7/30/2019 How Much Does GDP Increase

1/1

ResearchDigesWorld Bank

In developing countries an

additional dollar of public spending

can be expected to increase GDP

by about 40 cents on average in thesame year

How much does GDP increase

when government spending

increases? This is a perennial

question confronting macroeconomic

policy makersand one that has re-

ceived more attention as governments

have sought appropriate responses to

the recent great recession.

Providing empirical evidence on

this question is dicult, however, be-cause it requires isolating a source o

variation in government spending that

is unrelated to contemporaneous mac-

roeconomic shocks. Ater all, simply

observing that government spending

increases during economic downturns

may lead analysts to mistakenly under-

estimate any positive eect o govern-

ment spending on output. Conversely,

i government spending collapses

during recessions, the observed corre-

lation between government spending

and output would overstate any causaleect o government spending on out-

put. To make progress, it is necessary

to nd a reason or changes in govern-

ment spending in a given year that is

unrelated to macroeconomic shocks

occurring in the same period.

A new paper by Kraay uses a novel

loan-level data set covering lending by

ocial creditors to developing country

governments to provide new empiri-

cal evidence on the short-run eects

o government spending on output.

Loans rom ocial creditors (primar-

ily multilateral development banks

and bilateral aid agencies) are a major

source o nancing or government

spending in developing countries.

These loans typically nance public

spending projects that take several

years to implement, with multiple

disbursements linked to the stages o

project implementation.

The long disbursement periods or

these loans imply that the bulk o gov-

ernment spending nanced by ocial

How Much Does GDP IncreaseWhen Public Spending Increases?

creditors in a given year refects loan

approval decisions made in many pre-

vious years, beore current-year mac-

roeconomic shocks are known. This

provides a source o variation in gov-

ernment spending that is unrelated to

current-year economic shocks and can

thereore be used to statistically iden-

tiy the eects o government spending

on output.

The data set reports loan-level

commitment and disbursement trans-

actions rom the World Banks Debtor

Reporting System, covering nearly

60,000 loans over the past 40 years.

Because it provides inormation on

the timing o loan approvals and sub-sequent disbursements, the data set

makes it possible to isolate a prede-

termined component o government

spending associated with past loan

approvals. This can be used as an in-

strument to econometrically estimate

spending multipliers or a sample o

102 developing countries, where previ-

ous evidence on the eects o govern-

ment spending on output is scarce.

The paper estimates, reasonably

precisely, that the one-year govern-

ment spending multiplier is around0.4. This implies that an additional

dollar o government spending can be

expected to increase GDP by about

40 cents on average in the same year.

Since government spending itsel is a

component o GDP, a multiplier less

than 1 implies that increases in gov-

ernment spending lead to signicant

reductions in the other expenditure

components o GDP, such as private

consumption and investment.

These basic results are subjected

to a battery o robustness checks de-

signed to address potential concerns

with data quality as well as possible

objections to the identiying assump-

tion. While the estimates o the one-

year multiplier vary somewhat across

these checks, they typically remain

in a range rom around 0.3 to 0.5. In

addition, the large country coverage

o the data set makes it easible to in-

vestigate the empirical relevance o a

number o potential sources o hetero-

geneity in multipliers. There is some

suggestive evidence that multipliers

are larger in recessions, in countries

that are relatively less exposed to in-

ternational trade, and in countries wit

fexible exchange rate regimes.

The small multipliers estimated in

the paper suggest a rather limited ou

put eect o countercyclical response

o government spending in response

to economic downturns in developing

countries. This nding should be inte

preted in light o several qualication

however.

First, the empirical evidence can

support estimates only o the average

short-run eects o government spen

ing over the large set o countries andyears included in the data set; the

actual eects in particular situations

might very well be dierent. Second,

the empirical estimates o aggregate

spending multipliers should not be

thought o as deep structural param

eters, knowledge o which would be

crucial or understanding likely uture

eects o any given scal policy re-

sponse to an economic downturn.

Finally, the absence o evidence

in support o a large spending multi-

plier does not imply that there is norole or a scal response to economic

downturns. For example, in many de-

veloping countries there is a strong

rationale or expanding social protec-

tions to the most vulnerable during

economic crises, independent o any

macroeconomic stimulative eects o

such policies.

Aart Kraay. 2012. Government Spending Mul

tipliers in Developing Countries: Evidence rom

Lending by Ofcial Creditors. Policy Research

Working Paper 6099, World Bank, Washington

DC.

Volume 6 l Number 4 l Summer 2012