Temas y variaciones De los tres tiempos al montaje entrelazado

The aggregate demand component in this study consists of the total consumption expenditure that can be classified into the demand of real private consumption

CPR and government consumption CGC; in addition, investment is represented by one stochastic equation, which is the non-oil private investment expenditure

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KNOILR. Finally, the imports and exports are represented by three behavioural equations viz. real imports of consumer goods IMCONR, real imports of capital goods IMCAPR and oil exports, in millions of barrels EXOILMB, and one identity, which is the oil export in millions of Libyan dinars EXOILC.

4.2.1.1 Consumption expenditure

As mentioned above, there are two consumption equations in this block, the first is the real private consumption, and the other one is current government expenditure on goods and services. A discussion of these two equations will be undertaken in the following two subsections of the model.

4.2.1.1.1 Private consumption spending (CPR)

Consumer spending is one of the most salient elements of expenditure on GDP at the macroeconomic level, in developed and developing countries alike, in line with the objective of consumption maximizing, which is considered the axis of economic activity, whereby improving the standard of living is one of the most important goals pursued by all the world economies. This importance has been clarified through the controversy that accompanied the explanation of the consumption phenomenon, whereby many authors and economists contributed in the interpreting of this phenomenon in an attempt to explain the factors that affect consumer behaviour (for more details see Ferber, 1973). Unquestionably, the debate concerning the explanation for consumption expenditure behaviour dates back to 1930s and four fundamental hypothesises have emerged since that time.

These attempts clearly started when Keynes proposed in his book (‘The General Theory of Employment, Interest Rate and Money’ that was issued in 1936) his theory of consumption, which was called the theory of absolute income (AIH). This theory has shown that disposable income is the main interpreter of

100 consumer behaviour through the interaction of some psychological factors for consumers. Keynes noticed that consumer spending depends on income level, where ‘‘men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income’’ (Ferber, 1973; 1304). This proposition was developed through casual observations whereby Keynes concluded that there is a marginal propensity to consume less than the average propensity, which became the basis of his general theory later on.

The absolute income theory (AIH) has played a major role in determining the levels of employment and income; Keynes has made this theory as one of the main parts of the theory of macroeconomics through the relationship between consumption and saving and also through the impact of saving on investment (Glahe, 1973). This theory has had the greatest impact on the emergence of many theories and applied studies, which deal with the phenomenon of consumption. Contributions made by other authors’ studies were initiated in order to test the hypotheses that were created by Keynes, on the one hand, and to develop and test new hypotheses that could fit the practical reality on the other. Furthermore, it could be argued that the essential point in the explanation of the phenomenon of consumption in all the theories and empirical studies that have emerged since the theory of Keynes have, up until now, revolved around defining the concept of income, as well as clarifying the relationship of this concept with social and psychological factors in order to explain an individual’s consumer behaviour.

At the outset, the first of these contributions was that which were put forward by Duesenberry and Modigliani independently in 1949 (Ferber, 1973) which advanced the relative income hypothesis (RIH). Duesenberry and Modigliani assumed that consumption by any person is related to relative income. They

101 separately concluded that income is relative when compared with the highest prior value of the income, taking the perspective of time series’ analysis into account. This means that consumer spending depends on the highest income in the past. Moreover, this income is relative to the position of the person in the distribution of income for his surrounding reference group which deals with cross section analysis. In fact, the first proposal for the cross section formula was by

‘‘Dorothy Brady and Rose Friedman who suggested that the saving rate of an individual depends not on the level of his income but rather on his relative position on the income scale relative to the income of a reference group’’ (Ferber, 1973; 1305).

In other words, therefore, low income does not lead to lower consumption in the short term significantly, although it increases appropriately with increasing income in the same period.

Based on the previous presentation of this theory, one can say that consumer behaviour follows the pattern of relative consumption function in the long term and the pattern of proportional consumption function in the short term.

In addition to the theory of relative income, Brown’s theory of permanent income (Brown, 1952), later demonstrated by Friedman (1957), showed that customs and traditions have control on consumers’ thinking to the extent that they affect their behaviour and then become affected by inertia. Friedman explained that absolute income (current) is not the determinant factor of consumer spending but it is determined by permanent or fixed income (𝑌_𝑃). In this regard, Friedman stated that ‘‘the consumer plans his expenditures not on the basis of the income received during the current period but rather on the basis of his long-run or lifetime income expectation’’(Ferber, 1973; 1306).

102 It is noted that permanent income can be increased or decreased regardless of the amount of measured income, which is obtained by individuals during any period. This can be happen by increasing or decreasing the temporary or transitory income (YT) which results from non-periodic and inconstant circumstances. In addition, Friedman divided, in contrast to, the above theories, consumer spending into: permanent consumer spending (CP) and transitory consumer spending (CT). Furthermore, he assumed that there is no correlation between (YP) and (YT), between (CP) and (CT), or between (YT) and (CT).

Lastly, Friedman in 1957 asserted that consumption is proportional to permanent income, i.e. consumption is a fixed percentage of the permanent income whereby

the key relationship is that permanent consumption (𝐶_𝑃) is a linear multiple

(K), of permanent income (𝑌_𝑃) . To Friedman, the multiple depends on the interest rate, on the ratio of non-human to total wealth and on a catchall variable, which includes age and tastes as major components (Ferber, 1973; 1306).

Finally, the theory of life cycle for Modigliani and his associates (Modigliani and Brumberg, 1954, and Ando and Modigliani, 1963) is one of the prominent contributions in explaining the behaviour of consumption. This theory takes into account the income during a lifetime in determining the consumption during the same period. According to the LCH,

people distribute their consumption over their life cycle in order to maximize utility during their lifetime. That means dissaving when they are just starting out, saving during peak earning years, and then dissaving again during their retirement years (Evans, 2004; 129).

103 When the consumers know the level of their income during the lifetime, accordingly, they will be able to calculate the optimal consumption at any given time by maximizing their utility function, which consists of both the current and postponed consumption (in the future).

This analysis clarifies that the wealth of consumer plays an important role in the interpretation of their behaviour. Therefore, wealth is considered as one of the influential independent variables in the consumption function (for more detail see Spiro, 1962, and Evans, 1967) and its impact should be taken into account. There are two new revisions for the theory of consumption have emerged in economic literature after the theory of life cycle, namely the theory of random walk (Hall, 1978), and the implementation of behavioural economics (Mishkin, 2012).

There are two new revisions for the theory of consumption have emerged in economic literature after the emergence of the theory of life cycle, namely the theory of random walk (Hall, 1978), and the implementation of behavioural economics (Mishkin, 2012).

In the theory of random walk, Hall argued that consumer spending is not predictable; therefore, it follows the random walk pattern. There are four logical steps, which underlie the random walk hypothesis: firstly, most consumption theories, especially the permanent income and life cycle hypotheses, built their assumptions that consumers’ behaviour is based on future income using this expectation to determine their lifetime resources. This hypothesis states that lifetime resources are quantified by expectations of the future income (Evans, 2004). Secondly, depending on the first assumption, the expectation about lifetime resources will vary only if future income expectation changes. Thirdly, according to these above assumptions, consumption will change only if these expectations changes. Finally, this hypothesis depends on the rational

104 expectations’ pattern, where all the assumptions are derived from the available information; therefore, any unanticipated variations in this information will lead to changes in consumption. The main implication of this hypothesis is that it is very difficult to control consumer spending through certain economic policies (Mishkin, 2012).

Behavioural economics is, also, a new stream in economic research and it borrows its concepts from other social sciences, especially from sociology and psychology. Some economists have utilized social and psychological concepts to explain consumer spending behaviour. The basic idea behind the theory of behavioural economics is the doubt of its advocates in the ability of consumers to describe their desires and behaviour accurately, and thus the failure to represent their optimal behaviour in the right manner and to achieve their goals easily.

According to previously mentioned theories, variables such as disposable income, disposable income in the previous period, consumer spending in the previous period and the wealth of individuals, are important variables in explaining consumer behaviour. One can find these variables in most of the practical studies concerned with the explanation of consumer behaviour at the macro levels.

However, in addition to these variables, there are other variables which have been included in some studies including demographic factors such as population, age, life expectation and family distribution (Evans, 2004). In addition, the division of disposable personal income into employment income and property income has had an effect on the interpretation of the behaviour of consumption. Some studies have also indicated the importance of the pattern of distribution of income in determining consumption levels (Evans, 1969) as well

105 as the importance of some of qualitative factors relating to consumer tastes which have a role in explaining consumption behaviour (White,1978).

In addition, the general prices level (Klein, 1979), the interest rate (Weber, 1970) the availability of credit and future income play an important role in determining consumption (Evans, 2004). Some economists have confirmed that pent-up demand, which results in certain circumstances such as wars and economic crises, leads to an increase in the consumption of goods that have been affected by such circumstances. This factor is affected by the availability of durable goods and the role of expectation in influencing the behaviour of consumption.

The consumption equation in this study depends on disposable income, lagged disposable income (i.e. disposable income in the last period); consumer spending in the lagged period and liquid assets (expressed in the money supply as a proxy for real private wealth). All the variables are expressed in real values (the base year is 1990) to explain the behaviour of consumption during the study period.

LCPR = F (LCPR_1, LYPDR, LMSR)

Where:

LCPR = private consumption expenditure on goods and services, in real and natural logarithms,

LCPR_1 = lagged real private consumption expenditure on goods and services, in natural logarithms,

LYPDR = Real personal disposable income, in natural logarithms, and

LMSR=Real money supply, in natural logarithms.

This study assumes that consumption is positively related to lagged real private consumption expenditure, real personal disposable income, and real money

106 supply; therefore, it expected that these variables’ parameters would be greater than zero.

4.2.1.1.2 Government consumption spending (CGC)

The state in developing countries, such as Libya, plays a key role in the economy as a consumer and a producer alike. Additionally, it, directly and indirectly, drives the economy through its policies and profoundly influences economic activity in the country as a whole. This is due mainly to the fact that the private sector in most developing countries (and Libya is not exception) is still in an embryonic stage and does not have the ability to fulfil a vital role in

the country’s economy.

It is worthwhile noting that a balanced government budget was one of the main goals that was sought to be achieved by the makers of economic policies in most countries of the world. However, the budget now is employed as the main tool for economic policy, where it is intentionally utilized to achieve a surplus or deficit to reach certain goals. This intentionality in handling the budget is what is so-called, in economics, a fiscal policy.

In a similar manner, public spending is considered the most fundamental tool of the public budget and fiscal policy, whereby the government seeks (in addition to taxes and public debt) to achieve certain economic goals, such as increasing income, production and employment.

According to the theory of public finance, many categories can be taken into account when studying the behaviour of public spending. However, taxonomically, public spending can be divided into two major categories. Firstly, public consumer spending on goods and services, and secondly, public investment’ spending on goods and services. These categories of spending constitute the government demand for the available real resources of the

107 economy, which consists of public employees’ compensations, and government purchases of consumer and investment goods.

In this respect, it could be argued that the use of public spending as a tool in economic policy is not a new precept. As it originated from the contributions of Keynes during the Great Depression, whereby the prevailing view in that period was that the government could not spend more than its revenue because a budget deficit leads to increased public debt and then to inflation, unquestionably both of which are undesirable outcomes. In addition, changes in public spending are not free of adverse effects, as assumed by some studies (Heijdra, Ligthart and Ploeg, 1998), where it has been shown that public consumer spending is included in the private utility function through the direct crowding-out effect of public consumption spending.

More accurately, some studies attribute the problem of inflation, the accumulation of public debt, the disappointing investment performance, then the slowing down of the process of economic growth to the distorted intervention of the government in the conduct of the economy, which results in an imbalance in the government sector (Easterly and Schmidt-Hebbel, 1994). However, Keynes explained that spending creates demand. This demand in turn, will lead to increased production because an increase in both public consumer spending and public investment spending will lead to an increase in personal incomes and, in turn, to an increase in private consumption. This will be through the initial increase in the multiplier of spending without having any adverse impact on the marginal efficiency to invest in the private sector. In other words, according to Keynes, the net influence of government spending is to increase the national income. Moreover, other studies conducted by Hall (Hall, 1980) and Barro (Barro, 1981, 1997) have also concluded that an increase in government consumption leads to increases in output and employment alike.

108 In fact, public spending is treated, especially in the Keynesian theory, as a stimulant to activate the private sector, which means that initial public spending is directed in order to spur economic activity. This is accomplished through encouraging the increase in private investment by injecting a purchasing power or establishing new infrastructure, which works through ‘external economies’ to increase (crowd in), not replace, private investment. On the other hand, public spending might be treated as a compensatory spending to replace (crowd out) private investment spending when the latter is unable to play its role.

Therefore, it should be noted that the source, which is relied upon to finance spending has a great impact on the results that could be predicted from this spending. The impact on income and prices can differ depending on the source of the funding, for instance, the impact of funding through a tax levy differs when compared to financing through the sale of bonds (borrowing from public) or by issuing money.

Departing from this basis, the monetarism school shows that the financing of budget deficit through domestic borrowing, especially borrowing from the Central Bank, or by issuing money, will cause inflationary pressures as well as leading to increased interest rates. Also, the financing of expenditure (budget deficit) by external borrowing in turn leads to an imbalance in the balance of payments and may cause, in the end, a negative impact on the exchange rate (Matlanyane, 2005).

With respect to the variables that explain the behaviour of public expenditure, some of the famous models (see, for example, Rasche and Shapiro, 1968; Steindi, 1971; Aghevli and Khan, 1980) have linked the desired level of government spending with the desire and the ability of society to pay. This is represented in tax rates as a source of financing for public expenditure (Rasche

109 and Shapiro, 1968), in addition to government borrowing as an important determinant of public spending.

In addition, one of the prominent factors that affect the level of public consumer spending is the population growth (Ando, 1974) which is represented in the increase in demand for services that are provided by the government (Chu, 1988). Furthermore, some models indicate that nominal government spending adjusts proportionally to the difference between government spending that is targeted by the government and the actual level of such spending in the last period (Khan and Knight, 1981). Moreover, it is logical to assume that a government, in the long term, decides to increase their spending in parallel with the growth in nominal income.

Furthermore, some studies (Ando, 1974) show that real consumer spending and the level of real income are considered as important variables in explaining the behaviour of consumer public spending. Moreover, public consumer spending in the previous period and the general price level (Aghevli and Khan, 1980) are also valuable variables in explaining the variation in consumer public spending. As regards developing countries, some sources have indicated the possibility of linking government spending to the value of exports (Khan, 1974a), where government spending increases alongside exports increasing. This situation seems to be the case in the oil-exporting economies where oil revenue depends for contribution to public revenue on expenditure policy and on the related allocation of resources, whether on expenditure items, or on the various