Does Composition of Public Expenditure Matter for Economic Growth? Lessons from Sri Lanka

Abstract

In the context of surging public expenditure and crumbling output growth, the growth effects of public expenditure have provoked an extensive discussion in the economic and political arenas in Sri Lanka. Since 1977, both public expenditure and its composition have changed intensely and largely been accompanied by expansion in size of successive governments. Although it is difficult to determine whether Sri Lanka has reached its optimal size of public expenditure, understanding the growth effects of public expenditure would clearly link policy contributions made by public expenditure in spurring growth in Sri Lanka. The purpose of this study is to examine the growth effects of composition of public expenditure considering full implications of government budget constraints. This study considers public expenditure at a disaggregated level to isolate productive elements of public expenditure from the total. Accordingly, public expenditure on education, health, defence, agriculture and transport and communication are considered. These expenditure items are selected based on their share in total expenditure. This study found that the growth effects of public expenditure vary at disaggregated levels. A major finding showed that public expenditure in education, agriculture, transport and communication sectors is positively and significantly associated with economic growth while defence and health expenditure do not have any significant impact on growth. Given the high magnitude of positive and significant growth effects of public expenditure in the education sector, this study suggests reforming public expenditure in favour of human capital development is paramount to stimulate long-term growth in Sri Lanka.