Government expenditure and economic growth

CHAPTER II

REVIEW OF LITERATURE – THEORETICAL AND EMPIRICAL PERSPECTIVE

1.1 Introduction

Education is recognized as a critical input for the holistic development of the economy. Further, the elementary education plays a very leading role in acquiring larger positive externalities to the society. The provision of elementary education is one of the central responsibilities of the government. Many economic theories also suggest substantial role for the government in providing of basic education.

All states in India have undertaken the responsibility of providing elementary education to their citizens. Voluminous government expenditure was increased on education across the states, but there is no significant achievement among the states in terms of educational outcomes. This chapter makes an attempt to review the available literature to understand the theoretical linkages of development and problems involved. The review of literature very helpful in understanding the research problems and explore the research gap and identify the ways that lead to solve the problem.

1.2. A: Theoretical Models of Public Expenditure on Education

Review of literature is divided into two parts. The first part represents the theoretical literature on financing of education, public good discussion, externalities involved with education and government intervention in the provision of education in the system. The role of education in economic development and important factors influencing on productivity and externalities involved also discussed here. The second part describes empirical studies on relationship between education and economic growth, inter-state variation in educational performance, efficiency of education system and factors influencing educational expenditure.

Finance is commonly referred as providing funds for commercial activities. Public finance includes both public revenue and public expenditure, which plays an important role in influencing the other variables in an economy. Public expenditure is referred as the expenses incurred by the Government for the maintenance of the government responsibility and to stimulate the welfare of the society. Financing is an economic activity of the government to provide and manage necessary resources for satisfying the needs of the people. Education is not a pure public good, because in certain situations education might violate the principle characteristics of the public good such as non-rival and non-excludability. But education in general or elementary education in particular is considered as social good or collective good, which produces various positive externalities and social advantages to the society.

Several economists have supported public expenditure on education for providing better educational opportunities in the society based on the argument that expenditure on education impacts economic development positively.

During the ancient period most of the countries were following the laissez faire policy, where market forces play dominant role in adjustment of the economy. The role of the state was limited. Even under laissez-faire policy, the Government was expected to perform certain functions.

According to the father of economics, Adam Smith (1937) who provided a broad platform to laissez faire policy, the government has three important functions. They are

• Protection of society from foreign invasion.
• Maintenance of law and order and justice in society.
• The correction and maintains of public works such as educational institutions for the instructions of the people.

Smith greatly emphasized the role of public finance and emphasized the need for providing public services to the poor to live and maintain their human dignity.

J.S. Mill (1848) is another well known classical economist supported Adam Smith’s laissez faire policy in administration of the government. He purposefully divided the functions of the government in laissez faire into ‘Ordinary’ and ‘Optional’ functions. The ordinary functions are defence, maintenance of law and order and other functions essential for the maintenance of the system. On the other hand the Optional functions such as education, health, family welfare and others have positive impact on economic growth the long run. In his argument he also encourage government role in advancement of public expenditure because

1. Individuals are unable to evaluate the utility of certain goods,
2. Lack of foresight may prevent individuals from consuming the valuable goods.
3. Monopoly power or high prices necessitate government intervention in the provision of primary education.

For the first time Adolph Wagner (1835–1917) has commented on increasing state activities and through his experiment he found a positive relationship between public expenditure and economic growth among the selected countries. He postulated that when economy moves towards higher economic development path, public expenditure of the state also increases. The increasing public expenditure contributes to economic growth in various ways. In contrary, Peacock and Wiseman (1967) argued that the natural course of advancement and structural change in the economy, leads to constant and systematic expansion in the public expenditure. According to them public expenditure in the system will not continuously increase. It depends on the shocks and stimulus response in the society.

The Voluntary Exchange Theory was developed by Knut Wicksell (1896), Eric Lindahl ( ), Howard Bowen (1948) and Musgrave (1939). It suggests that the resources in public sector should also allocate in the same manner as in such a manner to their allocation in the market with its price system. Through this theory they argued for tax collection and public spending for improving the welfare of the people.

Dalton postulated the public expenditure theory (1967) and according to him maximum satisfaction can be yield by striking a balance between public revenue and public expenditure by the government. According to him economic welfare is achieved when Marginal Social Sacrifices (MSS) due to imposition of taxes is equal to Marginal Social Benefit (MSB) due to government spending. Prof. Pigou argued that net social benefit (NSB) is maximized in the equilibrium condition of MSS = MSB.

Public Expenditure and Decentralization

Since the SSA adopted decentralized model in government spending on education, theories relating to the public expenditure, decentralization and governance are reviewed.

Fiscal decentralization theorem (Oates, 1972) – states that sub central governments have a comparative advantage in providing public services due to heterogeneity preferences of the people residing in different jurisdiction. He strongly argued for the decentralization in the administration and performing the functions. According to him decentralization will bring good governance at the local level and satisfy more human wants through effective public expenditure.

Public expenditure and Distribution

Dreze and Sen (1989) propounded public support led strategies. According to them the holistic development of the system is possible only where each and every individual has a good standard of living. For better standard of living and for tracing number of activities, they strongly argued for the educational attainment. Apart from its intrinsic importance, education serves certain instrumental roles in ensuring the freedom of a person, which not only guarantees personal gains but also possesses social ramifications including empowering the disadvantaged and reducing inequality. Certain public service such as education, health, sanitation, family welfare, rural development and others are required particularly for the development of marginalized sections. In this regard, the government investment on social sector is essential for receiving the double benefit to the economy.

Samuelson’s Theory of Public good

The first place in defining the concept of public good belongs to Paul A. Samuelson (1955). Samuelson consider as the establisher of theory of public good. He made distinguish between public good and private good. The public good as the good, which brings benefits for members of the society as a whole and the consumption of the Public good doesn’t proclaim the consumption of the other person. In Indian context provision of elementary education is a right of children between the age group of six to fourteen years, therefore elementary education consider as public good. In this regard Samuelson’s argument in the provision of public good (elementary education) is justifiable. Non-rivalry and non-exclusion are two important characteristics of public good; education in general a good only obligatory education can meet the characteristics of public good. The elementary education is fulfilled the characteristics of public good and the consumption of this good does not reduce the consumption of other good. All these reasons emphasized the government role in public expenditure in the system.

Milton Freidman (1995) published his book entitled ‘The role of government’; in that book he postulated the role of government intervention in the provision of education. He positively argued that the government intervention in public good based on strong following reasons;

1. Capital market imperfection
2. Incomplete infrastructure
3. Possibility to create a monopoly
4. Existence of positive externalities

Friedman, M. (1955): ‘The Role of Government’. In: Solo, R.A, Economics and the public interest. New Brunswick: Rutgers University Press, 1955, 123-144.

He propounded and accepted the approach of efficiency in the allocation of public goods. It shows fundamental difference between the allocation of public and private good based on micro economic principle.

Prof. A.C. Pigou established the ability to pay theory for the determination of optimum level of public expenditure. He explained that the resources should be allocated among different uses and expenditure should be incurred in different uses in such a form that the marginal utility obtained from each different use is same.

The government sector would grow with increasing level of National income. According to him if a community were literally a unitary being, with the government as its brain, expenditure should be pushed in all direction as increases of the National income. Further Prof. Pigou observed that simple marginal rule of optimization implied on increasing public sector with increasing wealth, the optimum amount of public goods is likely to raise.

Justification for State Intervention in Education

Some of the justifications for state intervention in education sector are as follows

• Education is recognized as a social good, but through the Right to Education Act (RtE) Elementary education is recognized as a public good, where it is the responsibility of government and parents to provide certain level of education.
• People could ignorant about the advantages/benefits/values of the education, so they have no concern in educating their pupils.
• The imperfect market and asymmetric information in developing and developed economies make poor people to still consider education expenditure as a consumption rather than investment expenditure.
• Market mechanism is mainly determined by the demand for and supply of the product. But in the case of education which is a social good, the marginal cost of additional education unit is zero and its consumption is indivisible in nature. These factor causes market failure in the market for investment in Education. Scholars like (Vaizy 1962; Blaug 1965; Levin 1987; Tomilnson1986; Musgrave 1959; Tilak 1999 and others) have strongly supported the state intervention in provision of elementary education.

Contribution of Education to Economic Growth: Theoretical perspective

The role of education in development has been recognized since the days of Plato. He argued that the education has high economic value; therefore a huge part of community’s wealth must be invested on education. Education helps the society by enabling them to participate actively in the development process.

But, a major contribution to the discussion on relationship between education and economic growth was first made by Adam Smith (1776), followed by the subsequent contributions by the classical and neo-classical economists until Alfred Marshall. Marshall (1890) emphasized that, “The most valuable of all capital is that invested in human beings’. Further he also states that,” Knowledge is our most powerful engine of production. It enables us to moderate nature and force her to satisfy our wants”. Education is one of the most important components in capacity building. It provides a base for making a person capable of acquiring skills and becoming self-sustainable. Kuznets’s study of American economy (Kuznets, 1955) shows the significant contribution of ‘residual factor’ to economic growth. A study on agriculture of 31 countries shows that four years of elementary education makes a farmer more productive than the farmer who has no education at all. In another study of 88 countries for the period 1960-63 and 1970-73, it was found that an increase in literacy rates from 20 to 30 per cent contributed to increase in real GDP between eight to sixteen per cent. Personal earning and education have also been found correlated (UNDP, 1992). The significance of an adequately educated and technically trained manpower has been specifically recognized in economic literature since the middle of fifties when research studies in the economics of education and growth, pioneered by endogenous growth models propounded by Solow (1957), Schultz (1961) and Denison (1962). They highlighted the role of the ‘residual factor’, which mainly implied technology, learning, education and health. in contributing to economic growth (OECD, 1963). For many years, the proposition that educational expansion promotes and in some cases even determines the rate of growth of overall Gross National Product (GNP) remained unquestioned. Amazing statistics and numerous studies in the World has revealed that the growth of the nation was not due to the growth of physical capital but that of human capital that was the principal source of economic progress (Denison, 1962).

In the classical school of economic doctrine, later economists considered education as an effective tool measure for population control (Malthus, 1966), achieving social justice (Ricardo, 1971) and civilized development of the society (Senior, 1939). Thus in eighteenth and beginning of the nineteenth century, education considered as a means for bringing about improvement in purchasing power of labour force, economic welfare and social peace (Mill, 1909). In the Neo-Classical school of economic thought, education was considered as a strong source of human capital formation and an effective source to increase the income stream (Fisher, 1929).

Tilak (1989) argued that Education not only ensures economic growth with equity but also has positive externalities associated with it, which make the public financing of education imperative.

There are some arguments for the complementarity in public and private expenditure on the grounds of equity.

The benefits that accrue to the individual in terms of higher earnings are a reason why the individual should pick up a part of the cost. If we look at the state as a supplier of education and the individual as a buyer of it, then investments by both appear to be complementary; and this may be the best model on grounds of equity. Hence, the right balance between public and private expenditures is crucial to the success of any educational policy or programme (Psacharapoulos and Woodhall 1985; Majumdar 1983).

Conclusion

The above discussion reveals the importance of expenditure on education for the growth of the economy and also noted the growing perception that the greater relevance to the developing countries. But in the current atmosphere of growing scrutiny of the nature of state expenditures, whether education is to be treated as a public or a private good, and whether expenditure on education is to be treated as consumption or investment need to be understood correctly. If it is seen as consumption good, that is, private in nature, then the market mechanism may be regarded as the most effective means of ensuring its adequate supply. On the other hand the state expenditure on education must be reduced to increase investment in other areas of greater importance.

However, education not only offers private monetary as well as non-monetary benefits to its consumers but also has externalities associated with it, which confer benefits to society at large, even to those who have not had any education. Therefore the government should take major responsibility in providing education opportunities of its citizens.

Smith, Adam (1937): ‘ An enquiry in to the Nature and Causes of Wealth of Nations’, (Edwin Cannan eds.), The Modem Library, New York, 1937, P. 423

Wagner, Adolph (1958): ‘Three Extracts on Public Finance’ in R. A Musgrave and Allen Peacock eds., Classics in the Theory ofpublic Finance, Mcmillan, New York, 1958, PP. 1-16.

Peacock, T. Alan and Jack Wiseman (1967): ‘The Growth of Public Expenditure in the Untied Kingdom’, Allen and Urwin, London, (llnd Edition) 1967.

Bowen, R. Howard (1948): ‘Toward Social Economy, New York, Rinehart (1948)

Musgrave, R.A (1938): ‘The Voluntary Exchange Theory of Public Economy’. The Quarterly Journal of EconomicsFebruary (1938)53(2):213-237.

Dalton, Hugh (1967): ‘ Principles of Public Finance’, Augustus M. Kelley Publishers, New York, 1967, PP. 5-7

Samuelson, A. Paul (1954): ‘The Pure Theory of Public Expenditure’. Review of Economics and Statistics, November 1954, pp. 387-389.