Which among twin deficits hypothesis, twin divergence, and Ricardian's equivalence hold in a developing country?

• Date: 01 May 2019
• DOI: http://doi.org/10.1002/pa.1904
• Author: Thamaga Edwin Letsoalo,Thobeka Ncanywa
• Published date: 01 May 2019

ACADEMIC PAPER

Which among twin deficits hypothesis, twin divergence, and

Ricardian's equivalence hold in a developing country?

Thobeka Ncanywa |Thamaga Edwin Letsoalo

Department of Economics, University of

Limpopo, Sovenga, South Africa

Correspondence

Thobeka Ncanywa, Department of Economics,

University of Limpopo, Private Bag X1106,

Sovenga 0727, South Africa.

Email: thobeka.ncanywa@ul.ac.za

Funding information

University of Limpopo

South Africa witnesses the perpetual increase in budget deficit that hampers its ability

for inclusive economic growth while on the other hand facing trade balance instability.

To realise stability in the economy and sustainable yet inclusive economic growth, the

two deficits, namely, budget and trade deficits, should be closely monitored. The

study examined the empirical relationship between budget deficit and trade deficit

in South Africa in the postapartheid era, employing time series data from 1994 to

2016. The autoregressive distribution lag approach was employed to examine the

existence of a cointegration between the set of variables, both in the short‐and the

long‐run relationships and together with the error correction model. It was found that

there is a significant and positive relationship between budget deficit and trade deficit

in the short run. However, in the long run, the Ricardian's equivalence holds in South

Africa. The study recommends that policies aimed at reducing budget and trade def-

icits should take into account inflation and aim to increase some macroeconomic var-

iables such as fixed investment to ultimately achieve sustainable economic growth.

1|INTRODUCTION

The relationship between budget deficit and trade deficit represents

one of the topics debated among economists and policy makers in

both developed and developing countries (Suresh & Gautam, 2015).

Budget deficit is when government expenditure exceeds the income

of the government from taxation and customs duties from one fiscal

year (Alesina & Roberto, 1999). Trade deficit occurs when the

country's imports of goods and services exceed the country's exports

of goods and services during one fiscal year (Bernheim, 1988). An

increase in budget deficit that worsens the trade deficit is referred

to as the twin deficit hypothesis. Otherwise, if the budget deficit

improves trade deficit, it is called twin divergence hypothesis, and

Ricardian equivalence occurs when an increase in budget deficit has

no effect on trade deficit (Azgün, 2012; Sakyi & Opoku, 2016).

Countries with positive budget balance like, for instance, Qatar

enjoy inclusive economic growth. Mostly, a positive budget balance

enablescountries to investin industrial advancement,advanced universal

health care, education, and other important aspects of the economy

(Brender & Drazen, 2008). A healthy budget balance enables countries

to make decisionsthat are less costly for both presentand future gener-

ations.The greatest handicapencountered by most developingnations is

the limited tax revenuecollected from citizens, therebyforcing govern-

ment into borrowing, which leads to a budget deficit. According to

Njironge, Kosimbei, and Korir (2014), it is difficult for government to

cut spending because of its vitality for the survival of economy and its

responsibility of providing social amenities. Yet, developing countries

are characterised by their low investment activities, low industrial

advancement,and income inequality (Chipote& Tsegaye, 2014).

The two deficits have to be closely monitored to achieve stability

and inclusive yet sustainable economic growth (Stephen, Benjamin,

Francis, Njuguna, & Ngugi, 2010). The twin deficits hypothesis was first

tested in the United States in the 1980s because trade deficit and bud-

get deficit were experienced by the economy in question (Akbostanc &

Tunc, 2015). According to Baharumshah and Zubaidi (2006), most of

the developed countries, such as Sweden and Germany, also started

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This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided

the original work is properly cited.

© 2019 The Authors Journal of Public Affairs Published by John Wiley & Sons Ltd

Received: 23 October 2018 Accepted: 16 November 2018

DOI: 10.1002/pa.1904

J Public Affairs. 2019;19:e1904.

https://doi.org/10.1002/pa.1904

wileyonlinelibrary.com/journal/pa 1of8