Public Expenditure and its impact on Economic Growth: A case of Pakistan

Abstract

The public expenditures are very important and basic necessities of every country. It plays crucial and dynamic role in each economy and government has responsibility to provide them. This study examined public expenditures impact on economic growth by using time series data from1982-2017 in case of Pakistan. The variables are growth rate as GDP, development expenditure, defense expenditures, health expenditures and education expenditures. The ordinary least square (OLS) test and CUSUM, CUSUM Square tests are applied to check relationship between public expenditures and economic growth. This study concludes with mix results, which indicates that there is a significant positive relationship between development and health expenditures on economic growth. Furthermore, defense and education expenditures have negative relationship on economic growth. Moreover, it is recommended that public expenditures should be used in appropriate way; if it is not used in accurate place it would not be favourable for Pakistan economy.

Full text

Kashmir Economic Review
Vol. 26, No.1, Jan – June, 2017
Public Expenditure and its impact on Economic Growth: A case of Pakistan
Sadıa Ejaz
1
, Hina Amır
2
and Malik Shahzad Shabbir
3
Abstract
The public expenditures are very important and basic necessities of every country. It
plays crucial and dynamic role in each economy and government has responsibility to provide
them. This study examined public expenditures impact on economic growth by using time series
data from1982-2017 in case of Pakistan. The variables are growth rate as GDP, development
expenditure, defense expenditures, health expenditures and education expenditures. The ordinary
least square (OLS) test and CUSUM, CUSUM Square tests are applied to check relationship
between public expenditures and economic growth. This study concludes with mix results, which
indicates that there is a significant positive relationship between development and health
expenditures on economic growth. Furthermore, defense and education expenditures have
negative relationship on economic growth. Moreover, it is recommended that public
expenditures should be used in appropriate way; if it is not used in accurate place it would not be
favourable for Pakistan economy.
Keywords: public expenditures, economic growth, ordinary least square, Pakistan
JEL Codes: H50, H60, O50
1. Introduction
The public finance is deliberated actual of public policies targeted to improving economic
growth. However, relatively these policies are accomplished over public expenses and returns.
Therefore, knowledge related to trend, landscape and grade of the sound effects of variations in
public spending on economic growth has energetic significance such as, capital goods,
consumption goods and personnel expenditures include in public expenditures (Valentino Piana
2001). Theoretically, there are two opposite views of Keynesian and Wagner’s about association
among economic growth and domestic revenue. Through law of Wagner’s (1890) by increasing
1
Comsat Unıversıty, Lahore
2
Comsat Unıversıty, Lahore
3
(Corresponding Author) University of Brunei Darussalam

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Vol. 26, No.1, Jan – June, 2017
real per capita income public expenditures also increase. Causation must run from domestic
revenue to public expenditures and by increasing economic growth public spending also
increased. Though according to Keynesian economic growth is due to public expenditures and it
is an independent variable. Moreover, Keynes thoughts for improving economic growth (both
short and long run) public expenditures must be increased. According to Keynesian views
causality must run from government expenditures to national income. (Muhammad et al 2015).
However, economic inequalities act as an authoritative role in manipulating of goods and
services that are sponsored by municipal segment either that inequality is actual or perceived.
The public expenses on foreign aid, research and development, roads, defense, police and fire
services, have gains for all residents Shabbir and Rehman (2015). Furthermore, these expenses
do not openly impress the welfare of household apart from those directly involved in these
activities (Schwabish et al 2004). This analysis contains 51 developing countries by faculty at
International Monetary funds (IMF) establishes reliable association all-around the countries,
approving “a long-term relationship between government spending and output consistent with
Wagner’s law” (David Hall 2010). The public expenditures are basic aspect in economic growth
and enlargement. These are vital for funding structure, comprising road and rail network, energy,
and water facilities. It supplies schooling and health facilities vital for current marketplaces more
proficiently and effectively rather than the flea market might offer. In OECD countries
expenditure is great intensities of 40% of GDP and growing in emerging countries (David Hall
2010).
However, progressivity and regressively of public spending can be interpreted through
comparing the benefit concentration curve with 45 degree sloping as well as the ordinary curve
based on income and consumption. If the concentration curve is above the standard curve for
income and consumption but under the 45-degree line then remunerations from public spending
can be progressive. The concertation curve that fulfils this condition can be concave or convex.
But remunerations from public spending can be regressive when benefits are not distributed
equally than income and consumption (Chakraborty et al 2013).
Figure 1: Progressivity or Regressively of a Public Spending:

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Vol. 26, No.1, Jan – June, 2017
Total public expenditures in 1980s were 122153.9 million rupees according to handbook of
statistics of Pakistan economy. In 1990s total expenditures were 426506.5 million rupees. Both
figures of millions rupees show a significant increase in overall amount in one decade. In 2000s
this amount increased rapidly and reaches to 1174192.4 million rupees. In this era government
enhanced public expenditures and give subsidies to people as well. These significant increases in
public expenditures indicate a favorable ground for economic growth in Pakistan. The private
consumption expenditures are 79.20% of GDP and public consumption expenditures are 11.84%
of GDP. In outgoing fiscal year total consumption expenditures were 91.04% as compared to
91.46% of last fiscal year. In 2013-14 total expenditures were Rs.3, 446.2 billion but in July-
March 2014-15 it was 3731.6 billion, hence it increased with 8.3% growth rate on annual basis
Shabbir (2016). This study tends to investigate the impact of public expenditures on economic
growth. It shows at which level public expenditures are significant or which variable is positively

Kashmir Economic Review
Vol. 26, No.1, Jan – June, 2017
affect or negatively effect on economic growth. However, defense, development, health and
education are independent variables and GDP is used as per alternative of economic growth.
The analysis of this study is a new contribution in existing literature of public expenses and
economic growth through inspecting the effect of public outlays on economic growth, using such
variables as development, defense, education and health expenditures as an explanatory variables
and GDP as a dependent variable. Some of previous studies used education and health
expenditures in their studies but only these two variables can’t properly explain relationship of
public expenditures and economic growth. So this study enhances two more variables such as
development and education to check this relationship more accurately and effectively in the
context of Pakistan. Finally, this study fills the gap of existing studies with adding new more
variables and latest data set.
2. Literature Review
Desmond et al ., (2012) examined the effect of public expenditure on economic growth for
period 1970-2009, where they took variables as, GDP, government capital and recurrent
expenditures on economic services, social and community services and transfers. They were also
using OLS method for data analysis. However, investment and regular expenses on economic
services had adverse effects and investment expenditure has transferred the progressive impact
on economic growth. Al-Shatti (2014) examined the impact of public expenditure on economic
growth in Jordan during 1993-2013 by taking capital spending on education, expenditures on
health, spending on economic affairs and also spend on housing and community utilities using
OLS, augmented dickey fuller (ADF) tests. The present investment expenses on education have
negative effect, while expenses on economic concerns and health has positive effect.
Yilgör et al., (2012) examined the relationship between public expenditure and economic growth
for period 1980-2010 by using ADF, Philips Perron (PP) and Granger Causality tests on current
expenditures, transfers expenditure and investment expenditures. Their study revealed the results
that uni-causality was found from current, transfers and total expenditures to economic growth.
In order to ensure growth in Turkey’s economy, controlled increases should be realized in forms
of public expenditure. Patricia and Izuchukwu (2013) in Nigeria find out the effect of public
expenditures on education from 1977-2012 and GDP using VECM and ADL methods. The result

Kashmir Economic Review
Vol. 26, No.1, Jan – June, 2017
showed education expenditure having positive impact on growth rate. Whereas, government
should reduce recurrent expenditure and enhance capital expenditure but also increase
expenditure on education as it influence growth rate positively.
Egbetunde and Fasanya (2013) examined public expenditure impact in Nigeria during 1970-2010
on total expenditure, capital expenditure and recurrent expenditure using ARDL approach. The
result showed that total public spending impact on growth is negative and recurrent expenditures
having positive impact. Oyinlola and Akinnibosun (2013) examined the relationship between
public expenditure and economic growth in Nigeria during 1970-2009 on recurrent expenditures,
capital expenditures, administrative expenses, community and social services and transfers using
ADF and Phillips Perron (PP) tests. The long run elasticity result showed that there is negative
impact of recurrent expenditures, administrative expenses and transfers expenditures and positive
impact of capital expenditures as well as social and community services.
Alexiou (2009) provided evidence on economic growth and government spending in South
Eastern Europe. The variables consist on capital formation, development assistance, private
investment, and trade openness and population growth using pooled cross-section/time-series
data of 113 countries. The results indicate that there is a significant and positive effect on
economic growth by development assistance, government spending on education, trade openness
and private investment. And statistically significance shows in population growth. Bose et al
(2003) found out the growth effects of government expenditure for a panel of thirty developing
countries over the decades of the 1970s and 1980s on current and capital expenditures. Initially,
the government capital expenditures are positive and considerably associated with economic
growth but current expenditures are insignificant. Furthermore, overall expenditures and
investment are solitary expense should be considerably related on growth at sector level when
variables are taken into consideration that are omitted variables and budget constraint.
Asghar et al., (2011) examined the relationship between public spending in community sector
and GDP during 1974-2008 in Pakistan, where they took variables as income per capita,
education, health, law and order expenditures, subsidies and economic and community services
by using ADF, PP, KPSS, Ng-Perron tests, VECM and Johansen co-integration tests. The
outcomes of the study revealed the progressive correlation of social investment expenditures and

Kashmir Economic Review
Vol. 26, No.1, Jan – June, 2017
community services with GDP. However, expenses on law and order and subsidies showed
negative relationship with economic growth.
Rauf et al., (2012) examined the Wagner’s law causality among community spending and
domestic earnings and applicability during 1979-2009 data. Whereas, ADF, PP, ARDL
approach, Todo-Yamamoto approaches have been used. The research concluded no existence of
long run correlation among community spending and domestic earnings collectively. Moreover,
causation outcomes declared no causal relationship from community spending to domestic
earnings and domestic earnings to community spending. Muhammad et al (2015) inspected
influence of expenses on GDP consuming annually statistics from 1972-2013 in Pakistan. ADF
method was used to check stationarity of the data. To inspect the association between given
variables (expenditures and economic growth) Johansen co-integration and Granger causality
tests were applied. In Pakistan observed research didn’t care Keynesian and Wagner theory for
observed period and there were no long run relationship between expenditures and economic
growth.
Gisore et al., (2014) examined the government expenditure contributes to economic growth in
East Africa from 1980 to 2010 by applying Levin-Lin-Chu (LLC) and unit root tests. However,
this implied the Hausman (1978) test to reinforce the application of the balanced panel fixed
effects model in this analysis. The findings showed that expenditures on health and defense to be
positive and statistically significant effect on growth. In contrast, education and agriculture
expenditure were insignificant. Aladejare (2013) examined the relationship and dynamic
interactions between government capital and recurrent expenditures and economic growth in
Nigeria over period 1961-2010 using VECM, Granger causality tests, ADF and PP tests. The
government capital spending is more significant than government recurrent expenditure.
Moreover, government recurrent expenditure indicates negative effect on growth in the economy
while capital spending has positive effect.
According to previous studies on economy growth would be increased by increasing public
expenditures and human capital is a best measure to determine public expenditures and economic
growth relationship. However, increasing spending on economic growth obviously increased and
this can be acquired by doing more spending on it and became useful in production of goods and
services. While many researchers used only education as a public expenditure to measure

Kashmir Economic Review
Vol. 26, No.1, Jan – June, 2017
relationship between economic growth and public expenditures and this indicator has many
doubts and education expenditures can’t give short run return, so only education is not best
measure to check relationship between economic growth and public expenditures as a whole.
This study used education, health; defense and development expenditures to measure this
relationship and these variables are more convenient and can give accurate results in the context
of Pakistan economy.
3. Methodology
This study examines the impact of public expenditures on economic growth in Pakistan.
However, time series data is used from 1982 to 2017 and collected from handbook of statistics of
Pakistan for the variables of development, defense and health expenditures. Moreover, rest of
data on education expenditures and GDP is taken from World Bank Indicator (WDI). There is
one dependent variable that is GDP used in the model. The GDP is used as a percentage of GDP
and as a proxy of economic growth. Many previous studies have been used GDP as proxy of
economic growth in their studies. There are four independent variables used in the study. The
variables are defense expenditures (DEF), development expenditures (DEV), education
expenditures (EDU) and health expenditures (HEA). The education is measured as a percentage
of GDP. Many studies have been used education and health variables but we didn’t find any
study used defense, development, education and health expenditures collectively. This study
addresses following hypothesis
Hₒ = there is no relationship between public expenditures and economic growth
H₁ = there is a relationship between public expenditures and economic growth
The model of the study is given as below.
𝐼𝑛𝐺𝐷𝑃 = 𝛽ₒ + 𝛽₁𝐼𝑛(𝐷𝐸𝐹) + 𝛽₂𝐼𝑛(𝐷𝐸𝑉) + 𝛽₃𝐼𝑛(𝐻𝐸𝐴) + 𝛽₄𝐼𝑛(𝐸𝐷𝑈) + 𝜇ₒ
Where:
GDP: gross domestic product
DEF: defense expenditures
DEV: development expenditures
HEA: health expenditures
EDU: education expenditures

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4. Results and Discussions
The econometric techniques are used to check relationship between public expenditures and
economic growth. Moreover, statistical analysis is used to test the hypothesis as well. The details
steps for analysis are these:
Unit Root test
 ADF test
Ordinary Least Square test (OLS)
Stability tests
 CUSUM test
 CUSUM Square test
4.1 Unit Root Test
In order to find out the association of dependent and independent variables, first unit root test is
applied to check the stationary of variables. For unit root test ADF test is most commonly used.
The outcomes indicate that all variables are not stationary at level, so we take log of all variables
and after taking log all variables become stationary at level I (0). Furthermore, simple OLS
technique is applicable on this study.
Table 1: Unit Root Test
Variables
C
C&T
GDP
-3.173
(0.032)
-3.592
(0.048)
DEF
-3.241
(0.027)
-2.634
(0.269)
DEV
-4.431
(0.0015)
-5.177
(0.001)
HEAL
-5.604
(0.0001)
-5.724
(0.0003)
EDU
-6.009
(0.0000)
-5.950
(0.0002)

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Vol. 26, No.1, Jan – June, 2017
4.2 Ordinary Least Square test (OLS)
Variables
Coefficient
Std. Error
T-Statistics
Probability
C
4.813
1.457
3.303
0.003
LEDU
-0.406
0.328
-1.238
0.227
LDEV
0.351
0.176
1.998
0.057
LDEF
-0.542
0.184
-2.952
0.007
LHAEL
0.394
0.191
2.065
0.049
R squared
0.431
F-statistic
4.632
Adjusted R-
squared
0.312
Prob (F-statistic)
0.013
The OLS regression results indicate that development shows significant positive impact on GDP
growth rate. It means that on average other things remain constant 1% rise in development will
cause to 0.35% increase in GDP. Due to increase in development the infrastructure etc; of the
economy can positively affect the GDP of the economy. Moreover, health expenditures show
significant positive impact on GDP growth rate. It means on average other things remain
constant 1% rise in health causes to 0.39% rise in GDP. It will better affect the health of people,
which cause enhanced the growth rate and increase in GDP or growth rate. The healthy people
can contribute in best way to increase economic growth. While, rest of both variables indicates
such as defense and education expenditures insignificant negative results. Moreover education
expenditures give return in long run. The R square shows goodness or fitness of the model and
43% independent variables explained by the dependent variable. Finally, F-statistic is significant
at 5% level as p-value is less than 0.10.
4.3 CUSUM Test
The Pesaran and Shin (1999) estimated the constant of error correction model, which must also
be obviously examined. In graphs image of the Cumulative Sum (CUSUM) and the Cumulative

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Sum of Square (CUSUMSQ) of the recursive residual are also documented. The cumulative sum
(CUSUM) and cumulative sum of squares (CUSUMSQ) designs, which is presented in figure 1
from a recursive estimation of the model also show constancy in the coefficients over the trial
era.
Figure 2: CUSUM
-15
-10
-5
0
5
10
15
86 88 90 92 94 96 98 00 02 04 06 08
CUSUM 5% Significance
Figure 3: CUSUM Square
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
86 88 90 92 94 96 98 00 02 04 06 08
CUSUM of Squares 5% Significance
The CUSUM test shows the constancy of the limitations. According to our outcomes it indicates
blue line lie between the red region means that our parameters are stable. The second figure

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Vol. 26, No.1, Jan – June, 2017
indicates the blue line lies outside the red line in time period from 1994 to 1998; it may be due to
some economic shocks. In this time period may be economy faced some shock and due to that
parameters are showing instability.
4.4 Descriptive Analysis
The descriptive analysis of four independent variables is mentioned in below table. Where,
mean, standard deviation, minimum and maximum values of 36 observations are included in this
table. The defense and development values are in thousands while health and education values
are in percentages. However, mean value of defense expenditures is 117820.4, standard deviation
is 95384.28, minimum value is 10168 and maximum value is 378135. Furthermore, mean value
of development expenditures is 52736.25, standard deviation is 83309.38, minimum values are
4616 and maximum value is 316446. The least but not last the value of health is 0.748, 0.172,
0.51 and 1.19 for mean, standard deviation, minimum and maximum respectively. Finally, values
for variable education consists of 2.427, 0.302, 1.837 and 3.022 mean, standard deviation,
minimum and maximum values respectively.
Table 2: Descriptive Analysis
Variables
Observation
Mean
Standard
Deviation
Minimum
Maximum
Defense
36
117820.4
95384.28
10168
378135
Development
36
52736.25
83309.38
4616
316446
Health
36
0.747
0.172
0.51
1.19
Education
36
2.426
0.302
1.838
3.022
5. Conclusion and Recommendations
The public outlays show very significant title role in economic growth of every country and it is
compulsory for every country because it demands from general people. The public expenditures

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Vol. 26, No.1, Jan – June, 2017
should be completed in better and appropriate way and on deserving place. There is significant
amount of literature is available on community expenses and economic growth. In some studies
GDP used as proxy for economic growth, whereas most of literature shows positive effect on
GDP by public expenditures in emerging and developed countries as well. But few studies
showed negative impact of some variables also. Al-Shatti (2014) and Gisore et al (2014) results
showed negative effect of education expenditures and GDP.
This analysis is an addition to literature and it describes the public expenditures impact on
economic growth in Pakistan. It shows which variable is positively affected and which variable
is negatively effect on economic growth. However, education, health, development and defense
expenditures collectively used in this study, which is not used in previous studies and this gap is
filled by our study. The time series data is used and stationarity unit root test is applied to
identify the stationary and non-stationary among variables at constant or trend level. Finally
simple OLS method is applied and the results show that there is progressive association among
development expenditures, health expenditures and GDP, while defense and education
expenditures variables indicate negative impact on economic growth. This study concludes with
these remarks and recommends that public expenditures should increase on development and
health expenditures rather than education and defense expenditures. These education and defense
expenditures are also important but government should increase spending on health facilities and
on development services. These expenditures can be helpful to increase economic growth.
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