Determinants of Public Expenditure Growth in Ethiopia: An ARDL Bounds Testing Approach

Abstract

Ethiopia has been experiencing increasing public spending in the past thirty years, the increased expenditure unmatched by revenue, result fiscal and economic imbalance leading the government running persistent budget deficit and output fluctuation. The growth in public expenditure has been due to certain factors which are assumed to have significant effect on the fiscal stance of the country. These perceived implications of public expenditure growth on the economy necessitate the need to understand factors that are responsible for the increase in the level of real expenditure size. The objective of this paper was to analyze the major determinants of public expenditure growth in Ethiopia. The study used annual time series data for 39 years (1980-2018 inclusive). The data were analyzed using Autoregressive Distributive Lag (ARDL) model, which was applied on the basis of Wagener’s law of the increasing income effect on government expenditure using data from ministry of finance, national bank of Ethiopia, and Central statistical agency. Both ADF and PP test for unit root suggest only the natural logarithm of population variable were found stationary at level i.e. time invariant without their first difference, whereas the rest variables stationary at first difference, consequently, the existence of long-run relationship test was carried out by making the use of ARDL bound test. The bound test for co-integration showing that the existence of long run relationship; as a result, ARDL with ECM was used in estimating the long run and short run relationship. The coefficient of ECT is -0.8984 that shows any deviations from the long run equilibrium is corrected at 89.84% annually and converges towards its long run equilibrium. The result of the study revealed that domestic revenue, real GDP, population, aid, public debt and openness are the major determinants public expenditure growth in Ethiopia by exerting strong and significant effect on the level of real expenditure size. Among the determining variables domestic revenue, real GDP, aid and population are the most important variables for public expenditure growth of the country consecutively, while openness and public debt highly deteriorate the growth potential of public expenditure growth. Since real expenditure has a positive response for its growth trend under the influence of domestic revenue, real GDP, aid and population the government of Ethiopia can comfortably extend the growth of public expenditure by controlling those variables. Furthermore, avoiding unnecessary public borrowing and control over trade liberalization take in to consideration in line with other basic macroeconomic variables like deficit and inflation to balance the fiscal gap, so as to achieve a neutral fiscal stance for economy development and poverty reduction. Moreover, internal revenue is the most important determinants of public expenditure growth, so that due 6 attention should be given in diversifying the revenue base. Population reduction measure should also be take in to consideration to balance the demand and supply of public good with the growing population number in order to build up a parallel movement.