The Composition of Public Finances and Long-Term Growth: A Macroeconomic Approach
Francisco de Castro
Banco de Espana
José Manuel Gonzalez Minguez
Bank of Spain - Estudios Monetarios y Financieros
August 29, 2008
Banco de Espana Occasional Paper No. 0809
This study reviews, from both a theoretical and empirical perspective, the links between composition and quality of public finances, on the one hand, and long-term economic growth, on the other, focusing on the EU-15 countries. Specifically, for a given level of the general government balance, factors such us the composition of revenues and expenditures, an efficient use of public resources or even the public sector size may condition long-term growth insofar as they affect the allocation of resources.
On the expenditure side, the available empirical evidence suggests that resources devoted to public investment on transport and communication infrastructures entail positive spillovers on the accumulation of physical capital and the productivity thereof. Moreover, expenditure on education is deemed to increase human capital and labour productivity. Conversely, as far as other R&D and health-care expenditure items are concerned, despite the theoretical arguments supporting their beneficial effects of on long-term growth, the evidence is less conclusive.
In turn, public expenditure has to be financed by tax revenues, which on the other hand are also set to achieve other important goals such as income redistribution or macroeconomic stabilisation. However, taxes may involve a negative impact on economic efficiency by distorting agents' decisions. Nevertheless, from a theoretical point of view, the complexity of the analysis of the final incidence of the tax burden hampers a proper assessment of the effects of the different tax categories on economic growth.
Finally, the more efficient fiscal policy is, the higher the stimulus on economic growth will be. This advocates for the implementation of budgetary techniques aimed at the fulfilment of the targets set by the general government at the lowest cost possible, notably budgeting according to the results obtained, cost-benefit analysis or medium-term budgetary strategies. However, the implementation of such mechanisms has yielded only moderately satisfactory results, suggesting the need for further improvements. In particular, available analytical tools for the measurement of the efficiency of fiscal policies, in terms of the achievement of given targets at the lowest cost possible, are not accurate enough. Therefore, further progress in this area is a priority.
Note: Downloadable paper in Spanish.
Number of Pages in PDF File: 49
Keywords: economic growth, quality of public finances, efficiency
JEL Classification: H21, H22, H41, H50, O40
Date posted: October 22, 2008