1. Public Expenditure Analysis
ECON 453
Public Expenditure Analysis
E. Nketiah-Amponsah
Department of Economics
Room W.18
Dr. E. Nketiah-Amponsah
12/5/2018

2. 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
Dr. E. Nketiah-Amponsah
12/5/2018

3. 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.)
Dr. E. Nketiah-Amponsah
12/5/2018

4. 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
Dr. E. Nketiah-Amponsah
12/5/2018

5. Principles of Expenditure Analysis
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
Dr. E. Nketiah-Amponsah
12/5/2018

6. Principles of Expenditure Analysis
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.
Dr. E. Nketiah-Amponsah
12/5/2018

7. 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
Dr. E. Nketiah-Amponsah
12/5/2018

8. Types of Expenditures Expenditure can be categorized as:
Exhaustive and transfers
Non-Marketed Goods and Marketed Goods
Exhaustive expenditure embraces the purchase of inputs while transfer expenditure is not a claim on society’s resources( e.g. subsidies)
Dr. E. Nketiah-Amponsah
12/5/2018

9. Types of Expenditures 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
Dr. E. Nketiah-Amponsah
12/5/2018

10. Types of Expenditures
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
Dr. E. Nketiah-Amponsah
12/5/2018

11. Types of Expenditures
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
Dr. E. Nketiah-Amponsah
12/5/2018

12. Discretionary and Statutory Payments, 2000 – 2012

13. 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
Dr. E. Nketiah-Amponsah
12/5/2018

14. Models of Government Expenditure 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
Dr. E. Nketiah-Amponsah
12/5/2018

15. Models of Government Expenditure 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.
Dr. E. Nketiah-Amponsah
12/5/2018

16. 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.

17. 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)
Industrialisation
Increasing incomes
Social progress
The driving force:
Modern (textbook) version:
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.

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

19. (share of government spending
Testing Wagner’s Law
Government spending
Income elasticity:
GDP per capita
Absolute version:
Normal good
(share of government spending
in GDP increases).
Relative version:
Superior good
cross country
Time series in one country

20. 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.

21. 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 ηFG < ηGY
This leads to a situation where government is bound to spend more on public goods to meet the demand of the citizens
Dr. E. Nketiah-Amponsah
12/5/2018

22. Causes of Public Expenditure Growth in Developing Countries (Macro models)
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
Dr. E. Nketiah-Amponsah
12/5/2018

23. Causes of Public Expenditure Growth in Developing Countries (Macro models)
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
Dr. E. Nketiah-Amponsah
12/5/2018

24. Causes of Public Expenditure Growth in Developing Countries (Macro models)
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)
Dr. E. Nketiah-Amponsah
12/5/2018

25. 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.
Dr. E. Nketiah-Amponsah
12/5/2018

26. Macro Models of Expenditure Growth
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.
Dr. E. Nketiah-Amponsah
12/5/2018

27. Macro Models of Expenditure Growth
(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.
Dr. E. Nketiah-Amponsah
12/5/2018

28. The Displacement Hypothesis
(Peacock & Wiseman, 1961)
Government spending evolves in a step-like pattern,
where each step coincides with social upheavals, notably wars.
Key assumptions
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 citizens.

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

30. Graphical illustration
total spending
civilian spending
defence
time
normal
war
normal

31. Empirical tests What qualifies as a major social upheaval:
WWI and WWII
Great Depression?
Oil Shocks?
0 if year < 1914
test
1 if year = or >1950
0 if year < 1914 or
1 if year >1950

32. 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.

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

34. ARIMA model of spending in the UK
time series model
Dummy = 1 after WWII
Dummy for WWII
Result: b4 negative and significant!!!
Little systematic evidence of the
displacement effect

35. 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
Dr. E. Nketiah-Amponsah
12/5/2018

36. 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
Dr. E. Nketiah-Amponsah
12/5/2018