Public Expenditure, Institutional Environment and Economic Growth

Abstract

This study, based on the endogenous growth theory, evaluates the effects of public expenditures and the institutional environment on economic growth using data from 67 developed and developing countries from 1984 to 2017. Specifically, it investigates the effects of public expenditures on communication and health sectors and institutional factors on economic growth. Using real GDP per capita as the dependent variable, the analysis employed the Unconditional Quantile Regression (UQR) method. The findings reveal that the effects of public expenditure on growth is largely determined by the income level of countries. Public spending on communication and health fosters growth in high-income countries, while it proves insignificant to growth in low-income countries. Similarly, human capital shares positive relationship with growth in high-income countries but it is not a significant driver of growth in low-income nations. Additionally, total factor productivity (TFP) is positively related to growth in high-income countries whereas it negatively affects growth in lower-income countries. The relationship between institutional environment and economic growth varies by income level: Government stability promotes growth in wealthier nations but does not matter for growth in poorer nations. Furthermore, while corruption reduces growth (“sands the wheels”) in low-income nations, it appears to promote growth (“greases the wheels”) in low-income contexts. Initial tests suggest that total factor productivity is endogenous. After correcting for endogeneity issues, the analysis indicates that health expenditures interact with institutional factors such as corruption and rule of law. While corruption reduces the growth effect of health expenditure, rule of law, enhances these effects. A major implication of this study is that the structure of public expenditure needs to differ between low and high income countries. Moreover, there may be need to adjust the proportion of spending allocated to various sectors in line with country’s income level. This further implies that the total value or percentage of expenditure in poor countries may be insufficient to stimulate the desired level of economic growth.