Skip to main content
SpringerLink
Log in

Government size, composition of public expenditure, and economic development

  • Published:
International Tax and Public Finance Aims and scope Submit manuscript

Abstract

This paper analyzes the effects of government size and of the composition of public expenditure on economic development. Using the system-GMM estimator for linear dynamic panel data models, on a sample covering up to 156 countries and 5-year periods from 1980 to 2010, we find that government size as a percentage of GDP has a quadratic (inverted U-shaped) effect on the growth rate of the Human Development Index (HDI). This effect is especially pronounced in developed and high-income countries. We also find that the composition of public expenditure affects development, with the share of five subcomponents exhibiting nonlinear relationships with HDI growth.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. Just over a third of the poverty line of $1 25 per day. Values obtained from UNDP (2011).

  2. If part of the population does not go to school (or to good schools), or does not have access to proper medical care, the country’s health and education indexes (which are used to compute the Human Development Index—HDI) will be lower than when income and access to education and health are more equally distributed. Thus, in the presence of high income inequality, economic growth may not be completely reflected in the growth rate of the HDI.

  3. Kneller et al. (1999) empirically analyze the effects of the structure of taxation and public expenditure on economic growth for a sample of 22 OECD countries. They find that distortionary taxation reduces growth, while nondistortionary taxation does not, and that productive public expenditure enhances growth, while nonproductive expenditure does not.

  4. When using data on public expenditure composition, the estimations cover 79 countries.

  5. Public expenditure is less volatile and less susceptible to measurement errors than public revenue (Labonte 2010).

  6. On average, considering there is an asymmetry in government growth. For example, faster development of public expenditure in less institutionally constrained countries.

  7. The authors argue for the replacement of the arithmetic mean (used in previous reports) by the geometric mean because the values obtained for the indices are lower, occurring major changes only for countries where there is a greater inequality between the dimensions of development.

  8. As these maximum and minimum values vary over time, every year all indexes for all countries are recalculated. Hence, for temporal consistency, comparisons should not be made using different publications of the UNDP for the HDI. Thus, all HDI data used in this paper come from UNDP (2011).

  9. Corsetti and Roubini (1996), in their study of the effects of government expenditure in endogenous growth models, ensure that many forms of public expenditure are directly or indirectly productive affecting productivity in different ways.

  10. Labonte (2010) also highlighted the need to distinguish fluctuations in short-term growth, resulting from economic cycles, from sustainable long-term growth rates. The four action forms of the public sector (spending, transfers, taxes, and regulation) have the potential to influence long-term growth through labor supply, physical capital, and productivity. Tanzi and Zee (1997) concluded that, by using public financial instruments, tax policy can play a fundamental role in the performance and long-term growth of countries.

  11. For other theoretical models analyzing the effects of public expenditure on economic growth see, among others, King and Rebelo (1990); Lucas (1988); Meltzer and Richard (1981).

  12. See also Hauner and Kyobe (2010) and Afonso et al. (2005), who empirically analyzed the efficiency and performance of the public sector, finding evidence of a negative relationship between these indicators and government size.

  13. The functions representing (1) and (2) have, respectively, downward and upward concavity.

  14. HDI is available for periods of 5 years between 1980 and 2000. Only since 2000 till 2010, it is provided annually.

  15. Since life expectancy and years of education are used in the computation of the HDI, we use alternative indicators of health (infant mortality) and education (secondary school enrollment).

  16. Two problems are associated with these models and should be taken into account: autocorrelation due to the existence of a lagged dependent variable and the presence of a specific effect for each country.

  17. These can be obtained assuming the presence of stationarity of the dependent variable (the variable is convergent) and the lack of correlation between first differences of the instruments and the specific effects. Fisher-type unit root tests were performed for the dependent and independent variables used in our estimations. The null hypothesis that all panels contain unit roots was always rejected. These results are available from the authors upon request.

  18. Lagged levels, two, and three periods were used as instruments in the first-differences equation, and lagged first differences were used in the levels equation. The choice of the number of lagged levels also took into account the validity of AR(2), Hansen, and difference-in-Hansen tests.

  19. UN: General government final consumption expenditure (% GDP). Source: National Accounts Estimates of Main Aggregates, United Nations Statistics Division. PWT-kg: Government Consumption Share of PPP Converted GDP Per Capita at 2005 constant prices. Source: PWT 7.0, main file, variable kg. PWT-NA: Sum of government collective consumption expenditure and government individual consumption expenditure, i.e. gckon plus health and education services of Government consumed by households. (at constant prices). Source: PWT 7.0, National Accounts file, variable gkon.

  20. In order to facilitate the comparison, we used exactly the same model and the same observations of the sample.

  21. The same happens for the estimations of the other tables. This difference in results may be explained by the fact that, although HDI and GDP are related, they are different concepts. In fact, the correlation between the levels of GDP and HDI is 0.72, and the correlation between their growth rates is only 0.36. Given this low correlation, estimating models for HDI growth is by no means the same than running GDP per capita growth regressions.

  22. Since Area 1 of the Index of Economic Freedom is related to the size of government, which was already accounted for in the estimations, only the other four areas were considered in the estimations of Table 5. It is somewhat surprising that the legal structure and security of property rights does not seem to affect economic development.

  23. Government outlays on social protection include expenditures on services and transfers provided to individual persons and households and expenditures on services provided on a collective basis. Its main subdivisions in the IMF Government Financial Statistics are as follows: Sickness and disability; Old age; Survivors; Family and children; Unemployment; Housing; Social exclusion; R&D Social protection; and Social protection n.e.c.

  24. It is worth noting that the measures of health and education in the Human Development Indexes are outcomes measures, while government spending in health and education is investment measures.

  25. We do not expect defense spending per se to influence the HDI growth rate. But countries that have a greater share of defense spending in total expenditures will have fewer resources to apply on other expenditures, such as health and education, and HDI growth will suffer. Thus, the inverted U-shaped relationship conforms to our expectations.

  26. The U-shaped relationship for health expenditures is surprising. Although a positive effect for larger shares makes sense for practically all sample values (the maximum share in our sample is 24.8 %), it is strange that there is also a positive effect for very small shares.

References

  • Acemoglu, D., Johnson, S., & Robinson, J. (2005). Institutions as the fundamental cause of long-run growth. In P. Aghion & S. Durlauf (Eds.), Handbook of economic growth (pp. 385–472). Amsterdam, The Netherlands: Elsevier.

    Google Scholar 

  • Acosta-Ormaechea, S., & Morozumi, A. (2013). Can a government enhance long-run growth by changing the composition of public expenditure? IMF Working Paper WP/13/162.

  • Afonso, A., & Furceri, D. (2010). Government Size Composition, Volatility and Economic Growth. European Journal of Political Economy, 26, 517–532.

    Article  Google Scholar 

  • Afonso, A., Schuknecht, L., & Tanzi, V. (2005). Public sector efficiency: An international comparison. Public Choice, 123, 321–347.

    Article  Google Scholar 

  • Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies, 58, 277–297.

    Article  Google Scholar 

  • Arellano, M., & Bover, S. R. (1995). Another look at the instrumental variable estimation of error-components models. Journal of Econometrics, 68, 29–51.

    Article  Google Scholar 

  • Barro, R. (1990). Government Spending in a Simple Model of Endogenous Growth. Journal of Political Economy, 98(5), S103–S125.

    Article  Google Scholar 

  • Barro, R. (1991). Economic growth in a cross section of countries. Quarterly Journal of Economics, 106, 407–443.

    Article  Google Scholar 

  • Barro, R., & Sala-i-Martin, X. (1995). Economic growth. New York: McGraw-Hill.

    Google Scholar 

  • Bassanini, A., Scarpetta, S., & Hemmings, P. (2001). Economic growth: The role of policies and institutions. Panel Data evidence from OECD countries. OECD Economics Department Working Paper 283.

  • Blundel, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87, 115–143.

    Article  Google Scholar 

  • Bond, S. (2002). Dynamic panel data models: A guide to micro data methods and practice. Portuguese Economic Journal, 1, 141–162.

    Article  Google Scholar 

  • Corsetti, G., & Roubini, N. (1996). Optimal government spending and taxation in endogenous growth models. NBER Working Paper 5851.

  • Davies, A. (2009). Human development and the optimal size of government. The Journal of Socio-Economics, 38, 326–330.

    Article  Google Scholar 

  • Easterly, W., & Rebelo, S. (1993). Fiscal policy and economic growth: An empirical investigation. Journal of Monetary Economics, 32(3), 417–458.

    Article  Google Scholar 

  • Fölster, S., & Henrekson, M. (1999). Growth and the public sector: A critique of the critics. European Journal of Political Economy, 15, 337–358.

    Article  Google Scholar 

  • Fölster, S., & Henrekson, M. (2001). Growth effects of government expenditure and taxation in rich countries. European Economic Review, 45(8), 1501–1520.

    Article  Google Scholar 

  • Gwartney, J., & Lawson, R. (2012). Economic freedom of the world—2012 Annual report. Vancouver, BC: Fraser Institute.

    Google Scholar 

  • Gwartney, J., Lawson, R., & Holcombe, R. (1998). The size and functions of government and economic growth. Washington: Joint Economic Committee Study.

    Google Scholar 

  • Hall, R., & Jones, C. (1999). Why do some countries produce so much more output per worker than others? Quarterly Journal of Economics, 114, 83–116.

    Article  Google Scholar 

  • Hauner, D., & Kyobe, A. (2010). Determinants of government efficiency. World Development, 38(11), 1527–1542.

    Article  Google Scholar 

  • Heitger, B. (2001). The scope of government and its impact on economic growth in OECD countries. Kiel working paper no. 103.

  • Heston, A., Summers, R., & Aten, B. (2011). Penn world table version 7.0. University of Pennsylvania: Center for International Comparisons of Production, Income and Prices.

  • King, R., & Rebelo, S. (1990). Public Policy and Economic Growth: Developing Neoclassical Implications. The Journal of Political Economy, 98(5), 126–150.

    Article  Google Scholar 

  • Kneller, R., Bleaney, M., & Gemmel, N. (1999). Fiscal policy and growth: Evidence from OECD countries. Journal of Public Economics, 74, 171–190.

    Article  Google Scholar 

  • Labonte, M. (2010). The size and role of government: Economic issues. CRS Report for Congress. RL 32162.

  • Lucas, R. (1988). On the mechanics of economic development. Journal of Monetary Economics, 22, 3–42.

    Article  Google Scholar 

  • Meltzer, A., & Richard, S. (1981). A rational theory of the size of government. The Journal of Political Economy, 89(5), 914–927.

    Article  Google Scholar 

  • Mourmouras, A., & Rangazas, P. (2009). Fiscal Policy and Economic Development. Macroeconomic Dynamics, 13(4), 450–476.

    Article  Google Scholar 

  • Nafziger, E. W. (2012). Economic development (5th ed.). New York: Cambridge University Press.

    Book  Google Scholar 

  • North, D. (1990). Institutions, institutional change and economic performance. Cambridge, UK: Cambridge University Press.

    Book  Google Scholar 

  • Peltzman, S. (1980). The Growth of Government. Journal of Law and Economics, 23(2), 209–287.

    Article  Google Scholar 

  • Pomfret, R. (1997). Development economics. Hertfordshire: Prentice Hall Europe.

    Google Scholar 

  • Seers, D. (1969). The meaning of development. International Development Review, 11(4), 3–4.

    Google Scholar 

  • Tanzi, V., & Schuknecht, L. (2000). Public spending in the 20th century. Cambridge: The Press Syndicate of the University of Cambridge.

    Book  Google Scholar 

  • Tanzi, V., & Zee, H. (1997). Fiscal policy and long-run growth. IMF Staff Papers, 44(2), 179–209.

    Article  Google Scholar 

  • Ulbrich, H. (2003). Public finance: In theory and practice. Mason, Ohio: Thomson.

    Google Scholar 

  • UNDP - United Nations Development Program. (2011). Human Development Report. New York, NY: United Nations.

    Google Scholar 

  • Verbeek, M. (2008). A guide to modern econometrics (3rd ed.). Chichester: Wiley.

    Google Scholar 

  • World Bank. (2004). World development report: Making services work for the poor. Washington, DC: The World Bank.

    Google Scholar 

  • Yavas, A. (1998). Does too much government investment retard the economic development of a country? Journal of Economic Studies, 25(4), 296–330.

    Article  Google Scholar 

Download references

Acknowledgments

The authors wish to thank Atsuyoshi Morozumi, participants at the 2013 Congress of the International Institute of Public Finance, and three anonymous referees for very helpful comments, and Atsuyoshi Morozumi and Santiago Acosta-Ormaechea for sharing their data on the composition of public expenditure. The authors are also thankful for the financial support provided by ERDF funds through the Operational Program Factors of Competitiveness—COMPETE and by the Portuguese Foundation for Science and Technology (FCT) under research Grants FCOMP-01-0124-FEDER-037268 (PEst-C/EGE/UI3182/2013) and FCOMP-01-0124-FEDER-020420 (PTDC/EGE-ECO/118501/2010).

Author information

Authors and Affiliations

  1. NIPE, Escola de Economia e Gestão, Universidade do Minho, 4710-057 , Braga, Portugal

    Susana Martins & Francisco José Veiga

Authors
  1. Susana Martins
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Francisco José Veiga
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Francisco José Veiga.

Appendix

Appendix

$$\begin{aligned}&\hbox {Human Development Index (HDI)}_\mathrm{it} =\root 3 \of {\hbox {GNII}_\mathrm{it} \times \hbox {LEI}_\mathrm{it} \times \hbox {EI}_\mathrm{it}}\\&\hbox {Gross National Income Index}_\mathrm{it} (\hbox {GNII})\\&\quad =\frac{\ln (\hbox {GNIpc}_\mathrm{it} )-\ln (\hbox {GNIpc min observed})}{\ln ( \hbox {GNIpc max observed})-\ln ( \hbox {GNIpc min observed})} \\&\quad =\frac{ln(\hbox {GNIpc}_\mathrm{it} )-\ln (163)}{\ln (108,211)-\ln ( 163)}\\&\hbox {Life Expectancy Index}_\mathrm{it} (\hbox {LEI})=\frac{\hbox {Life Expenctancy at Birth}_\mathrm{it} -20}{83.2-20}\\&\hbox {Education Index}_\mathrm{it} (\hbox {EI})=\frac{\sqrt{\hbox {MYSI}_\mathrm{it} \times \hbox {EYSI}_\mathrm{it}} -0}{0.951-0 }\\&\hbox {Mean Years of Schooling Index}_\mathrm{it} ( \hbox {MYSI})=\frac{\hbox {Mean Years of Schooling}_\mathrm{it} -0}{13.2-0}\\&\hbox {Expected Years of Schooling Index}_\mathrm{it} (\hbox {EYSI})=\frac{\hbox {Expected Years of Schooling}_\mathrm{it} -0}{20.6-0} \end{aligned}$$

Source: UNDP (2011)

Rights and permissions

Reprints and permissions

About this article

Cite this article

Martins, S., Veiga, F.J. Government size, composition of public expenditure, and economic development. Int Tax Public Finance 21, 578–597 (2014). https://doi.org/10.1007/s10797-014-9313-4

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10797-014-9313-4

Keywords

Mathematics Subject Classification

Search

Navigation