Is it possible to accurately estimate the relationship between government spending on social sectors and selected social indicators? Social programmes such as health care and education are generally thought to have a bearing on human development. Consequently, increased government expenditure in these programmes is expected to result in better social outcomes. However, in traditional econometric models, where social indicators are used as proxies for the unobservable health and education status of the population, the link between expenditure and outcomes is weak. This paper written for the International Monetary Fund (IMF) uses a latent variable or covariance model to better understand the relationship.
Results from this paper tend to show that public spending is an important determinant of social outcomes, particularly in the education sector:
- The problem with the conventional approach to estimating the relationship between the social sectors and government spending is that true outputs in the production function are not observable.
- Applied research has been unable to deal with the econometric problems associated with unobservable multidimensional concepts, such as the education and health status of the population.
- The latent model reveals strong evidence that public spending affects school enrolment positively. However, unfavourable initial social conditions such as literacy and gender inequality tend to worsen social indicators.
- Estimates of government spending and income elasticities based on the covariance model are in general higher in magnitude than those obtained in the traditional approach.
In terms of policy:
- The use of the covariance model shows that the millennium goal of universal primary enrolment could be achieved by increasing the current level of social spending by one third on average.
- On a cautionary note, increases in social spending alone do not ensure better social outcomes. Removing unfavourable antecedents such as high illiteracy rates and sizeable income disparities could accelerate human development.
- Institutional factors such as corruption and fiscal decentralisation have not been considered and could have a direct impact upon the link between public social spending and outcomes.
