Is fiscal policy alone enough for economic growth?

CG_Machicado

During the last few years a new economic setting has emerged in the Bolivian economy lead by the fiscal sector that can be summarized by three facts: i) For the first time in history the Bolivian economy has recorded fiscal surpluses several years in a row; ii) there is a social policy to attack poverty based on transfers from the government to the households (conditional transfers like the Bono Juancito Pinto, Renta Dignidad and Bono Juana Azurduy); and iii) the aim of the government is to use fiscal policy and in particular public investment as the foremost instrument to promote growth and welfare.

These three elements have motivated the construction of a Dynamic Stochastic General Equilibrium (DSGE) model for a small open economy like Bolivia where different fiscal policy scenarios have been simulated taking into account the impact on output (aggregate and sectorial), consumption, investment (public and private) and welfare (1).

A long-run analysis shows that the best fiscal policy based solely on taxes is one that combines a fully opened economy with an increase in the value-added tax by 0.5 percentage points. In this setting the economy experiences long-run growth of 3.4 percent and the government is able to sustain its social policy without altering the transfers to households. Another interesting result shows that a reduction in the IDH (tax on the production of hydrocarbons) can have positive effects on output growth. A combination of an increase in the value-added tax by 1 percentage point with a reduction in the IDH by around 8 percentage points increases output by 5.5 percent in the long-run, even if the government is increasing its expenditures by 10 percent. This happens, because the reduction in the IDH generates a strong incentive for the production of hydrocarbons, which is Bolivia’s main economic sector. In addition, this result indicates that probably one of the main reasons for the fall that we have observed in the production of hydrocarbons in the last years is because production is highly taxed by the IDH.

Certainly a fiscal policy based in an expansion of public investment is better that a fiscal policy based on an expansion on public expenditures. A public expenditure policy affects negatively output growth because the transfers to households are strongly affected and therefore household consumption falls. But, a combination of a 10 percent increase in government expenditures and public investment with a 15 percent increase in the effectiveness in the provision of public capital (infrastructure) increases output by 12 percent in the long-run.

A big question in a long-run analysis is: How long does it take to attain these changes in output? For Bolivia, it takes more than 100 years, but if we add to these simulations the rock star of the economic growth literature –productivitythe economy is able to attain the “dreamed” output growth above 7 percent in 4 or 5 years. Therefore fiscal policy alone is not enough for growth and the government has to make the necessary efforts to promote productivity if it wants to be successful in the actual scenario.

What is (or should be) the role of fiscal policy for development? Leave your reply below.

Carlos Gustavo Machiado is a senior researcher Institute of Advanced Development Studies, La Paz. 


(1) Machicado, C.G. P. Estrada and X. Flores (2010). “Public Expenditure Policy in Bolivia: Growth and Welfare, Development Research Working Paper 04/2010, INESAD.


 

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