Fiscal Policy Interaction with Private Investment: the Case of the Baltic States

Abstract

Government's role in promoting the country's economy remains a relevant issue both in academics and politicians debates. Not only for individual countries but also for the European Union as a whole the promotion of high value-added activities, in particular in lower development small open economies which hardly recover from external economic shocks and experience significant social problems due to high unemployment level remains a relevant issue. The country's competitiveness and level of development, as well as the country's economy growth, depend on high value-added investment growth, and both private and public investments play a significant role in economy of each country. Government's role, in particular through the fiscal policy, in the promotion of these activities is crucial. The prevailing view in the scientific literature is that in developed countries public investment crowds out private investment, while in developing – crowds in, but it is not clear under what conditions these effects occur because the countries are very different. Also the effect of the taxes revenues and the government expenditure indicators on private investment is unclear because the effect of these variables on private investment has not been studied comprehensively. So the aim of the research is to evaluate the relationship between fiscal policy indicators, such as the government revenues from taxes and the government expenditure, and private investment comprehensively including indicators of macroeconomic environment in the Baltic States, by applying correlation and regression analysis.

The conducted research revealed the existence of strong direct relationship between the fiscal policy indicators and private investment in the Baltic States, showing the importance of fiscal policy to private investment. During the analysis of detailed tax and expenditure indicators it has been established that the strongest relationship exists between the current taxes on income, wealth, etc and public investment with private investment. The current taxes on income, wealth, etc indicator explains about 86 percent of the private investment fluctuations and the gross fixed capital formation by public sector indicator explains about 80 percent of the private investment fluctuations in the Baltic States, whereas the effect of these indicators on private investment is analyzed separately, while macroeconomic indicators of a country explain only about 8-13 percent of the private investment fluctuations.

DOI: http://dx.doi.org/10.5755/j01.ee.23.3.1934