Impact of Institutions on Budget Deficit: The Case of Pakistan

Weak institutions are root cause of mismanagement in public resources which lead to high budget deficit. In such conditions the budget deficit becomes a source of depressed economic growth, high seignorage inflation, crowding out ofprivate investment. To find the effect of institutions on budget deficit of Pakistan present study empirically investigates the impact of institutional quality on budget deficit for the period 1984 to 2014. The long-run estimates indicate that trade openness and inflation have positive effect on budget deficit. However, real per capita output has insignificant effect. Nevertheless, when the institutional variables i.e. corruption, law and order, political stability and military in politics are included in the model, real per capita output shows significant effect on budget deficit. This specifies that economic factors alone cannot determine the budget deficit of an economy. The results indicate that higher corruption, poor institutional quality and deteriorated law and order situation have can increase the budget deficit. However, political stability can have a positive effect on budget balance. It is suggested that policy makers should pay attention to improve institutions quality to improve the budget deficit.