Impact of Public Expenditure on Economic Growth: Empirical Evidence from Selected South Asian Countries with Special Reference to Pakistan

Abstract

In South Asia, like many other developing countries of the world, the role of public expenditure despite its relatively high share has not been satisfactory in addressing a number of social and economic issues over the years. Rising deficits, widening income inequality, mounting debts and low revenue earnings in South Asian countries demand for deep analysis of the issue. Direction of influence between public expenditure and economic activity, relative importance of the financing source of public expenditure and the optimal size of government needs to be investigated. This study targets expenditure-growth nexus in selected South Asian countries-Pakistan, India, Sri Lanka and Nepal-for the period 1975-2008. The study finds that public expenditure and economic development do not show any long run relationship in Pakistan India and Nepal. This shows that economic development and public expenditure do not affect each other and are determined by some other factors. However, in Sri Lanka public expenditure and per capita GDP are linked in the long run. At disaggregated level, various components of public expenditure do not show any long run relationship with per capita GDP in all the countries. This shows that existing structure of government expenditure is not conducive to economic growth and some other structure of government expenditure can be more efficient in stimulating economic growth. This can be achieved by reorganizing, restructuring and redefining the role of public expenditure. The study concludes that source of finance does matter in determining the impact of public expenditure on economic growth. Public expenditure financed through any source hurt growth in this region. However, seigniorage financed public expenditure has a larger negative effect on growth followed by debt financed and tax financed public expenditure. Therefore, it is suggested that reduction in public expenditure can boost growth in South Asia. However, in current scenario financing of public expenditure through taxes is the least costly option. The study also finds, assuming balanced budget, that current size of governments in these countries is higher than the estimated optimal size. However, the difference between current and optimal size is very small. This shows a small scope for reduction in government size. Government size is optimized when public expenditure ranges from 18 to 28 percent of GDP. Under the unbalanced budget scenario, it is found that the current tax to GDP ratio is below the estimated growth maximizing tax ratio. A large scope (10 to 30%) exists to increase tax to GDP ratio to attain the optimal level of taxes. However, the estimated threshold level of taxes is lower in comparison with the developed countries. Unfriendly environment for taxpayers, complex tax rules, rampant tax evasion, vested discretionary powers of the tax collectors, narrow and rigid tax base, among others, are responsible for this low threshold level of taxes. Strict fiscal discipline through cuts in public spending, restructuring and reorganization of the tax regime to mobilize more domestic resources is the suggested panacea for major economic concerns of the South Asian region.