BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

Budget deficit and economic growth prediction in the case of Vietnam

DAO Thanh Binh – Hanoi University1
BUI Huyen Tam – Hanoi University

Hanoi, July 2016

ABSTRACT

Along with monetary tools, fiscal policies have been strong instrument of
the government to boost the economy, especially in recession periods, as a
reason, the government always has to face budget deficit, whose effect is
still controversial. Thus, this paper is aim to clarify the impacts of budget
deficit on economic growth in the case of Viet Nam, and access long-run
relationship among macro variables, by applying Autoregressive
Distributed Lag (ARDL) to analyze quarterly data for the period from 2003
to 2015. After undertaking statistical method, it’s convinced that there is a
long-run relationship among macro variables. Besides, budget deficit has
no effect on economic growth, which is relevant to Ricardian paradigm.
Whereas, productive expenditures has significant positive impact.
However, non-productive spending and consumer price index (inflation)
both reveal adverse effect. Therefore, all government’s decisions in term of
spending are recommended to be taken under precautious.
Key words: budget deficit, economic growth, Autoregressive Distributed
Lag – ARDL

1. INTRODUCTION
From Revolution in 1986, the influence of government is always remarkable. In Vietnam,
the involvement of the government in macroeconomic issues does benefit the economy
and the whole country’s development to some extent (for example, the balance of trade,
forex..). Monetary and fiscal policies together have been strong instrument of the
government to develop the economy, especially in recession periods. However, along with
fiscal stimulus, the government always has to face budget deficit, which is the case when
expenditures exceed revenue and put the government under pressure of financing the
deficit. Globally, many theoretical and empirical studies have been done to measure the
relationship between budget deficits and macroeconomic variables. Consequently, there
are three main different views about the effects of government budget deficits on a
country’s growth. In Neoclassical perspective, budget deficits increase current
consumption in the short run but cause a long-term drop in private investment. On contrast,
Keynesian economists are convinced that government over spending increase a country’s
domestic production, thus, motivates businesses to invest more. Different from the
Neoclassical and Keynesian paradigm, the Ricardian theory insists that there are no

1
Hanoi University, Faculty of Management and Tourism, Department of Finance.
Address: Km9 Nguyen Trai, Thanh Xuan, Ha Noi. Email: binhdtt@hanu.edu.vn.

Electronic copy available at: http://ssrn.com/abstract=2816710

BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

influence of budget deficit on macroeconomic situations. Empirical studies also reveal that
for some economies, the increase in government expenditure that leads to the increase in
budget deficit is proved to be a stimulation for economic development. For other
economies, it is observed that budget deficit has damaging effect on the entire economy.
There are also economies that witness no significant impact of budget deficit. The rationale
is that, depending on an economy’s situation, the relationship between fiscal deficit and
other macroeconomic variables is different from that in another economy. In addition,
macroeconomic variables are generally interrelated and interdependent in a complex
manner.
Deficit spending by a government and how it relates to the economy as measured by the
GDP, and other macro variables is of fundamental importance in shaping economic policy
for a country, especially at a time of economic downturn (Morsheda, Raja, & Chang,
2014). It is essential to determine if budget deficit would have an influence on economic
growth. If fiscal deficit negatively affects growth, then fiscal austerity would be legitimate
as a remedy for an economic downturn. On the other hand, austerity measures would be
detrimental to the economy if deficit spending were the right stimulus for growth.
From the arguments above, it is clear that empirical studies to determine the relationship
between government spending and economic growth are of at most importance. In this
study, the author used time-series analysis techniques to investigate the relationship
between federal deficit spending and economic growth in Vietnam over the period 2003-
2015, which is detailed in two relationship-based questions:
(1) Does there exist a long-run relationship between Budget deficit and GDP, CPI
(Inflation), and Interest rate in Vietnam?
(2) How do budget deficit and government expenditures affect economic growth in
Vietnam?
In this paper, the author aims to employ quantitative methodology to reveal the connection
among macro variables in Vietnam. The variables taken into investigation are GDP, CPI,
Interest rate, Productive and Non-productive expenditures. The Autoregressive
Distributed Lag (ARDL) Model is undertaken to discover the impact of budget deficit and
government expenditures on economic growth in both short run and long run. The paper
will be organized as follows: the next part presents the literature review; the session three
presents the current budget situations, sample selection, and methodology; the session 4 is
the quantitative model on budget deficits and macro variables in Vietnam; then last session
5 ends with the conclusion and recommendations.
2. LITERATURE REVIEW
2.1 Theoretical literature on economic development
In the perspective of macro economy, there are controversial paradigms about the
relationship between budget deficit and economic growth. While the Keynesians that there
is positive relationship between these two, the Neoclassians are convinced of the opposite.
Meanwhile, the Ricardian equivalence claims that there is neutral relationship between
budget deficit and economic growth. The difference in opinions results from various
possible factors such as time dimension, types of countries, types of government policies,
as well as the degree of budget deficit (Abd, Hayati, & Nur, 2012).
Firstly, Keynesian economics is a term that describes some of the ideas of economist John
Maynard Keynes (1883–1946), a famous British economist in the twentieth century. The
key point of Keynesian economics is the use of government deficit spending to encourage
economic growth. Economic problems can be overcome by making functional use of

Electronic copy available at: http://ssrn.com/abstract=2816710

BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

financial instruments such as expenditure, taxation, borrowing and budget (Çınar, Eroğlu,
& Demirel, 2014). When government purchases goods and services, it may push up
aggregate demand. Similarly, when government announces a tax cut, household can save
additional income, and they will spend some of it on consumer goods, thus, increase
consumer spending. Because of sticky wages, sticky prices, or temporary misperceptions,
shifts in aggregate demand affect the utilization of the economy's factors of production,
and raise national income (Elmendorf & Mankiw, 1998). Therefore, appropriately timed
deficits are beneficial for the economy (Bernheim, 1989).
Nevertheless, this school of thought got some criticism. Only in cyclical downturn, when
there is an increase in private saving and unemployment, Keynesian theory is appropriate
to support government borrowing. When the economy turns into development,
governments should take the opportunity to decrease the fiscal deficit, and if appropriate
run a surplus (econ.economicshelp.org, 2010). The problem was that Keynes applied a
general theory to all times, rather than just the conditions of a deflationary depression.
Dated back to the 1970s stagflation crisis, public expenditure rise was uncontrollable, and
budget deficits damaged the manageability of economies severely (Greiner & Fincke,
2009). Regarding to monetarist theory, financing budget deficits via taxes badly affects
private consumption and investment demand, meanwhile financing via debt increases
interest rates and damages private investments (crowding out effect). Consequently, there
will be no rise in output (Carlson & Spencer, 1975).
Secondly, the Neoclassians believe that current budget deficit will put heavier tax burden
to the future. By considering that individuals planning their consumption over their entire
life cycle, taxes will be shifted to future generations, hence, budget deficits push up current
consumption. Giving an assumption of full employment of resources, and fixed output, the
Neoclassical school argues that increased consumption implies a decrease in saving
(Yellen, 1989). In this scenario, interest rates are supposed to rise in order to restore
equilibrium in the capital market. Higher interest rates would in turn trigger a decline in
private investments. These negative consequences are considered as the “financial
crowding-out” effects of budget deficit, which exposes the government’s limited
intervention on economic activities with fiscal measures. When the government sector
expands through deficit spending, the costs of essential economic resources (e.g., skilled
labor, raw materials) will also increase, making it difficult for the private sector to thrive,
that can be referred as “resource crowding-out”. Consequently, Neoclassical theory is
commonly believed to concern the long-run influence of budget deficit on the economy,
in the contrary with Kenessian theory.
While Keynesian economists and neoclassical economists have contradicting views about
the relationship between deficit and growth, Ricardo proposed “Ricardian equivalence”
positing that the relationship is neutral. The Ricardian theory begins with the observation
that, for a given path of government spending, a deficit-financed cut in current taxes leads
to higher future taxes that have the same present value as initial cut. Where public debt
can grow forever at the rate of interest or higher, the present values of taxes (and other
revenues) cannot be changed unless the government changes its current expenditures level.
This point indicates that there is no free lunch; government spending must be paid for now
or later, with the total value of receipts equal the total present value of spending (J.Barro,
1989). Moreover, the demand for bonds always rises to match government borrowing.
Since the timing of taxes does not affect an individual's lifetime budget constraint, it cannot
alter his consumption decisions (Douglas, 1989). As a result, budget deficits (both
temporary and permanent) have no real effects. However, Ricardian theory depends on a

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

variety of strong assumptions, which are considered too extreme and invalid in most
empirical cases.
2.2 Empirical literature
Empirically, there are many successive researches trying to explain the actual relationship
between budget deficit and different macroeconomic variables, in both developed (United
States, United Kingdom, Japan, etc.) and developing countries (India, Nigeria, Malaysia,
etc.). Those researches provide empirical evidence for all three theories.
Eminer (2015) examine the causal relationship of budget deficit, productive expenditures,
non-productive expenditures, and economic growth in the long run in North Cyrus, by
using both Granger Causality test, and Autoregressive Distributed Lag – ARDL. This
study uses time series secondary data for 28 years (1983-2010). The author concludes that
budget deficits and all kinds of government expenditures are related with economic
growth. The relation is on both direction and bivariate causality. The share of non-
productive expenditures is also causes economic growth and this contradicts with the
theory. However, this shows that North Cyprus economy is dependent to government
spending. In addition, todays, nonproductive expenditure and productive expenditure has
an impact on the next year economic growth rates, as there is a significant long run
relationship. However it is uncertain to say that today’s budget deficit have an impact on
the future economic growth. In conclusion, the study findings are similar to most of the
Keynesian approach literature except the significant causal relationship between non-
productive expenditure and economic growth
Mehmet, İlhan & Baki (2014) examined the potential effect of budget deficit policies on
economic growth from a Keynesian perspective. The author used the 2001Q1–2011Q4
data on the best five (Panel A) and five worst (Panel B) countries in European Union by
their debt levels, and used the panel ARDL model for examining the effect. There is short-
run negative relationship between public debt and economic growth for the two groups of
countries. In terms of public expenditures, the parameter was negative in Panel A and
positive in Panel B but statistically insignificant in the two groups. The effect of budget
deficit on economic growth was positive, significant in Panel B, and insignificant in Panel
A in the short run. The results indicated that the countries in Panel B only adopted
Keynesian budget deficit policies for supporting economic growth in the short run. The
long-run estimation results showed budget deficit policies had no effect on economic
growth in Panel A and B.
Hassan & Akhter (2014) explored empirically the relationship between budget deficit and
economic growth in the case of Bangladesh, using Johansen Co-integration test. Moreover,
according to the results of diagnostic tests, Vector Error Correction Model (VECM) has
been applied. The results were contrary to Keynesianism yet in conformity with
Neoclassical theory, by pointing out the negative and significant relationship between
fiscal deficit and economic growth in the end, which is conform to many other developing
countries of the world.
Fatima, Ahmed, & Rehman (2012) used regression analysis is conducted to ascertain the
impact of Budget deficit on the GDP, and explored a negative impact of budget deficit on
the economic growth covering period of 1978-2009 in Pakistan. It results from the shortage
of government resources to meet their expenses in the long run.
In the mean time, a time series data for the period of 1971-2007 has been applied to
measure the relation between budget deficit and economic growth of Pakistan (Ahmad,
2013). The results of Granger causality test show that there is bi-directional causality
running from budget deficit to GDP and GDP to budget deficit. The OLS results show that

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there is positive but insignificant relation between GDP and budget deficit, following the
Ricardian approach.
In the case of Malaysia, Abd, et al. (2012) used ARDL approach to analyze the long-run
relationship between all macro series. By using quarterly data from 2000 to 2011, it was
found that there is no long-run relationship between budget deficit and economic growth
of Malaysia, consistent with the Ricardian equivalence hypothesis. Furthermore, Abd, et
al. (2012) indicated that productive expenditure has positive long-run relationship with the
economic growth. He also concluded that if there is a shock in the Malaysian economy,
the only variables that can help to converge the economy to its equilibrium is the changes
in GDP and productive expenditures.
In Viet Nam, Van & Sudhipongpracha (2015) applied OLS for the period from 1989 to
2011, and demonstrated that the Vietnamese national government deficits from 1989 to
2011 had no clear direct effects on the country’s economic performance. This insignificant
relationship is consistent with the Ricardian equivalence theorem. Whereas, FDI is one of
the important factors that contributed to Vietnam’s economic expansion for more than two
decades, and the real interest rate is another independent variable that has a statistically
significant relationship with economic growth in Vietnam.
Besides, Dao & Hai (2013) applied both Cointegration and ARDL approach to analyze
relationship between budget deficit and other macro variables (GDP, CPI, Exchange rate,
and Money supply (M2)) for the period from 2003Q1 to 2015Q4. The cointegration
approach suggests that there exists a long-run relationship between these variables.
Whereas, the ARDL method ends with the results that there is a long-run causality running
from budget deficit and government expenditures to economic growth. Budget deficit is
found to have negative but insignificant effect on a country’s growth, corresponding to
Ricardian equivalence theory. Meanwhile, government expenditures have significant
influence on economic growth, in which productive expenditures are positively related to
economic growth and non-productive expenditures are detrimental to the growth of the
economy
3. GOVERNMENT BUDGET SITUATION IN VIETNAM
3.1 Government budget situation
3.1.1 Government budget deficit situations
Through the Revolution, Vietnam has created a critical mass of market institutions and has
instilled rational, market-based economic discipline in its enterprises and citizens -
changes that will serve as an engine of growth for the entire economy. Despite a great
burden resulted from the global economic crisis in 2008, Vietnam has been consistently
recovering with a relatively high GDP growth rate (6-8%). In 2015, GDP growth rate is
estimated to be 6.5%, highest in the period 2010 – 2015, and the increasing rate in CPI is
remarkably low, only 2% this year (lowest in the recent 15 years). Nevertheless, rapid
growth brings out a sign of macroeconomic instability in the economy, which deteriorates
the quality of growth and its achievements. The ratio of public debt to GDP has been
increasing sharply from only 54.9% in 2011 to nearly 64% in 2015 that reveals the
inefficient public investments, and unneccessary budget deficits.
Therefore, it is essential to investigate the current stance of government budget deficit, its
trends and most importantly, its long-run relationship with other macroeconomic variables
in Vietnam. Before focusing on detecting this empirical relationship, this paper will
provide an overview of budget revenues, expenditures, and deficit.

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

As in the classification and accounting system of Vietnam, there are three categories of
budget revenue: (1) taxes and fees, (2) capital revenues, and (3) grants. Budget revenue
excludes domestic and foreign debts. The decomposition of budget revenue in Vietnam
from 2003 to 2015 is as follows:

1,000,000 It can be clearly seen that, taxes and fees

are the major sources of government
800,000
revenue, contributing from the lowest of
600,000 89 percent in 2007 to the highest of 95
percent in 2014. Capital revenues show
400,000
slight acceleration and account for 5 to 9
200,000 percent, while grants are consistently
0
equal to 1 to 2 percent.
2003 2005 2007 2009 2011 2013 2015 Regarding its trend, budget revenue
Taxes and Fees Capital revenue Grants increases continuously and steadily in
value and in percentage of GDP, which is
equal to around 21 to 27 percent of GDP,
which is relatively high in the region and
in the world.
In terms of expenditures, Vietnam accounting system divides it into two major categories,
namely (1) current expenditures (which include all administrative expenses), and (2)
expenditure on investment development (which include capital construction expenditure
and other capital expenditures). In this paper, basing on the nature of expenditures, the
author defines all current expenditures as non-productive and all expenditures on
investment development as productive. The following figure illustrates the decomposition
of budget expenditure in Vietnam from 2003 to 2015, in quarterly account:
300,000

250,000

200,000

150,000

100,000

50,000

-
2007Q1
2003Q1

2004Q1

2005Q1

2006Q1

2008Q1

2009Q1

2010Q1

2011Q1

2012Q1

2013Q1

2014Q1

2015Q1

Productive Expenditure Non-productive Expenditure

Except for the fourth quarter of 2009, non-productive expenditures always exceed
productive expenditures with larger difference during the period. In particular, productive
expenditures are equivalent to nearly 50 percent of non-productive expenditures in 2003
but this percentage decreases steadily to about 25 percent in 2015. In addition, while the
increasing trend in productive expenditures is slightly clear (from around 59 trillion VND
in 2003 to 195 trillion VND in 2015), non-productive expenditures show sharply rising
trend during the past twelve years (from 118 trillion VND in 2003 to 952 trillion in 2015).

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

These figures provide lots of implication for both academic researchers and the
government of Vietnam concerning the efficiency of public spending in recent years.
It is observed that productive expenditures are usually highest in the fourth quarter of the
year while non-productive expenditures show more consistent figures among quarters.
This feature can be explained by the fact that non-productive expenditures are current
expenditures that the government has to pay frequently throughout the year, especially for
administration purpose.
Since government expenditures is always higher than its revenue, it is of note that Vietnam
has consistently experienced fiscal deficit with the significant increasing trend. It also
revealed that budget deficit is highest in the fourth quarter of each year.
Besides, in consideration as percentage of GDP, Vietnam’s yearly budget deficit is
approximately 5.1 percent, on average, considered one of the highest in the region.
3.1.2 Factors determining and methods to finance budget deficit in Vietnam
Generally, the fiscal deficit stance in each nation is determined by various factors, and in
Vietnam, some main causes are failure in taxes collection, inefficient public investments,
funding to push up aggregate demand, extremely large government spending scale
First, government revenue is mainly from taxes, however, inadequate legal system, and
lack management lead to the significant increase in taxes avoidance and evasions, and
consequently, the huge losses in taxes revenue. Besides, taxes reduction helps new
established enterprises to maintain production and expand, however, taxes reduction,
exemption, and delayed collection adversly effect government expenditure, and budget
deficit.
Second, in recent years, Vietnam has received a huge amount of external capital in order
to accelerate investment in infrastructure and national key projects development for the
benefit of the country. However, in practice, the state investment spread causing waste in
the locality has not been completely overcome, the progress of construction of national
key projects has been slow and inefficient. As a results, the state budget resources were
wasteful and the regional development was hampered.
Third, government stimulus packages are funded through: issuance of government bonds,
exemptions of taxes and the use of state reserves. These packages stimulate consumption,
and thus economic growth. However, it would make the budget deficit increase to
approximately 6 – 8 % of GDP or even higher (Ly, 2014).
Last, increased government spending has the economy temporary boosted in the short
term, but it creates the risk of long-term instability (ex inflation and financial risks) due to
the inefficiency of public spending and the lack of monitoring mechanisms to ensure the
healthy operation of the financial system.
In order to finance budget deficit, there are three main methods to finance budget deficit,
which can be applied separately or simultanously by the government, namely printing
money, borrowing, and levying higher taxes. Particularly, in Vietnam, the main method to
balance budget is to to issue bond, borrow from comercial banks, borrow from foreign
parties through ODA. Another way is to sell state owned capital with the divestment of
SCIC holding in big enterprises.
3.1.3 Relations of budget deficit with other macro variables
The relationship between fiscal deficit and other macroeconomic variables is always a
controversial topic in every macroeconomic discussion and academic researche all over
the world. The common question to be asked is whether fiscal deficit, through its

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

interaction with other macroeconomic variables, has negative or positive impact on the
economy. The following figures depict the trends of various macroeconomic variables,
including GDP, CPI in Vietnam in the past thirteen years. It is clearly shown that all
variables have experienced an increasing trend throughout the period.

Gross Domestic Product in Consumers Price Index in

Vietnam from 2003Q1 to 2015Q4 Vietnam from 2003Q1 to 2015Q4
104.00
1,500,000 103.00
102.00
1,000,000 101.00
100.00
500,000 99.00
98.00
- 97.00
2003Q1
2004Q1
2005Q1
2006Q1
2007Q1
2008Q1
2009Q1
2010Q1
2011Q1
2012Q1
2013Q1
2014Q1
2015Q1

2005Q1
2003Q1
2004Q1

2006Q1
2007Q1
2008Q1
2009Q1
2010Q1
2011Q1
2012Q1
2013Q1
2014Q1
2015Q1
Recall that budget deficit is also increasing (in amount) during this period, it is possible
that it has certain relationship with these variables. It seems that the higher fiscal deficit,
the higher inflation (increasing CPI). This implies that budget deficit may be detrimental
for the economy in several ways, which agrees with the situation in many other countries
in the world (India, Nigeria, Pakistan, USA, and UK, for example). According to Mankiw,
the budget deficit has causes the loss of confidence of citizens and new
Additionally, the two figures below present the trend of productive and non-productive
expenditures made by the government from 2003Q1 to 2015Q4. The increasing trend of
these two components is corresponded to that of budget expenditures as a whole, and of
budget deficit.

Productive expenditures in Non-productive expenditures in

Vietnam (in billion VND) from Vietnam (in billion VND) from
2003Q1 to 2015Q4 2003Q1 to 2015Q4
150,000 300,000
100,000 200,000
50,000 100,000
- -
2007Q1

2010Q1
2003Q1
2004Q1
2005Q1
2006Q1

2008Q1
2009Q1
2010Q1
2011Q1
2012Q1
2013Q1
2014Q1
2015Q1

2003Q1
2004Q1
2005Q1
2006Q1
2007Q1
2008Q1
2009Q1

2011Q1
2012Q1
2013Q1
2014Q1
2015Q1

It appears that the higher economic growth (increase in GDP), the higher level of
government spending and deficit. It is unclear about whether deficit and different
components of spending influence economic growth, and in what way they promote or
diminish economic development. The research question regarding the
relationship between economic growth, budget deficit, and public spending components
will thus be answered by applying econometric techniques as well.

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3.2 Sample and variable selection

The main aim of this study is to see the impact of budget deficit on economic growth in
Vietnam. Based on Keynesian theory, the author prefer to support the idea that Vietnamese
growth policy is related with productive spending of government which means the
government uses budget spending for pushing economic growth and this could result with
budget deficit. This study will intend to test the hypothesis that government fiscal deficit
has a positive impact on economic growth in the long run.
The below table summarizes the five selected variables, their corresponding sources of
data and their units of measure:
Table 1: List of selected variables
No Code Variable Unit Source

1 GOVD Budget deficit in Viet Nam Billion VND MOF

2 GDPG Economic growth Percentage GSO

3 PROD Government productive expenditure Billion VND MOF

4 NOND Government non-productive Billion VND MOF

expenditure

5 CPI Consumer Price Index Percentage GSO

3.3 Methodology
The paper has undertaken Autoregressive Distributed Lag (ARDL) approach by Perasan
(2001) to answer the research questions. Given the limited quantitative literature in
Vietnam, it is worth testing this approach in the context of Vietnamese market.
The analysis has started with the unit root tests in each series (i.e. testing for the presence
of non-stationarity). Then ARDL model are implemented to investigate the long-run
relationship between the identified series by comparing F-statistics of the unrestricted error
correction model with the corresponding critical value bounds; and once the series are
proved to have long-run relationship, the coefficients of this relationship are estimated by
ARDL method.
4. DATA ANALYSIS
4.1 Descriptive Statistics
Table 2 shows descriptive statistics of variables used for empirical analysis in ARDL
approach, derived by Eviews. The statistics include measures of concentration (Mean and
Median), dispersion (Standard Deviation – Std. Dev.), and normality (Skewness, Kurtosis
and Jarque-Bera JB statistics). The total number of observation is 52 (quarterly time series
data in 13 years).

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

Table 2: Descriptive statistics

It is clear from the table above that the standard deviation of GOVD, PROD and UNPROD
are rather high (42,016.2; 26,811.8; and 81,485.5) with regard to its mean (42,792;
37,362.1 and 125,879.8 respectively), showing remarkable fluctuation in these variables.
This can be explained that the government expenditures vary sharply in value among
quarters every year. GDPG and other variables when put into log-form show slight
deviation from their mean values.
Jarque-Bera (JB) statistics and the corresponding p-values reveal except for CPI and
LOG(CPI), all other variables are normally distributed as there are not enough statistical
evidence to reject the null hypothesis that those variables have normal distribution2. The
Skewness and Kurtosis statistics also support this conclusion by showing that for all
variables except for LECOG and PROD, Skewness tends to approach zero while Kurtosis
progresses to three.
4.2 Unit root tests
All series are tested for the presence of unit roots at both level and first difference in two
different cases: (1) with intercept, and (2) with intercept and trend. The Akaike
Information Criterion (AIC) suggest an optimal lag p equal to three (p = 3).
Table 3: Author’s summary of ADF unit root test
Level First difference
Variables Trend & Trend &
Intercept Intercept
Intercept Intercept
LOG(ECO) -2.6171 -3.4667 -2.7226 -4.0943
LOG(GDP) -0.9157 -1.3663 -4.6139 -4.6638
LOG(GOVD) -4.5806 -6.2228 -8.1905 -8.0829
LOG(PROD) -1.7915 -0.5689 -17.3774 -17.8033
LOG(NOND) -1.4237 -1.1977 -10.7561 -10.8579
LOG(CPI) -3.8476 -3.8982 -6.998 -7.0042
Note: Critical values for Intercept and Trend & Intercept are -2.92, and -3.51, respectively.

2
Jarque-Bera normality test is clearly discussed in Chapter 14.2, Econometrics, seventh edition, page 1-9
by Faculty of Arts, The University of British Columbia. Available at
[http://faculty.arts.ubc.ca/dwhistler/325ClassNotes/chapNorTest.pdf]

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

It’s obvious from the table that two cases of intercept and trend & intercept reveals similar
results, except for LOG(GDPG) at first difference. However, as described in section 3.1,
GDP growth has experienced an increasing trend, hence, the author accepts testing results
with trend & intercept.
Regarding to Augmented Dicky-Fuller Unit Root Test at the two cases of intercept and
trend & intercept, the results show that in case of LOG(GOVD), and LOG(CPI), absolute
value of t-value of at level is higher than absolute value of corresponding critical value.
Thus, these variables are found to be stationary at Level, I(0).
On the contrary, the remaining variables, including LOG(GDP), LOG(GDPG),
LOG(PROD), and LOG(NOND), GDPG, GOVD, PROD, NOND, are found to be
integrated at order one, I(1). The level of significance employed is 5 percent.
Besides, the Phillips – Peron Test (PP) test reveals similar results regarding the stationarity
of these series.
4.3 ARDL Model
ARDL model is implemented, where economic growth (GDPG) is considered to be the
dependent variable and the best lag distribution of the independent variables, budget
deficit, productive and non-productive expenditure, CPI, was modeled.
4.3.1 ARDL model
a) The optimal number of lags
The ARDL model was estimated from a recursive search of the optimal number of lags
through the Akaike Information Criterion (AIC) and from the diagnostic statistics.
The Akaike Information Criteria (AIC) suggest the best lag length for Model A is
ARDL(3,0,1,2,3). It means that LOG(GDPG), and LOG(CPI) will have three lags while
GOVD has no lag, and LOG(PROD) and LOG(NOND) have one and 2 lags respectively.
b) Model’s Coefficients and Interpretation
From the Eviews’ output representation, the estimated equation can be written as:
LOG(GDPG) =
0.6309 * LOG(GDPG(-1)) - 0.0443 * LOG(GDPG(-2)) + 0.2500 * LOG(GDPG(-3))
- 0.0007 * LOG(GOVD) + 0.1027 * LOG(PROD) - 0.0884 * LOG(PROD(-1))
+ 0.1601 * LOG(NOND) - 0.0146 * LOG(NOND(-1)) - 0.1796 * LOG(NOND(-2))
- 4.5806 * LOG(CPI) + 1.9193 * LOG(CPI(-1)) - 1.9194 * LOG(CPI(-2)) - 10.1187 *
LOG(CPI(-3)) + 67.5855
It is revealed that except for budget deficit, all other three variables have significant effect
on economic growth in different lags. In terms of economic growth, the previous one, and
the previous three positively affect current growth rate, with t-value equal 5.07 and 2.24
(p-value equal 0.00, and 0.03) respectively. Current productive expenditures positively
shape growth rate, on the contrary, the previous one reveals an adverse influence.
Similarly, non-productive expenditures make a difference for the current quarter, but it’s
proven to have negative effect after two quarters. It’s estimated that, holding other
variables constant, if the productive spending increases by 1 percent, economic growth
will increase by 0.1%, and the number turns out to be 0.16% with 1 percent increase in
non-productive spending, on average. In difference from other variables, CPI only takes
remarkable detrimental effect after three quarters (lag of three with t-value equal -3.5, and
p-value of 0.0013).

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

The model has an R-squared of 86.14%, which means that 86.14% the variance in
LOG(ECOG) can be jointly explained by LOG(GDPGt-1), LOG(GDPGt-3), LOG(GOVD),
LOG(PROD), LOG(PRODt-1), LOG(NOND), LOG(NONDt-2), and LOG(CPIt-3). The F-
statistic (at 5 percent level of significance) exceeds the corresponding F-critical value
(16.44 > 2.56), indicating that the independent variables jointly have significant influence
on economic growth.
4.3.2 Diagnostic statistics
After selecting ARDL model for univariate cointegration test, the thesis is intend to
provide some diagnostic tests indicate that the relationship between variables is verified.
From these diagnostic tests above, it is convinced that the selected model is free of
heteroskedasticity, multi-collinearity, serial correlation and the residual is normally
distributed
4.3.3 Test of long run relationships
The second step is to apply Bounds F
test to see if there is cointegration or
not, it can be done by using Eviews.
The bounds test is mainly based on
the joint F-statistic which its
asymptotic distribution is non-
standard under the null hypothesis of
no cointegration. The estimation of
the five equations tests for the
existence of a long-run relationship
among the variables by conducting
an F-test for the joint significance of
the coefficients of the lagged levels
of the variables.
Table 4: ARDL Bound test result
From the testing results, F-statistic = 5.097, whereas upper bound critical value for I(0)
and I(1) is only 2.56, and 3.49 respectively at 5% level of significance. Hence, the null
hypothesis is rejected, and it’s convinced that there exists a long-run relationship between
LOG(GDPG), LOG(GOVD), LOG(PROD), LOG(NOND), and LOG(CPI).
4.3.4 Estimated Long-run Coefficients
The third stage of an ARDL modeling for univariate cointegration test is to estimate the
long-run coefficients of model. Table below presents the estimates of regression using
ARDL approach.

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

Table 51: ARDL Cointegration and long run form

ARDL Cointegrating And Long Run Form
Dependent Variable: LOG(GDPG)
Selected Model: ARDL(3, 0, 1, 2, 3)
Date: 05/14/16 Time: 09:57
Sample: 2003Q1 2015Q4
Included observations: 49

Cointegrating Form

Variable Coefficient Std. Error t-Statistic Prob.

DLOG(GDPG(-1)) -0.198814 0.106959 -1.858795 0.0715

DLOG(GDPG(-2)) -0.249463 0.091315 -2.731885 0.0098
DLOG(GOVD) 0.003229 0.012505 0.258209 0.7978
DLOG(PROD) 0.099755 0.025385 3.929676 0.0004
DLOG(NOND) 0.146887 0.067843 2.165115 0.0373
DLOG(NOND(-1)) 0.176463 0.057075 3.091760 0.0039
DLOG(CPI) -4.695635 2.463258 -1.906270 0.0649
DLOG(CPI(-1)) 11.974482 2.498753 4.792183 0.0000
DLOG(CPI(-2)) 10.058981 2.443012 4.117451 0.0002
CointEq(-1) -0.163731 0.028090 -5.828739 0.0000

Cointeq = LOG(GDPG) - (-0.0046*LOG(GOVD) + 0.0873*LOG(PROD)

-0.2089*LOG(NOND) -89.9812*LOG(CPI) + 413.7180 )

Long Run Coefficients

Variable Coefficient Std. Error t-Statistic Prob.

LOG(GOVD) -0.004611 0.098108 -0.047000 0.9628

LOG(PROD) 0.087302 0.426739 0.204579 0.8391
LOG(NOND) -0.208891 0.328291 -0.636297 0.5287
LOG(CPI) -89.981234 71.545636 -1.257676 0.2168
C 413.718013 329.351571 1.256159 0.2174

Differentiating from short-run form, the estimated coefficients of the long-run relationship
are insignificant for all variables. Considering the impact of macro variables on economic
growth, budget deficit, non-productive expenditures and consumer price index reveal a
negative effect and their coefficients are -0.005, -0.21 and -89.98 respectively. In the
meantime, its of productive expenditure is insignificant positive at 0.09.
Besides, that CointEq (Error Correction Term) is negative at -0.1637 means that 16.37%
of error in short run will be corrected after 1 quarter.
4.3.5 Granger Causality tests
The Granger causality test is a statistical hypothesis test for determining whether one time
series is useful in forecasting another, first proposed in 1969. At first, regressions reflect
"mere" correlations, but Granger claimed that causality in economics could be tested by
measuring the capability of predicting the future values of a time series using prior values
of another time series. Since the question of "true causality" is deeply philosophical,
econometricians agree that the Granger test finds only "predictive causality".
A time series X is said to Granger-cause Y if it can be shown that those X values provide
statistically significant information about future values of Y.

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

Table 6: Pairwise Granger Causality Tests from Eviews

Pairwise Granger Causality Tests
Date: 05/15/16 Time: 01:26
Sample: 2003Q1 2015Q4
Lags: 2

Null Hypothesis: Obs F-Statistic Prob.

GOVD does not Granger Cause GDPG 50 20.3773 5.E-07

GDPG does not Granger Cause GOVD 0.95071 0.3941

PROD does not Granger Cause GDPG 50 14.1611 2.E-05

GDPG does not Granger Cause PROD 5.48623 0.0074

NOND does not Granger Cause GDPG 50 4.75669 0.0134

GDPG does not Granger Cause NOND 3.54198 0.0373

CPI does not Granger Cause GDPG 50 0.17394 0.8409

GDPG does not Granger Cause CPI 4.42492 0.0176

PROD does not Granger Cause GOVD 50 7.18315 0.0020

GOVD does not Granger Cause PROD 1.25231 0.2956

NOND does not Granger Cause GOVD 50 0.96909 0.3872

GOVD does not Granger Cause NOND 2.81746 0.0703

CPI does not Granger Cause GOVD 50 2.81179 0.0707

GOVD does not Granger Cause CPI 2.89372 0.0657

NOND does not Granger Cause PROD 50 6.50897 0.0033

PROD does not Granger Cause NOND 3.15461 0.0522

CPI does not Granger Cause PROD 50 0.24932 0.7804

PROD does not Granger Cause CPI 3.75274 0.0311

CPI does not Granger Cause NOND 50 0.11706 0.8898

NOND does not Granger Cause CPI 1.89352 0.1623

In accordance with Eviews results, there exist different granger causality links among five
variables. It’s illustrated that two pairs of NOND – GDPG, and PROD – NOND have
bidirectional causality effect, which can be noted for government policies to increase
spending to lift economic growth, and is consistent with ARDL estimation presented in
section 5.3. However, budget deficit – economic growth, NOND – GOVD, CPI – GOVD,
and CPI – NOND does not result from each other. Meanwhile, the other pair has only one
direction relationship, such as PROD – CPI, and PROD – GOVD. Surprisingly, from
Granger Causality test, productive expenditures accounts for the major part leading to
budget deficit. Hence, government should have more considerations for appropriate
spending for investment activities.

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

5. CONCLUSIONS AND RECOMMENDATIONS

This study analysis is aim to detect any significant long-run relationship among macro
variables, namely economic growth, budget deficit, productive, and non-productive
expenditures, and consumer price index by ARDL approach.
Data are collected on quarterly basis from 2003 to 2015, mostly derived from official
sources of the government, such as GSO (General Statistics Office), and MOF (Ministry
of Finance).
As indicated by the unit root tests for all examined variables, government budget deficit,
and consumer price index (in both linear and log form) are stationary at level, I(0).
Meanwhile, economic growth rate, productive, and non-productive expenditures are
integrated to order one, I(1).
As the stationarity of variables is different, the ARDL model is required rather than
cointegration approach. The test of long-run relationship proves that there exists a long-
run relationship between macro variables.
The Akaike Information Criterion (AIC) suggests the best ARDL(3,0,1,2,3) form with
three lag for LOG(GDPG) and LOG(CPI), two lag for LOG(NOND), one lag for
LOG(PROD), and no lag for LOG(GOVD). Furthermore, the ECM proves that 16.37%
percent of short-run errors will be corrected by the changes in independent variables after
one period.
Productive expenditures are concluded to significantly and positively influence economic
growth while non-productive expenditures and consumer price index have significant but
negative effect on economic growth. Budget deficit is found with insignificant effect on
economic growth, which is conformed to Ricardian paradigm that budget deficit is not
beneficial to the growth of the economy. Therefore, it can be concluded that when the
magnitude of relationship between deficit and economic growth is concerned, the
Ricardian school of thought is superior. The model is reliable as it passes all diagnostic
tests, which indicates that the models have no heteroskedasticity or serial correlation and
the residuals are normally distributed. The explanability of the model is 86.14 percent.
Besides, the model suggests that productive expenditures are significantly beneficial while
nonproductive expenditures are strongly detrimental for economic growth. It is
recommended, thus, that the government should be really cautious in any spending
decision, as the productivity of these expenditures will influence sharply the economic
condition. The government is also advised to pay more attention to the improvement of
investment efficiency, i.e., the ICOR coefficient in public sector, to magnify the positive
effect of public investments.

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 BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

APPENDICES
APPENDIX 1: Data for analysis (the data is provided upon request)
APPENDIX 2: Author’s summary of Empirical Literature on the relationship of Budget deficit and other Macroeconomic variables

Authors (Year) Methodology Variables (Time period) Context and Results T

Fatima, Ahmed, & Ordinary Least Inflation, Real exchange rate, Real interest rate, Budget Negative impact of the budget deficit on the economic growth in N
Rehman (2012) Square deficit, Gross investment (1978 – 2009) Pakistan

Mehmet, İlhan & Granger Budget deficit, public debt, public expenditure, growth Positive relationship between budget deficit and economic growth K
Baki (2014) Causality Panel rate (2000Q1 – 2011Q4) in the short run in both developed and developing European
ADRL test countries, but not in the long run.

Hashibul, Ayesha VAR-VECM Budget deficit, Real interest rate, Inflation rate, Real Long run negative relationship between Budget deficit and GDP N
(2014) Approach effective exchange rate, Gross investment, (1977 – 2011) growth of Bangladesh

Ahmad (2013) Granger FDI, Budget deficit (1971 – 2007) Positive but insignificant relation between GDP and budget deficit R
Causality ARDL, in Pakistan
OLS

Fehiman (2015) Granger Budget deficit, Productive, and Non productive Positive relationship between budget deficit, productive, and non- K
Causality ARDL expenditure (1983 – 2010) productive expenditures and GDP in North Cyprus

Nur hayati binti ARDL Budget deficit, Productive and Non prouctive expenditure No long-run relationship between budget deficit and economic R
(2012) (2000Q1 – 2011Q4) growth of Malaysia, but positive long-run relationship between
productive expenditure and growth in Malaysia

Van, OLS GDP, inflation, real exchange rate, real interest rate, No long run relationship between budget deficit and economic R
Sudhipongpracha, budget deficit, gross domestic investment (1989 – 2011) growth in Viet Nam.
(2015)

Dao & Hai (2013) Cointegration & Budget deficit, Gross Domestic Products, Consumer Price Budget deficit has negative but insignificant effect on economic R
ARDL Index, Exchange rate, and Money supply (2003 – 2013) growth. Government expenditures have significant influence on
economic growth.

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

APPENDIX 3: Eviews results for ARDL model

Dependent Variable: LOG(GDPG)
Method: ARDL
Date: 05/14/16 Time: 08:09
Sample (adjusted): 2003Q4 2015Q4
Included observations: 49 after adjustments
Maximum dependent lags: 4 (Automatic selection)
Model selection method: Akaike info criterion (AIC)
Dynamic regressors (4 lags, automatic): LOG(GOVD) LOG(PROD)
LOG(NOND) LOG(CPI)
Fixed regressors: C
Number of models evalulated: 2500
Selected Model: ARDL(3, 0, 1, 2, 3)
Note: final equation sample is larger than selection sample

Variable Coefficient Std. Error t-Statistic Prob.*

LOG(GDPG(-1)) 0.630951 0.124366 5.073331 0.0000

LOG(GDPG(-2)) -0.044312 0.155277 -0.285377 0.7770
LOG(GDPG(-3)) 0.250001 0.111325 2.245682 0.0311
LOG(GOVD) -0.000753 0.016031 -0.046987 0.9628
LOG(PROD) 0.102684 0.042745 2.402280 0.0217
LOG(PROD(-1)) -0.088423 0.040779 -2.168318 0.0370
LOG(NOND) 0.160116 0.074326 2.154236 0.0382
LOG(NOND(-1)) -0.014612 0.064084 -0.228008 0.8210
LOG(NOND(-2)) -0.179629 0.063930 -2.809783 0.0081
LOG(CPI) -4.580565 2.843918 -1.610653 0.1162
LOG(CPI(-1)) 1.919323 3.425998 0.560223 0.5789
LOG(CPI(-2)) -1.919433 3.353905 -0.572298 0.5708
LOG(CPI(-3)) -10.11878 2.885799 -3.506405 0.0013
C 67.58553 18.57727 3.638076 0.0009

R-squared 0.861483 Mean dependent var -2.744794

Adjusted R-squared 0.810034 S.D. dependent var 0.217950
S.E. of regression 0.094994 Akaike info criterion -1.635051
Sum squared resid 0.315835 Schwarz criterion -1.094531
Log likelihood 54.05876 Hannan-Quinn criter. -1.429979
F-statistic 16.74434 Durbin-Watson stat 2.062294
Prob(F-statistic) 0.000000

*Note: p-values and any subsequent tests do not account for model
selection.

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

Appendix 4: Heteroskedasticity error testing for ARDL model

Heteroskedasticity Test: Breusch-Pagan-Godfrey

F-statistic 1.538778 Prob. F(13,35) 0.1524

Obs*R-squared 17.82052 Prob. Chi-Square(13) 0.1645
Scaled explained SS 21.34263 Prob. Chi-Square(13) 0.0664

Test Equation:
Dependent Variable: RESID^2
Method: Least Squares
Date: 05/14/16 Time: 09:45
Sample: 2003Q4 2015Q4
Included observations: 49

Variable Coefficient Std. Error t-Statistic Prob.

C -3.015558 2.577846 -1.169797 0.2500

LOG(GDPG(-1)) -0.006120 0.017257 -0.354644 0.7250
LOG(GDPG(-2)) -0.003887 0.021547 -0.180386 0.8579
LOG(GDPG(-3)) -0.012939 0.015448 -0.837625 0.4079
LOG(GOVD) 1.53E-05 0.002225 0.006875 0.9946
LOG(PROD) -0.008211 0.005931 -1.384318 0.1750
LOG(PROD(-1)) 0.000454 0.005659 0.080217 0.9365
LOG(NOND) -0.006709 0.010314 -0.650514 0.5196
LOG(NOND(-1)) -0.003925 0.008893 -0.441380 0.6617
LOG(NOND(-2)) 0.008849 0.008871 0.997464 0.3254
LOG(CPI) 0.355264 0.394632 0.900243 0.3741
LOG(CPI(-1)) -0.647797 0.475403 -1.362625 0.1817
LOG(CPI(-2)) -0.113066 0.465399 -0.242943 0.8095
LOG(CPI(-3)) 1.069178 0.400443 2.669986 0.0114

R-squared 0.363684 Mean dependent var 0.006446

Adjusted R-squared 0.127338 S.D. dependent var 0.014111
S.E. of regression 0.013182 Akaike info criterion -5.585020
Sum squared resid 0.006081 Schwarz criterion -5.044500
Log likelihood 150.8330 Hannan-Quinn criter. -5.379948
F-statistic 1.538778 Durbin-Watson stat 2.453063
Prob(F-statistic) 0.152355

Appendix 5: Normality test

10
Series: Residuals
Sample 2003Q4 2015Q4
8 Observations 49

Mean 9.57e-15
6 Median 0.012146
Maximum 0.129768
Minimum -0.306060
4
Std. Dev. 0.081117
Skewness -1.248859
Kurtosis 5.694764
2

Jarque-Bera 27.56322
0 Probability 0.000001
-0.3 -0.2 -0.1 0.0 0.1

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

APPENDIX 6: Serial Correlation LM Test

Breusch-Godfrey Serial Correlation LM Test:

F-statistic 0.252477 Prob. F(2,33) 0.7784

Obs*R-squared 0.738481 Prob. Chi-Square(2) 0.6913

Test Equation:
Dependent Variable: RESID
Method: ARDL
Date: 05/20/16 Time: 11:00
Sample: 2003Q4 2015Q4
Included observations: 49
Presample missing value lagged residuals set to zero.

Variable Coefficient Std. Error t-Statistic Prob.

LOG(GDPG(-1)) 0.118393 0.210025 0.563709 0.5768

LOG(GDPG(-2)) -0.147217 0.268720 -0.547844 0.5875
LOG(GDPG(-3)) 0.035464 0.130760 0.271214 0.7879
LOG(GOVD) -0.001113 0.016475 -0.067541 0.9466
LOG(PROD) -0.011997 0.046939 -0.255585 0.7999
LOG(PROD(-1)) -0.004201 0.042234 -0.099466 0.9214
LOG(NOND) -0.005287 0.079997 -0.066094 0.9477
LOG(NOND(-1)) -0.016679 0.069656 -0.239442 0.8122
LOG(NOND(-2)) 0.034484 0.081780 0.421664 0.6760
LOG(CPI) -0.242999 2.954121 -0.082258 0.9349
LOG(CPI(-1)) 1.153206 3.886956 0.296686 0.7686
LOG(CPI(-2)) -0.954545 3.695594 -0.258293 0.7978
LOG(CPI(-3)) 1.007448 3.272663 0.307838 0.7601
C -4.387521 19.99232 -0.219460 0.8276
RESID(-1) -0.177856 0.273416 -0.650498 0.5199
RESID(-2) 0.113566 0.260265 0.436347 0.6654

R-squared 0.015071 Mean dependent var 9.57E-15

Adjusted R-squared -0.432624 S.D. dependent var 0.081117
S.E. of regression 0.097090 Akaike info criterion -1.568604
Sum squared resid 0.311075 Schwarz criterion -0.950867
Log likelihood 54.43081 Hannan-Quinn criter. -1.334236
F-statistic 0.033664 Durbin-Watson stat 1.897453
Prob(F-statistic) 1.000000

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BUDGET DEFICIT AND ECONOMIC GROWTH BUI & DAO, 2016

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