Dissertation - Anwesha Saikia

The Role of Public Expenditure on Economic
Growth: A Case Study of India in the Post

Reform Era
A Dissertation Submitted in Partial Fulfillment of the Requirements for the Degree

of Master of Arts in Economics (2020-2021)
Supervised by Submitted by
Dr. Preeti Singh Anwesha Saikia
Assistant Professor Exam Roll no: 19439ECO003
Department of Economics Enrolment no:415625
Vasanta College for Women
Dept of Economics
Vasanta College for Women
Admitted to the privileges of Banaras Hindu University
Varanasi, Uttar Pradesh – 221001
DECLARATION
I hereby declare that the dissertation entitled “The Role of Public Expenditure on Economic
Growth: A Case Study of India in the Post Reform Era”, for the partial fulfillment of the
requirements for the Degree of Master of Arts in Economics is the outcome of my own work in
the field of my own interest. Neither this dissertation nor any part of it has been submitted by me
elsewhere for the award of any degree or diploma. The information gathered by me for the
dissertation is original, true and factual.
Date: 02/07/2021 Anwesha Saikia

Exam Roll no: 19439ECO003
Enrolment no: 415625
I
CERTIFICATE
This is to certify that the dissertation entitled “The Role of Public Expenditure on Economic
Growth: A Case Study of India in the Post Reform Era” is a bonafide research work submitted
by Anwesha Saikia, a student of M.A. (Economics) of Vasanta College for Women, Rajghat
Varanasi (admitted to the privileges of Banaras Hindu University), during the academic year 2020-
2021 in partial fulfillment of the requirements for the award of the Degree of Master of Arts. The
dissertation or any part, thereof has not been submitted previously for the award of any degree,
diploma, associateship or any other similar title by the candidate.
Supervisor Principal
II
ACKNOWLEDGEMENT
I thank the Lord Almighty for having given me the strength and patience to continue with my
research pursuit. This endeavor of mine would be singularly hollow if it were done without any
purpose.
I express my gratitude for the expert guidance, encouragement and constant support through the
entire period in the Department of Economics, by my supervisor, Dr. Preeti Singh Ma’am,
Assistant Professor, Department of Economics, Vasanta College for Women, admitted to the
privileges of Banaras Hindu University. She was a source of inspiration to me and will continue
to be so in matters academic. It was a privilege to work with her and I have learnt a number of
things that will hold me in good stead in my future career.
I would also like to thank my teachers in the Department of Economics, Vasanta College for
Women, Dr. Ranjana Seth Ma’am, Dr. Vibha Joshi Ma’am, Dr. Yogita Beri Ma’am and Akhilesh
Singh Sir, all of who guided me and helped me, time and again, whenever I was confronted with
problems that defied solution.
I express my gratitude to my fellow mates, who were always forthcoming with their expert advice
whenever the going got rough.
Finally, I would like to thank my parents who has been a constant source of inspiration for me.
This task would never have been completed had it not been for her constant love and support.
Date:02/07/2021 Anwesha Saikia
Vasanta College for Women, BHU
III
CONTENT
S. NO. TITLE PAGE NO.

i) Declaration I
ii) Certificate II
iii) Acknowledgement III
iv) Content IV-VI
v) Preface VII
vi) List of Figures VIII
vii) List of Tables IX
viii) List of Abbreviations Used X
CHAPTER I INTRODUCTION 1-13
1.1. Introduction
1.2. Components of Public Expenditure
1.3. Theories of Public Expenditure
1.3.1. Wagner’s law of Increasing State
Activities
1.3.2. Wiseman-Peacock Hypothesis
1.4. Public Expenditure in India: A Brief Overview
1.5. Significance of The Study
1.6. Objective of The Study
1.7. Hypothesis
1.8. Methodology of The Study
1.8.1. Theoretical Underpinning of the Model
1.8.2. Specification of Dependent and
Independent variables
1.8.3. Source of Data
IV
1.8.4. Tools
1.9. Limitations of The Study
1.10. Chapter Planned
CHAPTER II REVIEW OF LITERATURE 14-21
2.1. Introduction
2.2. Literature that supports the causality of public
expenditure from economic growth, i.e., Wagner’s
law.
2.3. Literature that supports the causality of economic
growth from public expenditure, i.e., Keynesian
version
2.4. Literature that supports neither Wagner’s law nor
Keynesian law.
2.5. Gaps in existing literature
CHAPTER III TREND AND COMPOSITION OF PUBLIC 22-33
EXPENDITURE IN INDIA
3.1. Introduction
3.2. Trends in Revenue Expenditure of India
3.3. Trends in Capital Expenditure of India
3.4. Trend in Development and Non-Development
Expenditure
CHAPTER IV DETERMINANTS OF ECONOMIC GROWTH 34-39
AND PUBLIC EXPENDITURE
4.1. Determinants of Economic Growth
4.2. Determinants of Public Expenditure
4.3. Conclusion
CHAPTER V EMPIRICAL TESTING AND CONCLUSION 40-51
5.1. Introduction
5.2. Analysis and Interpretations
5.2.1. Test for Stationarity
V
5.2.2. Regression Analysis
5.3. Conclusion
5.4. Policy Suggestions
5.5. Limitations
5.6. Scope for further studies
5.7. Challenges
BIBLIOGRAPHY 52-56
VI
PREFACE
Public expenditure is a sine quo non to the welfare states. The concept of public expenditure plays
a pivotal role in public finance. Till the nineteenth century, the function of a state was limited to
only arms, police and justice. The situation changes with the passage of time and the demand for
public expenditure is also increasing thereof. In the words of Peacock and Wiseman, public
expenditure grows over time, but not at a constant rate.
So, at the dawn of the Millennium, the importance of public expenditure is increasing. Indian
economy was growing at a low rate of growth of 3.5% from 1950 to 1980. The plethora of rules,
regulations, permits, controls and protectionist policies created under the import substitution plan
along with different factors landed the Indian economy into the crisis of 1991, which reflected in
macroeconomic mismanagement viz high fiscal deficit, balance of payments deficit, high inflation,
low forex reserves, etc. This era has marked an obligation to review the relation of public
expenditures with economic growth of the country from a different standpoint. Since a larger
percentage of the income of the poor man is expended on the necessary items rather than the
comforts and luxuries of life, the poor state would be called upon to make larger relative
expenditures for the primary governmental functions than for those which come later in its national
development.
I would like to thank my supervisor Dr. Preeti Singh Ma’am for her excellent guidance and support
for completing my project effectively and moreover on time. My sincere thanks and regards to all
the teachers of the Department of Economics, Vasanta College for Women, BHU for their constant
encouragement and cooperation during the course of this study. I also thank my classmates for
their valuable input from time to time during the process of completion of this dissertation
VII
LIST OF FIGURES
SL. FIGURE PARTICULARS OF FIGURES PAGE NO.

NO. NO.
1 3.1 Real Total Public Expenditure and Real GDP 23
2 3.2 Ratio of Total Public Expenditure to GDP between 1990- 24
91 to 2020-21
3 3.3 Growth of Public Expenditure in India (in Rs. crore) 27
4 3.4 Revenue expenditure and Capital expenditure as a % of 28

total expenditure
5 3.5 Percentage share of non-developmental and 31
developmental expenditure in total revenue expenditure
of the central government
6 3.6 Percentage share of non-developmental, developmental 33
expenditure and loan & advances in total capital
expenditure of the central government
VIII
LIST OF TABLES
SL. NO. TABLE NO. PARTICULARS OF TABLE PAGE NO.
1 3.1 Revenue expenditure (in Rs. Crore and as a 25

percentage of total expenditure)
2 3.2 Capital Expenditure (in Rs. Crore and as a 26
percentage of total expenditure)
3 3.3 Share of Non-developmental and 30
developmental expenditure in total revenue
4 3.4 Share of Non-developmental and 32
developmental expenditure in total capital
5 5.1 ADF test result 42
6 5.2 Regression Analysis 43
7 5.3 Testing for Heteroskedasticity (Breusch- 45
Pagan-Godfrey test)
8 5.4 Testing for Normality (JB Test) 46
9 5.5 Testing for Autocorrelation (Breusch- 47
Godfrey Serial Correlation)
10 5.6 VIF Test 47
IX
LIST OF ABBREVIATIONS USED
TE Total Public Expenditure

RTE Real Total Public Expenditure
RE Revenue Expenditure
CE Capital Expenditure
GDP Gross Domestic Product
RGDP Real Gross Domestic Product
NI National Income
GNP Gross National product
EXP Export
FDI Foreign Direct Investment
OLS Ordinary Least Square
ADF Augmented Dicky-Fuller Test
VIF Variance Inflation Factor
AIC Akaike’s Information Criterion
S.E. Standard Error
SDG Sustainable Development Goal
X
CHAPTER I
INTRODUCTION
1.1. INTRODUCTION
Over the years the economic activities of the government vis-a-vis public spending have expanded
in all the states of India. A primary objective of the policy of public expenditure is to attain a
sustained and equitable economic growth. It has played a significant role in both physical and
human capital formation over a period of time. Appropriate public expenditures have been
accepted as an effective tool in boosting the growth of an economy even in the short term.
Therefore, the impact of public expenditure on economic growth can be considered as a
comprehensive indicator of the productivity of public expenditure. Moreover, the growth of public
expenditure as a percentage of GDP has gained a considerable attention from economists and
policymakers in the recent years.
The genesis of this discussion of public expenditures is the social income of which public income
is a part, and as the individual is limited in his expenditures by the income which he enjoys, so the
state is limited by the proportion of the social income which, under the existing political, social
and industrial conditions, may be rightly placed at its disposal. Since a larger percentage of the
income of the poor man is expended on the necessary items rather than the comforts and luxuries
of life, the poor state would be called upon to make larger relative expenditures for the primary
governmental functions than for those which come later in its national development.
Public expenditure is considered to be an important tool of fiscal policy of an economy, which

includes various expenditures such as interest payment, administrative cost, general services,
defense services, etc. The relationship between government expenditure and economic growth has
received a worldwide attention of economists and policymakers over the years. The question of
public expenditure has assumed immense importance in the recent past in India particularly after
the introduction of economic reforms in 1991. It has been declared as the avowed policy of every
1
government to curtail deficit financing as it spirals inflation and deflates real earning of the capital
of domestic as well as foreign. As deficit financing eventually leads to inflation and erosion of real
income, the national government is caught between the situation of reducing inflation on the one
side and financing expenditure on the other, through borrowing. The increase in public expenditure
is also possible through hikes in direct as well as indirect taxes which would dissuade private
capital from the investment.
As countries grow and progress, their expenditure on various goods and services apart from
administration and governance also increase and even at a higher rate than their growth. Initially,
it was noted by Adolph Wagner (1893) in the late 1800’s (Ghartey, 2006). In his book titled
‘Grundlegung der Politischen Okonomie’, Wagner has said that as economies grow,
industrialisation, modernization and urbanisation also grow, which inevitably put pressure on the
demand on social, health, education, infrastructure and security services, especially in the urban
areas. There is, therefore, the need for government to play a significant administrative and
productive capacity role by expanding these services resulting in higher government expenditure
(Ampah & Kotosz,2016). The growth in real income of the people leads to more and more demand
for the essential services. Wagner asserts that government will have no other option but to continue
to provide these services that will result in a never-ending growth in government outlays.
However, during the period of Great Depression in the early1930s, Keynes (1936) observes that
over-reliance of the countries on the interpretations of the Wagner’s hypothesis in the early 1900s
has obstructed the process of economic recovery. Therefore, in 1936, he advocated nations to
become the proponent of growth of their economies and thereby come out of the depression by
actively engaging in public expenditure. According to him, government spending is not an
endogenous variable as illustrated in the Wagner’s hypothesis, but an autonomous and exogenous
variable. He argued that during a period of economic depression, government intervention smooths
out the alternations in the business cycle, which eventually enhances the economic activities of the
nation. For this reason, public expenditure should not be considered as the consequence of
economic growth but rather the cause (Tang,2008). This stream is currently known as the
Keynesian economics.
So, in discussing the relationship between the public expenditure and economic growth, we find
two different and contrasting views in the literature relating to the direction of the causality
2
between public expenditure and economic growth. The first one is given by Adolph Wagner
(1893), who considers public expenditures endogenous to economic development, i.e., causality
runs from growth in community output to public expenditure (Wagner’s law of increasing state
activities). The second view is given by Keynes (1936), who advocates that government spending
is an exogeneous policy instrument which causes change in aggregate level in the short run.
Relying on this assumption, many developed and developing countries have used it as a fiscal
policy instrument for promoting growth through multiplier effect.
1.2. COMPONENTS OF PUBLIC EXPENDITURE
The components of government expenditure are very critical in the process of economic growth.
According to World Bank (2000), public expenditures can be grouped into four categories: of the
Centre, State and their ministries, regional and local bodies and separate public bodies. However,
according to the macroeconomic functions of public expenditure, it can be classified in terms of
various sectors like justice and public order, military, infrastructure (roads, railways, for example),
education, health care, environmental protection, rural and urban development, support for the
poor, the old, the disadvantaged, support for firms, export and production.
A.C. Pigou, the British economist has categorised public expenditure into transfer and non-transfer
expenditure. Transfer expenditure are the expenditure against which there is no corresponding
return. Such expenditure includes spending on national Old Age Pension Schemes, interest
payments, unemployment allowances, subsidies, welfare benefits to weaker sections, etc. By
incurring such expenditure, the government does not get anything in return, but these are some
additions to the welfare of the community, especially belong to the weaker sections of the society.
Such expenditure mainly results in the redistribution of money incomes within the society, that
ultimately aims at minimizing the gap between the haves and the have-nots. On the other hand,
non-transfer expenditure is related to the expenditure which results in creation of income, output,
such as building of economic infrastructure – power, transport, irrigation, etc., public
administration, etc.
Government expenditures in India are also classified into two categories such as current and capital
expenditure. Further, it is also being divided into developmental and nondevelopmental
expenditures. The developmental expenditures are expenditure on industry, agriculture, energy,
3
transport, communication, science, technology and environment and social services such as
education, employment, health, nutrition, housing and others. The non-developmental expenditure
includes expenditure on government administration, interest payments, pensions, defense and
other non-productive one (Ministry of Finance, Government of India, 1987).
1.3. THEORIES OF PUBLIC EXPENDITURE
Earlier, the economists and policymakers have emphasized more on the theory of taxation. The
theory of public spending has been more or less limited to that of generalities in terms of the effects
of public expenditure on employment and prices, etc. (Harris,1958). Of course, it can be noted that
lately this inadequacy is being removed by various studies in the field of public expenditure.
There are two very major and well-known theories of ‘Increasing Public Expenditure’. The first
one is associated with Wagner and the other with Wiseman and Peacock.
1.3.1. WAGNER’S LAW OF INCREASING STATE ACTIVITIES
Wagner's (1892) law of increasing state activity, developed has emerged at the end of the last
century, links the scale of government activities to economic development. Wagner's law
maintains that industrialization gives rise to an increased scale of government activities which arise
from: (1) the administrative and protective functions of the state, (2) attempts to ensure the proper
operation of market forces, and (3) the provision of social and cultural goods (Bird,1971).
He made his suggestion depending on empirical results obtained from a number of industrializing
countries. the principal implication of the study is that as community output stepped up in the past,
public spending grew as well. Wagner’s theory assumes that the growth of public expenditure is
consistently associated with the growth in community output in developing countries. however,
public expenditure grows at a faster rate than the growth of community output. From this
standpoint, Wagner has entitled it as “the law of increasing expansion of public, and particularly
state, activities’ becomes for the fiscal economy the law of the increasing expansion of fiscal
requirements...”. That’s why, this law is well-known as the ‘Wagner’s Law’.
Wagner’s law was more of an empirical investigation than a theoretical one. It did not reveal the
inter compulsions under which a government has to increase its activities and public expenditure
as time passes. It was applicable only in the case of a modern progressive government, which was
4
interested in expanding public sector of the economy for its overall benefit. The common
inclination of expanding state activities had a definite long-term trend, though in the short run,
financial difficulties and other obstacles could come in their way. But in the long run the impulse
for development of the progressive people will always surpass these financial difficulties.
So, Wagner gave more importance on a long-term tendency rather than the short-term changes in
public expenditure. Moreover, he was not concerned in the mechanism of increase in public
expenditure. Since his study was based on the historical facts, the explicit quantitative relationship
between the extent of increase in public expenditure and time taken by it was not expressed in any
logical or functional form. His argument was that public expenditure had been increasing over
time, it could not be used to extrapolate its future rate of growth. In future, the state expenditure
would increase at a rate slower than the national income though, it had increased at a faster rate in
the past. Thus, in the initial stages of economic growth, the State has to expand its activities quite
fast in different fields like health, family welfare, education, civic amenities, transport, etc. and
when the initial kick is no longer needed, then the increase in state activities of the government
may slow down.
1.3.2. WISEMAN-PEACOCK HYPOTHESIS
The second theory that deals with the growth of public expenditure was put forward by Wiseman
and Peacock in their study of public expenditure in UK covering the period 1890-1955. The
principal finding of the study is that public expenditure dose not rise in a smooth and continuous
manner, but in rises in steplike fashion. There were some social and other disturbance taking place,
leading to a need for expanding public expenditure which cannot be met by the existing public
revenue. Earlier, due to an insufficient pressure for public expenditure, the revenue constraint was
dominating and restraining an expansion in public expenditure, now under changed circumstances,
such a restraint gives way. The movement from the older level of expenditure and taxation to a
new and higher level is the displacement effect. The inadequacy of the revenue in comparison to
the required public spending creates an inspection effect in favor of the government. They have
attained a new level of tax tolerance. They are now prepared to permit more burden of taxation
and as a result the level of expenditure and revenue grows up. In this way, the public expenditure
gets stabilized at a new level until a new interruption occurs to cause the displacement effect. Thus,
each major interruption gives rise to the government assuming that there exists a higher proportion
5
of the national economy activity. In other words, there is a concentration effect. The concentration
effect introduces the clear tendency of the central government’s economic activity to grow at faster
rate than that of the state and local level government. Data taken from UK are consistent with this
hypothesis, but its applicability to other countries needs to be verified. Moreover, this aspect of
concentration effect is also closely connected with the political set of the country.
1.4. PUBLIC EXPENDITURE IN INDIA: A BRIEF OVERVIEW
The economic performance of the individual states of India has attained less attention than it should
get whole making economic policy. This neglect is to some extent the natural consequence of in
our National Plans, approved by the National Development Council don’t specify the state specific
growth targets. We are a federal democracy where our constitution has divided the powers between
the Centre and the states. Thus, the states are pre-eminent in many areas and co-equal with the
Centre in others. Moreover, the liberalization of the last decade of twentieth century has cut the
degree of control exercised by the Centre leaving much greater scope for the state. However, there
is sizeable variation in the performance of the states. The dispersion in growth across states has
raised very prominently in the last decade of the twentieth century. In the 1980’s, the range of
variation in terms of growth rates of per capita SDP was a low of 2.1 per cent for Madhya Pradesh
to a high of 4.0 for Rajasthan. In the 1990s, it was as low as 1.1 per cent (per year) in Bihar and
1.2 per cent in Uttar Pradesh, to a high of 7.6 per cent per year in the state of Gujarat and 6.1% in
Maharashtra. The increased variation in growth performance across states in the 1990s reflects the
fact that whereas growth raised for the economy as a whole, it actually reduced sharply in Bihar,
Uttar Pradesh and Orissa, all of which were the poorest states. There was also a reduction in growth
in Haryana and Punjab, but these states had achieved a relatively high growth rate in the 1980’s
and these were also the richest amongst all states, so this deceleration took place from a higher
rate. In the 1990s the acceleration was particularly marked in the states of Maharashtra and Gujarat.
We can see acceleration also in the states of West Bengal, Tamil Nadu, Madhya Pradesh and
Kerala, in terms of per capita SDP all of these states belonged to the middle group of states. Growth
performers in the 1990s were not concentrated in any one part of the country. The six states with
growth rates of SDP in the 1990s above 6 per cent per year are fairly well distributed regionally,
i.e., Gujarat (9.6 percent) and Maharashtra (8 percent) in the west, West Bengal (6.9 percent) in
6
the east, Rajasthan (6.5 percent) in the north-west, Tamil Nadu (6.2 percent) in the south and
Madhya Pradesh (6.2 percent) in the central part of India. The growth rate of the combined SDP
of all these states taken together has increased from 5.2 per cent in the before reform to 5.9 per
cent in the later period. This acceleration corresponds to a similar acceleration in GDP growth as
reported in the national accounts of India, GDP shows a very similar growth rate of 5.4 per cent
per year in the first period but it shows a much faster acceleration to 6.9 per cent in the second
period (Ahluwalia,2000).
It is very important to emphasize on the fact that states grow at different rates. But we should not
view it as a failure of policy. Rather, it is unrealistic to expect that the growth of each state will be
at the same rate given the size and diversity of the country.
Investment is a very critical determinant of growth process. Both public as well as private
investment are of great importance, but that the efficiency of the use of resources are at least as
crucial as the level of investment. Efficiency in turn depends on various factors such as the quality
of infrastructure, the economic policy environment, the level of human resource development, the
quality of governance, etc. and so on. The development of all these depends very much on the size
of the state plans. State governments announces state plans at the time of annual plan discussions.
This plan expenditure is not the same thing as investment. The revenue component of the plan
expenditure for all the states of India has increased continuously over the years (51 per cent in
1997-98). Notwithstanding, this is viewed as an important indicator of the level of investment
activity in a state. The percentage share of state plan expenditure to SDP has fallen from an average
of 5.7 per cent in the 1980s to 4.5 per cent in the 1990s.The fall in plan expenditures as a percentage
of SDP has occurred in both the better performing and the poorer performing states. This drip is
the largest in the state of Bihar. However, two of the best performing states, Gujarat and
Maharashtra also show a significant drop as do a number of good performers such as Madhya
Pradesh, Tamil Nadu and West Bengal. Moreover, the study couldn’t find any statistically
significant relationship between state plan expenditure as a percentage of SDP and growth
performance across states in either decade. Orissa had the highest ratio of state plan expenditure
to GDP at 7.1 percent in 1990s, but had a very low growth rate of only 3.25 percent only. West
Bengal, with the lowest ratio of plan expenditure to GDP of 2.7 percent, had a relatively high
growth of 6.9 percent. Maharashtra, which was the second fastest growing state, had seen an
7
average plan ratio of only 3.97 percent, which is below the average growth rate. Gujarat which
was the fastest growing state had a plan ratio almost uniform to the average.
1.5. SIGNIFICANCE OF THE STUDY
The successive governments from independence have been increasing public expenditure every
year, given the magnitude of the various social sector and developmental challenges in India.
Moreover, India is implementing a comprehensive array of schemes in order to achieve the various
SDG goals including poverty alleviation, zero hunger, good health and well-being, quality
education, water, sanitation, reducing inequality, etc. The current level of public expenditure was
not adequate and needs to be increased in the light of their significance in attaining economic and
social development of the country. States and UTs like Kerala, Himachal Pradesh, Telangana,
Karnataka, Goa, Sikkim, Chandigarh and Puducherry have performed well in terms of many socio-
economic indicators, while the performance of some other States like Rajasthan, Uttar Pradesh,
Madhya Pradesh and Bihar was not up to the mark (Economic Survey, 2010-11), i.e., the
government has been facing a range of challenges in building the foundation for sustainable growth
even after the 75th anniversary of Country’s independence, including lack of infrastructure, weak
education and health system, high unemployment, weak governance systems etc.
There has been a drastic change in the domestic political and global scenario of India since the last
2-3 decades of the 20th century. The old political and economic order at the home had collapsed.
Adoption of LPG reform in 1991 had suddenly opened the route for the interaction with
international economy. So, the importance of government expenditure in this post reform era has
also gained significance momentum from economist and policy-makers point of view. So the
current study aims to study the growth of public spending in India after the reform period i.e., the
period of the study is limited to twenty years from 1991 to 2030 in order to get a reasonable time
series data for major Indian states.
8
1.6. OBJECTIVE OF THE STUDY
The principal objective of the study is to examine the role of public expenditure on economic
growth of in India. Having elaborated the background of the study, the specific objectives of the
study have been formulated as follows:
1. To study the trend and composition of total public expenditure during the reference
period.
2. To analyze the determinants of public expenditure and economic growth.
3. To examine the role of public expenditure on economic growth in India during the
reference period of the study.
1.7. HYPOTHESIS
Given the objectives, our present study aims at testing the following hypothesis,
Null hypothesis, 𝐻0 : Public expenditure has no significant impact on economic growth.
Alternative hypothesis, 𝐻1 : Public expenditure has significant impact on economic growth.
1.8. METHODOLOGY OF THE STUDY
The study of the relationship between public expenditure and economic growth has some major
conceptual and empirical issues relating to the quantification of the size of government and
economic growth. There have been a number of empirical studies analyzing the impact of public
expenditures on economic growth so far. The results, however, are varied as different analysis
techniques and data samples are adopted. Keeping these issues in mind, an attempt is made to give
a comprehensive account of the major conceptual and empirical issues relating to the quantification
and inherent relationship between public expenditure and economic growth.
1.8.1. THEORETICAL UNDERPINNING OF THE MODEL
Various statistical and econometric tools and techniques have been used. Firstly, it is essential to
test for the stationarity properties of variables whenever dealing with annual data. A time series is
said to be stationary if a shift in time doesn’t cause a change in the shape of the distribution, unit
9
roots are one cause for non-stationarity. If the data sent is non-stationary, it means the mean and
variances of the data set is inconsistent or varies with respect to time and would yield spurious
result of regression parameters. Unit root test is widely popular as a test for stationary properties
of the time series. A ‘unit root test’ tests whether a time series variable possess a unit root. In the
present study, the stationarity of the time series data is checked with the help of Augmented
Dickey-Fuller (ADF) test. If the data series are found to be non-stationary at the level, then same
procedure is repeated on the first difference of the variable or data series. This procedure is
performed for all the variables under study.
While performing ADF test, the selection of the optimal lag is very important. The number of
lagged difference terms is usually determined empirically or on the basis of different criterion of
optimal lag length. In the present study, Akaike’s Information Criterion (AIC) is used here to find
out the lag order of each variable under study.
Overall, the aim of the stationarity test is to avoid the problem of spurious regression by choosing
the appropriate model for the estimation. After ensuring stationarity of the data, regression analysis
is carried out. Regressing one non stationary time series on another non stationary time series can
lead to the phenomenon of spurious regression. Hence, stationarity test was the primary task before
conducting regression analysis. Granger and Newbold (1974) present strong evidence for the
regression analysis involving unit roots are spurious when performed on the levels, but not after
differencing. Since all the variables turned stationary after first difference, it is possible to use
regression analysis. To find out how the change in economic growth within the period of study
could be explained by the explanatory variables taken in the model, first difference of economic
growth is regressed on the first differenced explanatory variables included in the model
According to Gujarati (2003), in order to have a good econometric model for OLS regression,
some a priori econometric assumptions should be fulfilled. Therefore, in order to fulfill these
assumptions, test for normality, heteroscedasticity and autocorrelation has been carried out. In
order to verify if the error terms have Breusch–Pagan–Godfrey test a normal distribution, the
matching criterion called Jarques–Bera (JB) Test is used. To detect the presence of
heteroscedasticity in the model, Breusch–Pagan–Godfrey test is used. lastly; to find out if the error
term has autocorrelation, Breusch-Godfrey Serial Correlation LM test is conducted; to check the
multicollinearity of the variables, Variance Inflation Factor test is conducted.
10
1.8.2. SPECIFICATION OF DEPENDENT AND INDEPENDENT
VARIABLES
It is found from the detailed review of literature that the relationship between economic growth
and public expenditure can be examined by various sets of variables and techniques. As stated
above, in most these studies, the dependent variable for measuring the growth of economy is
concerned, GDP in real term, per capita real income and their growth rate were taken as the. While
for the independent or explanatory variables, most studies have taken public expenditure at
aggregate as well as disaggregate levels such as total expenditure, revenue and capital expenditure,
expenditure on different services and sectors. However, as far as the present study is concerned, I
have taken GDP at real terms as the dependent variable of the study. Four variables are used as
independent variable viz total expenditure (TE), export (EXP), foreign direct investment (FDI).
1.8.3. SOURCE OF DATA
The proposed study has been principally based on the secondary sources of data. The relevant data
of actual figures are collected from the various Annual Financial Statements and the Memorandum
of the Budget Estimates of the Govt. of India from the year 1990-91 to 2020-21 published by the
Finance Department. Data on total public expenditure at constant prices from 1990-91 to 2020-21
is collected from the Statistical Handbook of India, published by Reserve Bank of India, Mumbai
and the data on gross domestic product are collected from the Economic Survey (Volume II) of
India, which is an annual document published by the Ministry of Finance, Govt of India. Data on
export of India are also taken from the RBI statistical handbook and the data on net foreign direct
investment (FDI) to India are taken from the fact sheet published by the Ministry of Commerce
and Industry, Govt. of India. The survey provides a very detailed report of the economic
performance of the country during the period of time. Besides, various budget speeches of the
Finance Ministers of India, data sources such as EPW Research Foundation, budgetary documents
of the Government, Reports of Planning Commission, Finance Ministry, Finance Commission has
been utilized and supplemented by published journals, old newspapers, articles, papers and
findings of relevant seminars, standard works on the subject relevant to the problem of the state
finances and growth has been consulted.
11
1.8.4. TOOLS
In order to calculate the percentage share of the public expenditure to the GDP, the public
expenditure such as total expenditure, revenue, capital expenditure and sectoral expenditure of
major states of India have been considered. The secondary data collected have been put into a
database, using the widely used EXCEL. The time series data consists of over the twenty-year
period for the select variables which includes GDP and various public expenditure components
and other determinants of growth.
Then statistical software EViews 11 has been used to perform all the required tests.
1.9. LIMITATIONS OF THE STUDY
Every research has its own limitations and the present study has no exception. The limitations of
the present study are summarized below.
1. The study covers only a thirty-year period, from 1990-91 to 2019-20.

2. This study is purely based on the secondary data collected from the Reserve Bank of India.
Hence, the inferences that are derived from the study may be not directly applicable to
individual states of India.
3. The study can be criticized on the ground that the number of variables taken into account
in this model is much smaller than is necessary for their satisfactory interpretation of
economic policy.
1.10. CHAPTER PLANNED
The present study is being organized in 5 chapters. A brief description of each of them is stated
below:
• The first chapter introduces the topic and then the problem is stated. The chapter also deals
with an overview of the public expenditure and economic growth in the broader context of
the Indian economy. In the introduction chapter, objectives, scope and significance of the
study have also been elaborated. So, gives a brief picture of the background of the study.
12
• Chapter 2 gives a detailed and critical review of existing literature on different strands of
thought in the area of public expenditure and their association with economic growth. The
gap in the literature is spotted to place the study in the vast pool of accumulated wisdom
on the area of the research in hand followed by a theoretical framework for the analysis.
• Chapter 3 gives a detailed explanation of the analysis on trend, structure and pattern of
government expenditure in India. (Objective 1).
• Major determinants of public expenditure and economic growth are discussed in Chapter
4 (objective 2).
• Chapter 5 analyses the relation between economic growth and public expenditure and its
interpretations during the study period (1990-91 to 2020-21) empirically (objective 3) and
then concludes the analysis with the important findings and policy implications for the
country along with the future research scope and limitations of the study.
13
CHAPTER II
REVIEW OF LITERATURE
2.1. INTRODUCTION
There are many studies analyzing the relationship between public expenditure and economic
growth with respect to different countries, though there is no consistent evidence that shows
whether the relationship between the two are in positive or negative direction. The relationship
between public spending and economic growth is one of the most controversial topics both
theoretically and empirically. The results obtained are contradictory, since with the changing of
countries and the temporal intervals considered, with the change in data-set used and the
methodology applied, the result leads to different conclusion, which has received great intension
from economists and policymakers from time to time.
The ‘Law of Increasing Extension of the State Activity’ postulated by Adolph Wagner more than
a century ago, continues to attract interest of researchers and policy makers and to generate a vast
literature on the subject. The law suggests the existence of a unidirectional causal relation from
national income to public expenditure. During the industrialization process, as real income per
capita of a nation increases, the share of public expenditure in total expenditure increases
(Wagner,1890).
However, according to the Keynesian theory, government expenditure is an exogeneous factor and
it acts as a policy instrument for increasing the national income of a nation. In other words, public
expenditure has a positive impact on economic growth, i.e., here causation runs from the
government expenditure to economic growth on contrary to the Wagner’s law. A proactive fiscal
policy, especially at the early stage of the development process, is an important instrument for the
government to attain efficiency and stability in the economy.
The aim of this chapter is, therefore, to review some of the important works done in India and
abroad on the nexus between public expenditure and economic growth. This chapter is divided
into three sections. The first section depicts about the literature that supports the causality of public
expenditure from economic growth (Wagner’s law), the second section reveals literature that
supported Keynes view. It includes those papers where the theory considers public expenditure as
14
an independent variable and the last section, we have literature that supported neither Keynes view
nor Wagner’s view.
2.2. LITERATURE THAT SUPPORTS THE CAUSALITY OF PUBLIC

EXPENDITURE FROM ECONOMIC GROWTH, i.e., WAGNER’S LAW.
In the nineteenth century, public expenditure under the influence of the classicals have played a
limited role in economic activity. There was neither any sound classification of government
expenditure nor any standard laid on which all such expenditures should be based (Verma & Arora,
2010). However, in the latter part of the nineteenth century, Wagner (1883) observes that there
exists a relationship between economic growth and public spending, which later formulated as
‘Wagner’s Law of Increasing State Activities’. The fundamental idea behind this relationship
between the two is that the growth in public expenditure is a natural consequence of the economic
growth over the period.
Reddy (1970) examines the secular trend of public expenditure in India for the period from 1872
to 1968. He concludes that the public expenditure moved in a step-by-step manner over the years
in response to social upheavals and natural calamities, which breaks the linear trend in expenditure.
It is in conformity with the Displace Effect theory of public expenditure and further proved that
Wagner’s Law was valid in Indian context. It meant that economic growth moved in tandem with
public expenditure in India.
Lai and Hsieh (1994) employ a multivariate time series analysis along with vector auto regressive
(VAR) model to examine the association between Public Expenditure and economic growth in G-
7 countries. The study found that the relationship between Public Expenditure and economic
growth differ by time within as well as across developed countries. In a sense, Wagner’s hypothesis
is proved and the study concluded that there is no evidence to infer that government expenditure
can increase economic growth and therefore Keynesian hypothesis is rejected.
John Thornton (1998) has examined the Wagner’s law for the six European countries by using the
data from mid-19th century to 1913. the results suggest that the nominal and real gross national
product (GNP), nominal and real government expenditure, and population-they all are
15
nonstationary at their levels, but they become stationary in first differences. The nominal GNP and
nominal government expenditure and real GNP and real government expenditure are cointegrated
in five out of the six countries, however these variables were cointegrated with population in the
remaining country. They also find that the Granger-causality is mainly unidirectional from income
to government expenditure. Thus, there is considerable support for Wagner’s law in 19th century
Europe
A.F. Al-Faris (2002) uses a dynamic model in their study that calibrated to the Gulf Cooperation
Council (GCC) countries viz., Saudi Arabia, the united Arabia Emirates, Oman, Kuwait, Bahrain
and Qatar from 1970 – 1977that tries to examine the relationship between government expenditure
and economic growth of the countries. The article concluded that national income is a ‘predictive
factor’ of the growing role of government as postulated by Wagner. Empirical investigations do
not follow the hypothesis of public spending that causes national income as proposed by the
Keynesian theory.
T. Chang (2002) empirically examines five different versions of Wagner’s law by employing
annual time-series data on six countries over the period 1951-1996. The results indicate that there
exists a long-run relationship between income and government spending for sample countries
studied with the exception of Thailand. It is found that the results concerning the validity of
Wagner’s law are also held for selected studied with the exception of Thailand.
Verma and Arora (2010) in their study attempt to investigate the validity of Wagner’s Law in
Indian case over the period 1950-51 to 2007-08. They have estimated the six versions of Wagner’s
hypothesis given by different economists. The study supports the existence of long-run relationship
between economic growth and growth of public expenditure. The empirical analysis says that there
exists a long-run relationship between economic growth and growth of public spending in case of
India. So, the results provide a strong empirical support for the existence of Wagner’s law in both
pre and post reforms period. However, empirical evidences for the short-run impact of economic
growth on public expenditure is insignificant that confirms the absence of any instantaneous
impact of increasing GDP on the size of government expenditure in India.
Bharat R. Kolluri, Michael J. Panik & Mahmoud S. Wahab (2010) have attempted to test the long-
run relationship between gross domestic product (GDP) and government expenditure in the G7
countries for the period 1960-1993. It provides evidence on both short- and long-run impact of
16
growth in national income on government expenditure by using the recent developments in the
theory of cointegrated processes.
Abdullab and Maamor (2010) tests Wagner’s hypothesis in Malaysia. There is a long run
significant and positive relationship between national income and government development
expenditure. The study concludes that Wagnerian hypothesis is proved operating in the context of
Malaysia.
Jamshaid et al. (2010) analyze the nature and the direction of causality between public expenditure
and national income in Pakistan with development expenditures (DE), administration expenditures
(AE), debt services (DS) and defense services (DF). The study applies the Toda-Yamamoto
causality test to analyze the data from 1971 to 2006. It is concluded that there is a unidirectional
causality between from gross domestic product (GDP) to government expenditure or the study
proved Wagner’s Law.
Akpan (2011) tests the validity of Wagner’s Law of causal relationship between public expenditure
and national income in Nigeria for the period of 1970 to 2008. The study shows strong support for
Wagner’s long run causal relationship between both the variables. The study also confirms the
short run causal relationship between public expenditure and economic growth.
Srinivasan (2013) tests the causal relationship between public expenditure and economic growth
in India with the use of cointegration and error correction model for the period 1973 to 2012. The
study shows a long run relationship between public expenditure and economic growth in India.
There is a one-way causality from economic growth to public expenditure both in the short as well
as in the long run and therefore concluded that the Indian economy followed Wagner’s law of
public expenditure.
Ahmad Masroor (2014) examines the validity of Wagner law for Indian economy with the use of
Engle-Granger and Engle Yoo Cointegration test. The study points out that there is unidirectional
causality from GDP to Expenditure, i.e., the Indian economy moves in conformity with Wagner’s
law.
17
2.3. LITERATURE THAT SUPPORTS THE CAUSALITY OF ECONOMIC
GROWTH FROM PUBLIC EXPENDITURE, i.e., KEYNESIAN VERSION.
Sinha (1998) explains the relationship between government expenditure and GDP in China during
1960-92. There is a strong relationship between government expenditure and GDP. The study
rejected Wagner’s hypothesis but accepted Keynesian hypothesis.
Jackson, Fethi and Fethi (1999) analyze the causal relationship between government expenditure
and national income for Northern Cyprus economy for 1977 to 1996. The study has found a
unidirectional causality between government expenditure and national income which is indicative
of the existence of Keynesian hypothesis of public expenditure in the Cyprus 24 economy.
Fan et al. (2004) estimate the effects of different types of government spending on the growth of
agriculture and rural poverty by taking district-level data in Uganda. The study has found that
Public Expenditure on agricultural research and extension has positive impact on agriculture
production (growth). Government expenditure on rural roads also has positive impact on rural
poverty reduction. In a different way, the findings supported Keynesian approach to public
spending.
Employing a bi-variate and tri-variate error correction model within a Granger causality
Framework John and George (2005) find that relative size of government measured in terms of
government expenditure (i.e., the share of total expenditure in GNP) drives rate of economic
growth in UK and Ireland both in the short run as well as in the long run.
The study done by R.P. Pradhan (2007) investigates the validity of a long-run relationship between
public expenditure and income in case of India over the period 1970-2004. The study finds
evidence of long-run relationship between public expenditure and income but rules out the validity
of Wagner’s law. This is because there is no unidirectional causality from public expenditure to
income. It eventually suggests that public spending is a crucial policy tool that effects the income
level in the economy.
K. Jiranyakul and T. Brahmasrene (2007) have tested the causation between government
expenditures and economic growth in Thailand using the Granger causality test. They have found
a unidirectional causality from government expenditures to economic growth existed. But, the
18
causality from economic growth to government expenditures is not proved. Furthermore,
estimation results from the ordinary least square has confirmed the existence of strong positive
impact of government spending on economic growth during the reference period.
Omoke (2009) studies the direction of causality between Government expenditure and National
Income (NI) in Nigeria for 35 years from 1970 to 2005. It is found that there is no long-run
relationship between government expenditure and growth in national income in Nigeria. However,
there is causality from government expenditure to growth in national income.
Cooray (2009) analyses the effects of government spending on economic growth in 71 countries.
The study infers that both government spending and good governance has positive impact on
economic growth.
Jayme Jr et al (2009) identifies the impacts of public 28 spending on transportation, infrastructure

and economic performance in Brazilian states. The study indicates that an increase in public
expenditure in infrastructure is productive and growth stimulating
The study done by M. Adetunji Babatunde (2008) for Nigeria using annual time series data
between 1970 and 2006 has found a weak empirical support in the proposition by Keynes that
public expenditure is an exogeneous factor and a policy instrument for increasing national income.
Cosimo Magazzino (2010) tries to assess its empirical evidence in Italy for the period 1960-2008.
He studies the linkages between public expenditure at a disaggregate level and GDP for Italy,
where he finds the direction of causality from public spending to aggregate income.
Dandan (2011) examines the impact of public expenditure on economic 29 growth in Jordan from
1990 to 2006. The study confirms that the government expenditure has positive influence on
economic growth implying that the Keynesian hypothesis is proved in the context of Jordan
economy.
Another study on Nigeria observes a unidirectional causality from government expenditure to

economic growth or the Keynesian hypothesis is proved (Sevitenyi, 2012)
Gurgul, Lach and Mestel (2012) explore the association between budgeted expenditure and
economic growth in Poland. The study uses expenditure data at aggregate as well as disaggregated
level on health, social services, education, defense, public security and administration. A direct
19
and positive association is observed between government expenditure and economic 30 growth in
Poland or in other words Keynesian theory is proved.
Ibrahem Mohamed Al Bataineh (2012) analyzes the influence of public expenditures on economic
growth for the period 1990 to 2010. Government expenditure has positive impact on the growth
of GDP or in other words the study finds the evidence in support of the Keynesian theory of public
expenditure.
Khundrakpam (2013) study on the dynamic interaction between national income and public sector
expenditure in India for 1960 to 1997 21 shows that the causality ran from public expenditure to
national income in India. The findings showed that there is a positive impact of public sector
expenditure on national income up to a level beyond which the impact turned negative. The study
suggests, therefore, that there is the need for maintaining a proper balance between public
expenditure and investment for economic growth in the long run.
2.4. LITERATURE THAT SUPPORTS NEITHER WAGNER’S LAW NOR

KEYNESIAN LAW
Singh and Sahni (1984) analyzes the causality between national income and public expenditure in
India for three decades from (1950-1981). The study observes a feedback relationship between
public expenditure and economic growth in India. The feedback relationship is defined as a
causality that works from both sides indicating that economic growth led to public expenditure
and vice versa. It means the causality is bi-directional and therefore both Keynesian and Wagner’s
law on public expenditure are found invalid in the Indian context.
Ahsan, Kwan and Sahni (1992) in their study has failed to find any evidence between these two
variables for Canada, Germany and U.S.
Afxentiou and Serletis (1996)’s study examines the convergence of government expenditure
within the expanded European Nation, which has shown no long run equilibrium relationship
between categories of expenditure and GDP. Causality test that runs from GDP to these
expenditure categories, in the spirit of Wagner’s law, proved as unsatisfactory as tests of reverse
causality.
20
S. Abizadeh & M. Yousefi (1998) have developd a model using Korean data that consisting of a
government growth equation and a GDP growth equation. Using Korean data, they estimate these
equations and compare the results obtained with those of Wagnerian causality tests. Then they
conclude that the government expenditures in Korean case have not contributed to economic
growth of the country.
Sahoo (2001) uses time series data from 1970-71 to 1998-1999 to test the validity of Wagner
hypothesis in India. The study reveals that there is a feedback relationship between public
expenditure and economic growth or bi-directional causality between public expenditure and
economic growth. In other words, Sahoo’s study indicates no evidence for both the Keynesian and
Wagner’s hypothesis in Indian scenario.
2.5. GAPS IN EXISTING LITERATURE
A detailed review of the literature has brought to light that relationship between government
expenditure and economic performance are not uniform either across countries or within countries
over a period. It is rather difficult to arrive at generalizations on the association between economic
performance and government spending. It is also observed that to reflect a comprehensive analysis
on the nexus between public expenditure and economic growth, a careful consideration of theories
and reality needs to be taken into account. The conceptual framework provides obvious
connections from all aspects or approaches that may determine the relationship between public
expenditure and economic growth. From the above review of the literature, it is found that the
relationship may be determined by different sets of variables under different models. Although the
literature mentioned above are associated with Economic growth and government spending, most
of such literature are in the context of other countries and there exist few studies in the Indian
context on the aspect of different dimensions of government spending. The present study intends
to make a detailed analysis regarding public expenditure in context of Indian economy.
21
CHAPTER III
TREND AND COMPOSITION OF PUBLIC
EXPENDITURE IN INDIA
3.1. INTRODUCTION
Since the onset of economic reforms in India in 1991, both the central and state governments have
been at their best to regulate public expenditure. India being a welfare country, unable to cut down
the expenditure on service sectors such as health, education and other services. So, given the
revenue expenditure, reduction in capital expenditure is the only way to match public expenditure
with income. However, in the long run a continuous drop in development expenditure leave its
radical impact on economic health of the economy. The objective of this chapter is to analyze the
trend in growth performance of the government expenditure for the period 1990-91 to 2020-21.
The functional classification of the budget system was made by the Government of India. The total
expenditure is classified into revenue and capital expenditure. In other words, all expenditures
incurred by the government are either in the form of revenue expenditure or current/capital
expenditure. Another important classification of public expenditure is the Development and Non-
Development Expenditure. In the budget allocation of resources, development expenditure
assumes great significance because it promotes growth. In other words, a higher allocation of
resources for the development expenditure indicates an inclination towards a higher economic
growth. A non-development expenditure is conventionally assumed to be a consumption
expenditure or an unproductive type of expenditure. Nonetheless, it is not always true because the
non-development expenditure supports consumption side of the development expenditure, without
which development expenditure is unlikely to be occur. Although, in recent times, the non-
development expenditure has recorded a higher growth relative to the development expenditure,
however, it is not an appreciable trend.
22
Fig 3.1 : Real Total Public Expenditure and Real GDP
16000000
14000000
12000000
10000000
8000000
6000000
4000000
2000000
0
1993-94
2004-05
2015-16
1990-91
1991-92
1992-93
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2016-17
2017-18
2018-19
2019-20
2020-21
RGDP RTE
Note: Vertical axis measures gross domestic product and total public expenditure in Rs. Crores
(both in real terms) and horizontal axis indicate year.
RGDP: Real Gross Domestic Product
RTE: Real Total Public Expenditure
Source: Calculated by using data from Statistical Handbook of India, published by Reserve Bank
of India, Mumbai and Economic Survey, 2020-21, Vol. II, Ministry of Finance, Govt of India,
New Delhi.
23
Fig3.2 : Ratio of Total government expenditure to GDP between 1990-91 to 2020-21
25
20
15
Ratio of total goovernment

10 expenditure to GDP
of India, Mumbai and Economic Survey, 2020-21, Vol. II, Ministry of Finance, Govt of India,
New Delhi.
Note: Vertical axis measures percentage share and horizontal axis indicate year.
3.2. TRENDS IN REVENUE EXPENDITURE OF INDIA

The revenue expenditure has been in a growing trend over the period of time. Such type of
expenditure is of consumptive kind and they do not involve creation of any productive assets. They
are either used in running a productive process or running a government. In Table 3.1, we find that
the annual growth of revenue expenditure of the Union Government has increased in the last 30
years period in nominal amount. Huge interest payments are made mainly due to heavy debt burden
of the Union Government. Expenditures like the pension and administrative services, increased to
a moderate level during this period. During the period 2005-09, expenditure on administrative
services and interest payments were higher than those of 1990-94. The increase in wages and
salaries were also a reason for the higher interest payments of the year 2005-09. (Economic Survey,
2009-10). The rising trend of revenue expenditure is shown with the help of a graph below (Figure
3.3).
24
Table 3.1: Revenue expenditure (in Rs. Crores and as a percentage of total
expenditure)
Year Revenue expenditure (in Rs. Crores) RE/TE (Revenue expenditure as a % of

Total Expenditure)
1990-91 73516 70%

1995-96 139861 78%
2000-01 277839 85%
2005-06 439376 87%
2010-11 1040723 87%
2015-16 1537761 86%
2016-17 1690584 86%
2017-18 1878833 88%
2018-19 2007399 87%
2019-20 2349645 87%
2020-21 2630145 86%
of India, Mumbai.
Note: data for 2019-20 are Revised Estimates and data for 2020-21 are Budget estimates.
Public Expenditure on revenue account was Rs.73,516 crores in the year 1990-91, which has
increased to Rs.277839 crores in the year 2000-01 and further it has increased to Rs.1040723
crores in 2010-11 and by 2020-21 it has reached Rs. 2630145crores. The growth of public
expenditure on revenue account is shown with the help of a graph in figure 3.3 and 3.4 below.
25
3.3. TRENDS IN CAPITAL EXPENDITURE OF INDIA
Many economists and policy makers have argued that productive expenditures like the capital
expenditure led to long-term growth in the country. Table 3.2 shows the capital expenditure in
absolute amount and also as a percentage of total expenditure during 1990-91 to 2020-21. The
increase in capital expenditure is expanding investment and building the physical assets and
machine building complexes for the various publicly provided services. It has aimed at promoting
growth and developing the quality of services provided by the Union Government. The annual
average share of the capital expenditure to GDP was declining from 4.34 percent in 1990-94 to
2.11 in 2005-09. The growth rate was slashed to -2.23 percent for the last decades.
Table 3.2: Capital Expenditure (in Rs. Crores and as a percentage of total expenditure)
Year Capital expenditure (in Rs. Crores) CE/TE (Capital expenditure as a % of Total
Expenditure)
1990-91 31782 30%
1995-96 38414 22%
2000-01 47753 15%
2005-06 66362 13%
2010-11 156605 13%
2015-16 253022 14%
2016-17 284610 14%
2017-18 263140 12%
2018-19 307714 13%
2019-20 348907 13%
2020-21 412085 14%
of India, Mumbai.
Note: data for 2019-20 are Revised Estimates and data for 2020-21 are Budget estimates
Total expenditure on capital account has amounted to Rs.31782 crores in the year 1990-91, went
up to Rs.47,753 crores in 2000-01, to Rs.1,56,605crores in 2010-11 and by 2020-21 it has further
26
increased to Rs.4,12,085 crores, which implies that capital expenditure has increased by more than
12 times in the last thirty years.
Fig 3.3 : Growth of Public Expenditure in India(in Rs. crores)

3500000
3000000
2500000
2000000
1500000
1000000
500000
0
1997-98
2006-07
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
2018-19
2019-20
2020-21
Revenue Expenditure Capital expenditure Total Expenditure
Note: Vertical axis measures Public Expenditure in Rs. crores and horizontal axis indicate year.
of India, Mumbai.
Figure 3.3 shows the pattern of the Public Expenditure. As shown in the figure, the total public
expenditure (TE) has increased over the study period and it has shown a steep rise after the year
2005-06, while during government revenue expenditure has also increased almost by fourth fold.
As also indicated in the Figure 3.3 above, the revenue expenditure has increased at a much faster
pace which is due to the increasing demand of different social and general services, to a certain
extent.
However, as far as the capital expenditure is concerned, it has grown at a very slow pace over the
years. As shown in Figure 3.3 above, the growth of capital expenditure in absolute term is not as
high as revenue expenditure, though it has shown a twelve-fold increase over the period.
The total expenditure on both accounts (revenue and capital account combined) has increased by
11.07 times during the study period. Total public expenditure was Rs.105298 crores in the year
27
1990-91 but it rose to Rs.325592 crores in the year 2000-01 and further increase to Rs.1197328
crores in 2010-11 and by 2020-21 it has reached Rs. 3042230 crores Thus, we find that there has
been a tremendous growth in Public Expenditure in India over the years but there exists a large
unfavorable combination in its two components, i.e., revenue and capital expenditure to provide
for the requirement of a strong foundation for overall growth and development in the country.
We have made an attempt to study the growth of public expenditure as a percentage of total growth
in expenditure.
Fig 3.4: Revenue expenditure and Capital expenditure as a % of Total

Expenditure
100
90
80
70
60
50
40
30
20
10
0
1999-00
2003-04
2020-21
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
2000-01
2001-02
2002-03
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
2018-19
2019-20
Revenue expenditure as a % of total expenditure

Capital expenditure as a % of total expenditure2
Note: Vertical axis measures percentage share and horizontal axis indicate year
of India, Mumbai.
Fig 3.4 shows that revenue expenditure and capital expenditure as a percentage of total
expenditure. In 1990-91, revenue expenditure constitutes 70% of the total expenditure, where as
30% was constituted by capital expenditure at that time. Share of revenue expenditure in total
expenditure is constantly high in the overall study period.
28
3.4. DEVELOPMENT AND NON-DEVELOPMENT EXPENDITURE
Expenditure on both revenue and capital accounts is again classified under developmental and
non- developmental expenditure. Developmental expenditure comprises of items such as
education, medical, family welfare, scientific services and research, housing, public health,
agriculture, veterinary, irrigation, multi-purpose river projects, power and electricity, co-operation,
rural development and community development projects, industries, commerce, mines and
minerals, roads and bridges, civil works and miscellaneous items. Administrative services
including district administration, police, public works, etc., charges for collection of taxes and
duties, debt servicing charges, pensions etc., are grouped under non developmental expenditure on
revenue account. Non-developmental capital outlay includes discharge of internal debt, repayment
of loans to the Centre, loans and advances by state government etc. Though developmental
expenditure is directly related to the pace of economic development of a backward economy,
certain non-developmental items such as expenditure on administration also exercises some
influence on economic progress. Hence, it is very important to follow a rigid distinction between
developmental and non-developmental expenditure.
Development expenditure comes mainly in terms of social and community services and economic
services. The developmental expenditure on social and community services under revenue account
includes items such as; secretariat- social services, education, art and culture, medical, family
welfare, water supply and sanitation, housing, urban and rural development, information and
publicity, labor and employment, social security and welfare, relief and natural calamities and
donations for charitable purposes. The development expenditure on social and community services
under capital account also includes the following items: education, art and culture, health and
family welfare, water supply and sanitation, housing, urban development, information and
publicity, social security and welfare, and other social services.
The developmental expenditure on economic services under revenue account includes: agriculture
and allied services, industry and minerals, energy, transport and communication and other general
economic services. Developmental expenditure on economic services under capital accounts
comprise of items such as: agriculture and allied services, industry and minerals, energy, transport,
special areas programme, science and technology, environment, rural development, irrigation and
flood control and other general economic services.
29
On the other hand, the non-development expenditure comprises of general and defense services.
The non-developmental expenditure on general services under capital accounts comprise of items
such as: expenditure on currency, coinage and mint, administrative building making, etc. Whereas,
the non-developmental expenditure on general services under revenue accounts comprise of items
such as: expenditure on parliament, president, vice-president, council of ministers, expenditure on
election, expenditure on CAG, their salary, allowances, etc. i.e., the spending on the working of
various organs of a state.
The non-developmental expenditure on defense services under capital accounts consists of items
such as: spending on tools and equipment of defense, spending on machinery, factory, etc. On the
other hand, non- developmental expenditure on defense services under revenue accounts consists
of items such as: salary and allowances paid to army, navy, air force, etc.
Table 3.3: Share of Non-developmental and developmental expenditure in total revenue
Year Non-Developmental expenditure Developmental expenditure

1990-91 59.29 36.08
1999-00 69.00 29.48
2000-01 66.79 29.04
2005-06 59.06 35.23
2012-13 52.9 43.3
2014-15 61.2 38.7
2015-16 64.7 35.2
2016-17 64.6 35.3
of India, Mumbai
30
Fig 3.5: percentage share of non-developmental and developmental
expenditure in total revenue expenditure of the central government
80
70
60
50
40
30
20
10
0
1990-91 1999-00 2000-01 2004-05 2005-06 2012-13 2014-15 2015-16 2016-17
Non-Developmental expenditure Developmental expenditure
Note: Vertical axis measures Public Expenditure in Rs. crores and horizontal axis indicate year
Source Calculated by using data from Statistical Handbook of India, published by Reserve Bank
of India, Mumbai
The share of development and non-developmental expenditure in total revenue expenditure was
between 25 to 45 per cent in favor of development and between 50 to 70 per cent in favor of non-
development during the study period. Data shows that state’s expenditure on non-development
type of expenditure was always more than development type of expenditure. In 1990-91, the share
of non-developmental expenditure was 59.29%. then it increases to 66.79% during 2000-01. It was
lowest in the year 2012-13, which was 52.9 % and then it has again started increasing. On the other
hand, the share of development expenditure was always lower than non-development. It was 36.08
% during 1990-91. It was highest in the year 2012-13 i.e., 43.3%, though it was much lower than
non-development type of expenditure in the year concerned.
31
Table 3.4: Share of Non-developmental and developmental expenditure in total capital
year Non-developmental Developmental Loans and advances

expenditure Expenditure
1990-91 19.63 29.36 51.01
1995-96 32.88 15.51 51.61
2000-00 35.90 27.47 32.71
2004-05 66.52 32.25 1.23
2010-11 45.5 43.5 10.9
2012-13 54.4 42.0 3.4
2014-15 49.9 41.7 8.2
2016-17 40.7 51.9 7.2
of India, Mumbai.
Data on developmental and non-developmental expenditure as a percentage share of total capital

expenditure shows that expenditure on non-development type of expenditure was more than
development type of expenditure in most of the years as in case of revenue expenditure. In 1990-
91, the share of non-developmental capital expenditure was 19.63%, and the share of
developmental expenditure was 29.36%, i.e., the share of developmental expenditure was more
than non-developmental expenditure for 1990-91. Then in the year 1995-96, the share of non-
developmental type of expenditure exceeds developmental expenditure as we can see in the table.
Non-development expenditure increases to 32.88% during 1995-96, whereas development
expenditure has reduced to 15.51% in that year. During the first decade after reform, the share of
loans and advances was much higher than both developmental and non-developmental
expenditure. It constitutes more than 50% in the first ten years period. But after that period, during
2004-05, it has reduced to only 1.23% of the total capital expenditure. After that, it has not
increased much.in 2016-17, the share of loans and advances was 7.2%.
32
Fig3.6: percentage share of non-developmental expenditure,
developmental expenditure and loan & advances in total capital
expenditure of the union government
70
60
50
40
30
20
10
0
1990-91 1995-96 1999-00 2004-05 2010-11 2012-13 2014-15 2016-17
Non-developmental expenditure Developmental Expenditure

Loans and advances
Note: Vertical axis measures percentage share and horizontal axis indicate year.
of India, Mumbai.
However, the considerably low level of developmental expenditure share in total expenditure and
higher share of non-developmental expenditure might be due to the increasing demand for law and
order and security expenditure and thus requiring more efficient functioning of the state
administration due to the changing political and social scenarios in the state caused by persistent
insurgency problem. On the other hand, the increasing fiscal debt services which is due to recourse
to loans and borrowing as a source of resource mobilization has led to increase in non-development
expenditure in the country. Administrative services, pensions and miscellaneous general services,
revision of pay and dearness allowances of state employees etc. are largely responsible for rise in
non-developmental expenditure on revenue account. Besides this, loan financing of unproductive
investment in the capital account has given rise to mounting debt burden on the state. On account
of this, expenditure on debt services has increased. This is a major factor in the growth of non-
developmental expenditure in revenue budget of the state. The non-developmental expenditure of
the Union Government improved due to the committed expenditure and this committed
expenditure has increased due to interest payments, pension amount and public debt, etc.
33
CHAPTER IV
DETERMINANTS OF ECONOMIC GROWTH AND

PUBLIC EXPENDITURE
4.1. DETERMINANTS OF ECONOMIC GROWTH
Economic growth is the increase in the real GDP or the GDP per capita of a country or the increase
of national product measured in constant prices (Denison,1962). Many economists, policy makers
and researchers have recognized the importance of the need for economic growth and prosperity
for the well-being of the human race.
Keynes (1935) places enormous importance on the size of the Public Expenditure and argues that
it is the size of the Public Expenditure that determines economic growth. The development of
Keynesian theory has recognized government expenditures as one important element in a macro-
static model. In words of Harrod (1948), “the more recent and growing interest in the associated
problems of economic dynamics and economic growth, a marked characteristic of economic
studies since World War II, has stimulated further interest in public expenditures along similar
lines.”
Dollar (1992) has used cross-sectional regression analysis in the study covering 95 counties for
the time period 1976 to 1985.The study shows that the index of real exchange rate distortion and
real exchange rate variability have a negative relation with the long-run economic growth.
Fischer (1992) in his study investigated the macroeconomic stability and growth in the Sub-
Saharan region of Africa, Latin America and the Caribbean countries covering the time period
1970 to 1985. The study provides evidences for the positive relation between human capital,
investment and budget surplus with economic growth. Other economists like Knight, Loazya and
Villanueva (1993) also study the relationship between investment, human capital, public
investment and trade policies on the economic growth. Their study suggests that physical capital,
34
human capital, trade openness, investment, population growth-all are very important determinants
of economic growth.
In a study done by Most and Berg (1996) found that foreign aid is playing a negative role in the
economic growth of six out of the eleven Sub-Saharan Countries, such as Ivory Coast, Togo,
Zambia, Rwanda, Nigeria and Botswana. They find a positive and a significant relation between
the two in countries such as Niger, Senegal and Mauritius. Another determinant of economic
growth ‘domestic savings’ is positively related with economic growth in Senegal, Ivory Coast,
Togo, Kenya, Cameroon, Togo and Nigeria; but negatively related in country like Zambia and
Mauritius.
Easterly and Levine (1997) has done their study by using an empirical cross-sectional study which
conclude that the logs of schooling, financial depth, fiscal surplus and a measure of telephone per
worker are positively associated with the economic growth. On the other hand, political
assassinations, black market and hoarding act as a negative factor for the growth of an economy.
The study reveals that these are the reasons for slow economic growth in Latin America and
Caribbean countries. These factors lead to a substantial amount of cross-country variation in the
growth of the economies.
Various socio-economic factors such as ethnic diversity, language, beliefs among the socio-
cultural determinants also have an important role on economic growth. These factors can have a
negative impact on attainment of education, political instability, underdeveloped infrastructure and
ultimately low economic growth of the country.
Mo (2007) suggests that except investment, all other government expenditures have a negative
impact on economic growth. The negative impact of the government spending on the economic
growth could be unfavorable to the economy as it could lead to unemployment and low levels of
investment in the economy if there is slow rate of growth
Lensink et al. (2009) in their paper says that various political factors like political instability, civil
war, the perception of policies also play a major role in the economic growth of a country. Political
instability plays a negative role in fostering economic growth as it discourages investment and
capital formation very badly and ultimately have a serous consequence on the growth of the
35
economy. Another study made by Aisen and Veign (2013) covering 169 countries in the period
1960 to 2004 show a negative impact of political instability on the economic growth.
Acemoglu (2009) investigates that geography can also impact the economic growth of the
countries. Soil quality, natural resources available in the region, climate, topography of a region
can have a positive or negative impact on the overall growth of the country.
Li and Liu (2005) examine the role of foreign direct investment on the economic development for
both developing and developed country. They have found a positive and significant influence of
this on economic growth. Foreign direct investment inflows can have a positive impact on the
economic growth and can accelerate the rhythm of economic growth especially in developing
countries (Johnson,2006).
4.2. DETERMINANTS OF PUBLIC EXPENDITURE
The factors that are working as determinant of government expenditure growth have been a
principal concern for economists going back as far as Wagner (1893). The growth of government
expenditure has a very large impact on the economic growth of any country. Studies by various
economists have proposed the factors that determine government expenditure as demographic
factors such as urbanization and growth of population (Shelton, 2007; Kimakova, 2009); and
macro-economic variables such as public debt and openness of trade (Rodrik, 1998; Mahdavi,
2004). According to Meltzer and Richard (1981), income inequality may create demand for more
redistribution, thus leading to a bigger government (Maluleke,2017).
However, there are limited studies on the determinants of government expenditure that have been
done in case of developing economies.
Folster and Henrekson (2001), in their study of some rich countries for the period 1970 to 1995,
found that there exists a negative relationship between government spending and economic
growth. In a multi-country study done by Lamartina and Zaghini (2010) investigate the impact of
government expenditure on economic growth for 23 OECD countries for the time period 1970 to
2006 by using a panel co-integration analysis. The result obtained from the study indicated a
positive correlation between public expenditure and per capita GDP and this correlation is found
to be usually higher in countries with lower per capita GDP. The study suggests that the catching-
up period is specified as a robust development of government activities with respect to economies
36
in a more advanced state of development. Chletsos and Kollias (1997) has used an error correction
approach and concluded that in Greece and found that relationship is valid only in the growth of
defence expenditure. According to Chletsos and Kollias (1997), the defence expenditures have
been influenced by the economic growth of the country that leads to the allocation of more
resources for the military purpose. For the US, Islam (2001) used the Johansen-Juselius co-
integration and also exogeneity tests and his study found evidences that supports causality of
public expenditure from economic growth. Chang (2002) examined different versions of Wagner’s
Law for six countries over the period 1951 to 1996 by using Johansen-Juselius co-integration test
and error-correction modelling techniques. The countries are Taiwan, South Korea, the USA,
Japan, Thailand and the United Kingdom. The study also shows that there exists a long-run relation
between national income and government expenditure in the countries, except for Thailand.
Trade openness is a very important factor that has been identified as a determinant of government
spending. The impact of this factor on government spending has received substantial attention.
Studies made by Rodrik (1998), Kimakova (2009) and Turan and Karakas (2016) have proved the
effects of trade openness on government spending. Rodrik (1998) suggests that the relationship
between trade openness and size of the government expenditure can be best described by the
compensation hypothesis. A country’s dependency of on foreign trade increases the volatility on
their domestic or internal markets, which is brought by the reliance on the development of its
trading partners. This generates stimulus for the government to supply social security against
internationally generated risks. Turan and Karakas (2016) in their study for Turkey and South
Korea found that trade openness has a positive impact on size of government spending for South
Korea, but it shows a negative effect in case of Turkey. It is important to choose the appropriate
proxy government size as not all the measures are suitable to be used in the estimates and to reach
robust and consistent results (Turan & Karakas,2016).
Foreign aid also plays a principal role in case of developing countries. Studies done by Remmer
(2004) suggests that the effect of foreign aid on government spending in both middle- and lower-
income countries for the time period 1970 to 1999 has a positive impact on growth. The study also
advocates that foreign aid is becoming an important determinant of government size; and that it
has a stronger influence on government spending than other variables like per capita income,
population size, age structure and trade openness.
37
Another important determinant of public expenditure is the size of the public debt. Mahdavi (2004)
has found in her study that a higher debt burden is highly correlated with a larger size of the
government spending in 47 developing countries for the time period 1972 to 2001. The study also
suggests that external debt has changed the composition of government expenditure in favour of
interest payments and displacing the share of non-wage goods and services category. The result
provides evidences that external debt has a very important impact on the allocation of the
government budget.
There is very high correlation between government expenditure and government revenue.
Nyamongo et al. (2007) in their study in South Africa provides evidences for the relationship
between the two. The results of the study show that both the variables are co-integrated in the long
run. The results of the study also provides short-and long-run policy implications for the
government. In the short-run, rejection of the fiscal synchronisation hypothesis confirms that
expenditure decisions are made in isolation from revenue decisions. Secondly, the support of fiscal
synchronisation hypothesis in the long-run implies that government expenditure and government
revenue decisions are not made in isolation (Nyamongo, Sichei & Schoeman,2007).
Per capita income, rate of unemployment and military spending have a very significant and
positive relation with total government expenditure ratio. The rate of openness and the two
dependency ratios for the old and youth respectively were found to be insignificant in explaining
the growth of government expenditure in the US (Huang & McDonnell,1997).
The results of the study done by Alm and Embaye (2010) using multivariate co-integration has
revealed that per capita government expenditure, per capita income, the tax ratio and the wage rate
are co-integrated. This shows that government expenditure is not only related to national income
and the cost of provision of public service captured by the wage rate, but also associated with fiscal
illusion which is created by the budget deficits. They conclude that institutional and a-institutional
factors explain the relationship very well between public spending, tax share, national income and
wage rate in South Africa. The external conditions like wars and oil price also play an important
role in explaining the effect of government spending per capita growth.
The existing literature gives contradictory results regarding the determinants of government
expenditure. The results differ based on the country, methodology used and the proxy of the
variables used in the study. Researchers can also examine other variables such as interest rates,
38
foreign direct investment, exchange rates, political stability, and corruption as determinants in the
future as they have not been studied extensively.
Among the different social service activities, the expenditure on education, health and family
welfare occupies a major place. The lower-middle income states like India spends only 3.1% of its
GDP on education. Expenditure on education, though, has increased in absolute amount since
2014-15, but in percentage terms it has stagnant at around 10.5% of the total government
expenditure. Relatively more funds have been allocated for the agricultural development of the
country during the study period. The allocation for health is surprisingly very low at 0.9 percent,
0.8 percent and 0.6 percent respectively for low-, middle- and high-income Group States. The
share of government expenditure for health purpose in India is also very low at 1 percent of GDP.
These are showing alarming trends given the low attainment of many states in the health indicators
like Infant Mortality Rate (IMR) and Maternal Mortality Rate (MMR). Proportion of resources
allocated for the industrial and transport sector by all the states is also low in India.
4.3. CONCLUSION
The existing literature provides different views regarding the determinants of government
expenditure as well as economic growth. The findings of various studies show that the relationship
between these variables with their respective determinants are significantly positive and negative.
These results vary based on the methodology used, proxy of the variables used and the country.
There are also scope to examine some other variables as determinants in the future studies as less
focus has been given in their study. The majority of the studies concluded that economic growth,
urbanization, revenue receipt, and trade openness have a positive impact on government
expenditure. On the other hand, human capital, budget surplus, political stability, etc. have shown
a positive effect in the economic growth of the country.
39
CHAPTER V
EMPIRICAL ANALYSIS AND CONCLUSION

5.1. INTRODUCTION
The objective of the present study is to analyze the relationship between economic growth and
public expenditure in India under the specified period 1990-91 to 2020-2021. The dependent and
independent variables used viz gross domestic product (GDP) as a dependent variable and total
public expenditure (TE), export (EXP)and foreign direct investment (FDI) as the independent
variable. The proposed study has been principally based on the secondary sources of data. The
survey provides a very detailed report of the economic performance of the country during the
period of time.
5.2. ANALYSIS AND INTERPRETATIONS
Here, the OLS regression analysis is carried out only after implementation of Augmented Dickey–
Fuller (ADF) unit root test, because according to Philips (1986), if the series are not stationary, t
and F statistics do not follow standard distributions. According to Gujarati (2003), in order to have
a good econometric model for OLS regression, some a priori econometric assumptions should be
fulfilled, such as error term residuals should have normal distribution, variance of the error term
should be constant, which is known as the principle of homoscedasticity, and there should be no
correlation among residuals. Therefore, due to the need to fulfil these assumptions, all of the above
test are performed so that it can be ensured that their model is not spurious.
5.2.1. TEST FOR STATIONARITY
It is essential to test the stationarity properties of variables whenever dealing with annual data.
Therefore, the first Step of Time series data analysis is to test the stationary properties of the
variables. The classical linear regression assumes that the time series variable should be stationary
or the mean, variance and covariance of the series should be independent of time. It is also known
as covariance stationary or Weak Stationary. If the data set is non-stationary, it means the mean
(µ) and variance (𝜎 2 ) of the data set is inconsistent or varies with respect to time and would yield
spurious result of regression parameters. As Granger and Newbold (1974), stated that the existence
40
of non-stationary variables in the OLS model would lead to spurious estimates. Therefore, it would
be essential to examine the stationarity characteristic of the data under study using appropriate test.
Here, Eviews11 statistical program has been used while performing the stationarity test.
There are different methods to identify whether the time series under consideration is stationary or
not; such as graphical method, correlogram, unit root test. Here unit root analysis is used to check
stationarity of the variables. The purpose of the unit root tests is to ensure that the data used are
valid and reliable for further analysis. All variables with time series in the model should be
stationary. If the variables are not stationary, it means that the standard assumptions for an
asymptotic analysis are not valid. In the present study, for testing stationarity of different variables,
Augmented Dickey-Fuller (ADF) test is conducted to pre-test the variables for unit roots to verify
whether variables are integrated of the same order. A series 𝑌𝑡 is said to be integrated of order d
denoted by 𝑌𝑡 ∼I(d) if it becomes stationary after differencing d times and thus 𝑌𝑡 contains d unit
roots. A series which is I (0) is said to be stationary. The Augmented Dickey-Fuller (ADF) is
considered as a superior to the Dickey Fuller (DF) test as the Dickey-Fuller test is based on the
assumption that the errors (residuals) are serially uncorrelated; But the ADF test overcomes this
limitation by assuming that the errors (residuals) may be serially correlated or ADF test
“Augment” by specifying the lagged value of the dependent variable. The Augmented Dickey-
Fuller (ADF) test is employed in three forms, viz
1. ADF with drift or constant terms;

2. ADF with drift and trend;
3. ADF without drift and trend.
Akaike’s Information Criterion (AIC) has been used to find out the lag order of each variable under
study. The variables tested for unit roots include the following 4 variables: gross state domestic
product (GDP), total public expenditure (TE), export (EXP) and foreign direct investment (FDI).
To ensure that the time series data are stationary or nonstationary, the following standard
regression model is carried out:
∆𝑌𝑡 = 𝑎0 + 𝑎1 𝑦𝑡−1 + ∑ 𝑎1 𝑖∆𝑦𝑡−1 + 𝜖𝑡 …………………. (1)
Where, Δ is the first difference operator and n are lag, 𝑎1 are parameters, ε is a white noise error
residual. According to the ADF test, these hypotheses are usually used:
41
𝐻0 : 𝛾 𝑖 = 0 (series contains a unit root);
𝐻1 : 𝛾 𝑖 ≠ 0 (series is stationary).
If the null hypothesis is rejected. then the series is stated to be stationary or non-rejection of null
hypothesis implies the presence of Unit Root in the series i.e., series is non-stationary. If the data
series is non-stationary at level, then same procedure is repeated on the first difference of the
variable or data series. This procedure is performed for all the variables under study. The results
of ADF test are presented in Table 5.1:
Table 5.1: ADF test result
Level 1st difference

Variable
Intercept Intercept & trend intercept Intercept & trend
Remark
t-stat P t-stat P t-stat P t-stat P
GDP 0.9295 0.9946 -1.5720 0.7801 -3.8948 0.0059* -4.0371 0.0186* I (1)
TE -0.7918 0.8065 -2.9857 0.1530 -3.5640 0.0132* -4.5564 0.0419* I (1)
EXP -1.910 0.3216 0.7451 0.9994 -3.7529 0.0446* -4.4916 0.0085* I (1)
FDI 1.9913 0.9998 -0.1897 0.9903 -4.5214 0.0012* -5.6572 0.0004* I (1)
Note: ‘*’ indicates rejection the null hypothesis of unit root at 5% significant levels.
Source: Calculated by using data from

1.Statistical Handbook of India, published by Reserve Bank of India, Mumbai.
2. Economic Survey, 2020-21, Vol. II, Ministry of Finance, Govt of India, New Delhi.
3. GoI. Ministry of Commerce and Industry. Department for promotion of Industry and
Internal Trade.
Table 5.1 shows the result that suggests the rejection of the null hypothesis for all the variables under
study at the first difference, i.e., all the variables are turned into stationary after the first difference. The
variables were found to be non-stationary at the levels but stationary at the first difference, as after the
first difference, all the p-values for all variables are significant at 5 %, meaning that hypothesis 𝐻0 is
42
rejected and the alternative hypothesis 𝐻1 is accepted. Therefore, since all the series were stationary in
the first difference it was possible to evaluate the regression analysis. Hence, test for the unit roots was
the primary task before conducting OLS analysis. Thus, all the variables are stationary at 1st difference
level according to ADF test and are of same integrated order I (1).
5.2.2. REGRESSION ANALYSIS
In the above table, the time series data is made stationary by first difference, so now the next steps
can be proceeded, i.e., regression analysis. If one nonstationary time series is regressed on another
nonstationary time series, it will lead to the phenomenon of spurious regression. Regression
analysis is performed to find out how the change in GDP over the years could be explained by
explanatory variables taken in the model. Though there exist various factors (already mentioned
in the Chapter 4) such as human capital, foreign trade, budgetary receipt, geography, etc. that also
effects the economic growth of a country, here, the study is limited ourselves to only three
independent variables. The data cover the time period of 1990-91 to 2020-21. To estimate the
regression coefficients, Eviews11 statistical program has been used. The general formulation of
the estimated model is given by the following function in equation (2),
Table 5.2: Regression Analysis
Source: Calculated by the author using EViews software.
43
In a regression model, higher the value of R-squared, better the data or model fitted. But, in this
analysis, the R-squared value is equal to 0.549497. It means only 54.9% variation in dependent
variable can be explained by the independent variables, here the remaining 45.1% variation on
independent variable can be explained though the residuals. i.e., our model is not very good-fitted.
If probability value for a variable is less than 5%, then it indicates that the particular variable is
significant to explain our dependent variable. In this model, the probability value of the all the
three independent variables is less than 5%, which indicates that all of the three variables are
significant to explain our dependent variable or it can be said that all the three variables
individually can influence our dependent variable.
For testing joint significancy of the explanatory variables, F-statistic and corresponding P-value is
used. Here corresponding P-value for our F-statistic is 0.000227, which is less than 0.05, meaning
that all the variables are jointly significant or can jointly influence the dependent variable.
103585.6 is standard error (S.E.) of C(constant). Standard error measures how reliable the
coefficient is. The coefficient for the independent variable tells us how much the dependent
variable change if the independent variable changes by 1 unit. The estimated value of the
coefficient of total public expenditure is 3.2070919 means that if public expenditure increases by
1 unit, then GDP will increase by 3.2070919 unit. The coefficient is positive it means the relation
between X and Y is positive or X (public expenditure) has a positive effect on Y(GDP). If we see
the other independent variable export of the country, then we see that the coefficient is 2.9393,
which also indicates a positive relation between the two. If the value of the coefficient is found to
be negative, then it means they have a negative relation or X has negative impact on Y as it can be
seen in the variable foreign direct investment (FDI). Its coefficient is negative, that means there
exist a negative relation between this variable and GDP growth.
Durbin-Watson statistics tells us whether our model suffer ‘serial correlation problem’. If it is
close to 2; No serial correlation in the model. If it is close to 0; positive correlation in the model.
If it is close to 4; Negative correlation in the model. In our model the value is found to be 2.233452
indicating no serial correlation in the model.
In order to have a good econometric model for OLS regression, the model must meet certain
econometric assumptions, such as the distribution of the variance of the error terms should be
44
constant, which in econometric terms means homoscedasticity. The variance of the error terms 𝑒𝑡 ,
conditioned by the variable X, should be the same for each t and denote Var [𝑒𝑡 ] = Var( 𝑒𝑡 )σ 2 for
𝑡 = 1, 2, 3, … 𝑛. If this condition is violated, then it means that the error terms are not constant, so
there is Heteroscedasticity. If the model has heteroscedasticity, the estimates obtained from this
model are not good and the actual values of t-statistics will be smaller and, on the other hand, will
increase the likelihood that hypothesis 𝐻0 will not be rejected.
To confirm whether the residual of error terms has heteroscedasticity, hypotheses were tested:
𝐻0: σ = 0, i.e., Constant variance (homoscedasticity);

𝐻1: σ ≠ 0, i.e., non-constant variance (heteroscedasticity).
To test these hypotheses, Breusch–Pagan–Godfrey test was used. The result of the test is concluded
in the table below:
Table 5.3: Testing for Heteroskedasticity (Breusch-Pagan-Godfrey test)
F-statistic 2.275379 Prob. F (3,26) 0.1035
Obs* R-squared 6.238447 Prob. Chi-Square (3) 0.1006
Source: Calculated by the author.
According to the results of Table 5.3, it can be established that the p-value is insignificant and the
null-hypothesis is accepted, i.e., probability = 0.1035> 0.05. This means that variance of error
terms is constant (homoscedasticity) and there is no problem of heteroscedasticity.
Normality distribution of the error terms is another test that must be performed and meet certain
econometric assumption before the model is being evaluated. Normality tests are used to determine
whether residuals have a normal distribution or not. In the present study, to verify if the error terms
have a normal distribution, the authors used the matching criterion called Jarque–Bera (JB).
Statistically JB is as follows:
𝑠2 (𝐸𝐾)2
𝐽𝐵 = 𝑛 [ 6 + ] …………………………………… (2)
24
The basic and alternate hypotheses used to test the normal distribution of the error terms are:
45
𝐻0 : μ~𝑁 (0, σ 2 ), i.e., error term follows normal distribution;
𝐻1 : μ ≠ 𝑁 (0, σ 2 ), i.e., error term doesn’t follow normal distribution.
Result for Jarques-Bera (JB) test for normal distribution is presented in table below:
Table 5.4: Testing for Normality (JB test)
Jarque-Bera 1.86963
Probability 0.4056
It can be established that the p-value is more than the probability of 0.05. According to Table 5.4,
probability = 0.4056 > 0.05. This means that null hypotheses cannot be rejected, so the residuals
of the best fitted model are normally distributed.
Another econometric assumption that the model must meet is that the observations of the error
terms are independent of each other. Each error term observation in two different time periods
should not be correlated, which implies that corr [ 𝑒𝑡 , 𝑒𝑆 ] = 0 for each 𝑡 ≠ 𝑠. If this assumption is
violated, it can be stated that there is autocorrelation in the model. It indicates that error term
observations in OLS are correlated. Autocorrelation in the context of the OLS model is a common
problem when causing time series data. When autocorrelation is present, the OLS procedure still
produces unbiased estimates. Therefore, the variation of error term observations may be smaller
than it is in reality and, as a consequence of this variation, coefficient of determination 𝑅-square
would be much larger than it is in reality. To find out if the error term has autocorrelation, the
following form is applied:
𝑒𝑡 = α + ρ1 𝑒𝑡−1 + ρ2 𝑒𝑡−2 + ρ3 𝑒𝑡−3 + . . . +ρ𝑝 𝑒𝑡−𝑝 + ε𝑡 ……………………. (3)
To determine whether the error term has autocorrelation, the following hypothesis has been tested:
𝐻0 : ρ1 = ρ2 = ρ3 = ⋯ = ρ𝑘 = 0, i.e., no autocorrelation;
𝐻1 : ρ1 = ρ2 = ρ3 = ⋯ = ρ𝑘 ≠ 0, i.e., positive autocorrelation. To test these hypotheses, the authors

used the Breusch–Godfrey method or otherwise the LM.
46
Table 5.5: Testing for Autocorrelation (Breusch-Godfrey Serial Correlation LM Test)
F-statistic 0.294518 Prob. F (2,24) 0.7475
Obs*R-squared 0.718657 Prob. Chi-Square (2) 0.6981
The result of LM test shows that the p-value is insignificant and the null-hypothesis is accepted.
According to Table 6, probability = 0.6981 > 0.05. Therefore, it can be concluded that there is no
autocorrelation problem in the best-fitted model.
Now, to check whether the independent variables of our regression model are correlated or not,
we go for the multicollinearity test. So, the hypotheses to be tested are:
𝐻0: No multicollinearity.
𝐻1: Multicollinearity.
To test these hypotheses, Variance Inflation factor test is used. The result of the test is concluded
in the table below:
Table 5.6: VIF Test
Variable Coefficient Variance Uncentered VIF Centered VIF
C 2.10E+10 2.453606 NA
DTE 1.445228 3.066765 1.447963

DFDI 957.2592 1.876100 1.375923
DEXP 0.334408 1.234667 1.128268
Source: Calculated by the author
We found that the VIF (Variance Inflation factor) s are all down to satisfactory values (all are near
to one), which indicates that there is no multicollinearity problem between the independent
variables.
47
5.3. CONCLUSION
From analyzing the overall model performed above, it can be concluded that the model estimated
can explain only 54.9 percent of variation in the dependent variable by the independent variables.
The coefficients of the independent variables are jointly as well as individually significant to affect
the dependent variable of the model as their respective p-values as well as the value of F-statistics
is less than 5 percent. So, the null hypothesis can be rejected and t the alternative hypothesis can
be accepted. The result has showed that out of the three independent variables used in the model,
total public expenditure (TE) and export (EXP) have a positive impact on the economic growth,
while the other variable foreign direct investment has a negative impact on the dependent variable.
Coming to the fiscal scenario, we have seen that expenditures on revenue account had grown at a
faster rate than expenditures on capital account and if there is any short fall on total expenditure,
then it is solved by curtailing capital expenditure or we can say, the government has favored
revenue expenditures at the expense of capital expenditure. Moreover, the state was borrowing
heavily to fulfill its current expenditures. It can be seen that, the fall on capital account was steeper
than that on revenue account.
The state witnessed an increase in the share of development as-well-as non-development

expenditure; however, the rate of growth is more pronounced in the latter than in the former. In
development expenditure the share of expenditure on social services had surpass the share of
expenditure on economic services and the former had grown at a higher pace than the latter
particularly in the present century.
5.4. POLICY SUGGESTIONS
Based on the literature reviewed, the analysis carried out and the result found from the present
study, following policy suggestions can be given:
1. In order to foster economic growth in the long-run public expenditure should be directed towards
education and skill development.
2. To increase investment in physical infrastructure, revenue component of the developmental

expenditure be kept to the minimum; then only developmental expenditure would work as the
crucial source of growth. Various cross-country evidences indicate that raising public expenditure
48
on infrastructure investment increases output in both the short and long run. Debt-financed projects
could have large output effects without increasing the debt-to-GDP ratio, if clearly identified
infrastructure needs are met through efficient investment (IMF, 2014). However, because of poor
project selection and execution the efficiency of various public investment project work less
efficiently resulting limited long-term output gains than it could produce otherwise.
3.Higher government spending should be assigned to power, transport and communication sector
to build an environment for business and entrepreneurship to strive through reduced cost of
production.
4. Borrowed funds be utilized for capital purposes only to yield adequate direct and indirect
returns. The pertinent question here is, for how long the citizens of India would continue to bear
the burden of a debt servicing by investing in productive but non-interest yielding assets even after
75 years of independence. Unless some careful attempts are made to reduce the net debt services,
the debt servicing may become unbearably burdensome in the years to come. Government should
adopt public debt in a planned magnitude.
4. Suitable measures to be taken to contract the non-plan revenue expenditure. Additional

resources should be mobilized both through the tax and non-tax sources.
5. Increased revenue expenditure (particularly in subsidies) while keeping capital outlays stagnant,
added to demand pressures, which were then mirrored in high inflation.
6. Resource insufficiency of the economy, which in turn has led to fiscal imbalances in the country
over the years. Poor collection of tax revenue in different states is the consequence of these two
factors such as inadequate tax effort on the part the state government and the relative inelasticity
of state’s own tax to state income. Moreover, unlike developed countries, the greater portion of
tax revenue collection in India comes from indirect taxes. But things should the exact opposite,
i.e., more collection should come from direct taxes as it tends to lower the post-tax income
inequality. One of the major reasons for providing subsidy, free ration etc. through public
expenditure aims at reducing poverty and inequality in the long term. However, more collection
through regressive tax will work against this long-targeted goal of government. Thus,
rationalization of the tax system would resolve the problem and should be carried out vigorously
49
by the state government. More attention should be given to increase efficiency and compliance in
tax revenue collection. Higher tax revenues can facilitate increases in public investment.
5.5. LIMITATIONS
The study covers only a thirty-year period, from 1990-91 to 2019-20. This study is purely based
on the secondary data of government of India. Gross Domestic Product, government expenditure,
revenue expenditure, capital expenditure, foreign direct investment, export, etc. are taken for the
period of 1990-91 to 2020-21, which may be considered as a very less time span. Due to the non-
availability of the data and resources, various important determinants of economic growth could
not be included in the present study. So, the results obtained from the analysis would be more
accurate if the time period of the study would have been longer and more and more determinants
are included in the model. The study can be criticized on the ground that the number of variables
taken into account in this model is much smaller than is necessary for their satisfactory
interpretation of economic policy. Also, the inferences that are derived from the study may be not
directly applicable to individual states of India.
5.6. SCOPE FOR FURTHER STUDY
The study has attempted to analyze mainly the role of total public expenditure on economic growth
or the GDP growth of India for the time period 1990-91 to 2020-21. However, the detailed analysis
of the present study indicates that still, there exists some research issues which are not undertaken
as far as our present study is concerned, which gives rise to more scope for further study and find
out new things. Mainly due to time and resource constraint, the present study could not focus more
on all the issues.
There is a scope for study of role of government expenditure on different sub-categories such as
Economic, Social, welfare, defense and general services expenditure can be analyzed along with
the Net State Domestic Product of the state.
The political approach of public spending can be taken in future studies of public expenditure and
economic growth.
The study found that the there are many other factors, both economic and non-economic, which
are also responsible for the growth of GDP in our economy
50
5.7. CHALLENGES
Fiscal policies are very essential in mitigating the Covid-19 crisis and in preparing the recovery of
the Indian economy. As the Covid-19 pandemic has torn the economies across world, the
policymakers and economists are continuously seeking effective ways to deal with the situation.
At this point, it is a good move by the government to increase spending, as it will create
employment and also increase purchasing power of the people and this will in turn help in reviving
the economy,” said Arun Kumar, former Professor at Economics Department, JNU. India is
already very heavily burdened with public debt. So, India needs to be particularly concerned as we
also happen to possess the least capacity to make tough decisions to return to a trajectory of fiscal
credibility. The government of India has spent 2.4 times (240 per cent) its earnings this financial
year between April and October in FY 2020-21. Against the total receipts of Rs 2 lakh crore
(including tax, non-tax revenues and capital receipts) in the April-October period, the expenditure
has been Rs 16.6 lakh crore. Given the acute constraints on fiscal policy in India, there is clearly a
need to start prioritizing expenditures away from low-priority, unproductive areas towards greater
spending on health and social safety nets for low-income households. This sharp increase in the
government expenditure in proportion to revenue collection, though, is not because of increased
spending but due to poor revenue as net tax collections for the central government have seen a
sharp decline, primarily because of the lockdown-induced slowdown in economic activities and
also disinvestment collections. The government has managed to keep its expenses in check despite
multiple rounds of stimulus packages announced to tackle the Covid-19 situation.
51
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Dissertation - Anwesha Saikia

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The Role of Public Expenditure on Economic

Growth: A Case Study of India in the Post

A Dissertation Submitted in Partial Fulfillment of the Requirements for the Degree

Date: 02/07/2021 Anwesha Saikia

Date:02/07/2021 Anwesha Saikia

Vasanta College for Women, BHU

S. NO. TITLE PAGE NO.

SL. FIGURE PARTICULARS OF FIGURES PAGE NO.

4 3.4 Revenue expenditure and Capital expenditure as a % of 28

SL. NO. TABLE NO. PARTICULARS OF TABLE PAGE NO.

1 3.1 Revenue expenditure (in Rs. Crore and as a 25

TE Total Public Expenditure

Public expenditure is considered to be an important tool of fiscal policy of an economy, which

1.2. COMPONENTS OF PUBLIC EXPENDITURE

1.3. THEORIES OF PUBLIC EXPENDITURE

1.3.1. WAGNER’S LAW OF INCREASING STATE ACTIVITIES

1.3.2. WISEMAN-PEACOCK HYPOTHESIS

1.4. PUBLIC EXPENDITURE IN INDIA: A BRIEF OVERVIEW

1.5. SIGNIFICANCE OF THE STUDY

Alternative hypothesis, 𝐻1 : Public expenditure has significant impact on economic growth.

1.8. METHODOLOGY OF THE STUDY

1.8.1. THEORETICAL UNDERPINNING OF THE MODEL

1.8.3. SOURCE OF DATA

1.9. LIMITATIONS OF THE STUDY

1. The study covers only a thirty-year period, from 1990-91 to 2019-20.

1.10. CHAPTER PLANNED

2.2. LITERATURE THAT SUPPORTS THE CAUSALITY OF PUBLIC

Jayme Jr et al (2009) identifies the impacts of public 28 spending on transportation, infrastructure

Another study on Nigeria observes a unidirectional causality from government expenditure to

2.4. LITERATURE THAT SUPPORTS NEITHER WAGNER’S LAW NOR

2.5. GAPS IN EXISTING LITERATURE

Ratio of total goovernment

3.2. TRENDS IN REVENUE EXPENDITURE OF INDIA

Year Revenue expenditure (in Rs. Crores) RE/TE (Revenue expenditure as a % of

1990-91 73516 70%

Fig 3.3 : Growth of Public Expenditure in India(in Rs. crores)

Fig 3.4: Revenue expenditure and Capital expenditure as a % of Total

Revenue expenditure as a % of total expenditure

Year Non-Developmental expenditure Developmental expenditure

Non-Developmental expenditure Developmental expenditure

year Non-developmental Developmental Loans and advances

Data on developmental and non-developmental expenditure as a percentage share of total capital

Non-developmental expenditure Developmental Expenditure

DETERMINANTS OF ECONOMIC GROWTH AND

4.1. DETERMINANTS OF ECONOMIC GROWTH

4.2. DETERMINANTS OF PUBLIC EXPENDITURE

EMPIRICAL ANALYSIS AND CONCLUSION

5.2. ANALYSIS AND INTERPRETATIONS

5.2.1. TEST FOR STATIONARITY

1. ADF with drift or constant terms;

∆𝑌𝑡 = 𝑎0 + 𝑎1 𝑦𝑡−1 + ∑ 𝑎1 𝑖∆𝑦𝑡−1 + 𝜖𝑡 …………………. (1)

Table 5.1: ADF test result

Level 1st difference

TE -0.7918 0.8065 -2.9857 0.1530 -3.5640 0.0132* -4.5564 0.0419* I (1)

Source: Calculated by using data from

5.2.2. REGRESSION ANALYSIS

Table 5.2: Regression Analysis

Source: Calculated by the author using EViews software.

𝐻0: σ = 0, i.e., Constant variance (homoscedasticity);

Table 5.3: Testing for Heteroskedasticity (Breusch-Pagan-Godfrey test)

F-statistic 2.275379 Prob. F (3,26) 0.1035

Obs* R-squared 6.238447 Prob. Chi-Square (3) 0.1006

Source: Calculated by the author.