How does Economic Freedom Influence the Relationship between Government Size and Convergence?

623 HOW DOES ECONOMIC FREEDOM INFLUENCE THE RELATIONSHIP BETWEEN GOVERNMENT SIZE AND CONVERGENCE? Le en e Nádasi Uni e si y o Deb ecen, Facul y o Economics, Ins i u e o Economics, Deb ecen, Hunga y nadasi.le en [email protected] Abs ac : In his pape we p esen some empi ical esul s abou absolu e and condi ional con e gence o eal GDP wi hin 121 coun ies using c oss-coun y da a. We assume ha he e is an in e ed U-shaped cu e, which desc ibes he ela ionship be ween economic g ow h and go e nmen spending. I is mainly because he ins i u ional condi ions o p oduc i i y do no exis a lowe le els o go e nmen spending. A highe le els, he go e nmen needs o le y highe axes o inance i s expendi u es, which hinde s g ow h. So he e can be somewhe e an op imal go e nmen edis ibu ion le el ha maximizes g ow h. This op imal le el depends on ins i u ional ac o s ha can be g abbed by ce ain Economic F eedom and Wo ldwide Go e nance Indica o s. I was no ou aim necessa ily o de e mine exac ly he le el o op imal go e nmen edis ibu ion, i would be di icul because o he he e ogenei y o he coun ies, only o make a compa ison be ween ee and less ee coun ies, and d aw some conclusions abou how his le el depends on hese ins i u ional a iables. Summing up we can say ha ou aim was o compa e ee and less ee, legally “good” and “bad”, as well as co up and less co up coun ies om he aspec o go e nmen edis ibu ion le el. I we di ide coun ies in o ee and less ee coun ies and assume ha bo h g oups ha e an in e ed U-shaped cu e, he op imal le el o go e nmen spending sha e is la ge in he iche coun ies because o hei be e ins i u ional sys em. These esul s do no con adic hose indings ha decla e posi i e o nega i e ela ionship be ween go e nmen spending and economic g ow h. One pa o he li e a u e p esumes ha he e is only one op imal le el o go e nmen spending, we poin ou ha he e can be a leas wo op imal le els, and hey depend on he ins i u ional quali y. Keywo ds: Economic g ow h; con e gence; go e nmen spending; c oss-coun y analysis JEL classi ica ion: O40; O47; H50 1. In oduc ion Va ious au ho s ha e examined he ela ionship be ween go e nmen size and economic g ow h. Some o he esea che s ound a posi i e link, like My dal (1960) and Eas e lin (1974), bu some o hem ound i nega i e, o example Rubinson (1977), Came on (1982), Landau (1983) and Ma low (1986). The mos ecen ones also ound i nega i e, like Rome o-A ila and S auch (2008), A onso and Fu ce i (2010) among many o he au ho s. They used mainly c oss-coun y and panel da a o illus a e i . All in all, he e is no gene al con incing empi ical e idence abou he sign o his ela ionship, bu some o he a iables will help o unde s and he p oblem. A nai e conclusion om he gene al amewo k o Solow (1956) model leads o he inding ha poo e coun ies a e g owing wi h a as e speed han he iche ones because o he dec easing ma ginal p oduc o capi al. So heo e ically, poo e coun ies can ca ch up (Solow, 1956, 1957). On he con a y, acco ding o Ba o (1990), we know ha he e is no absolu e con e gence wi hin he coun ies o he wo ld. Absolu e con e gence occu s only wi hin mo e homogeneous g oups like Eu opean Union o Eu ope and Asia oge he . A ican coun ies o example seem o lag behind and i is mainly due o ins i u ional di e ences. I he less 624 de eloped coun ies had he same ins i u ion quali y, hey would be able o con e ge o he de eloped coun ies. Summing up, absolu e con e gence is no ue due o ins i u ional di e ences, bu he e can be a condi ional con e gence. I he go e nmen spending is nea he op imal le el in a gi en coun y, his coun y can g ow as e . As we men ioned, oo high and oo low edis ibu ion hinde s g ow h. We assume ha iche economies ha e a highe op imal le el, and he ins i u ionally unde de eloped coun ies ha e a lowe op imal go e nmen size. Acco ding o Tanzi (2005) he op imal le el o go e nmen spending is 30 pe cen . We do no suppose ha he e is only one op imal le el. We assume ha he e is a leas wo op imal le els, and i depends on ins i u ional a iables. These a iables a e measu ed by Economic F eedom, Legal Sys em & P ope y Righ s, and Con ol o Co up ion. In Chap e 2 we examine 121 coun ies. Mos o he da a come om he Wo ld De elopmen Indica o s (WDI, 2014). A i s we p o ide some desc ip i e s a is ics o asce ain whe he i is an absolu e con e gence among all o he coun ies, han we di ided he sample in o g oups acco ding o he abo emen ioned he e ins i u ional a iables: Economic F eedom, Legal Sys em and P ope y Righ s, and inally Con ol o Co up ion. I ee economies a e iche , bu g ow slowe han he o he s, less ee ones can ca ch up. We will see ha i is no ue. F ee coun ies a e much weal hie and g ow as e a he same ime, so less de eloped coun ies do ha e a chance unde hese ci cums ances o app oach hem. The esul is simila in he o he wo si ua ions. So one di iding a iable is enough o un eg essions. In Chap e 3 we un h ee eg ession, he i s is o all coun ies, bu hese coun ies a e e y he e ogeneous, so he i is no so good. A e ha we un he same on only he ee coun ies, han only on less ee coun ies. O cou se, we know ha ee economies a e also weal hie , and ha e be e legal ins i u ions. Acco ding o ou esul s ee coun ies ha e a highe op imal go e nmen edis ibu ion le el han less ee, less de eloped, so hose coun ies ha ha e wo se legal sys em. 2. Va iables, sample and da a In he nex Chap e , om he ables we can see h ee ca ego iza ions o 121 coun ies. We examined an 18-yea pe iod be ween 1995 and 2012. We ook in o accoun he ini ial eal GDP pe capi a RGDP1995, he a e age eal g ow h a e o he pe iod, indica ed by g , and he s uc u e o go e nmen spending. G o a iable means he o al go e nmen spending as a pe cen age o GDP. This expense means cash paymen s o ope a ing ac i i ies o he go e nmen in p o iding goods and se ices. I includes compensa ion o employees (such as wages and sala ies), in e es and subsidies, g an s, social bene i s, and o he expenses such as en s and di idends (WDI, 2014). Gcon a iable means he go e nmen consump ion also as a pe cen age o GDP, mo e exac ly he inal go e nmen expendi u e including all go e nmen cu en expendi u es o pu chases o goods and se ices and compensa ion o employees (WDI, 2014). Ghea, Gedu and Gmil a iables simply mean he go e nmen expendi u e spen on Heal h, Educa ion and Mili a y as a pe cen age o go e nmen expendi u e. I also used some impo an a iables o di ide he da a in o wo g oups: The Economic F eedom o he Wo ld Index, indica ed by EFW (EFW, 2012), Legal Sys em & P ope y Righ s, indica ed by Legal (EFW, 2012), which is a componen o Economic F eedom, and inally he Con ol o Co up ion, indica ed by CC, also in 2012, which is a e y impo an componen o The Wo ldwide Go e nmen Indica o s (WGI 2014). 625 3. Desc ip i e s a is ics Le ’s see a i s some desc ip i e s a is ics by di iding he sample in o g oups. The i s ca ego iza ion is acco ding o Economic F eedom o he Wo ld Index, which is annually published by he Canadian F ase Ins i u e. Table 1 shows ha he e a e 64 uni s in he sample, whe e EFW>7, and 57, whe e EFW<7. Coun ies abo e 7 a e supposed o be ee, below 7 a e less ee. We can see om Table 1 ha ee economies had mo e han i e imes la ge eal GDP in 1995, and since hen ee economies a e g owing wi h as e pace han he o he s. So less ee coun ies will ne e ca ch up, because hei ins i u ional sys em does no allow g owing mo e apidly. F ee coun ies ha e la ge go e nmen edis ibu ion, because hey a e iche and hey can a o d i . Acco ding o Wagne ’s law, he demand on public goods is g owing in he de eloped coun ies (Ram, 1987). I we ca e ully examine he di e ences in he s uc u e o he expendi u es, we can see ha money spen on heal h is la ge , bu spen on educa ion and mili a y a e lowe in he de eloped coun ies han in he less de eloped ones on he pe cen age o o al go e nmen expendi u es. Table 1: Di e gence among ee and less ee coun ies EFW N Mean S d. E o Mean RGDP1995 >= 7,00 64 14747,84 1892,79 < 7,00 57 2737,82 627,83 g >= 7,00 64 2,66 0,21 < 7,00 57 2,36 0,25 G o >= 7,00 64 29,17 1,45 < 7,00 57 21,12 1,13 Gcon >= 7,00 64 16,52 0,64 < 7,00 57 14,39 0,68 Ghea >= 7,00 64 12,50 0,44 < 7,00 57 9,91 0,40 Gedu >= 7,00 64 13,32 0,43 < 7,00 57 15,73 0,61 Gmil >= 7,00 64 8,01 0,85 < 7,00 57 10,14 0,80 Sou ce o da a: EFW (2014), WDI (2014) The second di ision is acco ding o he quali y o Legal Sys em & P ope y Righ s (EFW, 2014). I he quali y measu e o he legal sys em and p ope y igh s (Legal) is mo e han 5.5, he gi en coun y is conside ed o be legally “good”, o i i is unde 5.5, we call i legally “bad”. We can clea ly see om Table 2 ha legally “good” coun ies we e mo e han i e old iche han legally “bad” ones, and he g ow h a e (g ) was also signi ican ly la ge , so his di e ence is con inuously inc easing. We can also clea ly see ha legally “good” go e nmen s spend a la ge sha e o hei GDP han he o he s. O cou se we do no know he causal ela ionship, bu we can guess ha he legally “good” economies a e also iche , so hey can a o d o ha e a bigge edis ibu ion. 626 Table 2: Di e gence among legally “good” and “bad” coun ies Legal N Mean S d. E o Mean RGDP1995 >= 5.5 60 15506,13 1968,87 < 5.5 61 2779,51 625,12 g >= 5.5 60 2,76 0,25 < 5.5 61 2,27 0,21 G o >= 5.5 60 30,38 1,46 < 5.5 61 20,45 1,04 Gcon >= 5.5 60 17,57 0,59 < 5.5 61 13,50 0,64 Ghea >= 5.5 60 12,31 0,44 < 5.5 61 10,26 0,44 Gedu >= 5.5 60 13,84 0,47 < 5.5 61 15,06 0,59 Gmil >= 5.5 60 7,96 0,92 < 5.5 61 10,05 0,73 Sou ce o da a: EFW (2014), WDI (2014) I also di ided he sample in o wo g oups wi h espec o he con ol o co up ion index om 2012. I ound ha he median alue was abou a -0.25. The di e ence is bigge han by he ea lie wo cases. Coun ies ha a e less co up , had 9 imes la ge eal GDP in 1995 han he co up ones, and he g ow h a e o hese wo g oups we e oughly he same, so he e is only a sligh ca ch up be ween hese wo g oups. Table 3: No signi ican con e gence among “co up ” and “less co up ” coun ies CC N Mean S d. E o Mean RGDP1995 >= -.2500 59 16678,46 1950,81 < -.2500 62 1869,18 324,75 g >= -.2500 59 2,44 0,19 < -.2500 62 2,59 0,26 G o >= -.2500 59 31,52 1,43 < -.2500 62 19,53 0,92 Gcon >= -.2500 59 18,48 0,57 < -.2500 62 12,70 0,54 Ghea >= -.2500 59 12,18 0,48 < -.2500 62 10,42 0,41 Gedu >= -.2500 59 14,08 0,56 < -.2500 62 14,81 0,52 Gmil >= -.2500 59 7,29 0,89 < -.2500 62 10,65 0,74 Sou ce o da a: WGI (2014), WDI (2014) 627 These desc ip i e s a is ics do no con ain new esul s, bu hese indings coincide wi h some o well-known ac s (Ba o 1990, Czeglédi 2007). I p o es ha his da ase is eliable, so we can un u he es s wi h hem. I is clea ha e e y ca ego iza ion p o ided almos he same esul , so he ea e only one a iable will be enough o di ide he sample. 4. Resul s o he eg essions As we assumed, he e mus be an in e ed U-shaped ela ionship be ween go e nmen spending and economic g ow h, because oo high and oo low go e nmen spending does no os e g ow h. So a simple eg ession model was used, in which we pu he G o and also he squa e o he G o as explaining a iables. Ou eg ession model was he ollowing: (1) This amewo k is acco ding o Mankiw a al. (1992). We omi ed some a iables, which can cause a li le bias, bu he o de o hese le els a e good. In his case we can es ima e he G o le el ha maximizes g ow h acco ding o he ollowing o mula: (2) O cou se, we know ha hese es ima ions a e no exac , because he e can be some omi ed a iable dis o ions, we only wan o use i in compa ing hese le els among ee and less ee coun ies. Table 4 shows he coe icien s o he whole sample, i con ains 121 coun ies. O cou se I ook he ini ial lnRGDP1995 as well, whe e ln means he na u al loga i hm. Theo e ically i we ge nega i e coe icien o he G o 2 and posi i e o G o , i e e s o an in e ed U- shape as we assumed, whe e G o 2 means he squa e o a iable G o . In addi ion, i we ge nega i e coe icien o he ini ial GDP, i e e s o con e gence. The op imal alue o G o can be calcula ed om he coe icien s, which maximizes g ow h. Fo he whole sample, i is 35 pe cen . O cou se we canno ake i se iously, because o he omi ed a iables, bu I will use his numbe only o compa e i o he o he cases. The Adjus ed R Squa e is e y low, i means ha he model i lea es much o be desi ed. We do no wan o d aw conclusions om his case. As we will see la e (Table 5 and Table 6), he op imal size is 49 pe cen o he de eloped coun ies and 27 o he less de eloped coun ies. Sadly hese numbe s a e no exac because o he dis o ions, hey do no show magni udes, we can only compa e hem, o which i is la ge . Table 4: Coe icien s o he i s eg ession (Adjus ed R Squa e=0,04) Model Uns anda dized Coe icien s Sig. B S d. E o (Cons an ) 3,898 ,873 4,468 ,000 lnGDP1995 -,447 ,122 -3,657 ,000 G o ,140 ,053 2,622 ,010 G o 2 -,002 ,001 -2,439 ,016 Sou ce o da a: WGI (2014), WDI (2014) 2 3210 1995ln G o G o RGDPg bbbb +++= 3 2 * 2 b b -=G o 628 Table 5 con ains only hose coun ies whe e he EFW index is la ge han 7. As we saw om desc ip i e s a is ics, hese a e mainly he iche , he de eloped coun ies. We can conclude con e gence om he coe icien o he ini ial GDP, and in e ed U-shape om he G o 2. The op imal G o le el would be 49 pe cen , so bigge han in he o he s. In his case, he Adjus ed R Squa e is e y much highe han in he p ecious case, pa ly because he sample is mo e he e ogeneous. Table 5: Coe icien s o he second eg ession (Adjus ed R Squa e=0,429) Model (EFW>7) Uns anda dized Coe icien s Sig. B S d. E o (Cons an ) 8,431 1,048 8,044 ,000 lnGDP1995 -,843 ,137 -6,161 ,000 G o ,098 ,056 1,756 ,084 G o 2 -,001 ,001 -1,748 ,085 Sou ce o da a: WGI (2014), WDI (2014) F om Table 6 i is clea ha he e is also a con e gence wi hin less ee coun ies, bu he e he nega i e coe icien is s a is ically no signi ican . Despi e his, i seems ha he e is an in e ed U-shaped cu e. The op imal G o le el o hese p obably less de eloped coun ies ha maximizes g ow h is 27 pe cen . O cou se, his eg ession esul does no mean ha i is exac ly he op imal le el, bu i is qui e su e ha lowe han in he iche economies. Acco ding o some esea che s, he ela ionship be ween g ow h and go e nmen size is in e ed U-shaped (Tanzi 2005, A mey 1995, Peden 2005, Sheehy 1995). In all hese cases, he coe icien o he G o 2 is nega i e, which e e s o he in e ed U-shape. The coe icien o lnGDP1995 is nega i e o he de eloped coun ies, i means he e is a signi ican con e gence among hem. I is a li le bi su p ising ha he coe icien o lnGDP1995 is nega i e o he whole sample, which a i s glance seems o con adic o Ba o (1990), bu we mus ema k ha he whole sample is no he whole wo ld. Finally, he e is no con e gence be ween he less de eloped coun ies, because he coe icien o lnGDP1995 is no signi ican , bu i seems ha he e is a U-shape ela ionship be ween he in es iga ed a iables, he coe icien o G o 2 is e en signi ican . Table 6: Coe icien s o he hi d eg ession (Adjus ed R Squa e=0,053) Model (EFW<7) Uns anda dized Coe icien s Sig. B S d. E o (Cons an ) ,477 1,966 ,243 ,809 lnGDP1995 -,295 ,223 - 1,327 ,190 G o ,324 ,143 2,262 ,028 G o 2 -,006 ,003 - 2,010 ,050 Sou ce o da a: WGI (2014), WDI (2014) 629 5. Concluding ema ks F om he desc ip i e s a is ics we can see he well-known ac , ha he ee , “legally” be e and he less co up coun ies a e also weal hie . And he e is a di e gence among hese coun ies, bu a leas does no seem o be any signi ican con e gence be ween hem. So i seems ha he ee , legally be e and less co up coun ies a e no only iche , bu g ow as e . Bu why do he poo e coun ies lag behind, and do no ca ch up? We can explain i wi h ins i u ional di e ences. I he poo coun ies had he same quali y o ins i u ional sys em, hey would be able o ake he ad an age o highe ma ginal p oduc o capi al and a ac much mo e in es men . Bu hese coun ies a e no so ee, he quali y o legal sys em is wo se, and he co up ion is bigge . We assumed acco ding o A mey (1995) and Tanzi (2005), ha he e is an in e ed U- shaped ela ionship be ween go e nmen spending and economic g ow h. I we ake he ins i u ional quali y in o accoun , we can assume ha he de eloped coun ies ha e a U- shaped cu e, and he less de eloped ha e ano he . By he de eloped coun ies, he go e nmen spending le el ha maximizes g ow h is la ge han by he less de eloped ones. We can see i om Table 5 and Table 6, ha ee coun ies ha e a la ge op imal le el. 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