Following the financial crisis in Asia of 1997-98, much attention has been devoted to its causes and solutions. One possible solution to the recession and stagnation which followed the crisis is for governments to pursue expansionary fiscal policies. This approach is now being tried in the Asian ‘tiger’ economies of South Korea, Taiwan and Thailand – but will it work?
This study from the Andrew Young School of Policy Studies at Georgia State University in the US deems it unlikely. It analyses data on government spending, gross domestic product and tax revenues from 1951 to 1995-96 in the three countries. The data are subjected to econometric processes such as cointegration and vector autoregression techniques to tease out possible relationships between the three variables. The authors conclude that fiscal policy has had little or no effect in stimulating growth, and is not recommended.
A brief review of the literature mentions existing theories on government spending and output, and statistical techniques used in the study. A historical overview tracks the countries’ economic growth since the 1950s, noting that Taiwan’s growth was based on trade and productivity, while South Korea’s was government-led. The two countries are nonetheless very similar in terms of population, dependency on energy imports, size of economy and economic growth. The data analysis then reveals:
- Long run independence of all three variables in Thailand
- In South Korea, increased output has led to increased spending, not vice-versa
- Increased spending has led to increased taxation in South Korea (spend-and-tax)
- In Taiwan, a positive link is made between spending and output, but the impact is considered to be small: a 10 per cent increase in spending brings a 2.6 per cent increase in output after ten years
- Taiwan has a weak tax-and-spend character, cautiously establishing a tax base before increasing spending.
Given this analysis, the study concludes that an expansionary fiscal policy will have mild but differing effects on the economic woes of each former tiger. It also concludes that output in all three countries depends primarily on external factors.
- In Thailand there is no causal relation between the variables, so fiscal policy will have no effect on output.
- In South Korea fiscal policy does not directly increase output, but has a gradual, cumulative effect over time. Taxes will also rise because of its spend-and-tax character.
- The weak effect in Taiwan suggests that fiscal policy will be ineffective here.
- Public spending in all three countries is low compared to OECD countries, so fiscal policy would not be expected to have strong effects.
- The 1997 crisis was financial, and the paper advises concentrating on correcting problems in the underlying financial system instead of directing efforts into fiscal policy.
