Impact of Fiscal Policies on Economic Growth in Developing Countries

Jaya Arun Mehar

Authors

Jaya Arun Mehar

Keywords:

fiscal policy, economic growth, developing countries, government expenditure, tax revenue, public debt

Abstract

Fiscal policy is among the main tools which developing country governments use to achieve growth, macroeconomic stability and poverty reduction, but its effectiveness is questionable due to inability to increase tax capacity, potential for debt distress and institutional limitations. This study analyses the relationship between fiscal policy and economic growth in developing countries for the time frame 2010 to 2022, based on secondary annual aggregate data for low- and middle-income countries taken from the World Development Indicators (World Bank, 2022) and other international sources. The Government expenditure, tax receipts, public debt, fiscal balance, and public investment explained descriptive statistics, correlation analysis, sub-period comparison and ordinary least squares regression for relatedness with real GDP growth, while a robustness check excludes the pandemic year 2020. Average growth fell from 5.68 per cent in 2010–2014 to 3.07 per cent in 2020–2022, while government expenditure rose from 14.64 to 16.17 per cent of GDP and public debt rose from 38.46 to 62.00 per cent of GDP. Expenditure is negatively correlated and significantly correlated with growth; tax revenue and fiscal balance are positively correlated and the two multivariate correlation coefficients do not show one to be statistically significantly different from the other at the 5 per cent level; and the association between expenditure and growth weakens significantly when 2020 is omitted. The evidence in fact suggests that the size of the fiscal aggregates is not an explanation of growth, but rather the quality, composition and sustainability of the fiscal policy in question. Finally, the paper argues that the most plausible expenditures in developing countries are those aimed at increasing DRM, preserving productive public investment, and establishing fiscal rules that are based on credible medium-term debt policies.

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