The impact of government consumption on the private expenditures in developing country: the case of Indonesia

Haryo Kuncoro

doi:10.15208/beh.2018.1

Abstract

The relationship between government actions and private reactions is an important subject of continuing discussion in fiscal policy. This paper provides empirical evidence on the impact of government consumption on private expenditures in the case of Indonesia over the period of 1990–2012. We use Almost Ideal Demand System (AIDS) model to analyze the quarterly data of household consumption, investment, government spending, and import in compliance with the national income product based on expenditure approach. The results confirm that the government expenditure crowds-out household consumption. In contrast, it crowds-in firm investment and import. The elasticity of government expenditure with respect to income is the lowest while that of investment is the highest. Those findings suggest that the public sector is decreasing in relative importance gradually taken over by private sector to promote economic growth. As the economy grows, the economic policies of governments should have a tendency to more heavily focus on economic stabilization especially in relation to external imbalance induced by tendency of increase in import.

Highlights

The importance of government expenditure has been received much attention by academician and policy makers in the last decade
We clearly find that a rise in government expenditure will reduce household consumption; the decrease in household consumption is followed by the increase in investment as precisely found from the direct effect of the increase in government consumption on investment expenditure
It is generally accepted that the impact of fiscal policy on the national output depends to a large extent on whether or not fiscal expansion crowds-out private consumption and investment

Summary

Introduction

The importance of government expenditure has been received much attention by academician and policy makers in the last decade (see for example: IMF, 2008). While in advanced countries private sector led economic growth, in developing countries, by and large, government dominates the economy. The primary role of fiscal policy in the rebalancing process is to help remove the structural impediments and distortions constraining private consumption and investment This brings us back to the third issue of crowding-out effect. This paper enriches the literature on fiscal policy in relation to private sector in developing countries with focus on Indonesia. The motivation for this approach associates to the fact that the size of government in the country is relatively small, the scope for actively promoting economic growth remains limited. We conclude with a summary of key findings

Literature review

Research method

Empirical results

Findings

Concluding remarks