CHAPTER 1

 

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Government expenditure and economic growth is one critical topic that needs to be taken into a serious consideration since the two have a great connection with each other(Stieglitz 1989). The problem mentioned above has attracted a great contention among economists as they try to identify how the expenditure impacts the economic growth(Jerono 2009). To some extent, government expenditure has been seen boosting economic growth, and to the negative side, it has been identified to impede the economic development of the nation.  Having that the government compete with the private investors, it tends to borrow finances to finance the public expenditure a fact that eventually leaves the country with a lot of foreign debts(world bank, 1991).

Moreover, Studies based on mercantilist ideology argue that government involvement in economic development is tied to market failure, externalities, and the public good. Research done by Amanda outlines that government expenditure is one of the critical factors that impact the economic development of Kenya. The study indicates that Kenya as a country had mixed economic growth since it attained its independence. The above facts make it necessary for this research to try to investigate the possible cause of the mixed economic growth of Kenya.

Overview of Public Expenditure and Economic Growth of Kenya (1989-2018)

It is evident that the country’s public expenditure has been on a steady increase over the years. To the contrary, the economic growth has not been proportional to the growth revenue. The above has come of the critical factor that leads to the budget deficit for the government a fact that forces the government to end up borrowing to implement its proposed budget. Due to the extreme hiring, the government has found itself in high public debt.

In the 1990s, the international lending institutions introduced a structural adjustment programme (SAPS), aiming at improving the austerity in the government expenditure, improve efficiency, restructure the state and reduce the fiscal burden on the country. The body also had a role of ensuring that the price controls are removed, and initiation of reforms in the civil service was implemented.

Between 1991 and 1994, the country was hit by high inflation levels. The above was because the economy had more money than expected. The increased supply of money into the economy during this time was due to the introduction of the multi-party elections which were held in 1992. The event above resulted in the devaluation of the Kenyan shilling and reduction of the price controls in the country. During this same period, the government came up with a reform aiming at reducing the number of employees in the public sector a fact was meant to reduce the fiscal burden on the government.

The period between 2002 to 2003, the government had its expenditure increase by 14.6%.  The growth is tied to the formation of the NARC government which came up with new policies with a development agenda which aimed at improving and expanding the government ministries and departments. The expenditure grew due to the increase infrastructural budget. Additionally, the introduction of free primary education also leads to increased government expenditure.

Between 2007 and 2008, the economic growth was entirely distorted, and this is the time, the country experience post-election crisis. All economic boosters came to a standstill. The formation of the Grand coalition government in 2008 lead to increase of the government ministries the fact that results in an increase in the government spending between 2008 and 2012. Another event that occurred in economic deterioration is the high cost of fuel which weakened the value of the Kenyan shilling and eventually leads to inflation of approximately 19% in 2011.  The above also resulted in the increase in government spending in 2012. By 2012, the government spending had exceeded one trillion Kenya shillings. The registered high public expenditure can be tied to an increased level of public debt, increased number of federal workers, corruption in almost every sector of the economy and the increased infrastructural development and expenditure. In 2013, the increased government spending was tied to the introduction of a new form of government, i.e. the devolved system of government and the allocation of the resources to the original projected promised by the new government.

Between 2014 and 2015, the government spending exceeded two trillion Kenya shillings. The above as an attributed to the increased budget allocation to the country governments and increased expenditure on the infrastructural development such as the standard Gauge Railway.  Despite the high public spending, the GDP growth has never been steady. The growth has been cyclic to be specific. The above makes it necessary for one to investigate the relationship between government expenditure and economic growth.

Between 2016-2018 the government spending increased by almost 200 million shillings. From what is experience and if all things go on as it is now, the government spending is rising to the high level of corruption identified in the country. The above makes the economic growth to be non-proportional with government spending.

Public expenditure policy in Kenya.

Public expenditures have remarkably changed over a period since independence through the use of sessional papers, constitution, medium-term plans and vision 2030 Kenyan government has full guidance on how to allocate its resources. It has also been noted that the country has been able to maintain a high level of investment financed by domestic savings which have increased from3.2% of GNP in 1965 to70s to 6% in the early 80s. Consequently, the country over dense on foreign financing can lead to a negative impact in case of a withdraw by external donors thus leading to a larger saving-investment gap resulting in the increase in the budget deficit from 4.9%of GDP in the early 1970s to 9.4% 1983.A sessional paper(Economic management for renewed Economic Growth published in 1986 by the government argued that for Kenyans to enjoy improved living standards, the number one priority of economic growth should be to enhance economic growth. Implying that policies to be implemented should aim at encouraging savings and foreign exchange.

 

1.2 Statement of the problem

Research indicates that Kenya has been registering high government expenditure since 1989. But according to concern designated by the policymakers is what are the implications of such spending to the economic growth. Despite high government expenditure, economic growth has never been steady. Research indicates mixed trends in the economic growth of the country. The fluctuation has been recorded between 1989 and 2018.   According to the finance record of 2015, it was identified that the GDP growth for Kenya was 5.7%, a 0.4% decrease from the value registered in 2013. Though Kenya’s real GDP has been fluctuating over time, there is the same hood it to decrease through 2018.

When looking at the impact of public expenditure on economic growth, the results produced are conflicting in nature. Research conducted by Pot and Nijkamp in 2012 identified 41 studies, and 29% of them indicated a negative relationship between the government expenditure and economic growth, 17% of them reported a positive relationship and 54% showed an inconclusive association. According to the model established by Barro in 2014, it was clear that since the government devotes most of its resources to the non-productive activities the same hood of the economic growth is limited. This study is going to look at how education, health, security, and infrastructure impact economic growth of Kenya.

The link between government expenditure components and economic growth is a vital aspect in the analysis since they are interrelated. The study aims at finding the impact of government expenditure components on economic growth in Kenya. The specific objective is to investigate the relationship between expenditure on health, spending on the military, spending on education, spending on fiscal balance, spending on social and physical infrastructure and economic growth in Kenya.

1.3 Research Questions.

The study sorts to answer the following questions.

1. What impact does government expenditure components have on the economic growth of Kenya?
2. What is the relationship between health expenditure and economic growth in Kenya?
3. What link is there in between expenditure on infrastructure and economic growth in Kenya?
4. What impact do expenditures on education have in the economy of Kenya?
5. What is the impact of expenditures on the deficit on economic growth in Kenya?

1.4 Objectives of The Study

The following are the main aims of carrying out the research:

• To determine the impact of public expenditure components on economic growth in Kenya
• To show the relationship between expenditure on health and economic growth in Kenya.
• To show the impact of expenditure on education on economic growth in Kenya.
• To find out the impact of government expenditure on infrastructure on economic growth in Kenya.
• To depict the linkages between expenditures on fiscal balance and economic growth in Kenya.

1.5 The significance of the study

The study purposefully aims at determining the analytical framework for assessing impacts of government expenditure components on economic growth. The above is to help policymakers an empirical way of calculating the allocation of public funds on key driving sectors to boost economic growth.

1.7 Scope

The study will use time series data for the period1989 to 2018. It will internalize only the allocation of funds to the individual components in the economy. The results obtained from this study will aim at helping policymakers the empirical way of determining the economic component allotment of funds to avoid the consequences brought forth due to inappropriate expenditure decisions. The variables include economic growth which is the dependent variable and the independent variables which are the components of government expenditure under study.

 

CHAPTER 2

LITERATURE REVIEW

2.1 Introduction

This chapter features a review of theoretical literature and verifiable literature of public expenditure and economic growth. The chapter has three parts these are; theoretical literature that is associated with the study, empirical research that is related to the study and the third part looks at the merging of the two parts in relation with the study at hand.

 

2.2 Theoretical Literature

 

There are several theories that help in explaining government expenditure. Some of these theories include;

2.2.1 Musgrave Rostow’s Theory.

This theory states that public expenditure should be encouraged in an economy that is in the early stages of economic growth. In addition, the theory states that in the early stages of economic growth, there are frequent market failures, and hence the government should always be on alert to tackle such failures. However, this theory has limitations because it does not include the private sector and the role that this sector plays in economic growth.

2.2.2 Wagner Theory of Organic State

This theory states that economic growth leads to an increase in public expenditure. The law also tries to show the relationship between government expenditure and income, and economic growth. The merit of this theory is it attempts to explain public spending and economic growth. Nevertheless, the theory has limitations because it assumes that a state is a separate entity from its citizens who play a major role in decision making of a country.

2.2.3 Keynesian Theory

The theory states that for the government to boost Gross Domestic Product (GDP) in recession periods, then it needs to expand its budget. The theory assumes that increase in government budget will lead to more people being employed, which in the end will lead to increase in domestic trade, as the employed people will now buy more goods from the local businesses. The government activities influence the direction of economic growth as shown by the Cobb-Douglas model (Barro & Sula-i-martin, 1992). The major limitation of this hypothesis is that it does not address the effect of inflation, which usually leads to an increase in government expenditure.

2.2.4 The Peacock and Wiseman Theory

This theory was invented by Peacock and Wiseman while they were studying the UK government expenditure from 1890 to 1955. The theory states that during hard financial times and emergencies such as war and calamities, the government usually increase expenditure, which means that there will also be an increase in taxation and yet the public usually allow the government to add the tax on such times. This phenomenon is called displacement effects, and it is generally meant to be a short time experience, but still has long-term effects (Wiseman & Peacock, 1971). This theory can explain why the Kenyan government expenditure usually rise when there are some shock and emergency experiences. For instance, there is an increased expenditure on military hardware and training to enhance the fight against terrorism in Kenya and our neighboring countries like Somalia. However, the major shortcoming of this theory is that it fails to show that the government can get financial support from other sources apart from increased taxation. The other sources can include; foreign donors, borrowing from firms and companies within and outside the country, the government can also sell its assets to get the money it requires to handle the emergencies.

 

2.3 Empirical Literature

In 1989, Ashauer conducted a study on the relationship between the United States government spending, and how it influences economic growth. The study found out that the government spending on major infrastructures has a significant impact on economic growth. On the other hand, spending on the infrastructure of services such as police and fire station had a smaller impact on the economic growth while spending on infrastructures related to education such as classrooms had minimal impact on economic growth.

Another study showed that developed countries had a positive impact on public expenditure while public expenditure had a negative impact on developing countries (Devarajan et al., 1993). By looking at the number of resources used and the resulting outputs on a given project, this study categorized expenditure into productive and non-productive investments.

A study by Albala and Mamatzakis(2001) by using information between 1960 and 1995 for public infrastructure in Chile, using Cobb-Douglas production function, found a vital relationship between infrastructure and economic growth. However, the limitation of this study is it omitted other sectors such as education health and security, which also have significant influences on economic growth.

Were (2001) while studying how external debts affect economic growth found out that investment in the development of human capital increase economic growth in Kenya. The undoing of this study is that the data it used was from a very short period.

Looking at the OECD countries between 1970 and 1999, Dar and Khlkali (2002) took a study on the impact the size of the government has on economic growth. The study showed that the size of the government had a negative impact on economic growth in most of OECD countries with the USA, Sweden and Norway as the only exceptions.

Jerono(2009) carried out a study on the relationship between government spending and economic growth in Kenya. The study found out that investment in education had a small significance on economic growth. The study also revealed that there was a surplus of those who had acquired college education to the jobs that were available in the country. The study revealed that the number of graduates was much higher compared to the jobs that were available for these graduates

Maingi (2010) conducted a study on the effects that government expenditure has on economic growth in Kenya. This study showed that there was an improvement in economic growth when the government invest in areas such as physical infrastructure and education. The study also shows that government spending on such activities as public order and security and salaries and allowances had a negative impact on economic growth.

 

2.4 Overview of literature

There has always been a debate on whether public expenditure enhances economic growth, some people believe that the government activities are very vital for economic growth while others think that the government play only a small role in influencing economic growth. Some studies still show that it is inconclusive to say that public expenditure is a primary determinant for economic growth (Najkamp &Pot, 2002). Most of the empirical literature based their studies and results on the developed countries. Still, the studies have failed to come up with a conclusive argument about the relationship between public expenditure and economic growth (Jerono, 2002). Hence, the methodologies used in the works of literature are not applicable in Kenya due to the political and economic difference between Kenya and the countries that the studies were based on. The reviews of the impact of public expenditure to economic growth are very few in Kenya, and those that have been done still have divergence views on the impact of public expenditure to economic growth (were, 2001). However, major studies still show that public expenditure is more likely to trigger economic growth either for a short time and a long time, for both developed and developing countries.

 

 

CHAPTER 3

 

METHODOLOGY

3.1 introduction

The first part of this chapter starts by stating the methodology and model used to study the impact that public expenditure has on economic growth in Kenya. The second part of this chapter explains the variables, the data, and the diagnostic tests used in the research.

 

3.2 Research Design

The objective of this research is to determine the effects of government expenditure components to economic growth in Kenya. The data on how the government had invested in infrastructure, education, health, and security from 1989-2018 will be used in the study.

3.3 Theoretical Framework

The theory that was used for this study is the Keynesian theory, which states that public expenditure determines economic growth. During difficult financial times, the government should increase its budget to increase aggregate demand on the economy and thus boosting the Gross Domestic Product (GDP). This leads to a rise in employment which in turn leas to increase in the internal or domestic trade

gpk = f (GEPGDPt)    (3.1)

3.4 Model Specification

The model that is based on the Keynesian theory is a function of public expenditure. gpk=ƒ(GEPGDPt)    (3.2).

Total public expenditure is a function of all the components of government expenditure (Jerono, 2009).

GEPGDPt =ƒ (government expenditure in all components)                         (3.3)

The use of these two models can help in estimating the effects of government expenditure on economic growth in Kenya

Government expenditure (GEPGDPt) is defined by five components of expenditure

GEPGDPt=ƒ(gdfn, ghlth, gedu, gtrnc, gpos), Ut                                             (3.4)

But, gpk =ƒ(GEPGDPt)

hence, gpk = ƒ[(gdfn, ghlth, gedu, gtrnc, gpos),Ut]                                       (3.5)

where;

gpk    = economic growth

gedu  = government expenditure in eduction

gpos  = expenditure on public order and security

gtlh   = expenditure on health sector

gtrc   = expenditure on infrastructure

Ut     =causes of economic growth not explained by the variables in the model

3.5 working hypothesis

• Economic growth in Kenya is affected negatively by expenditure on education.
• Expenditure on infrastructure contributes positively to economic growth.

III). Expenditure on security and public order resulted in positive growth in Kenya’s economy

IV). When the government invests on health sector the results to economic growth are

positive

3.6. definition of variables and measurements of variables

Economic Growth (GDP)

            This is the rate of increase in Gross Domestic Product expressed as a percentage. It is a calculation of the rate of change of values of goods and services in a given period.

 

 

Public expenditure on education(gedu)

This is part of government resources allocated to the education sector. It includes, money spend to build learning facilities, the resources spend on paying teachers and lectures of public learning institutions.

Public expenditure on health (ghlth)

This is part of government expenditure spent on the health sector. The resources involve spending resources in the construction of health facilities, buy of medical equipment and medicines, and training of doctors.

Public expenditure on infrastructure (gtrc)

This is the fraction of government expenditure used in main infrastructures such as public roads, seaports, railway construction such as the SGR, and laying of optic fibre cables for internet connections.

Government expenditure on public order and security (gpos)

This is the percentage of government expenditure used in the justice and administration sectors of the government.

3.7 Sources and Type of Data

The type of data used was secondary data from 1989 to 2018. The sources of data included;

Economic documents from government official documents, economic reports, and public expenditure reports.

3.8 Data collection and refinement procedure

The data collected was cross-checked to ensure that there was consistency in the sources for all the series. If the data obtained from the sources was not satisfactory data from other sources related to the study was also used. The data obtained was also converted where necessary so that they can be useful in the research.

3.9 diagnostic tests

the following test were done on the data collected in the study.

3.9.1 testing for co-integration

This test was done using Johansen Co-integration method. This method is used to examine the relationship between variables in a non-stationary series. In the test, a variable Xtis integrated d times till the variable becomes a constant number.

3.9.2 Granger Causality Test

This test shows how the current or future values of economic growth(Y) can be determined using a past value (X). This study indicates that the manner in which the government spend its resources can be used to determine future economic development. This model is also used to predict whether past economic growth influences the future government expenditures

3.9.3 vector error correction modelling

This technique adds error correction features in an equation that is made up of several variables

3.10 Data Analysis

The objectives of this study are to research the relationship between total government expenditure and economic growth. The government expenditure is further divided into five components which are health, education, infrastructure and public order and security. This will be achieved by the use of vector error modelling technique

 
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