Expenditure quality at state level key to sustainable growth

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In a recent article published in the RBI Bulletin explores the critical relationship between the quality of public expenditure and economic growth. Its empirical assessment at the sub-national level underscores the significance of sustained improvement in expenditure quality, particularly by prioritising productive spending. The authors of the study argue that this shift can not only drive economic growth but also generate employment opportunities and uplift living standards.

The study, titled Quality of public expenditure and economic growth: An empirical assessment at sub-national level, emphasises the transformative role that targeted and well-directed public spending can play in promoting inclusive and sustainable economic growth. By channelling resources into infrastructure development, research and development, healthcare, education, and other social services, governments can unlock a host of benefits. These include high multiplier effects, increased private investment, the removal of critical supply bottlenecks, improved productivity, and ultimately, elevated potential growth rates.

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India’s fiscal landscape operates under a unique paradigm, with states accounting for a significant portion of general government expenditure. As the study highlights, states’ quality of expenditure becomes pivotal in fostering higher growth rates. In fact, research has consistently demonstrated that state capital expenditure multipliers surpass those of the central government. This highlights the need for states to actively enhance their expenditure quality, as it has a direct bearing on their economic growth trajectory.

India’s policy landscape is undergoing a significant transformation, with an increasing emphasis on competitive federalism. The authors argue that public policies fostering competitive federalism will shape the quality of life and business environment in the country. With the goal of achieving sustainable economic development, states must embrace this shift and leverage it to drive their own growth agendas. In this context, analysing quality of expenditure trends and assessing their impact on economic growth assumes paramount importance.

Unravelling expenditure quality

The quality of public spending can be examined through two dimensions: expenditure composition and policy effectiveness. While the latter is challenging to measure directly, the former provides valuable insights. The study identifies several indicators commonly used to assess expenditure quality, including the share of capital outlay in total expenditure, capital outlay as a percentage of GDP, development expenditure as a percentage of GDP, revenue expenditure to capital outlay ratio, and the share of revenue deficit in the gross fiscal deficit.

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To gauge the relationship between expenditure quality and economic growth, the authors construct composite indices of the quality of expenditure for 14 major Indian states, representing approximately 80% of the country’s GDP. Using a pooled OLS framework, the study reveals a positive and statistically significant impact of the quality of public spending on gross state domestic product (GSDP) growth. This finding reinforces the critical role of quality of spending at the state level in fostering higher growth rates.

The analysis contributes to existing literature by providing composite indicators that offer a comprehensive picture of overall expenditure quality. It also reaffirms prior research indicating a positive association between the share of government capital expenditure, developmental expenditure, and economic growth.

Unlocking the growth potential

States in India wield considerable influence over the country’s growth trajectory, given their substantial share of government expenditure. Against this backdrop, the study’s findings gain relevance. In recent years, India has witnessed a shift towards increased capital expenditure at the state level. Consequently, the authors stress the importance of states utilising their fiscal headroom to prioritise productive expenditures, as doing so can yield significant benefits for economic growth.

The article’s findings underscore the critical importance of enhancing the quality of public expenditure to drive economic growth. States must focus on increasing productive spending, particularly in infrastructure, research and development, healthcare, and education. By doing so, states can not only stimulate economic growth but also generate employment opportunities and improve living standards.

As India continues to prioritise sustainable economic development, optimising expenditure quality at the state level will be instrumental in achieving these aspirations. By unlocking the potential of targeted public spending, India can chart a path toward inclusive growth and elevate its position on the global economic stage.