Fiscal Policy and Growth

This study seeks to examine the impact of fiscal policy on growth while accounting the level of development and controlling for the state of institutions. A theoretical framework is developed to examine the impact of fiscal policy on economic growth while controlling for institutionsWe extend the augmented Solow growth model by assuming that technological advancement depends not only upon constant rate of technological progress (as envisaged in the neoclassical model) but also upon fiscal policy and the quality of institutions. This provides a framework to analyze the impact of both the fiscal policy and institutions on economic growth. The empirical investigation uses panel data of 56 countries over 1981-2010. We use fixed effects model and a dynamic panel based on the System Generalized Method of Moments (SYS-GMM).In sum, the disaggregated results suggest that effectiveness of fiscal policy in generating growth is function of the level of development of an economy. Typically, in developed countries more resources are allocated to the sectors considered productive while in developing economies resources are not only misallocated but are also characterized by rent seeking and leakages. This difference in resource allocation is responsible for the different impact that government expenditures cast on growth. The resource allocation in a country, among other things, would depend upon the quality of institutions.