Empirical Evidence on Public Expenditures and Economic Growth
Sustained and equitable economic growth is clearly a predominant objective of public expenditure policy. Many public programs are specifically aimed at promoting sustained and equitable economic growth. Public expenditures can--and have--played an important role in physical and human capital formation over time. Appropriate public expenditures can also be effective in boosting economic growth, even in the short run, when limits to infrastructure or skilled manpower become an effective constraint to an increase in production.
Therefore, the effect of public expenditures on economic growth may be a comprehensive indicator of public expenditure productivity. Ideally, the two components of such an indicator should be measurable: the contribution of public sector outputs to economic growth, and the efficiency with which these expenditures yield their outputs. By pointing to a set of public sector outputs as particularly conducive to economic growth, as well as to the efficiency with which the expenditures contribute to public sector production, empirical studies on expenditures and growth can suggest ways to improve public expenditure composition and productivity. A cautious interpretation of the results of such studies is warranted, however, because not all public programs are necessarily aimed at economic growth and because public expenditures are not all that matter for economic growth. Moreover, the relationship between public expenditures and economic growth is not necessarily unidirectional. Public expenditures affect economic growth, but at the same time economic growth can lead to changes in either aggregate public expenditure (for example, in accordance with Wagner's Law)30 or some of its components (for instance, through changes in the demand for certain public services).
A variety of empirical studies, based on time-series or cross-country data, have aimed at estimating the contribution of public expenditures to economic growth. Some studies relate aggregate public expenditures to economic growth; others focus on the relationship between certain expenditure components, such as public investment, education or health expenditures, or their components, and economic growth. The major obstacles encountered in these studies include the difficulties involved in (1) valuing public sector outputs; (2) estimating separately the impact of how public expenditures are financed (including the possible crowding out of private investment); and (3) measuring the effects of other factors on economic growth. In addition, using contemporaneous cross-country data to relate public expenditures to economic growth may not yield correct results because many public expenditure projects (for example, those on primary education and physical infrastructure) have long gestation periods.
Many studies have aimed at estimating the effects of public expenditure on economic growth. Empirical studies have yielded conflicting results: some support the hypothesis that a rise in the share of public spending is associated with a decline in economic growth (Landau (1986) and Scully (1989)); others have found that public spending is associated positively with economic growth (Ram (1986)); and still other studies have found no significant relationship (Kormendi and Meguire (1985) and Diamond (1989)). Public expenditures were observed in one study to have no impact on growth in developed countries, but a positive impact in developing countries (Sattar (1993)). In general, studies of the relationship between aggregate public expenditure and economic growth have not yielded robust results, as the results of many are sensitive to small changes in model specification (Levine and Renelt (1992)).
A number of studies have tested the effects of certain public expenditure components on economic growth. In general, these studies suggest that public sector consumption does not promote economic growth (Diamond (1989), Barro (1991), Grossman (1990), and Easterly and Rebelo (1993)). A number of studies have found a positive correlation between economic growth and various education indicators or expenditures: primary and secondary levels of educational attainment (Barro (1991) and Easterly and Rebelo (1993)); the share of expenditures on education in total expenditure (Otani and Villanueva (1990)); and capital expenditures on education (Diamond (1989)). Other studies suggest indirect links between education and economic growth, for example, through the linkage between education expenditures and private investment (Clements and Levy (1994)).31
In contrast to the generally positive correlations between education and growth, a number of studies have reported only a weak correlation between labor productivity--a factor strongly associated with economic growth--and health indicators (Gwatkin (1983)), although there are exceptions (for example, World Bank (1993a)).
Other strands of research have aimed at identifying the effect of household investments in education and health or public outlays on specific education and health services; these studies have found, in general, robust results, indicating the positive effects of such investments on lifetime earnings or educational and health indicators. These studies point to the productivity of primary education and community health services, particularly in developing countries, as well as health education and preventive health care expenditures (Ryoo (1988); Haddad and others (1990); Winkler (1990); Atkin, Guilkey, Popkin, and others (1992); Jamison (1993); Psacharopoulos (1993); and World Bank (1993b)).
Some studies have aimed at assessing the effects of military expenditures on economic growth. Military expenditures can create jobs, and military research and development programs can promote technological progress. While some studies have reported a positive correlation between military expenditures and economic growth, this positive correlation reflects to a large extent the effects of an increase in military outlays on aggregate demand during recessionary periods (Benoit (1973)). When resources are fully employed, the simple theory of opportunity costs implies that military expenditures will crowd out other expenditures, including private investment. Several more recent studies (for example, Deger (1986)) suggest that this effect dominates any positive impact of military outlays on growth.32
Public investment is an area that can have direct relevance for economic growth. Public investment in basic infrastructure is an essential precondition for capital accumulation in the private sector. Public investment in education and health facilities improves human capital formation. However, public investment is also an area where grossly unproductive white elephants can be found.
While the contribution of public investment to economic growth has been invariably assumed theoretically, empirical studies based on aggregate public expenditure data have found only weak links between public investment and economic growth. Using cross-country data to test the relationship between public investment and economic growth, some recent research in this area has found only a statistically insignificant relationship (Barro (1991)). Other research has found that capital spending on education, health, and housing has a positive effect on economic growth (Diamond (1989)). Some others have used U.S. data to test the effects of public investment on the productivity of existing capital stock, private capital spending, and employment. While many studies have found positive effects, the effect of public investment on private capital spending appears to be strongly influenced by the extent of crowding out (for example, Aschauer (1989a) and (1989b), Munnell (1990), and Holtz-Eakin (1992)), while cross-country studies including the developing nations have failed to produce robust statistical results linking public investment and growth (Levine and Renelt (1992)).
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