Economic Growth and Government Spending in Saudi Arabia - Literature review Example

Economic Growth AndGovernment Spending In Saudi Arabia TABLE OF CONTENTS …………………………………………………………………………………..3 Introduction…………………………………………………………………………………4 Background………………………………………………………………………………….5 Literature Review……………………………………………………………………………8 References………………………………………………………………………………….12 Abstract Many economists in the world today are involved in major debates on whether the government expenditure of a country has a real impact on the economic growth. Policy makers who are in support of the motion argue that every government has to spend on projects such as infrastructure and education. The policy makers also state that the increased spending by a government can raise the economic growth through encouraging its population to spend more. An increase in population expenditure tends to boost production. The study will look deep into the state of government expenditure and economic growth as carried out by the government of Saudi Arabia. The research will also give a wide background on the economic growth and expenditure status of the country. A critical review of current literature on this topic will also be carried out. This study will examine the impact of various types of government expenditure in Saudi Arabia in an empirical manner. The various types of econometric techniques will be used to give an estimate of the short-term and long-term effects that come up as a result of increased government expenditure. Does the size of government expenditure on public investments have a great influence on the economic growth? The findings developed from this study will be used by the relevant policy makers to formulate some economic policies for Saudi Arabia. The planning of good policies will enable the optimization of returns for the economy as a result of improved government spending. 1. Introduction In the current literature on economic growth, the fundamental question asks if an increase in the government spending can promote economic growth. The empirical proof on this topic is however not conclusive. For instance, on one hand, improved spending by the government on key sectors such as health care and education can raise the productivity of labor.However, excessive spending on defense can discourage economic growth. On the other hand, further government spending on key infrastructures such as communications and roads goes a long way in encouraging private investments. As a result, private investment encourages economic growth through the proper use of natural resources. Baro (1991) argues that expenditures on defense and education are considered as a public investment other than a public consumption. In a more specific sense, such cases of government spending are likely to boost the productivity of labor that in turn attracts the economic contribution of the private sector. An increase in government spending also boosts the property rights that are an important factor for private investment. The issue of government spending must however not be misjudged. For example, an increase in the government expenditure may have a negative impact on the general economic performance of a nation. The disadvantage comes in when the government spending is being fuelled by an increase in population taxes. The application of government expenditure from borrowing sources may also have a direct negative impact on the performance of an economy. The macroeconomic policy of Saudi Arabia is characterized by a strong fiscal policy. The need to have such a strong policy comes about from learning the capabilities of guided public spending when carrying out financing of various consumption and investment activities. Public expenditures also facilitate the achievement of the objectives about the urge to provide proper public social services. In the literature today, the statistics on government spending prove that the amount of government expenditures has escalated from 1.6 billion USD in 1970 to 158.9 billion USD in 2010. These figures give a percentage increase of 9,800 in nominal and a percentage increase of 1,700 in real terms (Saeed, 2012). The statistics give a rough picture of the population growth that has resulted in an increase in demand for products and public services. The increase of the standards of living has resulted in the escalating cases of government expenditure. However, regardless of the increase in the standards of living, the issue of unemployment remains a real problem in the recent years. This scenario is enough proof that it is of great importance to structure the government expenditure properly. The government spending should be designed in such a way that it is flexible. For example, it can be changed to facilitate growth coming as a result of private investment and also reduce the problem of unemployment (Al-Yousif, 2000). There have been endless empirical papers looking into the interaction between the economic growth and government expenditure in Saudi Arabia. However, none of the work done has examined the interaction that exists between various categories of government spending and growth of the economy. The research question for this paper is whether the size of government expenditure has an effect on the economic growth of a country. This study will, therefore, give a vivid picture of the relationship between the government of Saudi Arabia’s expenditure and the country’s economic status. The other sections of this paper have been outlined as follows. Section 2 is a conclusive background on the core of the government of Saudi Arabia’s expenditure. The third section will give a deep review of the current literature relating to the topic. 2. Background Although there are some debates on whether Saudi Arabia is a qualified member of the fastest expanding countries in North Africa and Middle East, its economy is wholly built on the oil sector. The foreign exchange that is normally generated from the sale of oil is accountable for an estimated 90 percent of the whole government revenues. The exportation of oil generates roughly 88 percent of the total Saudi Arabian export earnings. Also, the oil sector is a primary economic pillar as it plays a role in a 35 percentage of the country’s gross domestic product. As a result of learning the importance of carrying out structured government spending when financing consumption and investment expenditures, the fiscal policy of Saudi Arabia is keenly formulated in order to play an important role in the country’s economy. Table 1the relationship between current expenditure and capital expenditure in USD for Saudi Arabia against time from 2005 to 2011. The activities of the Saudi government are divided into government expenditure and public investment. The national activities revolving around public investment are carried out by firms that are owned by the government. The government expenditure is made up of two sections that include current government expenditure and government capital expenditure. The current expenditure is made up of salaries, wages, transfers, subsidies, and other expenses that pile up to consumption. On the other hand, capital government expenditure is made up of spending that is carried out by providing social services and health care, reinforcing human resources, developing economic resources, communication and transportation, and increasing the access to housing and municipal services (Joharji and Starr, 2010). Table 2comparison of the various expenditures in USD against time from 2005 to 2010. To attain optimum economic growth, the Saudi Arabian government formulated a strategy that is based on deliberate planning followed by cautious implementation of several development programs that have clear and vivid goals. The optimum performance of the Saudi Arabian economy is constructed through the introduction of the First Development Plan that was introduced in 1970. After the first attempt, the Saudi government commenced on several plans each extending for five years that are exercised up to now. In the initial development plans that were exercised from 1970 to 1984, the Saudi Arabian government dwelt on carrying out financing activities for several projects (Saeed, 2012). These projects are necessary to improve the health, education, transportation, housing and telecommunication services. When the fourth and subsequent development plans were underway from 1985 to 1994, oil revenues have declined significantly as the slump in global oil prices continued to escalate. The revenue reduction was followed by a reduction in the real government expenditure. The government of Saudi Arabia continued to undertake major infrastructure projects that had to be completed thus eroding the quantity of capital expenditure. During the sixth development plan that was effected from 1995 to 1999, the strategic plans of the Saudi Arabian government shifted their focus to the development of human resources in the country (Al-Obaid, 2004). The actual government expenditure on the development sectors totaled to 112.1 billion USD. Out of this amount, 57.7 billion USD was exercised on the development of the human capital. The seventh development plan was carried out from 2000 to 2004. Through this plan, the Saudi government worked on prioritizing the development of human capacity. The total government spending totaled up to 129.4 billion USD. From this amount, a percentage of 57.1 was directed towards human capital development. A percentage of 19.1 of the expenditure was set aside to enhance the development of the social care services together with healthcare. In addition, a percentage of 12.6 of the total expenditure was allocated for improvement of infrastructure. During the eighth plan from 2005 to 2009, the expenditure of the Saudi Arabia government reached 230.4 billion USD. A 55.6 percentage was set aside to enhance further the development of human resources. 18 percent of the expenditure was allocated to social care services and healthcare. For resource development, the Saudi government allocated a 12.2 percentage of the total expenditure. Lastly, infrastructure consumed a 14.2 percentage of the expenditure (Saeed, 2012) The seventh development plan, an expenditure of 129.4 billion USD prioritized the development of the human capacity. Also in the eighth development plan, the total expenditure of the government rose to 230 billion USD. The pattern of increasing government spending gives a reflection of the progress made by Saudi Arabia to achieve economic development. Research Question The research question for this paper is whether the size of government expenditure has an effect on the economic growth of a country. 3. Literature Review The current empirical theory on the effect of government expenditure on the growth of the economy can be categorized into two categories. The first category includes literature sources that shed light on the impact of overall government expenditure on the progress of an economy. The second category narrows down on the various forms of government expenditure that have several impacts on the growth of an economy. In reference to the first category of literature sources, the theory investigates the interaction that exists between government expenditure and growth of an economy. Several empirical methodologies were applied in the research papers, but the results are still not conclusive. In reference to Landau (1983), a rise in the government spending’s share in real gross domestic product reduces the rate of escalation of per capita real GDP.He came up with a negative relationship that exists between a country’s consumption share and the development of the real per capita gross domestic product. Landau (1983) also states that the positive effects of government expenditure are quite insignificant. Josaphat et al. (2000) carried out an assay on the effect of government expenditure on the growth of the economy of Tanzania. The data used by Josaphat et al. (2000) was collected from 1965 to 1996, and the results obtained showed that an increase in productive expenditure has a negative impact on the growth of the economy. He also states that expenditure on consumption expenses can stimulate economic growth. In agreement with Niloy et al. (2003), the share of government expenditure on capital activities has a positive effect that is significant in terms of economic growth. The study was carried out to investigate the effects of government expenditure on economic growth for a sample of thirty countries from 1970-1980. In conclusion on the first literature strand, Alexander, (1990); Romer (1990); Folster and Henrekson (1999) also found that the overall expenditure of a government has a negative impact on the growth of an economy. In the second strand of theoretical work, Landau (1983) states that the impact of several groups of government expenditure can be differentiated. The author used data obtained from developing nations from 1960 to 1980. Landau (1983) was also carrying outanexamination of the interaction between the share of government expenditure and the rate of growth of real per capita GDP. He found out that the expenditure on consumption activities by a government has discouraging effects on the per capita output growth. The writer also discovered that the other forms of national expenditure give a little or an insignificant effect on the growth of output. The rate of increase of defense expenditure and education expenditure has a positive change on the economic growth of a country (Cypher &Sherman, 2002). During their study on the defense, education and welfare expenditures of the government, the researchers found out that the increase in expenditures on welfare has a negative effect that is insignificant in terms of economic growth. Deverajan et al. (1993) argue the expenditure of government in transportation, health care and communication gives a positive change in the rate of growth. In reference to Albala, Bertrand and Mamatzakis (2001), productive government expenditure on the improvement of infrastructure has a positive impact on economic growth. Their study tested the data collected from South Africa and Chile in terms of the effect of investment in infrastructure. M’Amanja and Morrissey (2005) used a similar approach when examining the Kenyan case from 1964 to 2002. Their conclusion was similar to the findings by Albala, Bertrand and Mamatzakis (2001). In line with the impact of expenditures by the Saudi Arabian government and economic growth, the empirical evidence is somehow mixed too. Using Ganger causality and Vector Auto Regression (VAR), Ghali (1997) did not find any proof that government expenditure from 1960 to 1996 improved the output growth. The economic growth cannot be attributed to increased government expenditure under any circumstances even following the disaggregation of the total expenditure into consumption and investment expenditures. Kireyev (1998) argues that there exists a positive interaction between a government’s expenditure and economic growth. His study on the relationship that exists between economic growth and government spending focused on using data to analyze the non-oil GDP growth from 1969 to 1997. Al-Yousif (2000) used two measures of government size that were differently designed to prove that the real effect of government expenditure varies with the manner in which the government size is measured. He states that when the government size is measured as a percentage change in total government expenditure, the government size is thus quantified to be positive with the economic growth. When the government size is measured as a ratio of the expenditure to the gross domestic product, the relationship between the government expenditure and economic growth is significantly negative. Albatel (2000) carried out an assay on the impacts of variations in government expenditure from 1964 to 1995. He concluded that the expenditure of government played a vital role to promote economic growth and development. Al-Obaid (2004) states that there exists a significant and positive long-term relationship between the size of government spending in Gross Domestic product and GDP per capita. Landau (1983) argues that there is evidence of bi-directional casualties. He found out that higher expenditure on defense can reduce the economic growth of a country in the long run. Joharji and Starr (2010) argue that there is an increase in the rate of economic growth because of increased government expenditure. He used time-series methods for data obtained from 1969 to 2005. Espinoza and Senhadji (2011) also emphasized the results by Joharji and Starr (2010). However, they concluded that expenditure on capital activities have the greatest effects on economic growth. Therefore, the actual relationship between economic growth and increased government expenditure has not been analyzed conclusively. This study is completely different from previous work in terms of applying relevant econometrics. Bibliography Albala-Bertrand, J., and Mamatzakis, E. (2001). “Is Public Infrastructure Productive? Evidence from Chile,” Applied Economics Letters, 8, 195-98. Albatel, A. (2000). “The Relationship between Government Expenditure and Economic Growth in Saudi Arabia,” Journal of Administrative Science, 12(2), 173-91. Alexander, W.R.J. (1990). “Growth: Some Combined Cross-sectional and Time Series Evidence from OECD Countries,” Applied Economics, 22, 1197-204. Al-Obaid, H., (2004). “Rapidly Changing Economic Environments and the Wagner’s Law: The Case of Saudi Arabia,” Ph.D. Dissertation (Fort Collins, Colorado: Colorado State University). Al-Yousif, Y. (2000). ”Do Government Expenditures Inhibit or Promote Economic Growth: Some Empirical Evidence from Saudi Arabia,” The Indian Economic Journal, 48: 92- 6. Barro, R. (1990). “Government Spending in a Simple Model of Endogenous Growth,” Journal of Political Economy, 98, 103-25. Cypher J.M. & Sherman H. J. (2002). The Process of Economic Development. London: Routledge. Devarajan, S., Swaroop, V., and Zou, H. (1996). “The Composition of Public Expenditure and Economic Growth,” Journal of Monetary Economics, 37, 313-44. Espinoza, R. &Senhadji, A. (2011). “How Strong Are Fiscal Multipliers in the GCC?, An Empirical Investigation,” IMF Working Paper 11/61 (Washington, DC: International Monetary Fund). Folster, S. &Henrekson, M. (1999). “Growth and the Public Sector: A Critique of Critics,” European Journal of Political Economy, 15(2), 337-58. Ghali, K. (1997). “Government Spending and Economic Growth in Saudi Arabia,” Journal of Economic Development, 22(2), 165-72. Saeed, A. F. (2012). Effect of Government Spending on Economic Growth: A Case Study of Saudi Arabia. Applied Economics Thesis. Paper 1. Joharji, G. A., and Starr, M. (2010). “Fiscal Policy and Growth in Saudi Arabia,” Review of Middle East Economics and Finance: 6(3), Article 2. Josaphat, P. K., and Oliver, M. (2000). “Government Spending and Economic Growth in Tanzania,” 1965-1996: CREDIT Research Paper (Nottingham, United Kingdom: University of Nottingham). Kireyev, A., (1998). “Key Issues Concerning Non-Oil Sector,” Saudi Arabia Recent Economic Development Issue, 48, 29-33 (Washington, DC: International Monetary Fund). Landau, D. (1983). “Government Expenditure and Economic Growth: A Cross-Country Study,” Southern Economic Journal, 49, 783-97. M’Amanja, D., and Morrissey, O. (2005). “Fiscal Policy and Economic Growth in Kenya,” CREDIT Research Paper No. 05/06 (Nottingham, United Kingdom: University of Nottingham). Niloy, B., Emranul, M. H., and Denise, R. O. (2003). “Public Expenditure and Economic Growth: A Disaggregated Analysis for Developing Countries,” JEL, Publication. Romer, P. M. (1990). “Endogenous Technological Change,” Journal of Political Economy, 98, 71-102. Read More