Public Spending And Social Progress

Studies | Federal Spending | Social

No. 232
Thursday, June 01, 2000
by Gerald W. Scully

Optimal Level of Government Spending

Figure I - Government Spending and Social Progress

General government consumption is government spending on wages, salaries, materials and supplies; it is the public spending that directly absorbs resources. Such expenditures are usually 40 percent to 60 percent of total government spending; the remainder consists mainly of transfer payments and interest payments on accumulated public debt. (Among the 112 countries in the sample, per capita government consumption spending ranges from $44.80 to $5,307.50 annually.)

"Beyond a certain point, there is strong evidence of diminishing returns to government expenditure."

The Relationship between Government Spending and the Quality of Life. As expected, we find increases in social progress as government expenditures increase. But social progress increases at a diminishing rate. [See Appendix for discussion.] There is strong evidence of diminishing returns to government expenditure for both the PQL index and the multidimensional index, no matter which weighting scheme is used. For example, the plot in Figure I of the Physical Quality of Life (PQL) index (equal weights) against per capita expenditures for the 112 nations in the sample clearly shows that the relationship between the PQL index and per capita government expenditure is nonlinear - and thus that the index will increase at a slowing rate as expenditures rise. The estimated relationship is drawn in Figure II. It appears that at a per capita spending level of around $3,000 to $4,400, no further gains in social progress occur. The profile of the data for the PQL index and the other indices seems to indicate a "saturation level" beyond which per capita government consumption expenditures have no effect on social progress. [See Appendix for discussion.]

"Once a country spends about $4,130 per person it derives no further gain from an additional dollar of spending."

Level of Expenditures at Which There Is No Marginal Benefit. At what level of per capita government expenditures is the marginal benefit of social progress, as measured by these indices, exhausted? In general, the results are not very sensitive to the weighting scheme used in constructing the indices. We find, using a polynomial model, that the level of per capita government expenditures at which the marginal benefit is equal to zero averages about $4,130.19 Based on this estimate:

  • At most, a country can spend $4,130 per person on government consumption before it derives no gain in social progress from an additional dollar of spending.
  • Countries that spend between $4,130 and the observed maximum of $5,307.50 on government consumption - which includes some of the world's most-developed economies - appear to be wasting up to $1,177.50 per person per year in spending that yields no improvement in social progress.

Of course, many of the countries in the sample are so poor they would have to spend many times their per capita GNP to reach the point at which the marginal benefit is exhausted. For instance, Zambia, with a per capita GDP of about $200, would have to spend 20 times its GDP to achieve parity with the developed nations. (Of course, long before Zambia reached the point of devoting 100 percent of GDP to social progress, it would have raised the tax burden to the point at which economic growth would have ceased!)20 Thus it is more relevant to examine developed countries that are able to spend enough to exhaust the marginal benefit of social progress.

Figure II - Estimated Relationship Between Government Spending and Social Progress

Results for Some High-Income Countries. For each of 22 high-income countries, Table II shows the percentage of GNP per capita that these governments would consume if they were at the average values of MB = 0 and MB = ME obtained above for the 112-country sample.21 The countries are mainly from the Organization for Economic Cooperation and Development and are ordered from high to low 1995 per capita GNP. The table also shows the average for each country of all six indices of social progress (rescaled to be in the interval 0 to 100), government consumption spending and the actual 1995 value of total government outlays as a share of GDP.

The results are consistent with the findings of Tanzi and Schuknecht, and all of these countries have high values for social progress.  Japan has the highest value on the social progress index, with a score of 100, and another 10 nations score above 90.22

  • Among the most developed, the five "small" government countries with public spending of less than 40 percent of GDP - the United States, Switzerland, Japan, Australia and New Zealand - have an average value on the social progress index of 89.
  • This differs little from the average index value of 91.3 for the 10 "big" government nations with public spending above 50 percent of GDP.
  • However, except for Singapore (Hong Kong would also be included if the data were available), the fiscal size of government in all these countries is well above the level that causes the marginal benefit of social progress to be zero.23

"The point at which marginal benefit equals zero is different for every country."

The share of output at which marginal benefit equals zero for government consumption expenditures is different for every country. It ranges from 15.3 percent of GNP for the United States to 32.6 percent for Portugal. Naturally, since GNP per capita declines down the list of countries, "maximal" government spending as a share of GNP rises. Thus, Portugal would have to spend about twice as much in government consumption expenditures to achieve a level of social progress similar to that of the United States. The average value of "maximal" public consumption spending for the top 26 high-income countries of the world is 21.0 percent of GNP.24

Table II - International Comparisons of Public Spending Shares and Social Progress

A Dollar's Worth of Progress for a Dollar Spent. More relevant is the level of government expenditure at which the marginal benefit of social progress is equal to the marginal per capita public spending necessary to bring it about. As Table II shows, optimal government consumption spending ranges from a low of 3.7 percent of GNP in the United States to 8.0 percent of GNP in Portugal. For the 26 high-income countries, the average is 5.1 percent of GNP.

Additional specifications were estimated to ensure that these findings are not the result of the particular function used, and nothing unusual was found. [See Appendix for discussion of additional tests.]

Read Article as PDF