At Exploring Happiness, at the end of 2019 we made the decision to reduce the frequency of our research article publications from monthly to quarterly, with the aim being that this would allow more time to produce unique and insightful research. This article is the first of these quarterly publications, and it is focusing on assessing the relationship between public finances and countries wellbeing.
Some governments believe that it is necessary to have a high level of government spending in order to provide a helping hand when things don’t go so well. In order for this to remain sustainable over a long period of time, government taxation also needs to be quite high in these countries, as this is used to fund the spending. However, in other countries they believe that is not the place for governments to get too involved and that the market will sort itself out in the end. In this article we are looking to assess which of these two approaches tend to lead to a greater level of wellbeing for its citizens, based on the data we have available. Importantly, we are not suggesting that there is a clear direction of causation in our analysis but we are looking to bring together the data and make inferences based on the relationships we observe.
Additionally, before we get into the detail our of study there is one key point that we would like to make clear: policy design matters much more than absolute spending or taxation. This matters now more than ever, as at the time of writing this, advanced economy governments all around the world are announcing significant stimulus packages in order to help combat the COVID-19 pandemic. As a result, we should expect to observe a significant increase in government expenditure as a percentage of GDP. These stimulus packages are currently necessary, in order to restore confidence, reduce the amount of people being laid off and the number businesses going into insolvency. However, whilst necessary, they are not likely to be well designed. These policies are more a case of throwing significant sums of money at the problem than anything else. It will not be efficient and much of this spending will have limited knock-on effects on the economy. Well-designed government policies considers how the government can play a role in the market in order to allow innovation to develop, in an environment that is stable and secure.
The relationship between countries wellbeing scores and their governments finances
In order to complete our analysis, we needed to merge two datasets. To get wellbeing scores for all countries around the world we used the recently updated data from the UN’s World Happiness Report. To get public finances data, we used the data published in the IMF’s October World Economic Outlook. We then needed to filter for all countries that had both sufficient public finances data (>10 years) and that are included in the UN’s World Happiness Report and as such our final sample came to 146 countries
We chose to also complete the analysis on a smaller sub-group of advanced economies (AE) in order to remove some of the income effect and allow for a more consistent comparison across countries. It is well known that more developed economies have higher wellbeing scores, meaning it is difficult to draw accurate conclusions when comparing countries with vastly different economic circumstances. Our main goal is to find a large enough group of countries that are similar in nature and wealth but choose to take different approaches for their public finances in order to observe how these different approaches may affect their citizens wellbeing.
We have summarised our key findings from our data analysis in the following points:
Countries with larger public debt-to-GDP ratios tend to report lower wellbeing scores. There is a small and positive correlation equal to 16% for the all country sample compared to a much stronger negative correlation equal to -63% for the AE sub-sample. More developed countries are able to accumulate greater amounts of debt as a proportion of GDP than developing ones and this has created the positive correlation in the all country sample. This is an example of the income effect dominating, due to richer countries reporting higher wellbeing scores. The income effect is removed in the AE sub-sample and the correlation coefficient becomes significantly negative.
Countries that are able to manage their public finances better, through fiscal surpluses, or small fiscal deficits tend to report higher wellbeing scores. The correlation coefficient for the all country sample is equal to 25% compared to 39% for the AE sub-sample.
Countries with higher government revenues and expenditure, as a proportion of GDP, tend to report higher wellbeing scores. The correlation coefficients are slightly larger for the all country sample, which is likely due to the income effect playing some role here too. AE’s tend to find it easier to extract greater amount of tax revenues from their citizens, due to low income countries shadow economies being proportionally larger and that their government institutions are less sophisticated. Nevertheless, there is still a relatively strong positive correlation in the AE sub-sample, meaning the income effect doesn’t significantly change this relationship.
AE’s countries that have run larger fiscal deficits over the last 10 years have reported greater increases in wellbeing scores over that same time period than AE’s who have put in place more stringent fiscal policies. This is a small amount of evidence to suggest that countries that have put in place austerity policies since the previous financial crisis may have constrained their citizens wellbeing during this time.
This is all discussed in greater detail in the full article below and we have explained some of the key concepts in the video above too.