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Journal of Business Management and Economics 3: 10 October (2015).

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JOURNAL OF BUSINESS MANAGEMENT AND ECONOMICS


Homepage: http://innovativejournal.in/jbme/index.php/jbme

The Effect of Public Expenditure on Economic Growth in the East African Community
1

Cynaida Miriam Kwendo, 2Dr Willy Muturi

Jomo Kenyatta University Of Agriculture And Technology


Senior Lecturer Jomo Kenyatta University of Agriculture And Technology
E-Mail- miriamkwendo2@gmail.com, mmuturi2001@gmail.com

DOI: http://dx.doi.org/10.15520/jbme.2015.vol3.iss10.151.pp09-13
Abstract: This study analyzed the effect of public expenditure on economic growth in Kenya, Uganda, Rwanda, Burundi and Tanzania. The
specific objectives of the study were to investigate the effect of public expenditure on components of consumption, health, defence and
agriculture. Using panel data covering the period 1995-2010, the study applied the Hausman test and verified results through the Fixed effects
method. The findings were that agriculture and defence expenditure had a negative impact on economic growth while health and consumption
expenditure had a positive impact on economic growth. Based on the summary of these findings, recommendations were prescribed to aid in
wise policy choices.
Key words: Public expenditure, economic growth, agriculture, health, consumption and defence.

an empirical question. As noted in the preceding literature,


there is a significant impact of public infrastructure on
economic growth. Nevertheless, there is an element of risk
involved for government policymakers who depend on such
research to financing public budgets, especially in emerging
economies where budgetary surpluses are difficult to
achieve and income flows are vulnerable to global forces
(Merna & Njiru 2002). Because incomes are lower in
developing countries, savings are low and thus investment is
low. Older and stronger economies have the financial
resources to recover quickly from an economic downturn.

INTRODUCTION
The relationship between economic growth and the size of
the public sector is an important subject of review and
analysis. The subject of debate is whether or not public
sector spending increases the growth rate of the economy.
Economic growth refers to a steady physical increase in a
countrys productive capacity which is identifiable by a
sustained increase in a countrys real output of goods and
services or real income over time (Mudida, 2009).
Sustained and equitable economic growth is an important
objective of public expenditure policy. Many public policy
programs are predominantly aimed at promoting sustained
and equitable economic growth. Public expenditures have
played an important role in physical and human capital
formation over time. Society demands for infrastructural
facilities such as education, health, electricity, transport
defence etc., to grow and improve on their standards of
living. Kenya, Uganda, Rwanda, Burundi and Tanzania are
no exception on this regard.

Generating sufficient public expenditure on economic goods


and funds arguably will remain an issue for these East
African Countries, and academic inquiry is necessary to give
some direction to the policymakers. It is under this premise
that this study finds a scope to understand the subject
collectively for these countries.
REVIEW OF RELATED LITERATURE

The East African Community (EAC) is among the fastest


growing regions economically. The average economic
growth rate for the past decade 2004-2013 has been at 6.2
percent. (IMF, 2014). Amidst the high economic growth,
public expenditure remains one of the main economic policy
issues facing EAC governments.The aim of this study is to
therefore examine the effect of public expenditure on
economicgrowth in Kenya, Uganda, Tanzania, Rwanda and
Burundi. Public expenditure is categorised into
consumptiondefence, health and agriculture expenditure.

Josaphat et al. (2000) examined the impact of government


spending on economic growth in Tanzania using time series
data over 1965-96 and found that increased industrious
expenditure has a negative effect on growth while
consumption expenditure stimulates growth. Landau (1983),
using data for developing countries over 1960-80, examined
the relationship between the growth rate of real per capita
GDP and the share of government expenditure in GDP. He
found that government consumption expenditure has
negative effects on the growth of per capita output, while the
other types of government expenditure have minimal effects
on output growth.

A considerable number of researchers have delved to


unearth the substantive impact of government spending on
economic growth in various economic jurisdictions all over
the globe, however, the results still remain contestable.
Tracing from the growth theories of Solow, Cob-Douglas
and many others, it still remains clear that this relationship is

Baum and Lin (1993) also investigated the effect of three


different types of government expenditures, that is defense,
welfare, and education, on the growth rate of per capita
GDP using cross-section data from developed and
developing countries over 1975-85. They found that the
growth rate of education and defense expenditures has
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Cynaida Miriam Kwendo et al, Journal of Business Management and Economics, 3 (10), October, 2015,

Yi,t(RGDP)i,t = o + 1EXP(H)i,t+ 2EXP(AGI)i,t +


3EXP(CONS)i,t+ 4 EXP(D)i,t + i,t
Where: RGDP Real gross domestic product
EXP H Expenditure on health
EXP AGI Expenditure on agriculture
EXP CONSExpenditure on consumption
EXP D Expenditure on defence
ErrorTerm
i,t
Dependent variable: Real gross domestic product
Independent Variables: Health expenditure, Consumption
expenditure, Defence expenditure and Agriculture
expenditure.

positive effects on growth rate, while the growth of welfare


expenditures has an insignificant negative effect on
economic growth. Al-Jarrah (2005) examined the causal
relationship between defence spending and economic
growth for 1970-2003 using time-series procedures. He
found evidence of bidirectional causations, wherein higher
defence spending lowered economic growth in the long run.
Albatel (2000) tested the effects of changes in government
expenditures using data over 1964-95. He found that the
government plays an important role in increasing economic
growth and development. Al-Obaid (2004) investigated the
long-run relationship between total government expenditure
and real GDP, and his empirical findings show a positive
long-run relationship between the stake of government
spending in GDP and GDP per capita. Kireyev (1998)
examined the relationship between growth in non-oil GDP
and government expenditure using annual data for 1969-97.
His empirical evidence suggests a significant and positive
association between government spending and growth in the
non-oil sector GDP.

In order to identify the stationarity of the variables the panel


unit root test was conducted. Fixed effects and Random
effects method of estimation were used for this analysis. The
Hausman test was used to determine whether to use the
fixed effects model or the random effects model.
RESEARCH RESULTS AND DISCUSSIONS
Panel Data Regression analysis:

Al-Yousif (2000) showed that the effects of government


spending depends on the way government size is measured.
That is, if the size is measured as a percentage change in the
government expenditure, then the government size is
significantly related to growth, but if it is measured as a
ratio of the government expenditure to GDP, then the
relationship is negative. Guseh(1997) in a study on the
impact of government size on the rate of economic
development conducted OLS estimation, using time-series
data over the period 1960 1985 for 59 middle-income
developing countries. The yielding results suggested that
growth in government size has negative effects on economic
development, but the negative effects are three times as
great in non-democratic socialist systems as in democratic
market systems. Further estimates provided by Engen and
Skinner (1992) for 107 countries over the period 1970-1985,
suggested that a balanced-budget increase in government
expenditure and taxation is predicted to reduce output
growth, whilst Carlstrom and Gokhale (1991) reported
replication results according to which government
expenditures increases caused a long-run decline in output.

Panel Unit root test


This test is used to test for stationarity and a series is
stationary if its mean and auto-covariances do not depend on
time. E-views panel unit root test Breitung (2000), Levin,
Lin and Chu (2002), Im, Pesaran all have the same
hypothesis the null hypothesis is that panel data has a unit
root while the alternate is that panel data has no unit root
meaning it is stationary. Hadri (1999) has a different
hypothesis the null is panel data has a unit root while the
alternate panel data has no unit root.
Table 1 Panel Unit root test
VARIABLES

GDP
HEALTH
AGRICULTURE
CONSUMPTION

ADF FISHER
CHI-SQUARE
44.019
(0.000)
60.276
(0.000)
64.634
(0.000)
39.668
(0.000)
38.094
(0.000)

LEVIN,
LIN &
CHUT
-7.378
(0.000)
-9.116
(0.000)
-13.668
(0.000)
-6.832
(0.000)
-3.870
(0.000)

CONCLUSION

AT LEVEL
1st DIFFERENCE
1st DIFFERENCE
1st DIFFERENCE
1st DIFFERENCE

MODEL SPECIFICATION

DEFENSE

The data that was used for the analysis was from the 1995 to
2010. The prime consideration in designing the
methodology was to incorporate all the important
expenditure variables and keep it straight and effective in
explaining their effects on economic growth. Under these
considerations, the following equation was estimated:

The above table shows that the different variables attained


stationerity at different levels GDP was stationary at level
while health agriculture consumption and defense attained
stationarity at the first difference. This shows that the data is
mean reverting.
Fixed effects model and Random effects model:

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Cynaida Miriam Kwendo et al, Journal of Business Management and Economics, 3 (10), October, 2015,
Table 2 Fixed Effects Model and random Effects Model
FEM
Variable

Coefficient

T-STATISTIC

P-Value

REM
Coefficient

T-statistic

P-Value

CONSTANT
Agriculture

3.639
-0.438

0.793
-0.657

0.431
0.5133

3.623
-0.109

1.637
-0.220

0.106
0.826

Health
Defence

0.4761
-0.544

0.695
-0.864

0.9630
0.3907

1.267
-0.335

3.254
-1.456

0.091
0.150

Consumption
R2

0.007
0.279

0.047

0.4896

-0.191
0.173

-1.716

0.008

DW
Probability(Statistic)

1.775

1.459

0.04

0.009

The results for the Fixed effects model table as shown in the
table 2above portrays that consumption expenditure and
health expenditure have a positive coefficient while
agriculture expenditure and defence expenditure have a
negative coefficient. All the variables were found to be
statistically insignificant because their P-values were more
than 5% and their corresponding t-statistic values were less
than two. The results for the random effects model show that
agriculture, consumption and defence have a negative
coefficient. Their P-values are more than 5% and t-statistic
values are less than two and they are insignificant.

The above equation shows that a percentage change in


agriculture expenditure causes a -43.8% change in GDP
growth. The negative relationship therefore implies that
agriculture expenditure is negatively related to economic
growth in East Africa. However government consumption
expenditure has a positive effect on economic growth . The
relationship is significant at 1% level. According to the
results each 1% increase in consumption expenditure will
cause a 0.7% increase in economic growth for EAC
countries holding other independent variables constant. This
is in contradiction with Barro (1991) who found the
relationship between consumption expenditure and
economic growth to be negative and significant. Landau
(1983) also found a negative relationship between
consumption expenditure and economic growth.

Health expenditure has a positive coefficient and it is


therefore significant to explain GDP. Its P-value is less than
5% and its t-statistic is more than two. In summary for the
two models, the Durbin-Watson test the FEM had no
autocorrelation while the REM suffered from an
autocorrelation problem. The FEM has an R-squared of 28%
which implies that the variables are significant to explain
GDP up to 28%. The REM has an R-squared of 17.3%
which shows that the variables are significant to explain
GDP up to 17.3%. In order to choose between the fixed
effects model and the random effects model the Hausman
test is applied.

Al-Jarrah (2005) examined the causal relationship between


defence spending and economic growth for 1970-2003 using
time-series methodologies. He found evidence that defence
spending lowered economic growth which is in-line with the
above findings that a 1% increase in defence spending will
cause a -54.4% decline in GDP growth for EAC countries.
Health expenditure has a positive effect on economic growth
a 1% increase in health expenditure leads to a 47.6% in
economic growth this is in accordance with Alshavin and
Alshadiq (2014) who found out that health expenditure is
one of the determinants of growth. Agriculture expenditure
has a negative effect to economic growth and this is shown
by the negative coefficient and a 1% increase in agricultural
expenditure leads to a -43.8% increase in economic growth
in the East African countries. This is in contradiction with I
Ismail that agriculture expenditure promotes growth.

Hausman Test:
The Hausman test is a diagnostic test used to differentiate
between fixed effects model and random effects model in
panel data. The fixed effects regression model allows the
intercept to vary but it does not change over time. On the
other hand the Random Effects model clusters the cross
sections and produces a common value for the intercept. The
Hausman test null hypothesis is that the Random effects
model is appropriate while the alternate is the Fixed effects
model is appropriate. In Appendix 3 the probability of the
test is 0.0464 we reject null hypothesis because the
probability 4.64% is less than 5% therefore the fixed effects
model is appropriate.

SUMMARY
This research empirically explores the effects of public
expenditure on economic growth. This study aims to find
out the impacts which are important to the policy makers in
the East African community. In order to account for the
impact of public expenditure on economic growth the unit
root test was done on the variables the independent variables
were all stationary at the first difference and GDP was
stationary at level.

Interpretation and Discussion of results:


According to the Hausman test, the fixed effects model was
found to be appropriate . Therefore the Fixed effects
regression model is per equation.
GDPi,t=3.639 - 0.438AGIi,t + 0.007CONSi,t 0.544Di,t +
0.476 Hi,t + i,t
(0.793)
(-0.657)
(0.046)
(-0.864)
(0.069)
Note: The values in brackets are the t-statistics

Thereafter, FEM and REM were estimated and from both


models health expenditure has a positive significance to
economic growth while agriculture and defence expenditure
have a negative effect to economic growth in East Africa.
Since the fixed effects model was found to be more
appropriate only two independent variables were found to
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Cynaida Miriam Kwendo et al, Journal of Business Management and Economics, 3 (10), October, 2015,

significantly affect economic growth. That is a 1% change


in health expenditure results to 47.6% change to economic
growth and a 1% increase in government consumption
expenditure results to a 0.7% change in economic growth.
Thus the East African countries should encourage health and
consumption expenditure. Defence expenditure should not
be promoted rather it should be discouraged.

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The R squared for the fixed effects model was 27.9% which
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of 17.3% which shows that the Fixed effects model is more
appropriate. The Durbin Watson statistics also shows that
the Fixed effects model is appropriate because its value of
1.775 shows it has no autocorrelation between the
disturbances.
CONCLUSIONS
This study set out to investigate the effect of public
expenditure on economic growth and public expenditure
was divided into government consumption expenditure,
health expenditure, defence expenditure and agriculture
expenditure. Health expenditure and consumption
expenditure had a positive impact on economic growth and
this means that the various East African governments should
invest more in this sectors and reduce their spending on
defence.
SUGGESTED AREAS FOR FURTHER RESEARCH
I would suggest studies on areas of how economic growth is
affected by other factors other than the components of
public expenditure in East Africa. In addition on the same
study I would also like to find out the effect on other
variables like education and infrastructure expenditure. The
study should also be extended to other regions like the
Economic community of West African states and the
Southern African Development Community, a comparison
between the various regions is also necessary.
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