Relevance of Keynesianism in Nepal: An Empirical
Analysis
Abstract
In this paper, the relevance of Keynesian postulates has been
examined in the Nepalese context for the period 1975 - 2012 using annual data.
The empirical results from the Johansen co-integration tests clearly show that
there is long run equilibrium relationship between government expenditure and
real GDP, and private consumption and gross fixed capital formation. Likewise, Granger
Causality test confirms that there is bilateral causal relationship between
government expenditure and gross fixed capital formation in Nepal. However, no
causal relationship is observed between government expenditure and real GDP and
private consumption. Thus, it is confirmed by this study that the Keynesian postulates
are relevant for capital formation rather than for increasing real GDP growth
and private consumption in Nepal.
JEL Classification: E12
Key Words: Keynesianism, effective
demand casual relationship, government expenditure, gross fixed capital
formation and real GDP
BACK GROUND
Keynesianism
is a
macroeconomic school of thought based on the ideas of 20th century
British Economist John Maynard Keynes. The concepts forming the basis of Keynesianism
were first published in “The General
Theory of Employment, Interest and Money” in 1936. This book is a
repudiation of the foundations of laissez-faire and advocacy of active government
because unemployment is primarily a matter of the volume of effective demand.
Keynes argues that some individually-rational microeconomic actions, if taken
collectively by a large proportion of individuals and firms, can lead to
ineffective aggregate macroeconomic outcomes, where in the economy operates
below its potential output level (Keynes, 1936). It is further argued that such
low level economic situation can be corrected by the Government through active monetary
and fiscal policies.
One of the tenets of
Keynesian theory is that government spending on consumption and investment, tax
cuts and lower interest rates can stimulate demand and induce investment which would
have otherwise remained idle to produce wealth (Keynes, 1936). Similarly,
redistribution of wealth from wealthy to poor, who are perceived to have higher
marginal propensity to spend would generate higher economic growth. Therefore,
for four decades from mid-1945 to mid-1970 Keynesianism dominated the thinking
of professional economists and public policy makers not only in the United
States, and Europe but also in a number of developing countries. However, the
Keynesian principles have also been subjected to considerable criticisms during
the same period. The critics argue that macroeconomic policies based on
Keynesianism are counter-productive to stabilize the economy and these will lead
to inflation, income inequality, and incite consumers to spend even more in
anticipation of future tax increase (Michael, 2006). At the same time,
Keynesians advocate an active stabilization policy for reducing the magnitude
of the business cycle, which they rank as the most serious economic problem by raising
aggregate demand thereby stimulating economic activities, reducing unemployment
and avoiding deflation.
Governments in Nepal have used
expansionary budgetary policy since long back to stimulate demand as a counter cyclical measure as well as for political reasons. It is believed that large budgets can play influential role in generating
higher growth and increasing employment. However, the reality does not confirm
this as government expenditure and growth do not seem to move together. Hence,
testing causality between government expenditure and economic growth or
examining the relevance of Keynesianism would be a worthwhile exercise.
The main objective of this paper
is to gauge the relevance and implication of Keynesian notions in the Nepalese
context. For this, the study aims to test the causality between government expenditure and real GDP, private
consumption and gross fixed capital formation for the period between 1975 and
2012. Conclusions drawn from the study would provide useful insights to fiscal
policy makers of Nepal.
The rest of the paper is
organized as follows. The second section provides a precise review of evolution
of Keynesianism which covers origin of Keynesian thoughts, dominance of
Keynesian policy and monetarist revolution followed by the counter revolution
of Keynesianism. Section three covers the review of empirical studies on
relevance as well as effectiveness of Keynesian thoughts available so far both
in global and Nepalese context. Section four briefly describes the data and
methodology used in this study. Section five presents the results and
discussion of empirical analysis. The last section concludes the discussion.
EVOLUTION OF KEYNESIANISM
Origin
John Maynard Keynes
(1883–1946) had acquired an international reputation shortly after World War-I
by “The Economic Consequences of Peace”. In his 1924 book, “A Tract on Monetary
Reform”, Keynes declared that gold was a “barbarous relic” and that governments
should control money supply to maintain a stable domestic price level as well
as a stable foreign exchange rate (Anderson, 1925). In 1930 Keynes published “A
Treatise on Money”, a two-volume work which established him as the reputed leading
monetary theorist for the next five years. Keynes' “The General Theory of
Employment, Interest, and Money” published in February 1936 is widely regarded
as the cornerstone of Keynesian thought. By the end of World War-II, The
General Theory became the foundation of the new “Macroeconomics”, which in turn
was popularized as Keynesianism (Hutt, 1963).
Keynesian Dominance: 1941–1979
From the end of the Great
Depression, Keynesian ideas quickly established in America and Europe also was
a leading inspiration for the English speaking common wealth countries of Asia
and Africa from 1941 to the mid-1960s. In late 1965, Time Magazine in a cover
story entitled "We are all Keynesians now" scaled Keynes's central
theme by stating that Keynes was one of the three most important economists
ever, and that his General Theory was more influential than the ‘magna opera’
of his rivals i.e. Adam Smith’s ‘The Wealth of Nations’ and Karl Marx's ‘Das
Capital’.[1]
Hence, from early 1940s to the mid-1970s, which is also known as the Golden Age
of capitalism, Keynesianism provides the main inspiration for economic policy
makers and for prominent economists including the academia.
Monetarist Revolution: 1979-1999
The stagflation of 1970s
including the oil crisis of 1973 followed by the recession questioned the logic
behind Keynesianism and lead to the development of new classical
macroeconomics. Thus, Austrian School of thoughts and Monetarism charged
Keynesianism and demand management as tools for 'fools' because wealth, in a
better society and cleaner world along with a higher level of development,
cannot be directed by the government. Meanwhile, the “Washington Consensus” which propagates that markets work best if
they are unregulated came to be used as a notable anti-Keynesian view. That
created the space to proliferate the Monetarism and new classical economics,
which in turn displaced the Keynesianism for 1979-1999 (Hoover, 2003).
Keynesian Counter Revolution: 1999–2007
The Asian Financial Crisis
of 1997 in the developing world and market failure as well as Dotcom crash of
the 2000 in advanced economies caused a turn back from free market policies to
Keynesianism. In the meantime, Britain and Japan had shown keenness to
Keynesianism saying "the real challenge was to interpret Keynes's insights
for the modern world" (Carabelli, 2010). By 2007 there had been high
promotion of Keynesianism in the English speaking countries including China,
India and south East Asia. In the academic world, the advent of the global
financial crisis in 2007 had caused the resurgence of Keynesian thought
(Anthers, 2010).
Keynesianism After 2008
During the global financial
crisis (2007–2009), the Keynesianism was receiving most attention as fiscal
stimulus was widely launched across the world. It was mid-2010 that the earlier
global consensus for ongoing Keynesian stimulus had broken, especially in
Europe, as there was an increasing demand for immediate fiscal tightening. By
mid-2012, with the on-going Euro crisis and persistent unemployment problem in the
US, there has been renewed consideration of stimulus policies by European and
American policy makers, although there is no return to the pro stimulus
consensus that existed in 2009 (Farrell and Quiggin, 2012).
LITERATURE REVIEW
Numerous studies have been
conducted to investigate the relationship between government spending and
economic growth with mixed results. Landau (1983) found that the share of
government consumption to GDP reduced economic growth which was consistent with
the pro-market view that the growth in government constrains overall economic
growth. Ram's (1986) study made a rigorous attempt to incorporate a theoretical
basis for tracing the impact of government expenditure to growth through the
use of production functions specified for both public and private sectors. The
author found government capital expenditure to have significant positive
externalities on growth particularly in the developing countries. Lin (1994)
used a sample of 62 countries (1960-85) and found that non productive spending
had no effect in growth in the advanced countries but a positive impact in LDCs.
Josaphat et al. (2000) investigate the impact of government spending on
economic growth in Tanzania (1965-1996) using time series data for 32 years.
The results revealed that expenditure on human capital investment was
insignificant in their regression and confirm the view that public investment
in Tanzania was not productive. Junko and Vitali (2008) in an investigation of
the impact of government expenditure on economic growth in Azerbaijan suggested
that the initial growth performance largely depends on the efficiency of
scale-up expenditure.
Komain and Brahmasrene
(2007) gauged the relationships between government expenditure and economic
growth for Thailand during the period 1970-2005. The results suggest that there
was a long-run relationship between government expenditure and economic growth,
thus supporting the Keynesian hypothesis. Jamshaid et al. (2010) found a wide
range of evidences on the impacts of government expenditure on economic
development and concludes that government expenditure contributes to economic
growth, both through supply and demand channels in the USA, Japan, Germany,
France, United Kingdom, Italy and Canada. The study suggested government
expenditure contributes in raising the quality of life by creating amenities,
providing consumption goods and contributing to macroeconomic stability.
Amid inconclusive evidences,
Keynesian policies have been able to exert some positive impact in the global
economy, especially during crises since 1930s great depression to the latest
financial crisis of 2007-2009. Skidelsky (2011) made a comparison between the
performance of the world economy during the Golden Age period (1951–1973) where
Keynesian policies were dominant and the Washington
Consensus
period (1981–2008) where free market policies were adopted. The study reveals
that the 'golden age' period was substantially more stable with higher growth,
employment and low inequality. However, during the 'Washington Consensus'
period the world economy was quite unstable with increasing inequality.
In Nepalese context,
Shrestha (2009) investigated the role of composition of public expenditure,
particularly the expenditure on physical infrastructure, on economic growth in
Nepal based on the endogenous growth model using time series data. The results
suggest that the impact of public expenditure on economic growth was positive.
However, Chaudhary (2010) found no causality between real GDP and government
expenditure in Nepal. The findings suggest that the increase in the size of
government expenditure has no influence on economic growth of Nepal.
Recently, Sharma (2012)
tested the impact of government expenditure on economic growth of Nepal. The
results reveal that although there is a weak influence on economic growth, growth
depends on the size, spending capacity, and effective use of capital
expenditure in the development process. Similarly, Kharel (2012) develops a
macroeconomic forecasting model focusing on fiscal policy and economic growth
in Nepal using annual data from 1992/93 to 2009/10. The evidence suggests that
fiscal policy, particularly government' capital expenditure affects economic
growth positively and also crowds-in private investment.
However, there exists a
trade-off between fiscal stability and high level of economic growth as the
policy goal of achieving both objectives seems to be unattainable. Within the
above theoretical and empirical evidences this study analyzes causality between
government expenditure and economic growth in Nepal.
DATA AND METHODOLOGY
Many empirical studies of
macro impact on government spending were based on the Vector Autoregressive
(VAR) model of major macroeconomic variables. A number of the studies were
focused to estimate the effect of government spending and fiscal deficit on
growth variables. Blanchard and Perotti (1999) used data pertinent to the
United States during the postwar period for VAR specification of taxes,
government spending and GDP in real per capita terms. Similarly, Heppke-Falk,
Tenhofen and Wolff (2006) used Structural Vector Autoregressive (SVAR) approach
to investigate short-run effects of fiscal policy shocks on the German economy.
As this study is primarily
based on the time series secondary data of Government Expenditure (GE) and
Economic Growth Variables, VAR models have been used. In order to test the
causality between natural log values of GE vis-à-vis real GDP, Private
Consumption (PC) and Gross Fixed Capital Formation (GFCF), time series annual
data for the period 1975 to 2012 have been used.
Model Specification
In order to find out the
causality between GE and Economic Growth Variables, natural log value of GE is
taken as independent variables while natural log values of real GDP, PC and
GFCF are taken as dependent variables. For this purpose the following models
have been developed.
As the present study is
based on the time series data, it is important to check whether a series is
stationary or not before using it in a regression. For this purpose, Augmented
Dickey-Fuller (ADF) test has been performed in this study. Since the ADF test
of unit root does not follow the conventional Student's t-distribution,
Mackinnon (1991, 1996) t-values have been used.
Economically speaking, two
variables will be co-integration if they have a long term or equilibrium
relationship. Although there are a number of methods for testing the
co-integration, the following Vector Auto Regression (VAR) method of order p developed by Johansen has been
utilized.
In this test, the null
hypothesis of r co-integrating vectors is tested against the alternative of r +1
co-integrating vectors. Thus, the null hypothesis r=0 is tested against the
alternative r=1 against r=2, and so forth. Johansen proposes
two different likelihood ratio tests of the significance of these canonical
correlations and thereby the reduced rank of the Π matrix: then the trace test and
maximum Eigen value have been folowed:
As the co-integration tests
are very sensitive to the choice of lag length, following Akaike Information
Criteria (AIC) and Schwarz Information Criteria (SIC) after existence of
co-integration between the variables in the equations, the Granger Causality
test has been performed.
Granger Causality Test
The common practice in
testing the direction of causation between two variables is the Granger
Causality test. According to Granger (1969), series X causes Y if the past
values of X can more accurately
predict Y than simply the past
values of Y. In simple words, if
past value X improves the prediction
of Y with statistical significance,
then we can conclude that X “Granger
Causes” Y.
RESULTS AND DISCUSSIONS
Findings
In order to gauge the
relevancy of Keynesianism in Nepal, in this study, first of all ADF test has
been performed to examine the unit root in all the set of 4 series comprising
log values of GE, GDP, PC and GFCF for the period of 1975-2012. The results of
ADF tests presented
in the table-1 support that the log value series under consideration are not stationary
at both level and first difference. This is confirmed as the calculated values
of t-statistics, in absolute sense, are smaller than the tabulated values at
both 1% and 5% level of significance accepting the null hypotheses that the
series are non-stationary. Thus, ADF tests confirm that all the series
under consideration are no stationary.
Table-1: Unit Root Tests-At Level
Variables
|
t-statistics
|
critical values
|
MacKinnon p-value
|
|
1%
|
5%
|
|||
NLGDP
|
0.535
|
-3.668
|
-2.966
|
0.9859
|
NLGE
|
-1.411
|
-3.668
|
-2.966
|
0.5770
|
NLPC
|
-2.192
|
-3.668
|
-2.966
|
0.2092
|
NLGFCF
|
-2.532
|
-3.668
|
-2.966
|
0.1079
|
Table-2: Unit Root Tests-First
Difference
Variables
|
t-statistics
|
critical values
|
MacKinnon P Value
|
|
1%
|
5%
|
|||
NLGDP
|
0.300
|
-3.675
|
-2.969
|
0.9774
|
NLGE
|
-0.787
|
-3.675
|
-2.969
|
0.8229
|
NLPC
|
-2.179
|
-3.675
|
-2.969
|
0.2141
|
NLGFCF
|
-2.779
|
-3.675
|
-2.969
|
0.0614
|
Johansen Co-integration Tests
After confirming the
non-stationary nature of series under consideration, it is required to test
whether the variables are co-integrated or not i.e. whether they exhibit the
tendency of co-movement over the long run and converge towards equilibrium.
Table 2 depicts the results
of the Johansen Co-integration tests. Both the trace test and maximum Eigen
value test reject the null hypotheses of all models that there is no
co-integration between the variables under consideration at 99 percent
confidence level.
Table -2: Results of Johansen Co-integration
Tests
GDP
and GE (Sample-1976 – 2012), Trend- Linear, Lags-1
Null Hypothesis (H0)
|
Eigen Value
|
Trace Statistics
|
Critical Value
5%/1%
|
Max-Eigen Statistics
|
Critical Value
5%/1%
|
r=0
|
0.59018
|
47.6995
|
15.41/20.04
|
31.2217
|
14.07/18.63
|
r≤1
|
0.37549
|
16.4778
|
3.76/6.65
|
16.4778
|
3.76/6.65
|
PC
and GE (Sample-1976 – 2012), Trend- Linear, Lags-1
Null Hypothesis (H0)
|
Eigen Value
|
Trace Statistics
|
Critical Value
5%/1%
|
Max-Eigen Statistics
|
Critical Value
5%/1%
|
r=0
|
0.56200
|
42.0988
|
15.41/20.04
|
28.8935
|
14.07/18.63
|
r≤1
|
0.31429
|
13.2053
|
3.76/6.65
|
13.2053
|
3.76/6.65
|
GFCF and GE
(Sample-1976 – 2012), Trend- Linear, Lags-1
Null Hypothesis (H0)
|
Eigen Value
|
Trace Statistics
|
Critical Value
5%/1%
|
Max-Eigen Statistics
|
Critical Value
5%/1%
|
r=0
|
0.61558
|
49.9874
|
15.41/20.04
|
33.4608
|
14.07/18.63
|
r≤1
|
0.37636
|
16.5266
|
3.76/6.65
|
16.5266
|
3.76/6.65
|
The above result of Johansen
co-integration tests confirms that there is co-integration of the Government
Expenditure vis-à-vis real GDP, Private Consumption and Gross Fixed Capital
Formation of Nepal. The existence of co-integration implies that there is
long-run relationship between the Government Expenditure variables and Economic
Growth Variables in Nepal partially supporting the Keynesian notion.
Granger Causality Tests
The results of Granger
Causality Test are reported in the following Table 3. The Wald F-statistics and
the corresponding critical values indicate there is no any causality between
the Government Expenditure vis-à-vis real GDP and Private Consumption, since
the null hypotheses of equations (1) and (2) that GE does not Granger Cause
real GDP and PC accepted with high probability values. However, there is a bilateral
causality between the Government Expenditure and Gross Fixed Capital Formation.
This is confirmed since the null hypothesis of equation (3) that GE does not
Granger Causes GFCF is rejected at 5 % level of significance to very low probability
values.
Table -3: Pairs
wise Granger causality (Wald) tests (Sample-1976 – 2012), Lags-1
Null Hypothesis (H0)
|
F-Statistics
|
Probability
|
Decision
|
GE does not granger cause
GDP
|
.40944
|
0.6675
|
(H0) Accepted
|
GE does not granger cause
PC
|
.39971
|
0.6738
|
(H0) Accepted
|
GE does not granger cause
GFCF
|
4.9003 (3.32)*
|
0.0139
|
(H0) Rejected
|
GFCF does not granger
cause GE
|
5.3341 (3.32)*
|
0.0100
|
(H0) Rejected
|
*
indicates the rejection of H0 at 5% level of significance
respectively. Figures in parenthesis are the tabulated values of F-distribution
for corresponding degree of freedoms.
CONCLUSION
This paper examined
co-integration and causality between the Government Expenditure (GE) vis-à-vis
real Gross Domestic Product (GDP), Private Consumption (PC) and Gross Fixed
Capital Formation (GFCF) with an aim of testing the relevancy of Keynesianism
in the context of Nepal using time series data of 1975 to 2012. Using the
methods of the unit root tests and co-integration tests, the study confirmed
that there is long-run equilibrium relationship between the Government
Expenditure variables and Economic Growth variables in Nepal. However, Granger
Causality test revealed that there is no causality between the Government
Expenditure and real GDP as well as private consumption for the review period. However,
there is bilateral causality between Government Expenditure and Gross Fixed
Capital Formation (GFCF) in Nepal.
The evidence from this study
reveals that Keynesian notion, which claims positive impact of Government
Expenditure on real GDP and private consumption, is not valid for Nepal. But
the Keynesian notion that the Government can play pivotal role in capital
formation through capital expenditure, which in turn stimulate the private
investment and growth of the economy is proved. The results of this study, in
line of some literatures, confirm that the notion of Keynesianism to promote
economic activities and growth through government intervention is partially
relevant in the developing countries like Nepal.
The finding of this study
suggests that the Government should not be involved in general kind of business
activities such as production and distribution of goods and services that the
private sector can perform far efficiently in more competitive manner. Rather
the Government should be focused in effective management of public utilities
and mobilization of resources in order to increase the capital expenditure,
which is considered as the vehicle of capital formation and infrastructure
development to promote economic growth.
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