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Effect of size and mix of public spending on growth and inequality

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Effect of size and mix of public spending on growth and inequality

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Effect of size and mix of public spending on growth and inequality

  1. 1. Paris, 24 November 2016 The effect of the size and mix of public spending on growth and inequality www.oecd.org/economy/economicoutlook.htm ECOSCOPE blog: oecdecoscope.wordpress.com
  2. 2. Key messages 2 On the size and effectiveness of government • Larger governments are associated with lower long-term growth • For countries with well-functioning governments, the adverse growth effect is smaller • Large governments tend to redistribute more, which fosters equity. On the structure of spending • Higher public investment is associated with large growth gains and lifts “all boats” as it raises average incomes without any adverse equity effects • The growth gains from higher investment decline at a high level of the public capital stock, though virtually all countries have room for additional spending • Improving student performance yields large gains for all by raising skills • Reducing the share of pension spending and of subsidies boosts growth. Lower pension spending has no adverse effects on disposable income inequality, but lower subsidies increase inequality • Spending more on family and child care benefits reduces inequality as they benefit lower-income families more
  3. 3. Impact of different instruments on growth and equity 3 Policy Growth Equity Income of the poor Countries with the most room for growth gains Decreasing the size of government Low to moderate government effectiveness + - + BEL, CZE, FRA, GRC, HUN, ITA, POL, PRT, SVN High government effectiveness n.s. - - Increasing government effectiveness + + + FRA, GRC, HUN, ITA, SVN Increasing education outcomes + 0/+ + CHL, GRC, MEX, PRT, TUR Increasing public investment (including R&D) + n.s. + BEL, DEU, GBR, IRL, ISR, ITA, MEX, TUR Pension reform + n.s. + AUT, DEU, FIN, FRA, GRC, ITA, JPN, POL, PRT, SVN Increasing family benefits n.s. + + CHE, ESP, GRC, PRT Decreasing public subsidies + - n.s. BEL, CHE Note: + stands for a positively significant, – for a negatively significant and n.s. for non-significant effect. Source: Fournier and Johansson (2016), “The Effect of the Size and the Mix of Public Spending on Growth and Inequality”, OECD Economics Department Working Papers, No. 1344.
  4. 4. 4 1. Motivation and approach
  5. 5. Changes to the spending and tax mix have gone in the wrong direction between 2007 and 2013 5 Source: OECD Public Finance Dataset, forthcoming.
  6. 6. Design of public spending, growth and inequality: the approach 6 Key issue: Raising long-term growth while addressing inequality Empirical setup: • Growth: Neoclassical convergence model • Inequality: Estimation of the impact of the mix of spending along the distribution of household income • The overall effect of public finance on the distribution of disposable income is the sum of the direct effect on disposable income and the indirect growth effect.
  7. 7. 7 2. Government size and effectiveness
  8. 8. Long-term GDP gains from reducing the size of government 8 0 5 10 15 20 25 30 35 Size of governmentPer cent Note: In countries where the size of government is above the average level of countries in the bottom half of the sample, the government size will gradually converge to this level (36% of GDP). The figure reports the effect after 45 years of a reform phased in over 10 years.
  9. 9. Long-term GDP gains from improving government effectiveness 9 0 5 10 15 20 25 30 35 Effectiveness of governmentPer cent Note: In countries where the effectiveness of government is below the average level of countries in the top half of the sample, government effectiveness will gradually converge to this level. The figure reports the effect after 45 years of a reform phased in over 10 years.
  10. 10. Government effectiveness and growth 10 The adverse effect of government size on potential GDP decreases with government effectiveness GDP gain of one spending point increase of public spending, in per cent Perception of government effectiveness -20 -15 -10 -5 0 5 10 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2
  11. 11. Government effectiveness and growth 11 Size of government and citizens’ perception of their effectiveness AUS AUT BEL CAN CHE CZE DEU DNK ESP EST FIN FRA GBR GRC HUN IRL ISLISR ITA JPN KOR LUX NLD NOR NZL POL PRT SVK SVN SWE USA 30 35 40 45 50 55 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 2.2 Perception of government effectiveness Size of government (primary spending, % of potential GDP)
  12. 12. Illustrative gains from reducing government size on poor, average and rich households 12 Effect of a reduction in government size on household disposable income Note: In countries where the size of government is above the average level of that of countries in the bottom half of the sample, the government size will gradually converge to this level (36% of GDP). Rich and average households tend to gain from a reduction of government size, while the effect on the poor depends on government’s effectiveness. -30 -20 -10 0 10 20 30 40 Average effects Effects on the poor Effects on the rich Per cent
  13. 13. 13 3. Changing the spending mix
  14. 14. Long-term GDP gains from increasing public investment 14 0 5 10 15 20 25 30 Public investmentPer cent Note: In countries where public investment to potential GDP is below the average ratio of countries in the top half of the sample, public investment will converge to this average ratio. The figure reports the effect after 45 years of a reform phased in over 10 years.
  15. 15. Decreasing returns to public investment? 15 The effect of public investment on potential GDP decreases with the level of capital stock GDP gain of one spending point increase of public investment, in per cent Public capital stock, per cent of potential GDP The analysis suggests that all OECD countries, except Japan, have room for additional public investment. -15 -10 -5 0 5 10 15 20 40 60 80 100 120
  16. 16. Long-term growth effects of an increase in the education level 16 0 5 10 15 20 25 30 Quantity of education (years of schooling) Quality of education (PISA)Per cent Note: In countries where the mean PISA score or average years of schooling are below the average level of countries in the top half of the sample, educational attainment is assumed to gradually converge to this level. The figure reports the effect after 45 years of a reform phased in over 45 years..
  17. 17. Long-term GDP gains from decreasing public subsidies 17 0 5 10 15 20 25 30 SubsidiesPer cent Note: In countries where spending to the potential GDP ratio on subsidies is above the average level of countries in the bottom half of the sample, spending will gradually decline to this level. The figure reports the effect after 45 years of a reform phased in over 10 years.
  18. 18. Long-term GDP gains from decreasing pension spending 18 0 5 10 15 20 25 30 Old age and survivors pensionsPer cent Note: In countries where spending to the potential GDP ratio on pensions is above the average level of countries in the bottom half of the sample, spending will gradually decline to this level. The figure reports the effect after 45 years of a reform phased in over 10 years.
  19. 19. Illustrative gains from raising family and child benefits on disposable income 19 Note: In countries where family benefits to potential GDP is below the average ratio of that of countries in the top half of the sample, family benefits will gradually converge to this average ratio. -10 0 10 20 30 40 Average effects Effects on the poor Effects on the rich Per cent
  20. 20. Illustrative gains from decreasing public subsidies 20 Note: In countries where subsidies to potential GDP are above the average ratio of that of countries in the bottom half of the sample, subsidies will gradually decline to this ratio. -10 0 10 20 30 40 Average effects Effects on the poor Effects on the rich Per cent
  21. 21. 21 More information Fournier, J-M. and A Johansson (2016), “The effect of the size and mix of public spending on growth and inequality”, OECD Economics Department Working Papers, No. 1344. Bloch et al. (2016), “Trends in public finance: Insights from a new dataset”, OECD Economics Department Working Papers, No. 1345. Johansson, A. (2016), “Public finance, economic growth and inequality: A survey of the evidence”, OECD Economics Department Working Papers, No. 1346. Fournier, J-M. (2016), “The positive effect of public investment on potential growth”, OECD Economics Department Working Papers, No. 1347. Disclaimers: The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law. This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.

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