How Does the Composition of Public Spending Matter?

Abstract

Public spending has effects on growth and distribution that 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 has been made conditional on increased expenditure on categories that are thought to be “pro-poor”. 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 and supported by empirical evidence are indicated. 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 and provides some evidence 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.