The Causal Relationship Between Government Revenue and Spending

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JOURNAL ECONOMICSAND FINANCE 9 Volume28 9 Number 2 9 Summer 2004 OF

THE CAUSAL RELATION BETWEEN GOVERNMENT REVENUE AND SPENDING: EVIDENCE FROM EGYPT AND JORDAN By Bassam AbuAI-Foul and Hamid Baghestani* Abstract In investigating the causal relation between government revenue and spending, our empirical results support the tax-and-spend hypothesis for Egypt and the fiscal synchronization hypothesis for Jordan. Breaking away from these historical trends is essential for both countries to eliminate the budget defa:it and therefore ensure the availability of domestic saving for private investment. To cope with unemployment and poverty, continuing privatization is recommended for both countries to improve productivity and efficiency in the domestic economy. Privatization should lead to higher domestic saving and investment and at the same time eliminate the budget deficit by enhancing revenue and curbing spending. (JEL H62, 1"163)

Introduction
The purpose of this paper is to investigate the causal relation between government revenue and spending for Egypt and Jordan. Given their fiscal circumstances, our investigation should help determine proper reforms for these countries to cope more effectively with their current economic challenges. A crucial challenge facing Egypt is unemployment. According to current official estimates, unemployment of about 8 percent is accompanied with an annual growth rate of 3 percent in labor force. To reduce unemployment to more manageable levels, it is estimated that Egypt needs to achieve a healthy and sustainable annual growth rate of at least 6 percent in real GDP. l In an attempt to reach this goal, Egypt has utilized a private-sector-led growth policy. Privatization and transition to a market economy are intended to improve productivity, efficiency, and competition in the domestic economy. However, the low levels of domestic saving and investment create an impediment for economic growth in Egypt. Improvements in the domestic saving rate stem from improving productivity, which, in turn, makes privatization an important factor in reducing unemployment and poverty. Promoting a more efficient pension system, restructuring the financial system, and further developing capital markets have provided additional ways to increase the domestic saving rate. Eliminating the budget deficit is a further step to ensure the availability of domestic saving for private investment. To this end, it is essential for the government to implement policies that reduce and eventually eliminate the budget deficit. It is therefore the aim of this paper to offer such policy actions, using the evidence on the causal relation between government revenue and spending in Egypt. Unemployment is also a crucial challenge facing Jordan. According to current official estimates, unemployment of about 15 percent is accompanied with an annual growth rate of 4-5 percent in the labor force. It is estimated that Jordan also needs a healthy and sustainable annual growth rate of at

* Bassam AbuAI-Foul,Departmentof Economics and Public Administration,American Universityof Sharjah, Sharjah, United Arab Emirates, babufoul@aus.ac.ae;Hamid Baghesteni, Department of Economics and Public Adminislration,American Universityof Sharjah, Sharjah, United Arab Emirates, hbagheslzni@ans.ac.ae.The authors gratefullyacknowledgethe commentsof an anonymousrefereeon an earlierdraftof this paper. l See the WorldBankGroup(2001).

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least 6 percent in real GDP to stabilize unemployment.2 To encourage economic progress, Jordan has focused on a private-sector export-oriented growth strategy. The government has aggressively pursued privatization of most public enterprises in transportation, electricity, water, and telecommunications. In addition to increasing efficiency, productivity, and competitiveness of privatized companies, the aim has been to encourage...
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