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IMF Programmes, Fiscal Policy and Growth: Investigation of Macroeconomic Alternatives in an OLG Model of Growth for Turkey

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Abstract

In this paper, we investigate the fiscal policy alternatives on domestic debt management and public expenditures on education, cohort welfare, and growth for the Turkish economy. We utilise a growth model in the overlapping generations (OLG) tradition with intertemporally optimising agents and open capital markets, calibrated to the Turkish economy in 1990s. We examine the macroeconomic effects of the current IMF-led austerity programme driven by the objective of attaining primary fiscal surpluses and illustrate the ruinous effects of constrained human capital investments due to insufficient funds to public education, and constrained real production activities due to the current mode of financing of domestic debt. We then examine various taxation alternatives to mitigate the reductions in the availability of public funds to reproducible factors of production. Our results suggest that the current fiscal programme based on the primary surplus objective suffers from serious trade-offs on growth and fiscal targets, and that an alternative public expenditures programme with the objective of reviving public funds for education and for social infrastructure is likely to produce superior economic performance.

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Notes

  1. 3 ‘Turkey's Program for Transition to a Strong Economy: Introduction’, http://www.treasury.gov.tr

  2. 4 In particular, TSEP targeted a primary surplus of 6.5% of GNP every year until 2006, and aims at reducing the net debt stock of debt to 63.9% of GNP by the end of that year. It foresees a real rate of growth of 5% for 2003, 2004 and 2005 and has assumed a nominal interest rate of 46% for 2003, 32.4% for 2004 and 27.4% for 2005. The targeted end-of-year inflation rate for wholesale prices has been set at 16.2, 12, and 8% for the same years, respectively. Thus, the programme implicitly assumes a significant real interest rate throughout implementation. See also the website ( www.bagimsizsosyalbilimciler.org ) of the Association of the Independent Social Scientists – Economists’ Group (Bağımsız Sosyal Bilimciler-Iktisat Grubu, 2001) for a set of critical assessments of the 2000–2003 economic policies.

  3. 5 A rigorous survey can be found in Aghion and Howitt (1998, Chapter 10). See also Bils and Klenow (2000), Romer (2000) and Temple (2001a, 2001b).

  4. 6 Educational spending is one of the largest expenditure categories in developed economies. In US, the average education expenditures is just under 7% of GDP (Bowles, 1999). Public and private expenditures on educational institutions accounts for over 6%, or roughly $1550 billion of the collective GDP of the OECD member countries each year (Temple, 2001a).

  5. 7 Perhaps the best known paper on the subject of public education is Stiglitz (1974). Among other seminal references are Glomm and Ravikumar (1992), St Paul and Verdier (1993), Fernandez and Rogerson (1995).

  6. 8 According to the Ministry of Education, in 2001–2002, in Turkey, 96% of all the schools are public schools, 98% of the schoolchildren are educated in public schools which employ 95% of the teachers: http://www.meb.gov.tr.

  7. 9 A survey of general large scale dynamic OLG models following Auerbach and Kotlikoff (1987) can be found in Voyvoda (2003, Chapter 3). Fehr (1999, Chapter 1) provides a beneficial survey of dynamic approaches to fiscal policies.

  8. 10 No bequest motive either in the form of physical or human capital (education) is a strong simplification given the effect of intergenerational altruism on capital accumulation of the economy and given the behaviour of a typical Turkish household.

  9. 11 The generic formulation is adopted from Glomm and Ravikumar (1997). Because the focus is on fiscal policy and the distinction between government productive and unproductive expenditures, the human capital accumulation function in Equation (1) is chosen.

  10. 12 Such a specification of the human capital production function creates a dynamic externality between generations as pointed out by Lucas (1988). Empirically, Borjas (1992) presents evidence for human capital externalities by showing that the average level of human capital of the previous generations positively affect the current generation's productivity level. This specification leads to a sustained growth path despite the constant returns to scale technology of the economy. Thus, human capital accumulation in this model constitutes the ultimate driving force of growth in the model. See Romer (1990, 1992) for more exposition and see Jones (1997) for a critical assessment of the human capital led specifications of sustained growth.

  11. 13 The period of education is assumed to bring no utility to the agent.

  12. 14 Here, the current period utility function u(c) is continuously differentiable, strictly increasing, strictly concave and homothetic. It turns out that the homotheticity of u allows a balanced growth path under labour-augmenting technology. See Caballé (1998).

  13. 15 Cobb–Douglas function in a numerical model is regarded as a plausible specification. Stokey and Rebelo (1995), for instance, report that the elasticities of substitution in production are rather insignificant for the quantitative impact of fiscal experiments.

  14. 16 We resort to this specification to avoid making ad hoc assumptions regarding public sector's saving and investment decisions.

  15. 17 The deterministic setup of the model avoids incorporation of any risk-premium or arbitrage on government debt. The interest rate of the model is equal to the marginal productivity of capital.

  16. 18 This should not be considered as a secondary market though, under the assumption of zero profits for the intermediary.

  17. 19 The choice of the ‘base-year’ in this initial ‘fitting’ procedure is crucial. Since an ‘equilibrium path’ is assumed, the base-year should not be a point of ‘structural break’ or coincide with a period of ‘high-frequency’ business cycles.

  18. 20 The model is calibrated with a given amount of foreign debt at this initial steady-state growth path. Buiter (1981) shows that current account deficit is possible along a balanced growth path in a one-good OLG model.

  19. 21 For comparisons of capital share parameter in OECD counties, see Hviding and Mérette (1998). They report values for α between 0.24 and 0.54 under a similar type of production function,

  20. 22 The estimates of αand β are consistent with the values from other studies on Turkey. See Selçuk (1997) and Mercenier and Yeldan (1999). The value of γ is taken to be consistent with the recent estimates. See Attanasio and Weber (1995).

  21. 23 We have chosen a higher rate of depreciation to reflect that a developing economy might not be that effective in passing the externality across generations, over time.

  22. 24 Because we assume no public investment, the variable under consideration at this step is the government expenditures in each period, generating the path of the government debt stock through 1990s.

  23. 25 Note that the parameter representing the share of government productive spending is one of the crucial parameters of the model since the fiscal policy alternatives analysed inevitably depend on the choice of the government funds available for bringing about the accumulative factors of production.

  24. 26 The question of how the economy would be able to transfer gains in the fiscal balances into real production activities and growth creates an additional ambiguity for ‘PSP’.

  25. 27 The assumption in carrying out the welfare analysis is that neither current nor the future generations involved in the analysis are obliged to bear any effects of the policy maneuvers to reduce the debt/GNP ratio.

  26. 28 Note once more that the interest rate is elementally equal to marginal productivity of capital in the model.

  27. 29 In a similar model, we ask the question of by how much should the tax rate on wage incomes had to be increased to obtain the amount of revenue as in a ‘WTP’ scenario with a 5% additional tax rate on wealth incomes. The finding is that the wage tax rate had to be increased by 60% over its current level in order to generate the same amount of revenue obtained form the implementation of wealth tax.

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Authors and Affiliations

  1. Bilkent University, Ankara, Turkey

    Ebru Voyvoda & Erinç Yeldan

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  1. Ebru Voyvoda
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  2. Erinç Yeldan
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Additional information

A previous version of this paper was presented at the VIth METU International Conference on Economics, Ankara, September, 2002. We are grateful to Marcelle Mérette, Jordi Caballé, Oktar Türel, Erdem Başçi and Serdar Sayan for their advice and suggestions and to colleagues at Bilkent and participants of the above conference for their valuable suggestions and comments on earlier drafts of the paper. We have also benefited from discussions with Irma Adelman, Xinshen Diao, Terry Roe, Özlem Onaran and Refet Gürkaynak. All usual caveats, of course, do apply.

2 See Akyüz and Boratav (2003), Boratav et al. (2002), Yeldan (2002), Ertuğrul and Selçuk (2001), Metin et al. (2001), Cizre-Sakalldoğlu and Yeldan (2000, 2002), Kepenek and Yentürk (2000), Uygur (1996), and Ekinci (1998) for a thorough overview of the post-1990 Turkish macroeconomic history. For the deterioration of fiscal balances see San (2002), Konukman et al. (2000), Özatay (1999), Türel (1999), Selçuk and Rantanen (1996), Atiyas (1995), and Zaim and Taşkιn (1997).

APPENDIX: A NOTE ON SENSITIVITY ANALYSIS ON MODEL PARAMETERS

APPENDIX: A NOTE ON SENSITIVITY ANALYSIS ON MODEL PARAMETERS

In order to test the sensitivity of the model results to the values adopted for structural parameters, we conducted a revision of the policy scenarios using a wide range of parametric values. We briefly summarise our findings in this appendix.

(1− δ ): human capital depreciation rate

Calibrating for a smaller value of δ (0.04): A reduction in the value of this parameter reduces the sensitivity of the consequences for growth of a reduction in public spending. Yet, the trade-off between fiscal and growth targets is still visible. The lower depreciation rate for human capital contributes to production of effective labour at a higher rate, thus higher growth rate under ‘PSP’ is observed. Nevertheless, because of the same reason, programmes that are effective in mitigating the reductions in the public ‘productive’ spending offers higher growth rates. But, the stabilisation of debt under ‘HP’ takes a longer time and a higher level of debt stock/GNP ratio (see Tables A1 and A2).

Table a1 Sensitivity analysis: ratio of deviation from the primary surplus programme
Full size table
Table a2 Sensitivity analysis: debt stock/GNP ratio and growth rate
Full size table

λ : effective rate of public education investment

This parameter can be regarded so as to represent the quality of public investment on effective labour. Given the stock of labour in the initial year (in efficiency units of labour) and the level of public educational spending, λ is one of the calibrated parameters of the model, in relation to the human capital depreciation rate, δ. Thus, for a given level of labour stock, δ and λ move together so as to satisfy equation (2) in the model. Therefore, if δ is reduced from its current value of 0.2 to 0.04, in calibration, λ takes a higher value.

If, for instance, for a constant level of δ (0.04), λ is increased by some 10% from its calibrated level, indicating an increase in the effective rate of public investment, then all programmes improve (compare sections II and III in Table A2). For a constant level of δ, an increase in λ raises the productivity of the upcoming generations, leading to higher growth rates. Yet, alternative programs ‘WITP’, ‘WTP’, and ‘HP’ improve more significantly then the case with a lower λ (see Table A1).

α : capital income share

If we test the model's sensitivity with respect to a higher level of α, thus a higher level of capital income share, we observe that cuts in education spending under the ‘PSP’ would have less severe impact on economic growth. Furthermore, due to the ‘relaxed’ investment opportunities under alternative programmes, the stated dilemma between fiscal austerity and growth deepens (see Tables A1 and A2).

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Voyvoda, E., Yeldan, E. IMF Programmes, Fiscal Policy and Growth: Investigation of Macroeconomic Alternatives in an OLG Model of Growth for Turkey. Comp Econ Stud 47, 41–79 (2005). https://doi.org/10.1057/palgrave.ces.8100065

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