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How Public Spending Can Help You Grow

Otaviano Canuto's picture

Last week’s State of the Union underscored the debate surrounding public spending as a measure to stimulate economic growth. President Barrack Obama argued that to “win the future” the US needs to make significant public expenditures to update the country’s infrastructure, health, and educational systems. The opposite view is that economic growth can only occur through decreased public spending and private sector growth.

Such varied opinions on public expenditures do not exist in the US alone—the debate is global. From the US to the UK, from Europe to Africa, from Latin America to Southeast Asia, to spend or not to spend is a question faced everywhere.

Beyond the epicenter of the economic crisis—the US and Western Europe—public spending has had an indeterminate effect on

spurring GDP growth in developing countries and it is not entirely certain that public spending on its own will serve as an engine for economic growth and development.

Are there any obvious differences in the level of public spending, its components, and their link to growth in developing countries? Does the composition of public spending have any bearing on growth performance? Are there any other domestic conditions that influence the effectiveness of public spending? These are precisely the questions addressed by Blanca Moreno-Dodson and Nihal Bayraktar in “How Public Spending Can Help You Grow: An Empirical Analysis for Developing Countries,” the most recent edition to the World Bank’s Economic Premise series.

Comparing two groups of countries—some with high growth rates (e.g., Korea, Singapore, Malaysia, Indonesia, Botswana, and Mauritius) and some with mixed growth performance records (e.g., Chile, Costa Rica, Mexico, the Philippines, Turkey, Uruguay, and Venezuela)—the authors examine the influence of public expenditures on growth in developing countries over a 35 year period from 1970-2005. Analyzing the growth rates of these two groups of countries, both with similar levels of public expenditure (as a percentage of GDP), leads to an interesting question: why have some countries flowered and others floundered?

“Public spending, especially its ‘core’ components, contributes to economic growth only in countries that are capable of using funds for productive purposes,” argue Moreno-Dodson and Bayraktar. But that’s not the whole story on public spending and economic growth. The authors also contend, “In addition, those countries must have an adequate economic policy environment with macroeconomic stability, openness, and private sector investments that are conducive to growth.”

To see a full account of their qualitative and quantitative findings, as well as the related policy implications and caveats, I strongly suggest downloading this latest Economic Premise.
 

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