Does More Consumption Promote Real GDP Growth?
| Author | Lan‐Hsun Wang,Mao‐Lung Huang,Shu‐Yi Liao |
| Date | 01 July 2019 |
| Published date | 01 July 2019 |
| DOI | http://doi.org/10.1111/sjpe.12189 |
DOES MORE CONSUMPTION PROMOTE
REAL GDP GROWTH?
Shu-Yi Liao*, Lan-Hsun Wang** and Mao-Lung Huang**
ABSTRACT
This paper employs Hansen’s (1999) panel threshold regression model [Journal
of Econometrics 39 (1999) 345–68] based on a time series dataset of 109 coun-
tries from 1960 to 2007 to investigate the threshold relationship between the
change in real GDP per capita and the consumption size (consumption-income
ratio, APC). The results show that the consumption level should not exceed the
49.68% threshold of real GDP per capita for each country regardless of the
income level. Also, the relationship between the change in real GDP per capita
and the consumption size seems to have ‘Armey curve’ or ‘inverted-U shape’
characteristic. In order to promote real GDP growth, our results suggest that
the high-income, low-APC countries should encourage more consumption while
the low-income, high-APC countries should encourage more saving.
II
NTRODUCTION
The Great Depression of the 1930s not only induced economic recessions but
also changes in macroeconomic policy to affect aggregate supply and aggre-
gate demand. From that time on, Keynesian economics gradually replaced the
Classical theory and became the main policy tool in the world. According to
Keynesianism, one of the main reasons for the economic collapse was the lack
of aggregate demand, and thus national policymakers were able to adopt a
so-called expansionary fiscal policy to create the multiplier effect, which means
that an initial amount of spending will be able to induce more consumption
spending to stimulate GDP growth. However, more recent expansionary poli-
cies especially in the late 20th century appeared to pose a strong challenge to
the Keynesian school because the underlying ideas have been failed to turn
back the economic decline and even worsened economic activities. For exam-
ple, during the 1990s, the Japanese government had implemented at least 10
fiscal expansion policies totaling more than 100 trillion yens to bring the econ-
omy away recession. However, each package failed to stimulate consumption
and instead resulted in an increase in the unemployment rate combined with a
huge public debt, which exceeded 200% of Japan’s GDP. Clearly, the
*National Chung Hsing University
**Tainan University of Technology
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12189, Vol. 66, No. 3, July 2019
©2018 Scottish Economic Society.
384
expansionary fiscal policy gave rise to some serious doubts. In order to deter-
mine the reasons for these developments, many studies have examined the
effects of government expenditures on GDP (e.g., Ram, 1986; Hsieh and Lai,
1994; Chen and Lee, 2005; Connolly and Lai, 2016). Nevertheless, very few
studies have sought to tackle the relationship between GDP growth and con-
sumption spending. Therefore, the main purpose of this paper is to explore
the relationship between consumption and real GDP growth and suggest how
countries can promote their real GDP growth under various consumption
spending conditions.
In a similar vein, efforts devoted to stimulate consumption can also give
rise to an increase in private debt and even weaken future spending power. In
fact, the GDP account can be broken down into consumption expenditure,
investment, government spending, and exports and imports. As mentioned
above, an expansionary fiscal policy may not necessarily succeed in promoting
economic growth, but instead the additional government expenditure may lead
to big fiscal deficits. Therefore, overspending may not only result in huge
debts but also reduce future income growth. Since the last two decades, in
order to increase real GDP growth, many countries have been adopting a
loose fiscal-loose monetary policy mix, a so-called ‘Intertemporal Policy Mix’,
to increase willingness to consume and invest.
Although some countries have succeeded in promoting short-term real
GDP growth, the additional spending has also resulted in more debts for the
private sectors and the government as well. During the last two decades, the
intertemporal policy mix gradually caused several financial crises worldwide,
such as the 1997 Asian financial crisis, the 2007 U.S. sub-prime mortgage cri-
sis, the 2008 Icelandic financial crisis, the 2009 Greek debt crisis, and the 2010
Dubai debt crisis. In other words, due to the huge amounts of debt incurred,
overconsumption can weaken the future spending power, while overinvestment
can induce financial speculation in commodities and create an economic bub-
ble.
Despite the failure of the intertemporal policy mix mentioned above, several
countries continued to adopt expansionary fiscal policy to encourage private
consumption and investment and avoid economic recessions. For example,
Taiwan’s legislature approved a special budget of US$2.6 billion to implement
a consumption vouchers policy in 2008. China and the United States also
announced successive launchings of a US$585 billion pro-active fiscal policy
and a US$787 billion economic stimulus plan in 2009, respectively. Several
scholars have made it clear that if funds for government expenditure are
financed via public borrowing, the government sector will face a heavy finan-
cial burden in the future. In other words, the greater the current level of debt,
the weaker the future consumption will be. This means that debt-financed
government spending could seriously damage long-term economic growth.
To examine the argument of what can cause the expansionary fiscal policy
to fail, many studies had tried to investigate whether the consumption–income
ratio, or the so-called average propensity to consume (APC), is stationary
(mean reverting) or non-stationary (non-mean reverting). The former means
DOES MORE CONSUMPTION PROMOTE REAL GDP GROWTH? 385
Scottish Journal of Political Economy
©2018 Scottish Economic Society
To continue reading
Request your trial