Effects of institutional quality and public expenditure on economic growth nexus in a small open economy

Abstract

This research aims to analyze the influence of institutional quality on the relationship between economic growth and public expenditure in a small open economy. This research uses the autoregressive distributed lag (ARDL) methodology. The results showed that (1) institutional variables have a significant and positive moderating effect on the relationship between public spending and economic growth; (2) lending rates that are too high hurt economic growth because they keep the private sector from borrowing money; and (3) inflation rates that are too high hurt economic growth rates. In optimizing the moderating impact of institutional quality on the relationship between public expenditure and economic growth, the government should adopt policies that build strong institutions through consistency in upholding the rule of law. Specific and concrete policy recommendations include a need to address the endemic problem of corruption, boost the economy’s industrial productivity, stimulate private sector investment participation in the economy, moderate excessive lending rates, and encourage the crowding-in of the private sector so that the private sector can readily access funding for business expansion.