Ricardian Equivalence: Some Macro-econometric Tests for Pakistan

The Ricardian Equivalence Hypothesis (REH) since resurrectedby Barro (1974) states that deficit fmancing and taxation produce thesame intertemporal allocation of consumption. To establish his theorem,Barro has to make a number of restrictive assumptions such as: allgovernment revenue is collected by lump-sum taxation, debt is believedto be eventually repaid, capital markets are perfect, there is nouncertainty and agents are 'effectively' infinite-lived. To motivate thelast assumption, Barro shows that because of purely altruistic motives,the agents derive utility from the welfare of their children and theirgrandchildren and so on such that through the inter-generationaltransfers, they act virtually like the infinitely lived. With thepublication of Barro's seminal paper, a flood of theoretical andempirical literature on Ricardian Equivalence has emerged whiCh waspublished mostly in the 1970s and 1980s. A complete review of theliterature is not possible. However, it must be pointed out that not asingle study to the author's knowledge, has appeared dealing withdeveloping countries. Kochin (1974); Aschauer (1985); Kormendi (1983);Leiderman and Razin (1988) have produced empirical support for theRicardian Equivalence Hypothesis using data on USA, Canada and otherdeveloped countries. On the other hand, Buchanan (1986); Brennen (1987);Modigliani, Jappali and Pagano (1985); Feldstein (1976); Feldstein andElmendorf (1987); Haque (1988); Buiter and Tobin (1980); Poterba andSummers (1988) produce evidence which is generally inconsistent with thebasic logic of the Ricardian Equivalence Hypothesis. The overall reviewsof the debate are presented in Bernheim (1987); Boskin, Flamming andGorini (1987); Bernheim (1989) and Leiderman and Blajer (1988), whichgenerally come to the conclusion contradicting the fmdings of theRicardian Equivalence Hypothesis. A comprehensive review of REHliterature is given in Kazmi (1991).