The macroeconomic effects of UK tax, regulation and R&D subsidies : testing endogenous growth hypotheses in an open economy DSGE model

• Main Author: Minford, Lucy
• Published: Cardiff University 2015
• Subjects: 338.941; HB Economic Theory
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.659269

This thesis investigates whether government policy had a causal impact on UK output and productivity growth between 1970 and 2009. Two policy-driven growth hypotheses are considered: first that productivity growth is systematically determined by the tax and regulatory environment in which firms start up and operate, and second that productivity is determined by direct subsidies to business R&D. Each growth hypothesis is embedded within an open economy Dynamic Stochastic General Equilibrium (DSGE) model calibrated to the UK experience; the agents optimality conditions imply a reduced form linear relationship between policy and short-run productivity growth. Each model is tested by an Indirect Inference Wald Test, a simulation-based test which formally compares the data generated from the model with the observed data, using an unrestricted auxiliary model; the method has good power against general miss -speciation. Identi�fication is assured for the DSGE model by the rational expectations restrictions; therefore the direction of causation in the model is unambiguously from policy to productivity. Both models are also estimated by Indirect Inference. Estimation results show that the tax and regulatory policy environment did have a causal effect on productivity and output in the 1970-2009 period, when policy is proxied by an index combining top marginal income tax rates and a labour market regulation indicator. The results are robust to changes in this proxy. Likewise, the hypothesis that productivity is driven by direct subsidies to business R&D is upheld in a 1981-2010 sample, though the results are weaker. This study offers unambiguous empirical evidence that temporary changes in policies underpinning the business environment can have long-lasting effects on economic growth.