kjncskncosld kncos nckwlsk kcwoicnw wkncwo

Public Expenditure Analysis
E. Nketiah-Amponsah
Department of Economics
Room W.18
enamponsah@ug.edu.gh
2/18/2024
Dr. E. Nketiah-Amponsah
1
ECON 453

Learning Outcomes
 Explain what public expenditure is
 Explain the types of public expenditures
 Explain some macro models of public expenditure
growth:
 Development Models of Public Expenditure
 Wagner’s Law of Public Expenditure Growth
 Peacock-Wiseman Analysis of Public Expenditure
2/18/2024
2

Public Expenditure-definition
 Public Expenditure refers to the cost of carrying out
government provision of goods and services, mostly
public goods.
 It can be expressed in absolute terms or as a percentage
GDP
 Can also be expressed in terms of its relative
contribution to other sectors of the economy such as
health, education, infrastructure, wage bill and
agriculture inter alia (see State of the Ghanaian
economy, 2013.)
2/18/2024
3

Principles of Expenditure Analysis
 This refers to the application of economic theory to
examine the consequences of government expenditure
programmes.
 Government expenditure has three types of effects:
 Allocation effects
 Redistribution effects
 Stabilization effects
 Fourth function if the government is identified in its
regulatory role
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4

 Allocation Effects:
 refers to the way an expenditure program affects pattern
of goods and services produced in the economy.
 For example, if government implements a subsidy policy,
we want to know whether the subsidy raise output in the
economy or it raises consumption in the targeted area of
the economy
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5

 Redistribution Effects:
 it looks at the redistributive effect of the expenditure
process i.e. how income distribution is affected by the
expenditure program
 NHIS, LEAP, Capitation, School Feeding, Free Uniforms etc are
examples of redistributive programmes
 It is concerned with who benefits from the expenditure
process and who loses in terms of income.
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6

Principles Of Expenditure Analysis
 Stabilization Effect:
 This refers to the role of government expenditure in
achieving specified targets of levels of output,
employment and inflation (i.e. Stabilization of prices)
 Expenditure outlays can be used to check inflationary
pressures
2/18/2024
7

Types of Expenditures
• Expenditure can be categorized as:
– Exhaustive and transfers
– Non-Marketed Goods and Marketed Goods
• Exhaustive and transfers
– Exhaustive expenditure embraces the purchase of inputs
while transfer expenditure is not a claim on society’s
resources( e.g. subsidies)
2/18/2024
8

• Non-Marketed Goods and Marketed Goods
– Expenditures on Non-Marketed Goods are expenditure
on goods for which the market normally does not supply
at all or it does so at lower than levels required by
efficiency
– Government may have to pay private firms to produce
these good or Government itself will have to hire the
resources and produce the commodity
2/18/2024
9

 In Ghana, government expenditure, under the
Medium-Term Expenditure Framework (MTEF) is
divided into:
 Discretionary expenditure and
 Statutory expenditure
 Discretionary expenditure (DE) consists of those
expenditures for which the government can
exercise some judgment with respect to the
quantum of resources it commits to such items.
 DE is classified into four (4) major categories, namely
Emoluments, Administration, Services and Investment
2/18/2024
10

 Statutory expenditure on the other hand is obligatory
for government to undertake since it is usually defined
by legislative instruments or backed by some legal
authority.
 Statutory expenditures include:
 Transfer to statutory funds such as the District Assembly Common
Fund(DACF)
 Transfers to households through the social security system and
gratuities
 Ghana Education Trust Fund(GETFUND)
 The Road Fund
 Debt Service
 NHIS levy 2/18/2024
11

Discretionary and Statutory Payments, 2000 –
2012
12

Models of Government Expenditure
Growth
 Bailey (1995) divides models of public expenditure
growth into macro models and micro models.
 In this classification, macro models attempt to account
for the long term growth of public expenditure whereas
micro models attempt to explain changes in particular
components of public expenditure.
 There are three types of such models/theories
 Wagner's Law/model
 Development model (by Musgrave and Rostow)
 Peacock and Wiseman model
2/18/2024
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Growth
• Wagner's Law/model
– In 1883, Adolph Wagner, a German political economist,
proposed an idea which became known as Wagner‘s law or
Wagner’s hypothesis of increased government activity.
– Wagner uses both relative growth and absolute growth in
public expenditure in his analysis.
– Using these measures of expenditure. the law states that “ as
per capita incomes increases, so also does government
expenditure
– Expenditure Elasticity: The percentage change in government
expenditure as a ratio of the percentage change in GNP
–
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14

Growth
• Wagner's Law/model
– In fact, there is no consistent view on the functional
form describing Wagner’s Law. The literature cites the
following functional forms
 GE = f (GDP)
 GCE = f(GDP)
 GE/GDP = f(GDP)
 GE = f (GDP/N)
 GE/N = f(GDP/N)
 GE/GDP = f (GDP/N)
 Where GE is the total government expenditure, GDP is the gross
domestic product, GCE is the government expenditure and N is
the population.
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Wagner’s law
 Wagner observed the share of the public sector in GDP
had increased over time
 According to Henrekson (1993), Wagner attributed
increased government involvement (spending) to three
reasons
 Industrialization and modernization- increases externalities
which necessitate intervention. Also results in an increase in
complexity requiring continued introduction of new laws and
development of the legal structure.
 Growth of real income (Economic growth)-The goods supplied
by the public sector have a high income elasticity of demand.
 Developments and Changes in Technology-need for government
to take over natural monopolies to enhance economic efficiency.

Wagner’s Law –A Recap
The “law of increasing expansion of public and
particular state, activities” becomes for the fiscal economy
the law of the increasing expansion of
fiscal requirements. Wagner (1883)
The driving force:
1. Industrialisation
2. Increasing incomes
3. Social progress
As per capita incomes rise in industrial countries, their
public sectors grow in relative importance, or the income
elasticity of “public services” is greater than 1.
Modern (textbook) version:

Industrialization
income
social progress
Structural
change
Direct effect Effect on government
complexity of econ.
relations.
Urbanization
population density
demand for income
elastic goods
demand for redistribution
New industries
with
economics of
scale
banking services
Law & order
congestion
regulatory services
Urban sanitation
education
Social services
transfers
Government enterprise
(transportation)
non-tax revenues
Notice no feedback effects are considered.

Testing Wagner’s Law
Absolute version:
Relative version:
 


y
d
g
d
ln
ln
Government spending
GDP per capita
Income elasticity:
0


1


Normal good
Superior good
(share of
government
spending
in GDP
increases).
i
i
i
i X
y
g 


 


 ln
ln 0
t
t
t
t
t X
g
y
g 



 



 1
1
0 ln
ln
ln
cross country
Time series
in one
country

The evidence
 The absolute version has considerable support, i.e.,
public services are normal goods.
 The relative version yields mixed results at best:
 most studies find estimates of the income elasticity less
than 1.
 those which do find larger effects are typically not
robust to proper econometric specification.
Ball game estimate: 0.75.

Causes of Public Expenditure Growth in
Developing Countries (Macro models)
 Lets contextualize the causes of government expenditure
growth
 1. Growth of per capita income (PCY) and product mix: as
PCY grows there is a tendency for pressure to mount on the
demand for public goods and this increases government
expenditure
 2. Engel’s Law: As incomes increase, a declining % is spent
on food. There is a likelihood that elasticity of demand for
private good (food) will be smaller than the elasticity of
demand for the public good ηF
G < ηG
Y
 This leads to a situation where government is bound to spend more on
public goods to meet the demand of the citizens
2/18/2024
21

 3. Provision of Capital Goods by Government: Social
infrastructure has to be provided in the early stages of
development. There is thus the tendency for the
government to spend more.
 4. Population Growth: Overtime age composition
changes, putting pressure on government facilities like
health, schools etc
 5. Structural Changes in the Economy: changes from
agro-based to industrial economy causes government
to spend more in the provision of social and economic
infrastructure
2/18/2024

 6. Political Ideology: Welfare oriented states have a greater
likelihood of spending more public resources overtime.
 7. Political Process/Governance: Is democracy costly?
General elections? parliamentary elections? District
Assembly elections? These require huge expenditures
financed by government (though donor support is
acknowledged). In Ghana electioneering years are
associated with huge expenditure outlays (check the facts)
 8. Increasing Patronage of the Public Sector has
implications for Public Sector Wage Bill??
 9. Corruption?
 Increases the tax-price of publicly provided goods and services
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 Wagner’s Law has been tested for many countries using
both time series and cross-sectional data sets.
 The hypothesis attracted a great deal of interest in the 1960s
 Sztyber (2001) asserts that the validity of Wagner’s Law for
Developed Countries holds for more than 100 years. Peacock and
Wiseman (1961), Musgrave (1969), Ram (1986, 1987) and Mann
(1980) inter alia
 have provided strong empirical support for the hypothesis
 However, findings from modern time series econometric
techniques cast some doubt on the validity or the potency
of the Law (see Hondroyiannis and Papapetrou, 1995;
Henrekson, 1993; Burney, 2002)
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Macro Models of Expenditure Growth
• Development model (by Musgrave and
Rostow)
– The economist, Musgrave, and the economic historian,
Rostow, (separately) suggested that the growth of public
expenditure might be related to the pattern of economic
growth and development in societies. The development
models traces the development process from industrialization.
2/18/2024
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 Identify three stages in the development process:
(a)The early development stage where considerable
expenditure is required on education and infrastructure of
the economy (also known as social overhead capital) and
where private saving is inadequate to finance this
necessary expenditure (in this stage, government
expenditure must thus be a higher proportion of total
output);
 During this stage, the population moves from the countryside to
the urban areas.
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(b) Middle Stage
 The phase of rapid growth in which there are large increases
in private saving and public investment falls proportionately
 Urbanization produces a range of externalities such as
pollution and crime
 Increasing proportion of expenditures diverted towards
control of externalities.
(c) Developed Stage.
 high income societies with increased demand for private goods
which need complementary public investment (urbanization).
 Expenditure driven by the desire to react to issues such of equity
 Transfer payments constitute a significant proportion of
government spending.
2/18/2024
27

The Displacement Hypothesis
 The government can always find profitable ways to expend
available funds (in terms of generating political support).
 Citizens, in general, are unwilling to accept higher taxes than
they have grown accustomed to in the past.
 Governments must be responsive to the wishes of their
(Peacock & Wiseman, 1961)
Government spending evolves in a step-like pattern,
where each step coincides with social upheavals, notably wars.
Key assumptions

The “tolerable burden of taxation” *
T
*
t
t
g 
 but *
*
t
t
g 

Actual spending spending desired by government
Social upheaval causes a permanent shift upwards
in the tolerable burden of taxation:
t
t g
g t
t




 

*
*
1 1
In times of crisis, formerly unacceptable means of
taxation will be tolerated and, importantly, this
higher tolerance persists.

time
)
ln(
y
g
total spending
civilian spending
defence
normal normal
war
Graphical illustration

Empirical tests
 What qualifies as a major social upheaval:
 WWI and WWII
 Great Depression?
 Oil Shocks?
t
t
WWII
WWI
t X
D
a
D
a
a
g 
 



 3
2
1

WWI
D
0 if year < 1914
1 if year = 1923-38 or >1950

WWII
D
0 if year < 1914 or 1923-38
1 if year >1950
test
0
1 
a
0
2 
a

Some Problems
 Upwards trend, serial correlation, stationarity,
endogeneity.
 No modelling of the wars (catch up spending)
 Data relatively sparse before WWI.
• Model the time series properties of government activity.
• Model the war(s).
• Evidence much weaker when these things are taken
into account.

time
)
ln(
y
g total spending
civilian spending
defence
normal normal
war
The weak version of the displacement
hypothesis
Underlying trend growth: level shift but not trend
effect.

ARIMA model of spending in the
UK
t
t
t
t
t
t
t
X
W
b
PW
b
g
b
g
b
T
b
b
g








 

b
5
4
2
3
1
2
1
0
time series model
Dummy for WWII
Dummy = 1 after WWII
Result: b4 negative and significant!!!
Little systematic evidence of the
displacement effect

Summary
 Government expenditure has three types of effects:
 Allocation effects
 Redistribution effects
 Stabilization effects
 Expenditure can be categorized as:
 Exhaustive and transfers
 Non-Marketed Goods and Marketed Goods
2/18/2024
35

Summary
 Wagner’s law states that “ as per capita income increases,
so also does government expenditure.
 Musgrave, and Rostow, suggested that the growth of
public expenditure is related to the pattern of economic
growth and development in societies.
 The empirical support for the Wagnerian hypothesis and
the displacement effect is often not robust enough
2/18/2024
36

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