53), and Namibia had the highest score of about 0.81. In 2016, Georgia
became the country with the highest score of control of corruption (0.67),
while Cambodia was at the bottom with a -1.3 score of control of corruption.
The real situation of global economies requires us to answer the question:
How does public finance correlate with countries’ income? Does governance
affect this linkage?
1.2.

Research motivation
First, public finance is a key source of government budget and its

effects are complicated. Holley (2011) argued that any change in public policy
could affect economic activities. However, until now a little research

examined the relationship between economic growth and public finance,
which measure by total tax revenue and general expenditure. Nevertheless,
government expenditure is a major source of public goods. Lump-sum taxes
for each person should guide government expenditure. In contrast, Barro’s
(1990) argument is too simple, because his assumption relates only to income
taxes. Tax revenue and government expenditure can demonstrate the full
effectiveness of government quality and capability. For instance, the
government can use the value from collecting taxes to develop labor force, to
supply the appropriate infrastructure, or to invest the new technologies.
Additionally, the labor force, infrastructure, and new technologies are key
sources, which promote the production and ensure the safety society.
Furthermore, any taxes change can drive the investors and households to make


11

a different decision (Aghion and Howitt, 2009). The total tax revenue includes
sale tax, income tax, export-import tax, capital and environment taxes, etc. In
case if government increase or reduce any tax rate or expand the tax base, so
investor or households could change their behavior in investment or
consumption. As we may know that, these activities can affect the capital
stock, which is a major factor of the economic growth model. However, the
almost previous study argued the role of the subcomponent of taxes or
expenditure only. The question, therefore, is “How closely does public finance
correlate with the economy?” In the last two decades, the results seem to be
mixed and confusing. Most researchers have examined and evaluated the
growth effect of subcomponents of taxes, such as income taxes, sale taxes,
property taxes, or direct and indirect taxes. In contrast, a large body of
literature has considered the influence of the share of government expenditure
on economic growth. However, evaluating a government’s capabilities may

require considering the full meaning of public finance. Additionally, a few
studies have revealed that the linkages between public finance and economic
growth are ambiguous, and need to be clarified (Dzhumashev, 2014.) That is
why this study measures public finance by the ratio between total tax revenue
and GDP and total general government expenditure per GDP rate and we try
to examine the relationship between these variables and economic growth to
fill in the above gap.
Second, in the last two decades, both public choice theory and costbenefit theory posed the challenge for future research to determine the longterm relationship of economic growth with public finance. In addition, shortterm effects of tax changes can be different from long-term effects because of
the elasticity of the demand curve. For planning future economic activities,
researchers should clarify these effects

(Stiglitz, 2000; Holley, 2011).

Additionally, determining the long-term economic relationship between tax
revenue and expenditure supports policymakers worldwide in designing