A Functional Classification of Government Spending and Economic Growth in Latin American Countries

Abstract

The objective of this article is to determine the effects of different components of government spending on the per capita economic growth rate in a set of Latin American countries over the period 1975-2000. Within the neoclassical framework (Solow, 1956; Swan, 1956), government spending, and public policy in general, has no role in determining the long-run economic growth rate, since this is determined by the exogenous population growth and technological progress rates. On the other hand, in some endogenous growth models developed mainly since the early 1990s, such as Easterly (1990), Barro (1990), Barro and Sala-i-Martin (1992, and 2004), Cashin (1995), Bajo-Rubio (2001), and Milbourne et al. (2003), fiscal policy affects the long-term growth rate through decisions on either taxes or expenditures.

The empirical literature tends to reject the prediction of the neoclassical model of no role of fiscal policy in determining the growth rate in the long term. However, results are far from conclusive. As long as theoretical models about the influence of public spending on growth is concerned, some of them such as Barro (1990), Cashin (1995), Bajo-Rubio (2000), and Milbourne et al. (2003) predict that a positive effect is expected to be found in countries where the size of government is smaller than a certain threshold, and a negative one in countries where the size of government is bigger than that. Therefore, since generally speaking, with few exceptions, one finds very large public sectors only in developed countries (DCs), studies evaluating the impact of public expenditure on growth should analyze DCs and less developed countries (LDCs) separately. Within the recent growth literature framework, the study uses a generalized method of moments, as suggested by Arellano and Bond (1991), to obtain consistent and efficient estimates for a dynamic model, such as an economic growth model.

Some literature finds growth promoting effects of government spending on education and health, which have been associated with spending on human capital. Nevertheless, these effects were not found in this study. The findings suggest that the only component of government spending significantly correlated with growth is that on transport and communications. Therefore, it is possible to conclude that the composition of government spending does matter for growth in the set of Latin American countries considered here.

Keywords: Economic growth, Endogenous growth, Generalized method of moments, Government spending, Less developed countries