Compositional Changes in Public Expenditure and Economic Growth: Time Series Evidence from Pakistan

Abstract

The role of government in achieving economic growth through its fiscal policy, particularly spending policy cannot be overlooked. Investigation of public spending policy and its transmission mechanism to sustainable growth is imperative to the ultimate objective of welfare maximization. This study aims to identify the growth-oriented components of public expenditure as it seems useful to know the contribution of each component of spending towards the objective of economic growth. The study adopts the Kocherlakota and Yi’s (1997) model as modified by Colombier (2008) to carry out the empirical analysis. To this end, ARDL is employed on annual data that ranges from 1973 to 2014 to estimate both the long-run and short-run dynamics between public expenditure composition and economic growth in Pakistan. The results indicate that public development expenditures are growth-oriented, while current expenditures reduce economic growth. Thus, sustainable economic growth and sustainable development can only be materialized by changing the composition of public spending in favor of development expenditure. Since Pakistan is in the dire need of infrastructure and energy, therefore, allocation of more funds to Public Sector Development Programs (PSDP) are expected to add directly to growth on one hand and set a crowding-in effect for private investments—thereby enhancing growth indirectly—on the other hand.