Budgetary Policies in Eastern European Countries

Available online at www.sciencedirect.com

ScienceDirect Procedia Economics and Finance 20 (2015) 428 – 432

7th International Conference on Globalization and Higher Education in Economics and Business Administration, GEBA 2013

Budgetary policies in Eastern European countries Andra Nichiteana, Dan Lupua*, Mircea Asanduluia a

Alexandru Ioan Cuza University of Iasi,Carol I Boulevard, no.11, Iasi 700506, Romania

Abstract The article aims to determine the optimal mix of public expenditure and its impact on economic growth for east European countries before and during the economic crisis. In order to achieve our objective we conducted a study on a sample of 5 CEE countries: Bulgaria, Croatia, Hungary, Romania and Slovenia for a 10 years period of time using the BARS curve model. Taking into consideration the fundamental differences between public investment policies pre and during the crisis we split our analysis in two distinct periods of time: 1992-2007 respectively 2008-2012. The results of our study consist in the identifications of optimal points of public expenses for each country in particular considering its specificity. © The Authors. Authors.Published Publishedby byElsevier ElsevierB.V. B.V. © 2014 2015 The This is an open access article under the CC BY-NC-ND license Selection and peer-review under responsibility of the Faculty of Economics and Business Administration, Alexandru Ioan Cuza (http://creativecommons.org/licenses/by-nc-nd/4.0/). University Iasi. responsibility of the Faculty of Economics and Business Administration, Alexandru Ioan Cuza University of Iasi. Peer-reviewofunder Keywords: public expenditure, economic growth, optimal value

1. Introduction Assessment of the state involvement degree in economic and social life can be done by monitoring the evolution of the total volume of public expenditure. It emerges from this an important issue, namely the general trend of increased public spending in all countries. Although, in short periods can see stagnation, for long periods, the public expenditure has an ascending evolution. If at the beginning of the century, their share in GDP was about 3%, in the 50s reached approximately 25%, and in the contemporary period, exceed an average of 40%, in some countries exceeding even 60% (Sweden). Although still in the 60s, governments of many countries have tried, through fiscal policy, to achieve a certain stability of

* Corresponding author. Tel.: 00232201569. E-mail address: [email protected]

2212-5671 © 2015 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Peer-review under responsibility of the Faculty of Economics and Business Administration, Alexandru Ioan Cuza University of Iasi. doi:10.1016/S2212-5671(15)00093-3

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public expenditure to GDP and to promote the principle that annual growth of public spending should not be higher than GDP growth, this does not was always respected. The debate on the role of public spending in the economy lasts for decades, dating back to classical political economy period, obtaining is still no consensus. Logically, the next question is: What level of public spending can lead to such maximization? It is necessary to mitigate rate (percent) of public expenditure of GDP, or should be increased, and at what level, if the goal is to increase the overall rate of economic growth?

2. Literature Review Growth phenomenon, now become the most important part of sustainable development of human society, was conceived from the beginning with the involving of public spending as variable impact, from the Keynesian model based on balanced economic growth, and developed, then by Samuelson, Hicks and Hansen. But, the important contributions were bringing by Harrod, Solow, Dornbusch and Fisher, in whose works; public expenditure analysis occupies a priority position. Barro (1989, 1990), using endogenous growth models, concludes that an increase in tax rates reduce economic growth by triggering negative effects. At the same time, however, the increase of public spending raises the marginal productivity of capital, and therefore, has a positive effect on economic growth; the optimal level of public services is when their marginal product is unitary. Armey (1995) bases on the fundamental law of diminishing return factors. At a very low public spending, the state is unable to ensure the private contracts and property rights protection and economic growth is very low. With a very high level of public expenditure, the firms does not have sufficient incentives to invest and produce, because the taxation needed to fund this level of public spending is excessive, and even in this case, growth is very low. Rahn and Fox (1996) conducted an empirical analysis using data of 57 developed countries for the period after World War II. Their study concluded that there is an optimum size of governments, and especially the U.S. one, expressed as a percentage of public spending in GDP, somewhere between 17-23%, also plotted as an inverted U curve. Scully (1994, 1998, 2002, 2008) examines the relationship between tax rates, government revenues and economic growth in 103 countries. He found that growth rates are maximized when public expenditure is between 21.5 and 22.9% of GDP. A study conducted only in the U.S. sets the optimum to 19.3 and this research shows that excessive growth in public spending leads to decreases in economic growth. These studies on the optimum of public expenditure suggested name for curve BARS (Barro, Armey, Rahn and Scully).

3. Research methodology In order to conduct a depth analysis of how the public sector has evolved in East Europe, being correlated with economic growth during 1992 - 2012, we staged this analysis based on changes that have occurred over time in the landscape east European economic and financial in two periods: the pre-crisis during the 1992-2007 years (characterized by the transition to market economy and high rates of GDP growth), and the crisis, 2008-2012 (manifestation of international financial crisis, sharp drop in GDP and worsening macroeconomic indicators). The choice of the analyzed states was the common historical past and transition to a market economy in a relatively similar, context, economic, social and even political equivalent. The countries in Eastern Europe chosen to be analyzed and classified in terms of the impact of public sector on economic growth are: Bulgaria, Croatia, Hungary, Romania and Slovenia. We estimate the relationship between economic growth and public expenditure using the model developed in the literature (Gallaway (1998), Pevcin (2004), Chobanov and Mladenov (2005) and Davies (2008)). The BARS curve assumes that an increase in public spending will lead to economic growth to a certain level (maximum), then will show the opposite effect of negative influence economic growth. The empirical testing is performed according to the following equations:

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Q = f (G, N)

(1)

where: Q is real GDP growth rate G is government intervention, the share of public expenditure in GDP N represents other factors. The model of BARS curve is the following: d(GDP) = c + b(exp) + a (exp)2

(2)

where: d (GDP) dependent variable, real GDP variation Exp independent variable, public expenditure as a percentage of GDP Considering the previous equation as a function of grade 2 to be maximized, we can calculate the optimal level of public expenditure as a percentage of GDP. Maximizing is realized by derivation and equalization the resulting function with zero. Thus, the result is given by the equation: 2a (exp) + b = 0

(3)

That, the optimal public spending will be equal to: exp =

b 2a

(4)

4. Analysis and results During pre-crisis period, the surveyed countries are experiencing uneven distribution of GDP growth: the highest value belongs to Slovenia (4.2%), and Bulgaria the lowest (1.12%). The other three countries, know moderate GDP growth, at around 2.5-3% (2.59 Romania, Croatia 3.21, Hungary 2.59). In terms of public expenditure share in GDP, it shows significant disparities in the five Eastern European countries. Thus, most developed countries in the region, Slovenia, Hungary and Croatia meet significant weight in around 45% (42,13; 48,94; 44,79). This value is similar to Western European countries, showing once again the degree of development and convergence of these three countries to Western countries. The other two countries, Romania and Bulgaria present low value compared to the previous countries, varying around 35% (33.57% and 37.66). The big difference between the two weights, from 45% to 35% can be explained by development gaps of the two categories of countries in the region. For the crisis period, the situation begins to know a uniform distribution. Thus, the countries in the region register anemic growth of GDP or decrease. Bulgaria, Romania and Slovenia recorded weak growth at around 0.5% (0.71%, 0.60% and 0.71%). The other two countries, Croatia and Hungary's have GDP declines during this period (1.11 and -0.58). Public expenditures in GDP know declines for 3 countries (Bulgaria, Croatia, and Slovenia) and increases for other two (Romania and Hungary). Table 1. The pre-crisis and crisis evolution of GDP growth and public expenditure Country

Bulgaria Croatia Hungary Romania Slovenia

Pre crisis (1992-2007) GDP growth Public expenditure (% GDP) 1.12 37.66 3.21 44.79 2.59 48.94 2.59 33.57 4.13 42.13

Crisis (2008-2012) GDP growth Public expenditure (% GDP) 0.71 35.48 -1.11 41.22 -0.58 49.46 0.60 36.74 0.71 35.73

Difference GDP growth 0.40 4.32 3.18 1.98 3.41

Public expenditure (% GDP) 2.17 3.57 -0.51 -3.17 6.39

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If we analyze the differences between the two indicators for pre-crisis and crisis periods, we see that there are significant differences. Thus, in terms of GDP growth differences, the most affected countries are Croatia with 4.32 (from 3.21 to -1.11), Slovenia 3.41 (from 4.13 to 0.71) and Hungary 3.18 (from 2.59 to -1.11). It observed a paradox; the most developed countries in the region have experienced the largest contraction of GDP. The other two countries, Bulgaria and Romania know a slight decrease of GDP (0.40 respectively 1.98). In terms of public expenditure, also we observed significant differences. Three countries, Slovenia, Croatia and Bulgaria register a decline for indicator, the largest being 6.39 and the lowest 2.17. Other two countries were showing increases in public spending Hungary an anemic -0.51, and Romania an important 3.17. Next, we calculate the optimal public expenditure which maximizes the economic growth in each of the five analyzed countries, according to the equation presented above. Table 2. The optimum public expenditure Bulgaria -57.57 4.67 -0.08 0.61 -28.123

C Exp Exp * Exp R-squared Maxim

Croatia -137.05 6.21 - 0.09 0.53 33.96

Hungary -0.83 0.38 -0.005 0.71 -33.58

Romania -40.63 1.202 -0.02 0.65 29.406

Slovenia -1.21 0.957 -0.01 0.70 32.926

As it can be seen from the table below, for all five analyzed countries, the optimal public spending is lower than the actual value of the indicator. And, the difference between current value and the optimal public expenditures manifest significant differences between countries in Eastern Europe. Thus, the biggest difference is registered by Hungary of 15.87, followed by three countries of half values , at around 7.5%: Bulgaria, 7.36; Croatia, 7.25 and Romania, 7.33. The lowest difference is found in Slovenia only 2.81. Table 3. The difference between the optimal and actual value of public expenditure Country

Optimal value

Actual value

Difference

Bulgaria Croatia Hungary Romania Slovenia

28.12 33.96 33.58 29.46 32.92

35.48 41.22 49.46 36.74 35.73

7.36 7.25 15.87 7.33 2.81

5. Conclusions If about Bulgaria, Croatia and Slovenia, this difference will shrink in the future given that governments policies to reduce social costs and their trend began to the financial crisis; in other two, the hopes are poor, both countries increasing the public spending during the crisis. Regarding Romania, it is still a good sign because the difference is not very large, and it can be realized in future. In the case of Hungary, the difference is huge and hardly feasible 15.87 in terms of costs incurred by the population. The concerns shown towards the global financial situation, studies that demonstrate the desire of governments to make strategic changes and the public interest to the financial health of their country, all indicate the need to redefine the role the public sector. Reducing costs, postponing major projects, improving financial management and efficient management consultants are not themselves measures necessary to ensure financial impact. The pressure faced by public finances in many countries in the recession imposes for fundamental changes to public services. The Eastern European governments have lately turned increasingly for public-private partnerships (PPP) and private finance initiatives (PFI). The using of the "user pays" schemes has become more widespread in transport, education, the reformed pension system and health. Some governments are considering appealing again to the sale of state assets and the use of outsourced services will certainly increase.

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