The Analysis of the Effect of Government Expenditure and Balance

of Payment on Indonesian Economic Growth

Muhammad Nasir and Eddy Gunawan

Faculty of Economics and Business, Syiah Kuala University, Banda Aceh, Indonesia

Keywords: Government Expenditure, Balance of Payment, Economic Growth.

Abstract: This research is aimed to analyze the effect of government expenditure and balance of payment on economic

growth in Indonesia. The data used in this research is secondary time series data on government expenditure,

balance of payment, and economic growth in Indonesia during the period of 1990 until 2017. Model of

analysis used in this research is Auto regressive Distributed Lag (ARDL). This model is regression model that

includes not only the value of variable explain current situation but also the value of the previous years. The

research results show the government expenditure for the current year and one year before affects GDP with

the probability of alpha 1 percent. Meanwhile balance of payment for current year affect GDP only at

probability of alpha 10 percent, but the balance of payment for one year before has the effect on GDP at 5

percent of alpha. Based on the Long run test it is found that both government expenditure and balance of

payment variables do not significantly affect GDP. Meanwhile for the Short run test it is found that

government expenditure has a negative and significant effect on GDP at 5 percent of alpha. So far, the variable

of balance of payment also has negative and significant effect on GDP at 1 percent of alpha. It is hoped that

this research can contributes and gives policy recommendation to the Government of Indonesia in the effort

to increase economic growth and welfare of the people.

1 INTRODUCTION

During many years, the rate of global economic

growth has increased compared to the previous

periods. It seems there the contrast between

developed and developing countries. The economy of

developed countries is better compared to the

developing countries. On the other hand, developing

countries run with stable growth in terms of economic

growth.

In terms of economic indicator especially the

inflation rate, Indonesia experiences the increase in

inflation rate above 5 percent since year 1970 up to

economic crisis period. Not only in term of inflation

rate, has the unemployment in Indonesia also showed

increasing trend. In response to the economic

performance shown by economic indicators,

Indonesian government undertaken the

macroeconomic policy in order to foster economic

growth. This has been undertaken using both fiscal

and monetary policies.

The Indonesian government policy has also

focused on public finance sector via the control in

government revenues and expenditures. Not only in

Indonesia, had majority of developing countries put

more attention on budget deficit that becomes greater.

The increase in budget deficit usually comes from

reduction in government revenues. The increase in

budget deficit is also aimed to force economic growth

via fiscal policy in each country.

Suhartoko (2013) studied the relationship

between budget deficit and balance of payment or

well known by twin deficit. Traditional paradigm

according to him predicted that there is no correlation

between budget deficit and international balance of

payment.

Furthermore, Baharumshah et al. (2017) studied

the sustainability of fiscal policy in Malaysia. The

result shows that the former fiscal policy makers had

followed sustainable fiscal policy except when the

economic crisis during short period. In this case, the

government have to reduce the deficit if it exceed the

certain level I order to ensure the sustainability in

long-term. Specifically, it is found that the public debt

after it exceeds 55 percent than gross domestic

product (GDP) will have negative correlation with

economic activities.

480

Nasir, M. and Gunawan, E.

The Analysis of the Effect of Government Expenditure and Balance of Payment on Indonesian Economic Growth.

DOI: 10.5220/0009259204800484

In Proceedings of the 2nd Economics and Business International Conference (EBIC 2019) - Economics and Business in Industrial Revolution 4.0, pages 480-484

ISBN: 978-989-758-498-5

The development process in developing countries

is undertaken with greater government expenditure

compared to government revenue. Thus it needs more

budget with greater external debts in order to fill the

budget deficit. Suhartoko (2013) explained the close

relationship between primary budget deficit with real

economic growth with the correlation coefficient as

much as 0.6.

Based on the data from International Financial

Statistic (2018), it shows that balance of payment

indicates the positive correlation with GDP. This can

be proven by the Indonesian data for the period of

2004 to 2017 with the fluctuation. In year 2004,

Indonesian balance of payment was USD 1,563

billion with GDP growth rate as much 5.03 percent.

Then, in year 2009, the GDP had declined to be 4.62

percent but with the increased in balance of payment

to be USD 10,628 billion. Then for the next many

years, the GDP continuously fluctuates whereas the

balance of payment experience deficit.

The government policy in financing economic

development using debt especially external debts thus

only benefit in the initial time of development. Thus,

beside government put attention on economic growth,

the future government debt also has to be considered

by the government.

There are many researches on the fiscal policy

and national such as the research by Badinger (2017),

Baharumshah (2017), and Badinger (2015). This

research put more focus on deficit budget. Secondly,

the researcher does not find the study on balance of

payment and economic growth in Indonesia.

Based on those research background and

literature reviews, majority of research put more

attentions on fiscal policy and national debt and also

the movement in international trade. The research on

government expenditure and balance of payment are

still limited. Thus based on the above research

background the researcher would like to study about

“The Effect of Government expenditure and Balance

of Payment on Indonesian Economic Growth”.

2 LITERATURE REVIEW

Economic growth is defined as the change in

economic activities in the economy that cause the

goods and services produced increases (Sukirno,

2013). Conventionally, the economic growth of one

country can be measured by the percentage increase

in gross domestic product (GDP). It is also applied for

regional economic growth by using the percentage

increase in gross regional domestic product (GDRP).

By measuring economic growth, it is also can be used

in evaluating the effectiveness of the economic

policies.

GDP is one of the best measures in evaluating

economic performance of one country. The aim of

GDP is summarizing the economic activities in

certain monetary unit during certain period of time.

GDP can be measured using two approaches those are

income and expenditure approaches (Mankiw, 2007).

The economy basically saves a certain amount of

national income in order to increase capital goods that

are not out of order. But, in order to foster the

economic growth, it is needed new investment that is

the additional in net capital stocks. This theory states

that investment affects aggregate demand via

increasing in production capacity. In this case the

government expenditure has the role as one of

investment given by the government in induce

national income.

According to Ilyas (1989), the government

expenditure relates to all of the expenditures that

aimed to increase the welfare of overall society.

Furthermore, according to Soediyono (1992),

government consumption expenditure that usually

called government expenditure or government

purchase includes all of the expenditures where the

government directly receives the compensation. In

Indonesia, the government expenditure is allocated in

National Budget (APBN) or Regional Budget

(APBD). Every year, the budget is allocated into

many sectors via the development program and

activities (Suparmoko, 1998).

Furthermore, balance of payment can be defined

as the systematic account that record the transaction

undertake by the citizens include the organization and

private sectors with foreign citizens in the period of

one year. Balance of payment is useful because it

shows the structure and composition of economic

transaction and also international finance of one

country. On the other hand, balance of payment is

also the important indicator about the situation of the

economy of one country.

When the balance of payment of a country deficit,

this means that the citizens of the country has to pay

more for the foreign citizens compared to the income

from the payment of foreign citizens. Whereas the

surplus shows vice versa condition. In addition,

International Monetary Fund (IMF) and World Bank

use balance of payment indicator as one of indicator

in loan giving decision for a country.

The deficit of balance of payment is also can be

caused by the domestic inflation. If the balance of

payment experiences deficit then the international

companies in the country have to adjust with the

condition such as price, inventory, and stock

The Analysis of the Effect of Government Expenditure and Balance of Payment on Indonesian Economic Growth

481

adjustment. The government has to undertake the

policy in anticipating trade deficit by market

measures and non-market measures. The market

treatment is undertaken in order to anticipate deficit

such as currency evaluation. Meanwhile Non-market

treatment is such as tariff, quota, and currency

control.

So far, there are many studies about the relation

between government expenditure, balance of

payment, and economic growth. Badinger (2017) in

his research estimated the impact of fiscal institution

on fiscal policy result, and also issues relate to the

measurement and endogenity with new method. The

result showed that the countries with tight fiscal

policy have high fiscal account and low output.

Lelis et al. (2018) found that the balance of

payment is the problem for the economic growth in

Brazil that cover the ratio between export and import

income elasticity. Lelis et al. (2018) also found that

export is more sensitive upon the change in real

exchange rate.

On the other hand, Fatas et al. (2006) argued that

the limitation in the budget cause low policy volatility

and the limitation of fiscal reduces the response of

fiscal policy on output shock. Fasanya et al. (2018)

also found that import is cointegrated with relative

price and income, and the optimal level of economic

growth.

Furthermore, Maulana (2015) also studied the

effect of foreign investment, net export, and deficit

budget policy on the economic growth of ASEAN

countries. The result shows that Foreign Direct

Investment (FDI) and net export have a positive and

significant relationship on economic growth in

ASEAN countries. Whereas the variable of

government budget deficit has a negative and

significant affect on the economic growth ASEAN

countries.

Nizar (2013) studied twin deficit from perspective

balance of trade with VAR method. The result shows

that budget deficit caused the increase in government

expenditure by 1 percent of GDP that cause the

equilibrium of balance of trade change.

3 METHODOLOGY

This research is aimed to verify and analyze the effect

of government expenditure and balance of payment

on economic growth in Indonesia both in long-run

and short-run. Meanwhile the urgent of the research

is to give the policy recommendation to the

government both regional and national on how the

effect of government expenditure and balance of

payment on Indonesian economic growth.

Furthermore, the innovation is hoped is the policy

recommendation in the effort to increase economic

growth and the welfare of society.

The scope of this research is Indonesia. The

variables used are GDP as the dependent variable,

meanwhile government expenditure (GE) and

balance of payment (NP) as the independent

variables. The focus of methodology is on the effects

of the variables. So far, the researcher also test and

verify the causality relationship between government

expenditure and economic growth in Indonesia.

In order to analyze the data, the data used is time

series data that covers government expenditure,

balance of payment, and economic growth during the

period of 1990 to 2017. The data sources are from

Indonesia Statistic Board (BPS), World Bank, and

other institutions.

The model used in this analysis is Auto

Regressive Distributed Lag Model (ARDL). This

model is the regression mode that can explain well the

economic variables. Meanwhile, the Auto Regressive

Distributed Lag Model is the regression model that

ensure not only the current variables but also the

previous one with the model of distributed lag model

with introducing one or more in the variables in the

past (Gujarati, 2003:233). Thus the ARDL Model in

this research is:

The form of ARDL:

∆

LNPDB =



+ ∑







∆

LNPDB





∑







∆LNGE



+∑







∆LNNP





LNPDB



+ϴ



LNGE



+ϴ



LNNP



+ e

,

…….............................................(1)

Where LNPDP is natural logarithm of economic

growth that is measured in term of percent, LNGE is

natural logarithm of government expenditure that is

measured in term of the amount of government

expenditure in billion rupiah per year, and LNNP is

natural logarithm of balance of payment.

4 RESULTS AND DISCUSSIONS

Based on the estimation procedures as explained in

the research method, the first step undertaken is

stationarity test in order to verify whether the

variables are stationary at level i.e. I(0), first different

i.e. I(I) or second different i.e. I(2). According to

stationarity test using Philips Perron (PP) test, thus

the results of stationarity is as in Table 4.1 below:

EBIC 2019 - Economics and Business International Conference 2019

482

Table 4.1 The Results of Stationarity Test Based on

Phillips-Perron test statistic

Variable

At Level First-Difference

Results

Prob.* Prob.*

GDP 0.0104 0.0000

I(0)

LOGBP 0.5734 0.0001

I(I)

NP 0.5254 0.0014

I(I)

Note: Significant at alpha of 0.05.

Source: Estimation Result.

Based on Table 4.1 it can be seen that there is the

difference in level of stationarity of the variables

where only GDP stationary at level, whereas LOGBP

and NP are stationary at first difference.

Furthermore, Lag Length Criteria estimation

conducted by determining optimal lag. The lag is used

in order to see the time needed for Y response. The

appropriate choice of lag can be chosen using

Schawrtz-Bayesian Criteria (SBC), Akaike

Information Criteria (AIC) or other information that

has smallest criteria. In this research the optimal lag

is chosen based on AIC value. By looking at AIC

criteria then it can be chosen the lag that gives the best

model that is at lag 1.

Table 4.2 The Result of Length of Optimal Lag (Lag Length

Criteria)

Lag LR AIC SC HQ

0 NA 57.97712 58.12438 58.01619

1 118.2003* 52.81711* 53.40614* 52.97338*

2 10.39969 52.95536 53.98616 53.22883

3 6.076845 53.27130 54.74387 53.66197

4 6.481176 53.43210 55.34644 53.93998

Source: Estimation result.

The next step is cointegration test for the model.

This test is aimed to determine whether the

nonstationary variables are cointegrated or not. Based

on Pesaran et al. (2001), the cointegration test used in

this research is Bound Test Cointegration.

Table 4.3 The Results of Cointegration Test (Bound Test

Cointegration)

F-statistics:

7.122981

Critical Values

Conclusion

ower Bound

I(0)

Upper Bound

I(1)

1% significance level

5.15 6.26

Cointegrated

5% significance level

3.53 4.42

10% significance level

2.91 3.69

Source: Estimation result.

Estimation of ARDL model conducted in this

research is to know the effect of government

expenditure and balance of payment on Indonesia

economic growth. Table 4.4 shows the estimation of

Lag model of ARDL (1 1 1).

Table 4.4 Estimation Result of ARDL Model

Note:

***

significant at 1%, 5%,10% level of alpha.

Source: Estimation Results.

Based on the estimation, it can be seen that there

are many independent variables that have the effects

on GDP those are current government expenditure

and the lag of government expenditure with the

probability of 1 percent. For the variable of balance

of payment for the current year has the effect on GDP

by 10 percent alpha, but the balance of payment for

the previous year has the effect on GDP at level of

alpha 5 percent.

The ability of the regression mode in explaining

the relation between dependent and independent

variables can be seen from coefficient of

determination as much as 0.329591. This means that

government expenditure for the current year and one

year before and also balance of payment for current

year and one year before explain the model by 32.9

percent.

The Long-run and Short-run Effects

Based on the cointegration bound test, then it is

found the long-run equilibrium in this analysis that

affects Indonesian GDP. The result of long-run and

short-run analysis can be seen by Table 4.5 below.

Table 4.5 The Long Run Model

Dependen Variable: PDB

Variable CoefficientStd. Erro

t-Statistic Prob.

LOGBP -0.442007 0.641691 -0.688816 0.4985

P 2.69E-11 7.71E-11 0.348800 0.7307

C 13.36411 8.394936 1.591925 0.1263

Note:

***

significant at 1%, 5%,10% level of alpha.

Source: Estimation results.

The Analysis of the Effect of Government Expenditure and Balance of Payment on Indonesian Economic Growth

483

The estimation results as in Table 4.5 shows that

both the variable of government expenditure and

balance of payment do not have significant effect on

GDP. But even though the government expenditure

and balance of payment do not affect GDP in the

long-run, the reality is reverse in short-run. Table 4.6

shows the estimation results for the short run.

Table 4.6 Short Run Model

enden Variable: D

(

PDB

)

Variable Coeficien

Std. Erro

t-Statistic Prob.

(

LOGBP

)

-16.47604 3.490927 -4.719676 0.0001

D(NP) -1.93E-10 8.20E-11 -2.352704 0.0285

CointE

-1

)

* -0.804832 0.141042 -5.706330 0.0000

Note:

***

significant at 1%, 5%,10% level of alpha.

Source: Estimation Results.

5 CONCLUSIONS

Based on the research findings, it can be concluded

that generally, the government expenditure for the

current year and one year before has the effect on

GDP with the probability of 1 percent. The balance of

payment in current year affect the GDP only by 10

percent, but balance of payment of the previous year

affects the GDP by 5 percent. Based on long run test,

it is found that both the variable of government

expenditure and balance of payment do not affect

GDP significantly. But for the short run test, it is

found that the government expenditure has a negative

and significant effect on GDP by alpha of 5 percent.

The variable of balance of payment has a negative and

significant effect on GDP by alpha of 1 percent.

ACKNOWLEDGEMENT

This research is part of my research project with

Assistant Professor Research Skim funded by Centre

for Research and Social Work (LPPM) of Syiah

Kuala University. The research project is under year

2019 funding resources from Syiah Kuala University

Own Income (PNBP) 2019.

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