Government Spending, Budget Financing, and Economic Growth: The Tunisian Experience

Author(s): Khalifa Ghali

Reviewed work(s):
Source: The Journal of Developing Areas, Vol. 36, No. 2 (Spring, 2003), pp. 19-37
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The Journalof Developing Areas

Volume 36

Number 2

Spring 2003

GOVERNMENT SPENDING, BUDGET

FINANCING, AND ECONOMIC GROWTH:
THE TUNISIAN EXPERIENCE
Khalifa Ghali
Kuwait University

ABSTRACT
programswithouthavinganyclear
Manydevelopingcountriesadoptedthe IMFdebt-stabilization
evidenceon whetherpublicsectoractivitiespromoteor depresseconomicgrowth.The existing
literatureon the subjectdid not providea consensusjudgmenton whicha policy conclusioncan
safelybe made.In addition,the questionof whetherthe impactof governmentactivitieson growth
budgetis still opento debate.Thispaperraises
dependson the sourceof financingthe government
these issues in the case of Tunisia,which is a small developingcountryimplementingdebtstabilizationprogramswithouthavingany clearguidanceon how governmentactivitiesinteract
with macroeconomicvariablesin affectingits growthprocess. In contrastto the conventional
procedureof estimatinga single growthequation,this paperdevelopsa vectorerror-correction
model and identifiesboth the directas well as the indirectchannelsthroughwhich government
spendingcanaffecteconomicgrowth.Theseeffectsarethenanalyzeddependingon whethera debt
fiscalpolicyis followed.The empiricalresultssuggestthatgovernment
financedor a tax-financed
spendingin Tunisiahas an importantrole in shapingthe generalefficiencyof the economy,
whereas governmentreliance on debt financinghas adverseeffects on economicgrowth.
INTRODUCTION
In the aftennath of the debt crisis, many developing countries adhered to the IMF
sponsored debt-stabilization programs, which called for shrinking the size of the
government in order to control the debt and promote economic growth. However, for
most of these countries, there is no evidence on the way government activities interact
with macroeconomicvariables in affecting the growthprocess. Moreover, the existing

20 KhalifaGhali

literature produced conflicting results and raised doubts about the nature of the
relationshipbetween governmentspending and economic growth.
The economic literatureon the subject witnessed the emergence of two conceptually
opposite views about the impactof governmentspendingon economic growth.One point of
view suggests that higher government spending is likely to be detimental to economic
growth. One reason is that governmentoperationsare often conducted inefficiently. For
example, state owned firms are often politicized and their main objective is to satisfy
interestsof bureaucratsand politicians. To maintaintheir power and prevent social unrest,
these groups favor excess employment,ineffective locations,and underpricingof output.In
addition,public investmentundertakenby heavily subsidized state-ownedmonopolies has
more often reduced the possibilities for privateinvestmentand long-runeconomic growth.
Another reason is that the financing of public expendituresthroughexternal and internal
indebtedness imposes excessive burdens and costs on the economic system resulting in
adverse effects on economic growth. At the other extreme, there are points of view that
attributeto the government a non-negligible role to play in the process of economic
size is likely to have a positive impacton
developmentand argue that a largergovenmment
long-run economic growth. One argument is that government plays a critical role in
harmonizingconflicts between the private and social interestsand in providing a socially
optimal direction for growth. Moreover, in countries characterizedby the existence of
monopolies, the lack of fully developed markets of capital, insurance,and information,
govemment can make factor and product markets work more efficiently and generate
substantialspillovereffects for the privatesector.
On the empirical side, most investigationsof the impact of governmentspending on
economic growth were conductedusing cross-countrymodels. These studies attemptedto
link aggregatemeasuresof fiscal policy with averagegrowthratesof GDP using measuresof
the overall size of the govemment in the economy, disaggregatemeasuresof government
spending, or measures of the growth rate of government expenditures. The main
contributionsto this literaturewere made by Rubinson(1977), Feder(1983), Landau(1983),
Kormendi and Meguire (1985, 1990), Ram (1986), Grier and Tullock (1989), Grossman
(1988), Barro(1990, 1991), Romer(1989), Levine and Renelt (1992), and Barroand Sala-iMartin(1995), amongothers.
However, as far as economic policy is concemed, the cross-countryliteraturedid not
provide the basis on which a particular country can decide whether an expanding
governmentsize would accelerateor depresseconomic growth, and thatfor many reasons.
First,the cross-countryliteratureon the subjectproducedconflictingresultsand did not
provide any consensus judgment on the impact of government spending on economic
growth. For example, Landau (1983), Grier and Tullock (1987), Grossman (1988), and
Barro (1990) found a negative and significantrelationshipbetween the growthrate of real
GDP and the growthrate of the governmentsharein GDP, while Ram (1986) and Rubinson
(1977) suggest that govenmmentsize has a positive impacton economic growth.Kormendi

Spending21
Government

and Meguire (1985), however, found no significant relationshipbetween the share of

governmentconsumptionin GDP andeconomic growth.
Second, since economicpolicies tend to be country-specificand their success depends
largely on the institutionsimplementingthem, policy recommendationscannot safely be
made by generalizingthe results of cross-countrymodels to individualcountries. This is
because the pooling process in cross-country regressions imposes strong parametric
restrictionsacross countriesthat differ greatly in terms of their economic structure.Pooled
estimates in these models are obtained by pulling the extreme values of the parameters
towards a common mean. This view seems to be consistent with the recent studies by
Maddalaand Wu (2000) and Lee et al. (1996) who providedevidence on the problemsof
heterogeneity,stability,and interpretationinherentto cross-countrymodels. Moreover,it is
fair to argue that, while a concept such as the long run is a dynamic one, cross-country
models do not include sufficienttime and, hence, are not useful for analyzingthe dynamic
propertiesof growth. Therefore, it is hazardousto draw policy conclusions from crosscountrystudies and a betterstrategywould be to investigatethe issue in a time-seriessetting
where the particularcharacteristicsof the country under consideration are taken into
account.
Finally,an importantissue thathas often been neglectedin the literatureis the impactof
the source of financinggovernmentexpenditureson economic growth.In this respect, it is
importantto notice that cross-countrystudies examine the impact of governmentspending
on economic growthby looking at the sign and significanceof the relevantvariablein the
growth equation. In this context, governmentspending would have an acceleratingor a
depressingeffect on growthdependingon whetherits sign is positive or negative.Following
this literature,a policy conclusion would be for the governmentto withdrawfrom any
activitythathas a significantnegative impacton growth.However, one could arguethat the
negative impactmay be the resultof the way this activitywas financedand not the activity
size may affect economic growthin two opposite
itself. For instance,a growinggovenmment
ways dependingon whethera debt-financedor a tax-financedexpansionaryfiscal policy is
followed. Theoretically,there is a controversialdebateon whethera tax- or a debt-financed
governmentbudgethas the same effects on growth.The two competingviews known as the
Ricardianequivalence proposition and the traditionalview are well documented in the
literaturebut did not provideany consensusjudgmenton the issue. Examplesare Leiderman
and Blejer (1988), Kormendiand Meguire (1990), and Dalamagas(1992). Consequently,
the question of whether the tax collection policy or the debt accumulationprocess is
responsiblefor the distortionaryeffects of governmentexpenditureson economic growthin
still an open questionin countrieswherethe issue has not been addressedbefore.
The objective of this paper is to investigatewhetherchanges in governmentspending
constitute an effective policy for promoting economic growth in the small, developing
economyof Tunisia.The analysisfocuses on two mainissues of interest:(i) investigatingthe
causal channels throughwhich govenmmentspendingcan affect economic growth;and (ii)
investigating the impact of alternative sources of budget financing on the growth
performance. Upon recommendationsby the IMF and the WorldBank, Tunisia started

22 KhalifaGhali

large-scaleprogramsof restructuring
its public sector in an attemptto reducethe size of the
governmentin the economyand, hence, accelerateeconomic growth. However,thereis no
empiricalevidencethat provides policymakerswith informationconcering the particular
causal patternsthat link public sector activitiesto economic growth.Althoughsome of the
past studies have analyzedissues relatedto growth,economic development,and economic
policymakingin Tunisia,none of them has empiricallyassessed the impactof government
activities on economic growth.'Examplesof these are: Nsouli et. Al. (1993), World Bank
(1996), Ilker and Ghiath (1999) and Ghali (1999). The availabilityof such infonnation
would provide policymakersin this countrywith insightfulindicationson the mechanisms
throughwhich fiscal policy and macroeconomicvariablesinteractin affecting the growth
process. Furthermore,the analysis would help the Tunisianfiscal authoritiesto assess the
impact of altemative sourcesof financing the governmentbudget on economicgrowth.
After reviewing some specificationissues raisedby past empiricalresearch we model
the dynamic interactionsbetween govermmentspending and economic growth in a sixvariablesystem consistingof real GDP, govemmentspending,privateinvestment,exports,
imports,and labor.In particular,we use the Johansen(1988, 1991, 1992) and Johansenand
(VEC) model
Juselius(1990) cointegrationtechniquesand develop a vectorerror-correction
useful for identifyingall possible channelsthroughwhich governmentspendingmay affect
economicgrowth.
The results of the empirical analysis can be summarizedas follows: (i) there is a
meaningful,stable long-runrelationshipthatties the long-runbehaviorof real outputto that
of governent spending,investment,exports,importsand labor;(ii) there are four possible
channels throughwhich governmentspending can affect economic growth in Tunisia. In
additionto its direct effects, governmentspendinghas also indirecteffects on growth and
thatthroughinvestment,importsand labor;(iii) governmentactivitiesdesignedto shape the
general efficiency of the economy, and to improve the productivityof labor and imports
seem to have an acceleratingeffect on growth, whereas governmentinvolvement in the
economy as a producerseems to crowd-outprivateinvestnent fromprofitableopportunities,
resultingin a depressingeffect on economic growth;and (iv) the governmentreliance on
debt to fmance its budget seems to induce adverse effects on economic growth. The
remainderof the paper is organized as follows. Section II presents the model and the
method,section IIIpresentsthe empiricalresultsand sectionIV concludes.
THE MODEL AND THE METHOD
While the main focus of the paperis on the relationshipbetweengovernmentspending
and economic growth,we also consider some specificationissues raised by past empirical
research,especially those raisedin cross-countrygrowthstudies.The mainreasonfor this is
the non-existenceof a consensus theoreticalframeworkthat guides empiricalresearchon
growth. In addition, the existing literatureusing cross-countrygrowthlmodels does not
completely specify the variables that should be held constantwhen inferences are made
aboutthe relationshipbetweeneconomicgrowth and the variablesof interest. For example,

Spending23
Government

Feder(1983) and Ram (1986) use an augmentedneoclassicalproductionfimctionto conduct

their empirical studies, while Romer (1989) and Barro (1990) use endogenous growth
models. Kormendi and Meguire (1985) and Grierand Tullock (1989) use a variety of
models to justify an assortnent of variablesthat they use in their empiricalresearch.In our
empirical investigationsof the causal links between govenmmentspending and economic
growth we will also consider variables such as internationaltrade, investment,and labor.
Apartfromtheirtheoreticalrelevance,the inclusionof such variableswould also avoid, or at
least minimize,the problemof non-causalitydue to omitted variables (Lutkepohl,1982).
The theoreticalties between internationaltradeand economic growth were formalized
by Romer (1986, 1990b), Grossmanand Helpman (1990), and Rivera-Baptizand Romer
(1991), among others. Althoughtheoreticaldiscussions frequentlyconsider the relationship
between internationaltrade and economic growth, the empirical literaturehas typically
examined the relationshipbetween exports and growhi.2In our empirical investigationsof
the dynamic propertiesof growth in Tunisia we consider the effects of both imports and
exportson the economic performanceof the country.
Anotherissue that we considerhere is the interactionbetween growth, investmentand
trade. Theoretically,the relationshipbetween trade and growth is based on the improved
allocation of resources and not necessarily on enhancedresource accumulation.However,
results from Levine and Renelt (1992) indicate that the relationshipbetween growth and
tradebecomes insignificantwhen investmentis introducedin the growthequation,whereas
the relationshipbetween investmentand the tradevariablesis a significantone. Given that
investment was found positive and significant in the growth equation, they suggest the
existence of a two-link chain between trade and growth throughinvestmentand conclude
thatthe relationshipbetween tradeand growthis based on enhancedresourceaccumulation
and not the improvedallocationof resources.
Given the importanceof these issues, our investigationof the causal links between
governmentspending and economic growth in Tunisia is made witiin a 6-variablesystem
containing real GDP, government spending, investment, exports, imports and labor.
The empiricalanalysisof causalityis conductedwitiin a frameworkbased on unit root
model (VECM)
testing and cointegration.In particular,we develop a vector error-correction
of growthwhere all variablesare allowed to be endogenousto the system. The advantageof
this approach,as opposed to single growthequationestimation,is the possibility to capture
both the direct as well as the indirecteffects of govemment spendingon economic growth.
Withiin this framework, we first investigate all the possible charmels through which
governmentspending can affect economic growth, and then we investigate the impact of
alternativesourcesof financingthe govemmentbudgeton economic growth.
A VECTOR ERROR-CORRECTION MODEL OF GROWTH
Considerthe set of variablesconsistingof real GDP and the respectivesharesin GDP of
privateinvestment,total governmentexpenditures,exports,importsand labor. All variables
are transformedinto theirnaturallogarithm.These variableswill be denotedhereafterby Y,

24 KhalifaGhali

I, G, X, M and L, respectively.Now considerthe vectorautoregressive(VAR) model

A-

1 t-I +

2 Zt-2 +- ...+

4kt-k

+
t nt,

t1,....,T

(1)

where Zj is a 6 x 1 vector containingY I, G, X, M and L. Supposethat these variablesare

I(O)afterapplyingthe differencingfilteronce. If we exploit the idea thattheremay exist comovementsof these variablesand possibilitiesthat they will trendtogethertowardsa longrun equilibrium state then, by the Granger representationtheorem, we may posit the
following testing relationshipsthat constitute a vector error-correction(VEC) model of
growth
AZ

+sit,

1t-kI

l.

,T

(2)

where AZ4 containsthe growthratesof the variables.The F's are estimableparameters,A

is a difference operator, lit is a vector of impulses which representthe unanticipated
movementsin Z, with flt niid (0, 3) and r is the long-runparametermatrix.With r
cointegratingvectors (1? r < 6), D has rankr and can be decomposedas rI = ap', with a
and f3both 6 x r matrices. , are the parametersin the cointegratingrelationshipsand a
are the adjustmentcoefficientswhichmeasurethe strengthof the cointegratingvectorsin the
VEC model.
The Johansen (1988) approachestimates the long-run or cointegratingrelationships
between the non-stationaryvariablesusing a maximumlikelihoodprocedurewhich tests for
the cointegratingrankr and estimatesthe parameters f3and a.
On expandingout equation2, the VEC model of growthcan be expressedas follows:
r
p
AYt =pLi
s +y3,sAIt_s
+Jlx,,vkt_p+Y (yi,sAYt_s
1,t (3)
+y2,sAGt
+y4,sAXA-s 75sAMt-s+y6,sAL_t
s)+11
k=l
s=l
r
p
+
AGt =p2
(4)
+(O,sAYts+02,sAGt?s+O3
Ya2,kvkt-p
sAIt-s+04AXt-s+05,sAMt-s+06,sAL-s)+i2,t
s-l

k=l

r
Alt =p3 +EVtp
k=l

p
+

s-l

(8sAYt-s+62 sAGt-s+63sIts+4,Xt-s+66sAMt-s

+66,sALts) +13,t

(5)

Government
Spending25

r
AXt=W +Ea4.kvk,t-p
k=l

p
+E (4LsAYt-s+4

s=l

+44,sAXt-s+0s,sAMt-s+4
2,sAGt-s+4 3,sAIt-s
6,sALt-s)+Tn4,t (6)

AMt=ps +Ea5kVkt-p+E (l,sAYt-s+92,sAGt s+(p3,sAIt

(7)
s+94,sAXt-s+sp5sAMt-s+96,sAI-t-s)+Ss5t
k=l

s=l

AL =p6 +

X,kVkt-p +E

kl

(ki,sAYt s+2,sAGt s+k3,sAIt-s+4.sAXt-s+X5,sAMt-s+h,s

s)

+fn6,t (8)

s=l

where aXi,kare the adjustment coefficients, vkt-p are the cointegrating vectors, and pt,...,

ts

are intercepts.
The advantage of modeling the relationship between government spending and
economic growthin a system of equationsas in (3) - (8), insteadof a single growthequation,
is the possibility to identifyboth the direct as well as the indirectlinks between them. The
directeffect of governmentspendingon economic growth,which is conventionallytested in
a single growth equation,can be detected from equation(3) throughthe distributedlags in
governmentspending.The additionalequations(4) - (8) offer the possibilityto identifythose
indirect effects that may result from the impact of govemment spending on any of the
remaining variables that has, in turn, a direct link with economic growth. That is, the
interactionof government spending with investment, trade and labor may result in an
indirectimpacton economic growth.
EMPIRICAL RESULTS
Data and Variable Definitions

Data used in the study are annualseries for Tunisia and cover the period 1960-2000.
The variablesand theirdefinitionswhere In denotes the naturallogarithmare as follows:
Y = ln(realGDP),
I = ln(theratioof privateinvestnent to GDP),
G = ln(theratioof total governmentspendingto GDP),
X = ln(theratioof exportsto GDP),
M = ln(theratioof importsto GDP),
L = ln(labor force),

D = ln(theratioof governmentdebt to GDP), and

T = In(theratioof tax revenuesto GDP).

26 KhalifaGhali

GDP is gross domesticproduct,real GDP is GDP deflatedby the GDP deflator.Private

investmentis measuredby the totalrealgross private-businessinvestment.Total government
spendingis measuredby governmentcurrentand capitalexpenditures.Exportsand imports
refer to total exports and total imports. The labor force refers to the total labor force
employed in the different sectors of the economy, including agriculturalemployment.
Governmentdebt refers to the budget deficit of the government,and tax revenues are the
totaltaxes collectedby the government.
The first differenceof Y is taken to be a proxy for economic growth.Data on GDP,
exports,and importsare gatheredfrom variousissues of the IMF publicationInternational
Financial Statistics (IFS).

Data on private investment,

labor, government

debt, and tax

revenueswere obtainedfromthe TunisianMinistryof Economy.

TEST RESULTS FOR UNIT ROOTS
Since the VAR specificationin (1) requiresthat some or all variablesare integratedof
orderone, I(1), we herein investigatethe stationaritystatusof all the series defined above
using the augmentedDickey-Fuller(ADF) and the Phillips-Perron(P-P) tests of stationarity.
These tests are performedboth on the level as well as on the firstdifferenceof the variables
allowing for a time trendwheneveris its significant.In each case the lag-lengthis chosen
using the Akaike InformationCriterion(AIC) after testing for first and higher order serial
correlationin the residuals.
Table 1 reportsthe resultsof the unit root tests. The first half of the table containsthe
resultsof testing for unit roots in the level variables.These resultssuggest that each of the
time-serieshas a unit root. The second half of the table reportstests for unit roots after
differencingthe data once. In this case both tests reject the null hypothesis of unit root.
Because the data appearto be stationaryin first differences,no firther tests are performed.
Therefore, we maintainthe hypothesis that each of the series is integratedof orderone.
Table 1. Test Results for Unit Roots
Variable
ADF
P-P
Variable
ADF
P-P

Y
-1.182
-1.212
AY
-4.562
-6.691

I
-1.714
-1.699
Al
-3.829
4.718

G
-1.942
-1.640
AG
-3.864
4.628

X
-1.642
-2.300
aX
-4.605
-5.176

M
-1.390
-1.558
AM
-3.752
-5.031

L
-1.563
-1.436
AL
-3.296
-4.672

D
-1.992
-1.966
AD
4.514
-6.754

T
-1.565
-1.601
AT
-3.692
4.930

NOTES: Variables are as defined in the text. The above tests are performedusing the following

regression
p

Ayt= po+ plYt-I p2T

dsAYt,s+vt,
s=I

Govenment Spending 27

where yt is the relevanttime series, T is a time trend,and vt is a residualterm.The time tend in this
regression is allowed only when found to be significant.The lag-lengthp is chosen using the AIC
criterionaftertesting for first and higherorderserialcorrelationin the residuals.The criticalvalues for
ADF and P-P are -2.967 and -2.970, respectively.

TESTRESULTSFORCOINTEGRATION
Before applyingthe Johansenprocedureto estimate a and f3, it is5necessaryto
determinethe lag length,k, of the VAR, equation(1), whichshouldbe high enoughto
ensure that the errorsare approximatelywhite noise, but small enough to alIow estimation.
Since the Johansenprocedureis sensitive to the choice of the lag length, we based our
decision on the Akaike' s FinalPredictionError(FPE) criterionand selected k-=3.Using this
lag length,we conducteddiagnosticcheckingtests for normalityand serial correlationin the

residualsfor eachof the 6 equationsin VAR.Theresultsof thesetests,not reportedhere,

indicate that with k--3 the residuals are approximatelyindependentlyidenticallynormally
distributed(niid) for all the equations.
The results of testing for the numberof cointegratingvectors are reportedin table 2,
which presentsboth the maximumeigenvalue (X.,) and the trace statistics,the 10 percent
critical values as well as the corresponding X values. This test is performedusing an
unrestrictedinterceptterm in VAR, which assumes the existence of a deterministictime

vector
trendin the data.The resultsof the test indicatethe existenceof one cointegrating
drivingthe data. The check the robustnessof this result,we jointly test the hypothesesthat

therankis equalto oneandthatthedatacontaina timetrend.We do thisusingtheJohansen

(1992)likelihoodratiotest.Theresultsof thistest,notreportedhere,confirmthattherank
the
Consequently,
of D is equalto oneandthatthedatado containa timetrendcomponent.
space.
andnotto thecointegration
termwill be associatedto the VECequations
intercept
in table3. Fromthe a vector
Theestimatesof the P and a and,vectorsarepresented
Testingthatthis
small
and
insignificant.
is
of
labor
coefficient
we cansee thattheadjustment
ratiotest=
a
and
likelihood
is
yields
exogenous
labor
weakly
is
a
test
that
coefficientis zero
to
=
us
acceptthe
easily
3.84
enables
value
x2(1)
critical
1.64,whichcomparedto the 5%
on L
restriction
weak
the
exogeneity
after
imposing
nullhypothesis.Estimatesof a and p
completely
is
now
that
the
model
arepresentedin table4. Theresultsof thistableindicate
identified.
The results of cointegrationindicate the existence of a meaningful, stable long-run

thatties togetherthe long-runbehaviorof re4 outputto thatof

relationship
equilibrium
investment,governmentspending,exports,imports,and labor.With this, the short-run
state.In each
to thislong-runequilibrium
dynamicsof outputcanbe seenas an adjustment
on
its
changesin
feed
back
this
will
period,deviationsof outputfrom equilibrium
short-term
a
Fromthe vectorin table4
orderto forceits movementtowardsits long-runequilibrium.
to its long-run
of
a
has
in
Tunisia
high speed adjustment
we can see that real output

28 KhalifaGhali

equilibriumstate.The short-mn behavior of outputis being correctedby about62% of the

imbalance occuring in the previous period between output and its long-rn equilibrium
value.
Table 2. Testing the Rank of n
Trace
-HO

HI

r=0
r<1
r:< 2
r< 3
r<4
r <5

r> 1
r >2
r> 3
r> 4
r> 5
r >6

Stat.

93.99
42.24
25.03
15.03
8.03
1.03

90%

HO

89.37
64.74
43.84
26.70
13.31
2.71

r 0
r <i
r? 2
rc3
r< 4
r<~5

Table 3. The

Variable

90%

Stat.

HI

r= 1
r 2
r= 3
r =4
r 5
r =6

35.75 24.63
14.21 20.90
9.03 17.15
3.98 13.39
2.05 10.60
1.03 2.71

0.355
0.288
0.178
0.125
0.088
0.064

and a and Vectors

Yt

it

Gt

Xt

Mt

-0.359
(-11.120)

-0.354
(-3.411)

-0.471
(-7,101)

0.278
(2.856)

-1.540
(-20.078)

0.026
0.441
-0.552
0.357
0.528
-0.622
(1.032)
(-2.630)
(3.227)
(4.020)
(3.971)
(4.301)
aret-statistics.
on Y andthefiguresin parentheses
vectoris normalized
NOTES:Thecointegrating
Table 4. The Restricted 0 and

Variable
,B

ax

Vectors

Yt

it

G'

Mt

Lt

-0.367
(-11.121)

-0.351
(-3.408)

-0.470
t-7.015)

0.277
(2.856)

-1.546
(-20.078)

-0.558
0.528
0.441
-0.620
0.35"7
(-2.633)
(4.024T
(3.970)
(3.229)
(-4.320)
arei-statistics.
on Y andthefiguresin parentheses
NOTES:Thecointegrating
vectoris normnalized

Spending29
Govemment

Table 5. Estimates of the VEC Model

Variable
Intercept
Vt-I

AYt-i
AYt-2
Alt i
AIt-2

AGti
AGt-2

AXt-i
AXt-2

AYt
1.4003
(3.116)

ALT-i
ALt-2

R2

a
TSC(10)
N(2)
RESET(1)

AGt
-0.455
(-2.083)

AXt
0.104
(1.998)

AMt
1.277
(2.441)

-0.620

0.528

0.357

0.441

-0.558

(-4.320
-0.315
(-2.788)
0.517
(3.116)
-0.027
(-0.770)
0.319
(3.001)
0.261
(2.702)
0.075
(2.290)
-0.007
(-0.113)
0.216
(2.768)

(3.970)
0.110
(2.661)
0.088
(1.177)
0.322
(2.801)
0.221
(1.701)
-0.231
(-3.005)
-0.066
(-2.183)
0.338
(2.529)
0.018
(1.327)
0.671
(3.593)
0.212
(2.642)
0.311
(2.818)
0.115
(2.091)
0.69
0.0428
2.701
0.415
0.813

(4.024)
0.522
(2.662)
0.407
(2.011)
0.202
(1.708)
0.223
(1.421)
0.233
(1.094)
0.118
(1.002)
-0.127
(-0.728)
-0.032
(-0.401)
-0.004
(-1.201)
-0.013
(-0.801)
0.381
(2.552)
0.227
(2.016)
0.42
0.0477
8.802
0.453
2.487

(3.229)
-0.344
(-0.081)
0.453
(2.013)
0.219
(2.337)
0.045
(1.116)
-0.241
(-1.443)
-0.070
(-0.844)
-0.031
(-0.112)
-0.012
(-0.304)
-0.108
(-0.313)
-0.033
(-0.019)
0.015
(1.002)
0.012
(0.974)
0.26
0.0772
6.551
1.399
0.562

(-2.633)
0.237
(2.670)
0.102
(2.455)
0.417
(3.058)
0.214
(2.309)
0.216
(2.913)
0.083
(1.054)
-0.040
(-0.836)
-0.019
(-0.026)
-0.412
(-1.225)
-0.327
(-0.981)
-0.028
(-0.985)
-0.016
(-0.335)
0.21
0.0981
7.733
1.520
1.644

AMti,0.026
AMt-2

Alt
2.601
(2.891)

(1.009)
0.418
(3.811)
-0.075
(-1.103)
0.251
(3.716)
0.78
0.0164
6.12
1.041
0.236

ALt
0.563
(3.119)

2.916
(3.530)
1.881
(3.016)
-0.082
(-1.456)
1.557
(1.490)
2.056
(5.733)
1.408
(3.339)
-0.976
(-1.002)
-0.620
(-0.839)
-0.540
(-1.036)
-0.033
(-0.025)
-0.753
(-2.566)
-0.216
(-1.499)
0.36
0.0544
4.102
0.836
0.721

NOTES: T-ratiosare in parentheses.TSC(10) is a test for up to the tenth-orderserialcorrelation,N(2)

is the Jarqueand Beratest for normality,and RESET(1)is a test for parameterinstability.

Table 5 reports the OLS estimates of the vector error-correctionmodel using the
cointegrationvector in Table 4. Since these estimatesare sensitive to departuresfrom the

30 Khalifa Ghali

standardassumptions,we subjectedthe estimatedresidualsin each equationto a batteryof

diagnostictests. The firsttest, TSC(10) is a test for up to the tenthorderserialcorrelationin
the residuals, which is distributed X2(10).The second test, N(2), is the Jarque& Bera
normality test whichis asymptoticallydistributed Z2(2).The thirdtest, RESET(l), is the
RESET test for parameterinstabilitywhich is asymptoticallydistributed X2(1).The results
in table 5 suggest that residualsfrom the 6 equationspass the tests at the 95% significance
levels and, hence, there is no significant departure from the standard assumptions.
TESTING FOR GRANGER NON-CAUSALITY
The recentliteraturehas shown thatthe conventionaltestingprocedurefor grangernoncausalityusing the F-statistic has size and power problems due to its,dependenceon the
pretestingfor cointegration(Zapataand Rambaldi, 1997). A much accurateand simpler
procedurewas proposed independentlyby Dolado and Lutkepohl(1996) and Toda and
Yamamoto(1995) and is knownas the augmentedVAR approach.As shownby Zapataand
Rambaldi(1997) and Giles and Mirza(1999), the augmentedVAR testingprocedureis very
simple to compute and is independentof the cointegrationpropertiesof the data. For the
purposesof this paper,this proceduregoes as follows:
1. Since the VAR model contains3 lags and since the highestorderof integration
in the datais one, we firstestimatea VAR in levels with4 lags, then
2. We testjointly thatthe first3 lags of the relevantvariableare zero using a Waldtest which has a chi-squareddistribution.
Table 6. Test results for Granger non-causality
Variable

AY

AY

Al

AG

AX

AM

AL

24.68*

18.30*

15.67*

17.45*

11.21*

2.01

13.87*

14.11*

3.17

2.05

13.81*

11.77*

2.01

2.66
1.16

Al

18.45*

AG

16.55*

15.67*

AX

21.36*

13.07*

1.19

AM

16.47*

10.33*

1.56

0.88

--

AL

12.22*

15.09*

13.61*

1.30

2.47

NOTES. The flow of causalityin the table is from the variablesin the first columnto the variablesin
the first row. A star * indicates that the null hypothesis of non-causalityis rejected at the 5%
significancelevel.

Spending31
Government
Table 6 reportsthe resultsof testing for Grangernon-causalitybetween the 6 variables
in the system. The flow of causalityin the table is from the variablesin the first column to
the variables in the first row. In this setting, table 6 identifies all the possible channels
throughwhich governmentspendingaffects economic growth.The main conclusions from
table 6 can be summarizedas follows:
1. There are four possible channels throughwhich governmentspending can affect
the growthprocess in Tunisia.From table 6, we can see that governmentspending
affects economic growth directly through the growth equation and indirectly
through its impacton investment,imports,and labor. Since governmentspending
Granger-causes investment, imports and labor, which in turn Granger-cause
economic growth, then government spending has an indirect causal impact on
economic growth through its effects on these variables. The advantage of
identifyingthese indirectcausal links is the result of modeling growth dynamics
withina systemof equationratherthana single growthequation.
2. Looking at the results of tables 5 and 6 together, we can identify three causal
channels throughwhich an expandinggovernmentsize has an acceleratingeffect
on economic growth in Tunisia. These are promotion of economic growth,
imports, and labor. This result seems to be consistent with the Tunisian reality.
The Tunisiangovernment'sinterventionin economic activity has for long played
a critical role in promotingthe country's economic growth and development. In
particular,the governmentwas heavily involved in promotingsocial policies and
economic infrastructure.Government spending on social policies played a
critical role in promoting the standard of living. The provision of free basic
health care, education, and training were necessary for the development of the
country's human capital. Given the relatively low contribution of the private
sector, the governmentremainsthe main importerof technology. In addition,the
provision of an adequateinfrastructurealong with political stability has attracted
foreign direct investmentin many key sectors of the economy.
However, governmentspendingis having an indirectnegative effect on economic
growth and that throughits negative impact on private investment.This could be
the resultof the heavy involvementof the Tunisiangovernmentin manyproductive
sectors of the economy, which crowded-out the private sector from profitable
opportunitiessuch as in banking, agriculture,energy, telecommunications,and
transport.
3. As to the relationshipbetweengrowth,investmentand trade,our time-seriesresults
do not support the results of Levine and Renelt (1992). In our case, trade and
investment are both significant in the growth equation. In addition both trade
variables are significant in the investment equation. Hence, the relationship
between trade and growth in the case of Tunisia seems to be based on both the
enhanced resource accumulation as well as on the improved allocation of
resources.

32 KhalifaGhali

4.

Finally, regarding the relationship between economic growth and labor, our
results suggest that labor is an importantinput into production in the case of
Tunisia. Labor is highly significantin both the long-runrelationshipas well as in
the growth equation.This resultcontrastswith the resultsof the panel-datastudies
investigatinggrowth convergence. In referenceto the study by Islam (1995) as a
typical example of the availablepanel data studies, one of his main conclusions is
thatthereis no room for labor accumulationin a growth equation.3This is
because labor appears to be always insignificantafter controlling for the fixed
effects. However, our result seems to be rather supportive of the arguments
advanced by Maddala and Wu (2000) against the assumption that the theory
implicitin Islam'smodel appliesto all countries.
In light of these results, the recommendationby the IMF and the World Bank that
Tunisia should reduce the size of its governmentin orderto promoteeconomic growthdoes
not seem to be the appropriateone.4An appropriatepolicy recommendationwould be for the
Tunisian governmentto enhance its involvement in those activities that shape the general
productiveefficiency of the economy andto withdrawfromthose activitiesthatarehamful to
private investment and economic growth. In particular,Tunisia can build on its relative
strengthsin termsof the young profile of its population,its stability,prosperity,and its closer
integrationwith Europeto furtherfacilitatethe country'sabsorptionof new technologiesand
new ways of doing business. The governmentshould, however, reorient its development
strategyfrom one thatheavily depends on state-ownedmonopolies to one that encouragesa
greater participationof the private sector in most aspects of economic activities. The
privatizationand deregulationof public enterprisesalong with the enforcementof regulations
encouragingprofitable opportunitiesare the sorts of measuresthat would stimulateprivate
investmentand allow the economy competein a global environment.
BUDGET FINANCING AND ECONOMIC GROWTH
We have so far focused on assessing the impact of changes in governmentsize on the
growth performancein Tunisia. In this respect, we clearly identified the channels through
which governmentactivitiescan promoteeconomic growth.However,given the burdenof the
govemmentbudget constraintas being a binding factorin formulatinggovernmentbehavior,
a requiredadditionalinformationis for policymakersto know whetherthis outcomewould be
the same irrespectiveof the method used to finance governmentexpenditures.For this, we
now turn to investigatingthe impact of the different sources of financing the government
budgeton economic growth.
Given the flow budget constraintof the govemment,G = T + D, we now decomposetotal
government expenditures,G, in our VEC model into two components;the ratio of tax
revenuesto GDP (T) and the ratioof govemmentdebt to GDP (D). With this, we now have a
7-variablesystem.Using the same methodology, we firsttestedfor cointegrationbetweenthe

Spending33
Government

variables and then estimated a VEC model in order to assess the separateeffects of tax
revenuesand governmentdebt on economic growth.
Table 7 reportsthe growthequationfrom the estimatedVEC model and table 8 reports
the results of testing for Granger-causalitybetween economic growth, tax revenues, and
governmentdebt. As shown in these tables, while tax-revenuesand debt both Granger-cause
economic growth,they have opposite sign effects in the growthequation.Both coefficients
of the debt ratio are negative and statisticallysignificant.In contrast,the coefficients of the
tax ratioareboth positive but only the firstcoefficientis statisticallysignificant.
Table 7. Effects of Debt and Tax Revenues on Economic Growth

ALt-

0.228
-0. 103

t-statistic
(2.011)
(4.706)
(-1.206)
(3.078)
(-0.524)
(3.886)
(-3.541)
(-2.007)
(2.364)
(0.129)
(-0.155)
(3.001)
(1.272)
(2.344)
(- 1.105)

Al-t2

0.306

(2.776)

Variable
Intercept
vt,
AYt-l-0.329

AYt
1.238
-0.346

Yt-2

0.436
-0.038
0.326
-0.205
-0.134
0.688
0.256
-0.037
0.016

Alt-i
AIt-2

ADtADt-,
ATt-I
ATt-2

AXt-i
AXt-2
AMt-l0.103
AMt-2

R2

0.86

0.015

TSC(10)
N(2)
RESET(1)

5.32
1.778
0.452

NOTES: T-ratiosare in parentheses.TSC(10) is a test for up to the tenth-orderserialcorrelation,N(2)

is the Jarqueand Beratest for normality,and RESET(1)is a test for parameterinstability.

34 KhalifaGhali

Table 8. Testing The Causal Impact of Tax Revenues and Debt on Economic Growth
Null Hypothesis
Debt does not Granger-cause economic
growth
Tax revenues do
economicgrowth

not

Granger-cause

Test Statistic

x2(3)

19.45

7.81

14.13

7.81

In light of these results,it seems that the methodof financingthe governmentbudget is

not inconsequentialon the growth performancein the case of Tunisia. The govemment
reliance on debt seems to induce adverse effects on economic growth, while tax-financed
government expendituresseem to have an acceleratingeffect on growth. With this, the
positive effects of governmentspendingon economic growththatwe foundpreviously(table
5) shouldbe the outcomeof tax-revenueeffects offsettingthe negativeeffects of governmentdebt on growth.Hence, an additionaluseful policy recommendationis for the Tunisianfiscal
authoritiesto adopt a strategyof fiancing public outlays by relying more on tax-revenues
thanon debt-accumulation.
CONCLUSION
Following the debt crisis, Tunisiawas amongmanydevelopingcountriesthatadoptedthe
IMF debt-stabilizationprogramswithouthaving any indicationon how governmentspending
interacts with macroeconomic variables in affecting its growth process. In addition, the
existing literaturedid not provide a consensus judgment on which a policy can be safely
formulated.Consequently,this paperattemptedto empiricallyinvestigatethe causal channels
throughwhich governmentspendingcan affect economic growthin Tunisiaand the extent to
which govemment activities can have an acceleratingor a depressingeffect on the growth
performancein this.country.An additionalissue thatwe investigate,but which was neglected
in the relevantempiricalliterature,is whetherthe impactof governmentspendingon growth
is independentof the sourceof financingthe governmentbudget.
In an attemptto improveupon the conventionalprocedureof estimatinga single growth
equation,the paper developed a vector error-correction(VEC) model that allows to identify
not only the direct effects of governmentspendingon growthbut also the indirectlyinduced
effects resultingfrom the interactionof governmentspendingwith othermacro-variablessuch
as investment,trade and labor. With this, we were able to identify-three channels through
which govenmmentspending may have an acceleratingeffect on economic growth and one
channel through which govemment spending may have a depressing effect on economic
growth.

GovernmentSpending 35

The main conclusions useful for the conduct of economic policy in Tunisia are that
governmentspendingaimed at shapingthe generalefficiency of the economy and promoting
the productivityof laborand importshave acceleratingeffects on economic growth.Whereas
governmentinvolvementin the productivesectors of the economy has a crowding-outeffect
on privateinvestmentand, hence, depresseseconomic growth.In addition,given the adverse
effects of debt-accumulationon growth performance, it is recommended that fiscal
authoritiesin Tunisia adopt a strategyof financingpublic activitiesby relying more on taxrevenuesthanon governmentdebt.
ENDNOTES
IFor detailedbackgrounddescriptionsof the Tunisianeconomy, interestedreadersmay refer
to WorldBank (1996).
2Several studies of fiscal policy have excluded trade indicatorsfrom their analysis. These
include Landau (1983), Ram (1986), Grier and Tullock (1989), and Barro (1990, 1991).
Other studies have ignored fiscal policy when studying trade policy. These include Feder
(1983) and Edwards (1989). Studies that included both exports and imports include
Kormendiand Meguire(1985), Romer(1990a), and Levine andRenelt (1991, 1992).
3See also Knightet al. (1993), Easterlyet al. (1993), and Cashinand Loayza (1995).
4The World Bank (1996) Progress Report referredto the results of cross-countrygrowth
studiesand recommendedthatTunisiashouldreducethe size of its govermment.
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