Culture and Fiscal Policy

Abstract

This thesis, structured around three empirical studies, examines how culture affects policy and economic outcomes in a sample of 62 developed and developing countries spanning the period 1980-2015. More specifically, the studies investigate different cultural traits and their impacts on various outcomes such as fiscal policy choice, fiscal response to cyclical fluctuations and economic volatility. In so doing, this thesis enriches the emerging literature on the economics of culture and the political economy literature to examine: (i) how cultural differences can explain variation in different aspects of fiscal policy across countries, (ii) how culture and fiscal policy jointly determine economic volatility and (iii) the stabilising role of fiscal policy. The first two research areas have remained largely unexplored in the literature whilst the third is still under intensive debate given a lack of consensus among researchers. The first study focuses on the role of culture in determining the size of government. To that purpose, three theoretical hypotheses on the relationship between “thrift” (the proxy of culture) and government consumption are tested using panel data. Data for thrift and other culture variables used in this thesis are from the World Values Survey. Thrift represents the wise management of money and resources and it is also a summary concept for all psychological factors that affect saving. The main finding of this study is that government consumption is higher in thriftier countries, which is put down to thrifty individuals preferring to substitute their own consumption with government consumption, thus resulting in increased private savings and larger governments. The positive effect of thrift on government consumption, however, weakens in more corrupt societies. The second study extends the aforementioned investigation in considering culture as a driver of fiscal policy. Of particular interest is the extent to which fiscal policy is used countercyclically in order to stabilise the business cycles, with the emphasis on the downside of the cycles. Therefore, this study concentrates on the discretionary fiscal expenditure rather than the total government size. The relevant culture proxy captures individuals’ attitude towards economic stability, denoted in this thesis as “stability preference”. Estimations using both panel and cross-sectional models report that a stronger cultural preference for stability effectively results in governments increasing expenditure to counter negative cyclical shocks. This in turn makes fiscal policy more countercyclical. The third study more generally examines the relationship between cultural and economic volatility. In particular, the chapter tests the proposition that societies with a higher level of “trust” tend to trade and invest more, thus leading to more diversified economic structures that are less vulnerable to idiosyncratic shocks. This high trust – low volatility hypothesis is tested using a regression framework that has volatility as a dependent variable. Independent variables are trust and other determinants of volatility such as macroeconomic policy, term of trade and geographical variables. Thus, while assessing the impact of trust on output volatility, this study also revisits the stabilising role of fiscal policy. Empirical evidence shows that high trust levels have volatility-reducing effects. Moreover, although fiscal policy does respond to business cycles, there is neither a significant stabilising nor destabilising effect of fiscal policy. The overall findings from these three inter-related studies contribute to the literature on the economics of culture and, more generally to the political economy literature. Empirical results suggest that culture is a fundamental driver of economic development. Different aspects of culture shape different aspects of policy outcomes as well as aggregate macroeconomic outcomes. This thesis also provides policy implications regarding the size and scope of government, types of fiscal response during economic downturns and the effectiveness of fiscal policy in stabilising the economy.