The Role of Fiscal Policy in Economic Growth: A Comparative Analysis of Developed and Developing Countries

The Role of Fiscal Policy in Economic Growth: A Comparative Analysis of Developed and Developing Countries

Md. Shahinul Islam¹, Md. Al Amin², Md. Billal Hossain³, SM Al Imran⁴, Nusrat Jahan⁵, Fahad Bin Asad⁶, Abdullah Al Mamun⁷

^1,2,3,6Department of Economics, Pabna University of Science and Technology, Pabna, Bangladesh

⁴Department: Swaruupkathi Sub Branch, Islami Bank Bangladesh, PLC, Bangladesh

⁵Department of Mathematics and Economics, Playpen School, Bangladeash

⁷Senior Officer & Branch Operation Manager, Pubali Bank PLC, Bangladesh

DOI: https://dx.doi.org/10.47772/IJRISS.2024.8120115

Received: 05 December 2024; Accepted: 10 December 2024; Published: 05 January 2025

ABSTRACT

This objective is to provide a comparative research study that explores the role that fiscal policy plays in economic growth, with a special focus on both industrialized nations and developing countries. The study will explore the effect that fiscal policy has on economic development. Another area that is examined in this study is the connection that exists between fiscal policy and economic development. Another way of putting it is that it is a convoluted link that, depending on the economic climate in which it is being evaluated, might take on a somewhat different aspect. Given the nature of the relationship that exists between fiscal policies and expanding economies, it may be difficult to comprehend the link. The role that fiscal policy plays in the process of economic growth is influenced by a variety of factors, each of which has its own unique effect. Factors such as the organization of the government and the economy, as well as the specific channels through which fiscal policies are implemented, are included in this category. There is a significant gap between the industrialized nations and the developing countries in terms of the significance that fiscal policy plays in the process of economic growth. This gap is particularly pronounced in the development countries. In order to accomplish the aim of shining light on these discrepancies, which will be accomplished via the evaluation of empirical data and theoretical frameworks, the purpose of this comparative research is to achieve the purpose of illuminating light. Over a variety of different routes, fiscal policy has the potential to impact economic development. When it comes to industrialized nations, fiscal management that is solid often results in lower interest rates, which in turn supports private investment and consumer activity. In contrast, successful fiscal policies may boost human capital development in poor countries by directing public expenditure on education and infrastructure in a targeted manner, which can result in long-term economic gains.

INTRODUCTION

It is important to remember that fiscal policy plays a significant part in determining economic development, and it exerts its influence on already established nations as well as those that are still in the process of expanding via a variety of channels. Regarding this particular matter, it is important to take it into mind. ([1])This comparative study investigates the many ways in which fiscal policy contributes to economic development, each of which is executed in a manner that is distinct from the others. In view of the fact that each of these two groups of countries must contend with a different category of difficulties and possibilities, this is done in order to accommodate the situation. (Anderson, J. E. , 2005)

Theoretical Framework

The relationship between fiscal policy and economic growth may be understood by using both macroeconomic and microeconomic channels. This is so because economic analysis makes use of both types of channels. At the macro level, stable economies, more confidence among businesses, and more investment may be the result of strong and successful fiscal policies. It is possible to achieve all of these goals without compromising efficiency. The implementation of fiscal policies allows for the realization of each and every one of these goals. Ineffective budget management may cause macroeconomic instability, which in turn deters private investment and slows development. However, it’s also true that instability may occur as a consequence of poor financial management. The increasing volatility of the macroeconomic system is the root cause of everything that has transpired. (Schmidt, M , 2018)

Through taxation and the obligations linked with public expenditure, fiscal policy influences business actions within the framework of microeconomics. Looking at it through the lens of microeconomics confirms this. The expansion of the economy is dependent on human capital as well as productivity. It is possible to improve education and infrastructure, two factors that contribute to economic growth, by increasing government spending in these areas. As an example, potential investors may be provided customized tax incentives to entice them to participate in research and development (R&D). In order to increase investment, this would be done. The scenario is still the same, even if public spending on education and infrastructure may help grow human capital. ([1])

Empirical Evidence

According to the findings of empirical research, it has been shown that there is a relationship between fiscal policy and economic growth, and that this connection is often advantageous. This connection has been proved to be helpful. It is feasible that the impact of fiscal policy on economic growth may be significant for countries that are considered to be industrialized, according to some calculations. This is something that is probable. In accordance with the results of a number of studies, the effective implementation of fiscal policies has the ability to result in an increase in growth rates that are up to 0.75 percentage points higher than they would be in the absence of such policies. Because developing nations sometimes rely heavily on public expenditures to fuel investment and growth, it is probable that this effect will have an even greater degree of influence in these countries. This is because of the fact that public expenditures are typically the primary source of funding for these countries. [6]

Developed Countries:

• In general, private investment is stimulated by decreased borrowing rates caused by fiscal austerity.
• Government spending on infrastructure has historically yielded large economic rewards when executed well.
• However, if the government borrows more money than it needs, interest rates might go up and private investment could decrease.
• Given the lower starting points for capital accumulation, fiscal policy has the potential to have a significant influence.
• If we want sustainable development, we must increase public investment in healthcare, schools, and roads.
• Corruption and wasteful use of resources are two obstacles that might reduce fiscal programs’ efficacy.

Comparative Analysis

It is evident that there are extremely significant disparities between the fiscal policies of industrialized nations and those of developing countries when the efficiency of fiscal policy is compared:

LITERATURE REVIEW

Relevant Research

This literature review will investigate the economic, social, and infrastructure elements of developing nations with the intention of comparing and contrasting the similarities and contrasts that exist between industrialized countries and emerging countries. The objective of this research is to explore the economic, social, and infrastructure aspects of developing countries. The objective of this research is to emphasize the most relevant indications, trends, and difficulties that both sets of countries are now dealing with. To do this, the study pulls from a range of various studies.

Fiscal policy has a substantial impact on economic growth across all levels of development. Recent research has increased our understanding of the many elements that influence fiscal policy’s impact on GDP. Fiscal policies do not work the same way in different countries’ economies, as the findings demonstrate. [7]

A study that focused on China found that expenditures by state and local governments, as opposed to the central government, had a more significant impact on economic growth. The results point to the superiority of decentralized fiscal strategies in stimulating local economies. Public expenditure on manufacturing and R&D, in particular, considerably increases output growth during economic downturns, according to the study. [8]

Economic Indicators

When compared to other countries, industrialized nations frequently have a relatively high GDP per capita, sometimes approaching $12,000 per year. A significant percentage of the population in developing nations gets by each year on less than $1,000, and their GDP per capita is far smaller. The wide spectrum of economic inequality is reflected in this noteworthy gap.

A research study that integrates a century of data (1920-2020) found that rising countries, particularly those in Eastern Europe and East Asia, have succeeded in reducing the income disparity. This is true despite the fact that many African countries’ economies remain severely imbalanced. Parts of Eastern Europe and East Asia are particularly affected by this.

The study by Cervellati et al. (2019): While it’s true that these nations’ achievements have been uneven, it’s also true that many impoverished countries have made great strides in reducing their deficit in important measures like GDP per capita, education, and health between 1920 and 2020. The fact that these countries have achieved such impressive gains only serves to confirm this. Meanwhile, some parts of the world, including East Asia, have made great strides towards convergence. In contrast, there are a number of African states that persist in not adhering to the established norms. There has been some regional variation, but generally speaking, the developing world has closed the gap with industrialized countries by around 25% in the last century. Even while the general trend indicates that this decrease has taken place, this is still the case. [9]

Social Indicators

The socioeconomic indices also reveal that there are significant disparities between the two groups. Individuals living in industrialized nations often have easier access to medical care, improved educational opportunities, and financial assistance from the government. There are a lot of developing countries that are struggling with high unemployment rates and infrastructure that is obsolete. When it comes to improving patient care, the healthcare systems in developed nations have depended on information and communication technology (ICT) for a long time. However, in many developing countries, this is only now becoming a reality.[10]

Methodological Approaches

A large amount of variety may be seen in the research methodology that was used across all of the studies that investigate these discrepancies. When it comes to analyzing economic data over extended periods of time, some studies concentrate on qualitative evaluations of social structures and governance, while others make use of quantitative instrumentation. Qualitative assessments are less accurate than quantitative techniques, which explains why this is the case. For instance, a literature study on Okun’s Law, which describes how unemployment reacts differently to increases in production in emerging environments as opposed to established contexts, is an example of this kind of analysis. When doing a study of economic responsiveness, this brings to light the inconsistencies in approach that are present in the process.[11]

Challenges Faced by Developing Countries

• Dependence on the Economy: A great number of nations are very reliant on assistance from other nations or the selling of raw materials.
• Political Uncertainty: Issues with governance have the potential to be a barrier towards the achievement of success in development initiatives.
• When it comes to the distribution of wealth and access to resources, there are some substantial disparities across different communities. Here is an illustration of socioeconomic inequality in action.

Economic Growth and Infrastructure

The relevance of infrastructure to economic development has been highlighted by several studies, especially those that concentrate on nations that are still in the process of building their economies. As an example, this is particularly the case for nations that are in the process of developing. When compared to industrialized nations with well-established infrastructure, a research that examined data from 2000 to 2018 across several nations discovered that infrastructure is less evident in emerging nations, despite its vital role in building economies. The study included a wide range of countries. Data analysis from several nations allowed for this discovery to be made. The research found that education expenditure had a little impact on economic development in developing nations, but investments in energy, transportation, and communication had a larger impact. The Solow development [12] Theory states that in order to set up economic development and facilitate production processes, public capital which includes things like infrastructure is essential. The preceding claim is supported by all of this.

Financial Development and Institutional Quality

There is a vast array of institutional elements that both industrialized and developing countries may point to as the source of their economic success. Government openness, political stability, and law quality were the three most important factors influencing economic success among 131 countries studied between 2000 and 2021. Advanced econometric models proved that the institutional frameworks of developed countries surpassed those of poorer ones. The significance of effective leadership in determining economic success is emphasized by this. [13]

Comparative Analysis of EIA Systems

While comparing the practices of developed and developing nations with regard to Environmental Impact Assessments (EIAs), we uncovered several major protocol violations. The results demonstrated that whereas EIA systems in rich nations are well integrated, underdeveloped nations often face challenges due to a lack of public participation and review processes. Improving poor nations’ ability to conduct EIAs is necessary since this discrepancy has detrimental impacts on the environment.

Economic Inequality

Another subject that has been discussed in literature is the disparity in wealth between developed and developing nations. Another benefit of economic advancement is the low unemployment and poverty rates seen in industrialized countries. Emerging countries, on the other hand, have significant unemployment, terrible living conditions, and wide economic disparities. In addition to reflecting economic realities, this variance influences social structures and political policies. [14]

METHODOLOGY

Research Design

It is essential to investigate a variety of socio-economic, political, and infrastructure variables that differentiate these two types of nations while conducting a comparative study of established countries and growing countries by comparing and contrasting them. This is because these two types of nations are vastly different from one another. The reason for this is because these factors are a contributing factor to the variations that exist between the two categories of nations. Both of these groups of nations are distinguished from one another by the features that are being discussed here. Many other subjects, including economics, environmental studies, and public policy, are excellent candidates for the use of this approach. These are only a few examples of the many fields that are suitable for its application. In addition to being outstanding possibilities for this profession, there are a wide range of diverse fields among the available options. This endeavor’s objective is to find significant differences and similarities that have the potential to serve as a source of inspiration for the formation of plans for development and development cooperation. The purpose of this endeavor is to identify these differences and similarities. The execution of this attempt will result in the achievement of this goal. [15]

Data Collection

In order to conduct any form of comparative research, statistics are a fundamental need. The use of the following sources is considered to be standard practice:

Economic Indicators: There are a number of important metrics that are used in the process of assessing the success of the economy. These metrics include Gross Domestic Product (GDP), Gross National Income (GNI), and Gross Domestic Product (GDP) per capita. The International Monetary Fund (IMF) and the World Bank are both possible sources of information. Both of these organizations are also potential sources. [16]

Human Development Index (HDI):  The Human Development Index (HDI) is a composite statistic that takes into consideration factors such as the average income per capita, the level of education, and the average life expectancy. Rather than focusing just on economic data, it provides a broader overarching perspective on development.

Infrastructure Data: Infrastructure-Related Information and Data In order to have a comprehensive understanding of the development landscape, it is necessary to have information on transportation, communication, educational facilities, and access to energy sources. The database of World Development Indicators, which is a very helpful resource, is where you may go for this particular facts. [17]

Classification of Countries

• Developed nations are those that have reached a high degree of industrialization, possess modern infrastructure, have low rates of poverty, and have high standards of living. These nations are regarded to be developed nations. These nations are regarded as being developed and advanced in their respective fields.
• It is not unusual for a nation to be deemed to be developing if it has lower levels of industrialization, higher rates of poverty, and a significant dependency on agriculture. These characteristics are all indicators of the country’s situation. They are usually confronted with a number of problems, such as inadequate infrastructure and limited access to a broad array of resources. This kind of situation occurs rather regularly. [29]

Selection of Variables

Selecting variables that are relevant and that highlight the differences between industrialized countries and developing nations is an important step to take if you want to carry out a full comparative analysis. Among the most often seen variables are: [18]

Economic Indicators:

• GDP per capita
• Economic growth rate
• Employment rates

Poverty rates as a proxy for social inequality

• Educational options that are readily available
• Healthcare quality

Infrastructure Indicators:

• Easy and rapid access to many modes of transportation and communication
• Power and potable water are within easy reach.

Research Design

• Econometric models analyse the relationships between the provided variables by using a variety of econometric approaches. An example exemplifies this:
• When studying panel data across time, these models could be helpful for controlling for unobserved heterogeneity like random and fixed effects.
• Data that may be endogenous might benefit from the Generalized Method of Moments (GMM).
• To describe the data’s features and spot patterns, descriptive statistics are often used in the first stage of research.

Analytical Techniques

Statistical Analysis:

Through the use of descriptive statistics, we are able to consolidate all of the information that we have obtained on a variety of social and economic issues into a single cohesive whole. In order to arrive at some statistical findings, we will utilize regression analysis to investigate the relationship between the growth of a country’s GDP and the amount of money spent on infrastructure construction in a variety of nations. [19]

Econometric Models:

The purpose of this study is to analyse panel data over a specific time period (for example, from the year 2000 to the year 2021) using both fixed effects and random effects models in order to determine the extent to which the quality of institutions influences the financial growth of both developed and developing countries. This will be accomplished by analyzing the data over a period of time that spans from the year 2000 to the year 2021. This will make it possible for the researchers to ascertain the degree to which the quality of institutions has an impact on the expansion of the financial sector. [28]

Comparative Policy Analysis:

The objective of this project is to establish a comparative framework in order to carry out an assessment of the effectiveness of climate change policies in industrialized nations in comparison to those in developing countries. A special focus will be given throughout the evaluation on the method in which the policies are implemented as well as the outcomes that are produced as a consequence of how they are implemented. [20]

RESULT ANALYSIS

this is the situation that now exists, despite the fact that fiscal policy plays a significant part in determining the course that economic growth will follow in the future. However, the outcomes of fiscal policy in industrialized nations and developing countries are significantly different from one another in a way that is quite significant. Both nations are experiencing this phenomenon. In addition to shedding light on the differences that have been seen between these two types of countries, the objective of this study is to provide a knowledge of the mechanisms that are responsible for the influence that fiscal policy has on economic performance. This research will be conducted in order to accomplish both of these goals. Over the course of this research project, the United States of America and the United Kingdom will serve as the principal subjects of examination. The reason for this is that the study is a collection of information that was obtained from a wide range of further research studies that were conducted in the past. This is the reason why things are the way they are. [21]

Mechanisms of Fiscal Policy Impact

Aggregate Demand Management: Administration of Aggregate Demand One of the ways in which fiscal policy may be able to assist in the stabilization of the economic cycle is via its capacity to have an impact on aggregate demand. More government spending has the capacity to increase demand during times of economic crisis, while tax cuts have the power to raise private consumption. Both of these measures have the potential to enhance demand. [22]

Public Investment: Making Strategic Investments in the Public Sector Strategic public investments, particularly in sectors like as education, health, and infrastructure, have the potential to significantly boost both productivity and long-term growth. In the case of investments in research and development, for example, it has been shown that such investments support both economic growth and innovation. [23]

Microeconomic Channels

Incentives Related to Taxes: Tax incentives that are well-conceived have the potential to encourage investment in the private sector as well as advancements in productivity. Providing that the incentives are established in an acceptable manner, this is the case. It is most probable that this strategy will be successful when it is applied to industries that are the primary drivers of development, such as the manufacturing and technological sections of the economy. [27]

Human Capital Development: The allocation of public funds to education and health care is what contributes to the formation of human capital, which is of the highest relevance for the maintenance of sustainable economic growth. Human capital development is a result of this allocation. There is an evident relationship between the quality of human capital and the ability for innovation as well as the productivity of labour. This connection is a fundamental aspect of human capital. [24]

Comparative Analysis: Developed vs. Developing Countries

Developed Countries

It is common for the fundamental aim of fiscal policy in economies that have developed to a certain degree to be the maintenance of macroeconomic stability via the implementation of smart budgeting and the reduction of public liabilities. A fall in interest rates has been proven to have the potential to bring about a reduction in budget deficits, which in turn encourages private investment and consumption. This has been shown via study.

In general, the relationship between fiscal policy and growth is linear. However, the efficiency of fiscal policies may decline as the size of the government increases due to the likelihood of inefficiencies and the distortionary effects of taxes. Overall, the relationship between growth and fiscal policy is linear.

Empirical Evidence

China’s Experience: One of the most important aresa in Chine’s economic development is fiscal policy, especially local government expenditures that have exceeded central government ones. The implement of countercyclical fiscal stimulus during the global financial crises (GFC) is regarded as one of the reasons as to how recession was prevented and recovery was encouraged.[25]

Pakistan’s Case: A research done on Pakistan indicated that money and fiscal both have positive relationship with growth but money was most effective. Nevertheless, increasing efficiency of fiscals by such problems as corruption could increase its influence upon the growth.[26]

CONCLUSION AND RECOMMENDATION

Conclusion

The comparative research of the role that fiscal policy plays in economic development across rich and developing nations gives substantial insights into the ways in which government interventions may alter economic trajectories. Fiscal strategies in industrialized countries often focus on the stabilization of the economy via the implementation of countercyclical measures. These measures have the potential to boost corporate confidence and private investment. For instance, empirical studies imply that well-targeted public spending and tax changes may lead to large economic advantages. Estimates suggest that fiscal adjustments can generate up to 0.75 percentage points of growth in advanced countries such as the United States and the United Kingdom.

On the other hand, the influence of fiscal policy is often more evident in developing nations. This is because the economies of these countries are relatively more sensitive to interventions by the government. Evidence shows that good fiscal policies, particularly those focused at raising public investment in infrastructure, education, and healthcare, may considerably promote long-term economic development. This is especially true for policies that seek to increase public expenditure in these areas. Particularly noteworthy is the fact that a move away from consumption and towards productive expenditures might help develop a more sustainable growth path24. The fact that these efforts may be undermined by obstacles like as corruption and poor resource allocation, however, indicates that there is a need for enhanced governance and institutional frameworks.

Recommendation

• Improvements to Fiscal Policy Frameworks: The construction of solid fiscal frameworks that guarantee sustainable public finances should be a priority for both developed and developing nations. Among these requirements is the maintenance of a balance between the creation of income and expenditures, as well as the avoidance of large deficits that have the potential to destabilise the economy.

Concentrate on Productive Expenditures: Governments should allocate their financial resources towards expenditures that provide substantial returns, such as the development of infrastructure, education, and healthcare. This not only stimulates economic activity in the short term, but it also helps to create human capital, which is crucial for growth over the long run.

• Developing nations need to address problems of governance and corruption in order to improve the efficiency of their fiscal policies. This may be accomplished by strengthening their institutional capacities. In order to guarantee that public resources are used effectively and that they are able to accomplish their goals, strengthening institutions is essential.
• The implementation of tax reforms is something that both developed and emerging countries have to take into consideration. These changes should widen the tax base while simultaneously cutting rates on efficient investments. The use of this strategy has the potential to increase activity in the private sector and drive greater levels of investment.
• Promotion of Public-Private Partnerships (PPPs): In order to maximise the influence of fiscal policy on growth, particularly in the context of infrastructure projects, governments should encourage partnerships with the private sector. This allows for the sharing of risks associated with significant investments while having the potential to harness extra resources and knowledge.
• Policy Monitoring and Evaluation It is essential to conduct ongoing policy monitoring and evaluation in order to have an understanding of the success of fiscal policies and to make any required modifications. It is essential that governments devise transparent criteria in order to assess the influence that budgetary interventions have on the expansion of the economy.

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