How Does the Composition of Public Spending Matter? A Framework Relating Public Spending to Growth, Equity and Poverty-Reduction Objectives

Abstract

Public spending has effects on growth and distribution which are complex to trace and difficult to quantify. But the composition of public expenditure has become the key instrument by which development agencies seek to promote economic development. In recent years, the development assistance to heavily indebted poor countries (HIPCs) has been made conditional on increased expenditure on categories that are thought to be “pro-poor”. The recent decision by the G-8 to expand debt relief and to increase aid volumes is likely to increase the pressures to allocate resources to particular sectors and functions with a view to promoting growth or reducing poverty. This paper investigates the conceptual foundations and the empirical basis for the belief that poverty can be reduced through targeted public spending. While it is widely accepted that growth and redistribution are important sources of reduction in absolute poverty, a review of the literature confirms the lack of an appropriate theoretical framework for assessing the impact of public spending on growth as well as poverty. The dangers of policy decisions that are not well-grounded in theory are self-evident and the paper points to the need to address this weakness. Building on a review of recent approaches that begin to address this gap, it proposes a framework that has its foundation in a broadly articulated country development strategy and its economic goals such as growth, equity, and poverty reduction. Combining principles of public economics and endogenous growth theory offers one way to develop appropriate guidance for public expenditure policy. Public economics principles help to clarify the roles of the private and public sectors and to recognize the complementarity of spending, taxation, and regulatory instruments available to affect public policy. With regard to the impact of any given type of public spending, policy recommendations must be tailored to countries and be based on empirical analysis that takes account of the lags and leads in their effects on equity and growth and ultimately on poverty. The paper sketches out such a framework as the first step in what will have to be a longer-term research agenda to provide theoretically and empirically robust and verifiable guidance to public spending policy.

Keywords: expenditure allocation, poverty reduction, growth, equity

JEL Classification: H11, H50, I38