Causality Between Public Expenditure

and Economic Growth in Rajasthan

Synopsis of the thesis to be submitted to

Central University of Rajasthan
In partial fulfillment of the requirements
For the award of the Degree of

DOCTOR OF PHILOSOPHY
By

Kirandeep Kaur

Supervisor
Dr. Hemlata Manglani

Department of Economics
School of Social Sciences,
Central University of Rajasthan
Bandarsindri, Kishangarh, Rajasthan, India-305817
Website: www.curaj.ac.in
August 2016
 Causality Between Public Expenditure and Economic
Growth in Rajasthan
Public expenditure is an important instrument of fiscal policy. The goal of the public
spending is the allocation of scarce means and maximization of welfare. With the passage
of time, there has been an increasing trend in public expenditure in developing and
developed countries. After World War II, the ratio of public expenditure to GDP has
significantly increased in India as in the case of other countries in the world. There exist
divergent views points and standpoints on the role of government and its engagement in
economic activities. The classical economist proposed little or no government
intervention in economic activities of a nation or the role of the state was suggested to be
confined to maintenance of law and order. According to classical school of
thought, (Smith 1776, Ricardo, 1821) increase in government expenditure would
negatively influence the role of private capital. Disagreement with the classical school on
state’s initiatives in the economic sphere is that increase in taxation is a disincentive to
private capital and deficit financing through tax or other means would reduce the
competition among capitalists in the economy. More or less the same was
proposition was put forwarded by the predecessors of classical economists, viz.,
Physiocrats in France or Mercantilist School in England.

In the light of the changing economic environment in India and Rajasthan, particularly
after the introduction of economic reforms in India in 1991, the study broadly analyze the
trend and pattern of government expenditure and the implications of its changing
composition and structure over the years on the state economy of Rajasthan. There has
been considerable debate on the issue of the relationship between government
expenditure and economic growth. Although many studies have undertaken in the recent
past on different aspect of public expenditure, both nationally and internationally, yet not
much is available on the state level particularly for Rajasthan state. The present study
tries to fill this gap. In addition to analyzing the causality, the study had made attempts to
identify the direction of causality between public expenditure and economic growth in
Rajasthan, causality between tax revenue and public expenditure and various factors
influencing public expenditure in the state.

Chapters 1 and 2 – Introduction and Review of Literature

The question of public expenditure has assumed immense importance in the recent past in
India particularly after the introduction of economic reforms in 1991. It has been
declared as the avowed policy of every government to curtain deficit financing as it
spirals inflation and deflates real earning of the capital of domestic as well as foreign. As
deficit financing eventually leads to inflation and erosion of real income, the national
government is caught between the situation of reducing inflation on the one side and
financing expenditure on the other, through borrowing. The increase in public
expenditure is also possible through hikes in direct as well as indirect taxes, which would
dissuade private capital from the investment.

In the 19th century Adolf Wagner (1835-1917), a German political economist,

propounded, “increasing state activities”. It is known as Wagner’s law or Wagner
hypothesis of public expenditure. According to the Wagner Hypothesis, there is a positive
relationship between economic growth and public expenditure or in other words, the
causality runs from economic growth to government spending. On the contrary,
Keynesian School of thought (1936) emphasized the role of government in the economy,
especially in the period of economic depression, to supplement effective demand in the
crisis or resolve the crisis emerging out of under-consumption or over production. The
government has a political, social and economic responsibility of balancing the
economy. Although Keynesian view on public expenditure has gained wider currency
over the standpoints of classical political economists with respect to the role of the state
in the economic activities, Keynes has left unanswered the question of why there is the
periodical slowdown in the economy or why does business cycle occur?

The neo-classical economists advanced more or less the same proposition as

classical economists on the role of government in the economic sphere. One of the major
proponents of the neo-classical school of thoughts, Robert Solow argued that economic
growth and public spending were not significantly related to each other in the long run.
According to him, technological change and rate of growth in population determined the
performance of the economy. Romar (1986), Lucas (1988), Barro (1990)
and Rebelo (1991) supported the growth model proposed by Solow. Barro (1990) upheld
the view that the government expenditure should focus on productive sector, which
would stimulate economic growth through expenditure on the productive sector. In short,
growth in expenditure in the non-productive sector or on welfare measure would leave
adverse consequences on its growth performance of any economy. To an extent, the
viewpoint is rooted in Malthusian population theory which states that increase in wages
or income with the laboring poor make them lazy and cause higher rate of growth in
population. However, endogenous growth theory of Solow and other neoclassical
economists supported government spending on education, infrastructure, research, and
development, which would generate positive externalities and add onto growth
stimulants. In the parlance of government in the present era, such standpoints tantamount
to the view that capital expenditure is preferred to current expenditure by the state. To an
extent, it is a positive deviation from the avowed position of classical economists on the
role of the state in the economy. In modern times, the vital idea about the principles of
public expenditure is that the government should spend more to accelerate the economic
development of the country. In developing countries, governments do increasingly resort
to stimulate economic growth and it has resulted in an enormous increase in public
expenditure. The theory of state functions has also undergone a total change from the
police state to that of the welfare state, which has led to an expansion in state activity.
Thus, the modern theory of public expenditure under democratic paradigm makes it clear
that no economy can function effectively without accepting the importance of the role of
public expenditure and spending on the welfare of its people, particularly for the socially
and economically vulnerable sections.

The level of public expenditure influences tax buoyancy as well as government

revenue. If the government has resources in dispossession to spend, the level of
government expenditure will be augmented and vice versa. According to Franklin
Roosevelt, the government would spend a little more than the revenue of the government
like any family but the continuous tendency of spending more than the revenue may not
be appropriate for the economy (Amoah and Loloh, 2008). In the literature, there are
four hypotheses on the causal relation between government expenditure and revenue.
According to the first hypothesis, public revenue causes public expenditure (Friedman,
1982). Buchanan and Wagner (1978) forwarded an alternative explanation for the tax and
spend hypothesis and stated that the taxpayer is under a fiscal illusion and the cut in the
tax rates would bring down the price of goods and services, which would, in turn, drive
up the effective demand in the economy. The second hypothesis is related to the
association between tax and expenditure. It is known as the spend-tax hypothesis
(Peacock and Wiseman, 1961, 1979). Government spending leads to tax revenue of the
government. Barro (1974, 1979, 1986) stated in his tax smoothing hypothesis that the
government spending is an exogenous variable, and it increases the tax revenue of the
government.The fiscal synchronization hypothesis (Meltzer and Richard, 1981;
Musgrave, 1966) states that tax revenue and government expenditure is dependent on
each other and there is bidirectional causality between both. The fiscal neutrality
hypothesis, on the contrary, proposes that government revenue and expenditure decision
are independent to each other (institutional separation hypothesis) and it’s the long run
economic growth, which determines the level of public expenditure and rate of taxes in
the economy (Baghestani and McNown, 1994).

In the above context, different economic experts give different reasons for
enhancement of public expenditure in an economy. According to Hicks (1995), “Rapid
expansion of public sector is now universal phenomenon”. Adolf Wagner (1958) has
established a functional relationship between industrialization and relative importance of
public sector activities. Expansion of public expenditure is in proportion to the growth of
the gross national product. This is due to the fact that, the government has to perform a
number of functions more efficiently which has led to an intensive growth in public
activities thereby increasing public expenditure.

Although Williamson does not directly state about the importance of government
intervention in the modern world, his assertion provides the pointer to the fact that rapid
industrialization and urbanization warrant augmented role of the government manifested
in terms of its spending. Wagner’s has forwarded three main reasons for the increase in
the government’s spending. First, industrialization and modernization lead to the
replacement of private sector with the public sector. Second, an increase in real income
would lead to an expansion of income elastic “cultural and welfare” expenditures.
Wagner cited education and culture are two areas where the government could be a better
provider than the private sector. Thus, the public sector would grow in tune with the basic
needs of the people and the expenditure pattern of people widens with the expansion
of education and other culture needs of the society. Third, natural monopolies such as
railroads are needed to taken over by the government because private companies would
not deliver efficiently the desired outcome. It is on account of the fact that the private
capital would not be in a position to raise required finance for the development of natural
monopolies. The importance of public expenditure and reasons for increasing public
expenditure stated above reveal that over a period of time, public expenditure in an
economy is bound to increase.

Rajasthan is one of the largest states occupying 10.41 percent of the total
geographical area and 5.61 percent of the population in India. Rajasthan is predominantly
an agricultural economy with 62% of the population engaged in agriculture and allied
activities. Rajasthan is a water deficient state with only 1.07 percent of total water
resource in the country. The Industrial sector contributed 28.54 percent while the
contribution of agriculture was 20.27 percent in the NSDP of the state economy of
Rajasthan in 2013-14. The share of service sector in NSDP was 51.19 percent in 2013-14.
In the fiscal management, the government of Rajasthan is not significantly different from
many other states in India. Notwithstanding a mismatch between government revenue
and expenditure, for the last three years, the state has managed to bring down its fiscal
deficit well below the target of 3.0 of NSDP as stipulated in the Fiscal Responsibility and
Budgetary Management Act (FRBM Act) of 2005. The fiscal deficit of the state economy
has been brought down to 1.3 percent of the NSDP in 2012-13. However, it has to
be admitted that reduction in fiscal deficit well below the target of FRBM Act
considerably curtail space for fiscal maneuverability of the state especially in a time of
crisis, which occurs rather intermittently particularly after the introduction of market
integration in 1991. To a great extent, adherence to the stipulations of FRBM Act
undermines the role of the government in the sphere of economic activity and it traces its
philosophical routings identifies with the statement of Franklin Roosevelt which in turn
has its ideological bonding with classical as well as the neo-classical paradigm or free
market economy.

There are certain characteristics features of the fiscal management of the

government of Rajasthan for the last half a decade. Important among the characteristics
are; (i) relative share of wages and salaries in the total revenue receipt of the state has
declined from 35 percent to 26.3 percent between 2008-09 and 2012-13; (ii) as
percentage of revenue expenditure, share of wages and salaries accounted for 47.3
percent (with annual variations) in 2008-09 and the share has declined to 36. 5 percent in
2012-13. It is primarily on account of the fact that wages and salaries increased at a much
slower pace as compared to revenue receipt of the state. It is partially attributable to the
downsizing of the government. (iii) interest payment on past loans has also declined
continuously from 18.6 percent to 12.5 percent and interest payment as percentage of
revenue expenditure has declined from 18.2 percent to 13.1 percent between 2008-09 and
2012-13; (iv) fiscal liabilities of the government of Rajasthan as percentage of NSDP has
also declined consecutively from 36.4 percent to 25.7 percent during the reference period;
(v) Although the relative share of own tax revenue in the total receipt of the state
government has remained almost stagnant, the share of state government in central taxes
has registered a marginal decline from 27 percent to 25 percent between 2008-09 and
2012-13; (vi) in the total capital expenditure, relative share of loans and advances has
substantially increased from 5.44 percent to 18.41 percent during the reference period
implying that the interest payment is likely to escalate further leaving profound impact on
revenue or current expenditure, which would, in a way, cripple the state government from
investing in productive assets from revenue receipt in future; (vii) Relative share of
capital expenditure has registered only a marginal increase from 15.39 percent to 17.10
percent during the period under reference here (Government of Rajasthan, 2014). It is not
an appreciable trend in the context of the adherence of the state government to stick to the
stipulations of FRBM Act of 2005.
Objectives of the Study

1. To analyze the structure, trend and pattern of government expenditure and revenue in
Rajasthan for the period 1970-71 to 2013-14;

2. To analyze causal relationship between government expenditure and economic growth

(NSDP) in the state of Rajasthan during the reference period of the study;

3. To test the validity of different theories on public expenditure and revenue in

Rajasthan.

4. To compare the economic growth and performance of government expenditure

and NSDP in the pre and Post Economic-Reform period in Rajasthan.

5. To identify major determinants of public expenditure in Rajasthan.

6. To suggest a public expenditure policy for the state of Rajasthan.

Scope and Significance of the Study

Public expenditure influences economic development and growth of an economy.

Government spending is rather crucial in deciding the welfare of a region, particularly for
the economically and socially vulnerable sections in the society. Moreover, public
expenditure or government spending is a major catalyst force of leveling up economic
inequality in a state, as government expenditure is concentrated mostly on social goods
like infrastructure development and welfare of the vulnerable sections of the society.
Fiscal instruments, particularly tax policies have become an important tool with the state
for redistribution of income generated by the existing system of development in the
country. Therefore, a direct relation between government expenditure and economic
growth and vice versa. In this context, the present study will be confined to the state of
Rajasthan for the period of 1970-71 to 2013-14. The choice of the period is influenced
mostly by the availability of secondary data on different aspects of public expenditure in
the state of Rajasthan and the broad objective of the study is limited to testing the existing
and accepted theories on the association between economic growth and public
expenditure. However, the study prefers to deviate from a deductive approach as the
empirical analysis explores inductive explanations for the statistically valid relationship
in the context of Rajasthan economy.

Chapter 3: Data and Methodology

Hypotheses

H01: There is no causal relationship and unidirectional causality between public

expenditure and economic growth in Rajasthan

H11: - There are the causal relationship and unidirectional causality between public
expenditure and economic growth in Rajasthan.

H02: There is no causal and unidirectional relationship between economic growth and
public expenditure

H12: There are causal and unidirectional relationship and causality between economic
growth and the government expenditure.

H03: - There is no causal relationship between tax revenue and public expenditure

H13: - There is causal relationship between tax revenue and public expenditure;

H04: - There is no significant difference in public expenditure in Rajasthan between pre

and post economic reform period;

H14: - There is significant difference in public expenditure in Rajasthan between pre and
post economic reform period.

H05:- There is no significant association between the size of government spending and
different determinants of public expenditure in Rajasthan.
H15:- There is significant association between the size of government spending and
different determinents of public expenditure in Rajasthan.
The study used secondary data on government expenditure, revenue, and NSDP at
constant prices for the state of Rajasthan. The variables were transformed from current to
constant price employing implicit deflated as well as splicing of data to shift base year.
Trends in growth rate for different time periods were estimated with the same degree of
freedom employing kinked exponential function. Known and advanced statistical tools
and econometric modeling were used for analysis. Important statistical tools used were
ADF, PP and KPSS tests, Engle-Granger, Johansen cointegration method
and ARDL Method to find out the long run co-movement of the variable under study.
VAR, VECM, and Toda-Yamamoto Causality tests have been used to analyze the
causality between the variables. The study also used the structural break with Known and
Unknown Break analysis for government expenditure and economic growth. Period of
the Study: The period of the study is chosen from 1970-71 to 2013-14.

Chapter 4: Trend and Pattern of Government Expenditure and Revenue in

Rajasthan-1970-71 to 2013-14

Analysis of government expenditure and revenue of Rajasthan for 1970-71 to 2013-14

showed that there were different phases in the overall movement of different components
of capital and revenue expenditure and state’s income. It was observed that both
expenditure and revenue of the state of Rajasthan moved in tandem with the
macroeconomic scenario of the country at large during the period of the study. Although
government expenditure is a broad term, it is composed of different components with
varied connotations. From the perspective of political economy, the relative share of
expenditure under different heads of accounts are important and it was found that capital
expenditure on economic services had been on the decline while social service had been
on the rise. It is indicative of the fact the state government’s capacity to generate income
from productive activities would fall in the long run. Expenditure on revenue accounts
has substantially increased over the years, particularly after the implementation of the
fifth Pay commission (2005) in the state. There has been a significant shift in the
structure of public debt over the years and the interest payment as the percentage of
revenue expenditure has substantially increased accounting for 25% of the total revenue
expenditure of the state economy of Rajasthan until the first half of the 2000s. It can,
therefore, be concluded that the expenditure, revenue and public debt of Rajasthan have
turned favorable from a growth promotion viewpoint in the first half of 2010. The trend
in public debt revealed that there were different phases in its overall movements.
However, it is worth mentioning that the phases of debt of government of Rajasthan are
closely connected to the same in the government of India. The fall in revenue and
reduction in the transfer to state government leads to raise in borrowing by the state
government. It is also important to note that the recessionary tendencies at the national
level leave its ripples in the state economy too, which in turn means that different phases
of public debt in Rajasthan is associated with the performance of the national and state
economy.

Chapter 5: Analysis of Causality between Public Expenditure, Economic Growth

and Public Revenue in Rajasthan

It was found that there was co-integration or rather co-movements between government
expenditure and economic growth measured in terms of NSDP in real terms in Rajasthan
during 1970-71 to 2013-14. Different mathematical formulations of Wagner’s Law
empirically tested the association between government expenditure and NSDP. Peacock
and Wiseman’s versions used government expenditure and NSDP in real price while
Gupta’s version used per capita government expenditure and per capita NSDP.
Guffman’s version used government consumption expenditure as a dependent variable
and NSDP as an independent variable. Differences in the specifications of dependent and
independent variables make generalizations on the association between government
expenditure and NSDP rather cumbersome. However, it can be broadly concluded that
government expenditure moves in tandem with NSDP in the long run. In other words,
there exists a synchronized and co-movement between government expenditure and
economic growth in the economy of Rajasthan for the period 1970-71 to 2013-14. Its
policy implication is that government intervention plays a crucial role in the
performance of the economy, which supports of the Keynesian theory of public
expenditure in the state of Rajasthan.
 Musgrave & Musgrave and Mann used the ratio of government expenditure
to NSDP (in real price) as the dependent variable and NSDP & per capita NSDP as
independent variables to test the association between government expenditure and
economic growth. Those versions of Wagner’s Law showed that there was no long-run
relationship between government expenditure and NSDP or the economic growth in
Rajasthan. The theoretical premise of specifying government expenditure as ratio
of NSDP lies in the fact that it is not the absolute size of government expenditure per
se but government expenditure in relation to the size of NSDP or relative size
of government expenditure with respect to the income of the economy, which is more
relevant and determine the overall performance of the economy in question. Although
the Musgrave and Musgrave and Mann versions of Wagner’s Law are superior in terms
of its mathematical formulation as compared to other four variants of Wagner’s
Law, analysis of Musgrave and Musgrave and Mann versions showed that there was no
long-run relationship between the relative size of government expenditure and per
capita NSDP. In other words, government expenditure has no significant influence on the
economic performance of Rajasthan. Its policy implication is that even if government
expands more, there is no assurance that it would reflect in economic growth or economic
growth is not driven by the intervention of the government in economic activity. To an
extent, Musgrave and Musgrave and Mann versions do support the economic theory
of rolling down the role of the State from economic activity. In other words, the
findings support the economic philosophy of the economic reforms in India.

In the association between government expenditure and economic growth,

causality matters. Causality implies the cause and effect relationship between government
expenditure and economic growth. From a policy perspective, the cause and effect
relation assumes special significance. The analysis showed that there was a long run as
well as short run causality between government expenditure and NSDP. Further, the
causality runs from government expenditure to NSDP in the long run and from NSDP to
government expenditure in the short run. Its implication is that economic performance
enables the government to expand more in the short run while the government
expenditure drives economic growth in the long run. In other words, the economy of
Rajasthan was found following Wagner’s Law (Economic growth is positively
associated with public spending) in the short run and the Keynesian theory of
public expenditure (Government expenditure drives economic growth) in the long
run. The study found that Gupta’s version of Wagner’s Law did not work in the state of
Rajasthan as there was no causality between per capita government expenditure and Per
capita NSDP both in the long run and short run. In the short run, the association between
government expenditure and per capita NSDP showed a different relationship (Guffman’s
version). There existed a bi-directional causality between government expenditure
and per capita NSDP in the short run while government expenditure influences per
capita NSDP in the long run. It amounts to saying that Keynesian theory of public
expenditure works in the long run in Rajasthan. There was unidirectional causality
from NSDP to government consumption expenditure in the long run while there was no
such causality between those two macroeconomic variables in the short run. It shows that
Pryor’s version of Wagner’s Law does not work in the economy of Rajasthan in the short
run. Conversely, as observed in the case of the relationship, there was no causality
between the relative size of government expenditure and economic growth in
Rajasthan during the period under study and it can be concluded that Musgrave &
Musgrave and Mann versions of Wagner’s Law did not work in Rajasthan. Analysis
of unknown break in the regression on government expenditure and NSDP of
Rajasthan in different versions of Wagner’s Law showed that there was a common
break point in the year 1980. It is indicative of the fact that there was a structural
shift in the long run association between government expenditure and NSDP. An
important reason for the shift is the substantial hike in capital expenditure in 1980-
81 periods. From an abysmally small share of capital expenditure of 19% prior to
1980-81, it has substantially increased to 55% in 1980-81. In the following years too,
the capital expenditure of Rajasthan remained high. There is a positive associaiton
between economic growth the capital expenditure in Rajasthan. The shift in NSDP
and government expenditujre took place because of the increase in the share of
capital expenditure in 1980-81. Capital expenditure further leads to higher
irregation and more Agriculture growth further supplemented to higher
manufacturing and industrial growth. Capital expenditure .on Aggriculture heads
at current prices in 1974-75 was 81 crore and increased to 151 crores in 1980-81.

It was observed that the causality runs from public expenditure to economic growth in
Rajasthan in the long run. The findings of the study are in conformity with the Keynisian
school of thought government expenditures leads to higher rate of economic growth.
Reasons for the positive association between government expenditure and economic
growth are: (i) impact of accelerator and multiplier effect of government expenditure is
much higher than the private investment; (ii) government expenditure attracts private
investment in the productive sector because capital investment by the state in productive
sectors like agriculture and industry attracts small capital or petty commodity producers
such as small and marginal farmers, Micro, Small, Medium Enterprisers (MSME) to the
sector. It is worth mentioning here that there is no causality between government
expenditure and economic growth in the short run. It further confirms that government
expenditure in the infrastructure sector causes long term growth in the economy. To a
great extent, it arugues caution against the withdrawal of the state from economic
activities. Primarily, government spending on infrastructure leads to higher growth and it
could be reasons for the association between government expenditure and economic
growth. However, generalization of the observed statistical relationship calls for further
detailed analysis on accelerator and multiplier effect of government expenditure and it is
outside the purview of the present study.

The association between government expenditure and government revenue was

statistically tested. Important conclusions derived from the analysis are: (i) there is a
causality from government revenue to government expenditure in the short run as
well as in the long run. It means, if the government increases or decreases its revenue, it
would lead to a proportionate or corresponding change in government expenditure;
(ii) there is no causality from government expenditure to government revenue in the
short run as well as in the long run. It implies that even if the government increases its
expenditure, it does not ensure a proportionate change in the revenue of the government
or tax collection. Analysis of unknown break in the association between tax revenue and
government expenditure showed that there was a break in the association between two
variables under consideration in the year 1980. Its implication is that there could be a
structural shift in the long run relationship between government spending and tax
revenue by 1980. There is a co-movement of variables in the long run and the
government expenditure caused government revenue in Rajasthan or the causality ran
from expenditure to revenue.

The causal relationship between tax revenue and government expenditure is

indicative of the theoretical postulate that the increased expenditure will improve the tax
buoyancy of the state of Rajasthan through its multiplier effect on economic growth. The
finding further confirm the Keynisian theory of government expenditure which harps
against the downsizing of the government in economic sphere.

Chapter 6: Pre and Post Economic Reform Analysis of Government Expenditure

and Economic Growth in Rajasthan

Analysis of pre and post economic reform periods showed that there was
the substantial difference in the long run association between government expenditure
and economic growth in Rajasthan during the two phases of the study. In the pre-reform
phase (1970-71 to 1991-92), there was no cointegration between government expenditure
and NSDP of Rajasthan. Its implication is that there had been no long-run equilibrium
relationship between government spending and economic growth in the pre-reform phase.
However, there was co-movement of variables under consideration in the short run
during that period. As per the results of Vector Autoregressive Model (VAR), it was
found that there were short run relationships between government expenditure
and NSDP in Rajasthan. The statistically observed relationship confirmed that
government expenditure positively influenced NSDP of Rajasthan. However, the
causation did not run from the NSDP to the government expenditure in the pre-reform
period in Rajasthan. It can be concluded that the Keynesian Hypothesis was valid for
Rajasthan economy during the pre- reform period (1970-71 to 1991-1992). The
association between government expenditure and NSDP turned different during the post-
reform period. Conversely, the post-reform analysis of the relationship between
government expenditure and NSDP indicated that there was a co-integration
between those two variables in the long run in Rajasthan It means that there exists a long-
run equilibrium relationship between government expenditure and NSDP in Rajasthan
during the period 1992-93 to 2013-14. Its implication is that government of Rajasthan
should resort to alternative sources of financing public spending rather than the
accelerator and multiplier effects tricked up and down from growth momentum generated
with NSDP during the period. It was on account of the fact that the government
of Rajasthan had given more emphasis to spending rather than its sources of
borrowing or financing of spending. On the contrary, government spending was
sourced mostly from the accelerator and multiplier effect of economic growth in the
post-reform period. The observation is in conformity with the
development paradigm of the government of India since the early 1990s.

Analysis of the period into pre-economic reform phase and post-economic reform phase
showed that the causality between government expenditure and economic growth in the
post economic reform phase (after 1991) as compared to pre-economic reform phase. As
part of neo-liberal economic policies, both central and state governments have increased
their spending on growth driving infrastructure as compared to the pre-economic reform
phase. It could be primary reasons for the observed strength in the association between
government expenditure and economic growth in the post-reform phase. Rate of growth
in public expenditure in the pre and post economic reform periods indicate that there is a
higher growth in government expenditure in the post-reform period although the
government spending is discriminatory by sectors in characters.

Chapter 7: Determinants of Public Expenditure in Rajasthan State:

A Disaggregate Analysis

Tax revenue is one of the major determinants of government expenditure in the

state of Rajasthan while the association between government expenditure and
the NSDP is found relatively weak. However, there is a derived relationship
between NSDP, tax revenue and government expenditure, which is indicative of the fact
that changes in NSDP cause changes in government revenue. It, in turn, leads to changes
in government expenditure. Moreover, different components of government expenditure
are directly and positively associated with government tax revenue. There is a positive
and significant association between government expenditure, tax revenue and public debt
with the current level of government expenditure. It is indicative of the fact that a
reduction in tax revenue, which if not supplemented with the commensurate increase in
public debt would leave the direct effect on government spending. If government
expenditure is financed through borrowing, it may augment government spending
in initial years, but pull down the economy’s financial maneuverability in the long run. It
is suggestive of the fact that if government expenditure is financed through borrowing, in
the next two following years, the accelerator and multiplier effect of the government
spending would leave the government with a relatively better growth prospects in the
short run, but it would invariably drag the economy down in the long run as revealed by
the Impulse Response Function (IRF). Broadly, the analysis indicated that government
expenditure is the major indicator of the economic strength of the regional economy
of Rajasthan and the findings from the study are in conformity with the Keynesian
theory of effective demand and public spending. If the government of Rajasthan
wishes to give a tilt to its economic growth, the possible means to expand more on capital
as well as revenue expenditure. It could be on account of the failure of the private capital
to take a substantial leap forward to be prominent in the sphere of economic activity. In
this context, state government should increase the expenditure to develop both productive
as well as service sector for the development of the economy of Rajastha. It is on account
of the fact that capital expenditure expands income and employment generating capacity
of the economy while spending on welfare activities give a boost to effective demand of
the economy. In the above analysis, the observed relationship between governernment
expenduture and NSDP prove that the keynisian principle does work in the state of
Rajasthan.

Chapter 8: Conclusion & Policy Implications

The present study has undertaken to examine the causality between public
expenditure and economic growth further investigated that the causality runs from growth
to public expenditure. This shows that growth is the cause of public expenditure in
Rajasthan. The study recommended that the government should increase the expenditure
on transportation, infrastructure, education and other social and economic services so that
the government expenditure can lead to the growth of the state. Pre and post-reform
analysis of the study concluded that pre-reform interventions of the government of
Rajasthan were causing growth whereas after reform period public expenditure is not
leading the growth. This further indicates the policy formation and implementation were
lagging somewhere in Rajasthan after the reform period. Analysis of major determinants
of public expenditure was carried to identify and measure the scale and magnitude of
each variable on public expenditure.

Most importantly, the study has found that the tax revenue determinant was
causing significantly to public expenditure of Rajasthan, indicated that public expenditure
is highly contributed by tax revenue sources of Rajasthan. As compare to other states of
India, Rajasthan is a low-income state, where increasing taxes for enhancing revenue
sources is not a good idea. Therefore, the study recommends re-shuffling the tax system
and policy formation for resource generation by which economy can lead to the growth.

To put it in its nutshell, the study proved that government spending was the most
powerful fiscal weapon in the armory of the government of Rajasthan to activate the
regional economy. To a great extent, deficit financing or enhanced government
intervention in economic activity is recommended to give the fresh lease of life to the
regional economy of Rajasthan, particularly when the economy is in its recessionary
phase. Periodic occurrence of a recession has become the order rather than an exception
in the international economy since the early 1990s India and the state of Rajasthan are
not an exception to it. The study recommends more active intervention by the
government in economic affairs of the state of Rajasthan as tax revenue is the primary
determinant of government expenditure. For the widening and deepening of resource
mobilization for government spending, opening up of new spaces for resource
mobilization for government expenditure has become the need of the hour. To cut the
story short, given the present scenario and very fragile size of private capital,
expanding the activity of the government is recommended to be an important driver of
economic growth in Rajasthan.

Policy Implications:

The causality between government expenditure and economic growth clearly indicated
that there exist well-defined limitations for the private capital, particularly at the state
level to pull up economic growth. On the contrary, government expenditure still holds the
key for accelerating economic growth in the state of Rajasthan. An important policy
implication emerging from the study is that the private capital expenditure has not yet
emerged as an important variable to stimulate growth in the economy. It implies that the
government has to find ways to spend more on economic sphere to promote economic
growth. Decline in the spending in the primary production sector, especially agriculture
has to be corrected to stimulate economic growth in the state for two reasons: (i) it is
rather less likely that the agriculture sector would attract private investment without
complementary and substantial growth in government spending on the sector; (ii) In a
state like Rajasthan, government spending in agriculture assumes special significance
because more than 70% of the rural households depend on agriculture for their livelihood.
Given the financial constraints to channel large funds into the development activities,
government has to explore newer and fresher avenues of tax collection which could be
possible only from the booming sectors like real estate, health and education. Resorting
to traditional material production sectors like agriculture and allied sector, manufacturing
and mining and quarrying do not suggest a prudent decision especially in the light of
looming large intermittent economic crisis which is again linked to the ups and down in
the international market.

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