The goal of this research was to investigate empirically how government expenditure contributes to economic growth in East Africa. Most existing studies on the association between government expenditure and economic growth show conflicting results and mainly focus on developed economies. Hence this study focused on both the functional and composition of public spending of the East African countries over the period from 1980 to 2010, with a particular focus on sectoral expenditures: Education, Agriculture, Defense and Health. The objective of the study was to establish these government expenditure components that have effects on economic growth using panel data series for East Africa (for 31 years) in order to provide a guide for policy formulation. The study used the neoclassical augmented Solow growth theory as the theoretical framework. In this study, both descriptive and econometric inferential analyses were carried out. In the econometric analysis, total government expenditure was disaggregated to scrutinise the effect of different components of public spending on economic growth. This study used secondary data which was obtained from sources such as the specific countries Bureau of Statistics, Statistical abstracts and World Bank. Employing Levin-Lin-Chu test, this study tested for panel unit root and found that only two variables, that is, real GDP growth and investment expenditure are stationary at level while others were stationary at the first difference level. The collected data was estimated by balanced panel fixed effect model. The findings showed that expenditures on health, defense and investment were found to be positive and statistically significant effect on economic growth in East Africa. In contrast, expenditure on consumption was found to be negative and statistically significant effect on economic growth. Finally, education, agriculture and human capital expenditure were found to be insignificant. This study suggests that for East Africa, the policy of increasing government spending on health, defence and investment budget to promote economic growth will be appropriate, but fewer funds should be channeled towards other governmental programs.

Background Information 
Economic theory does not automatically generate strong conclusions about the effect of government expenditure on economic performance. Indeed, most economists would agree that there are circumstances in which lower levels of government spending would enhance economic growth and other circumstances in which higher levels of government spending would be desirable. If government spending is zero, presumably there will be very little economic growth because enforcing contracts, protecting property, and developing an infrastructure would be very difficult. In other words, some government spending is necessary for the successful operation of the rule of law (Mitchell, 2005). 

The role of government in economic growth is an issue of debate since the time of Adam Smith. Recent wave of privatization in many developing and developed countries is based on perceptions that, "for sustainable development and efficient output, the role of government in economic policies should be reduced"(Kakar, 2011). Economists are of two different views about the role of government in economic activities. According to the neo- classical economists, reducing the role of private sector by crowding-out effect is important because it reduces the inflation in the economy; increase in public debt, increases the interest rate which reduces inflation in the economy as well as output. The new-Keynesians present the multiplier effect in response and argue that the increase in government expenditure will increase demand and thus increase economic growth. The vision of ensuring sustainable economic development and reduction of mass poverty is enshrined, in one way or another, in the government’s development strategy documents of virtually all developing economies. In this respect, economic growth, which is the annual rate of increase in a nation’s real GDP, is taken as main objective for overcoming persistent poverty and offering hope for the possible improvement of society (Kakar, 2011). 

Faced with the financial crisis and global economic recessions, governments have rediscovered the importance of public finance. They use it to rescue the bankrupt banks, and to create more economic activity to hold back recession. Tens of millions of workers are in jobs today and would be unemployed without that economic boost from public spending. But now there is a backlash demanding that the deficits used to create the stimulus must be cut back by cutting public spending on a grand scale. The backlash comes not only from governments, but from international institutions, led by the International Monetary Fund (IMF) and World Bank (WB), which are insisting that public services are now ‘unaffordable’, and that healthcare, education and pensions in particular should be dependent on the market (Mitchell, 2005). 

The relationship between government expenditure and economic growth has continued to generate a series of controversies. While some researchers conclude that the effect of government expenditure on economic growth is negative and insignificant (Akpan, 2005) and (Romer, 1990), others indicate that the effect is positive and significant (Korman and Bratimaserene, 2007) and (Gregorious and Ghosh, 2007). Government expenditure on investment and productive activities is expected to contribute positively to economic growth, while government consumption spending is expected to be growth retarding. This instrument of fiscal policy promotes economic growth in the sense that public investment contributes to capital accumulation. Other importance of government expenditure includes the provision of those facilities that are not fully covered by the market economy such as health and education. That is, human capital promotes positive benefits associated with economic growth, but the financial source for public expenditure which is taxation, reduces the benefits of the taxpayers and as such reduces the benefits associated with economic growth (Barro, 1990). 

There are some components of government expenditures that are productive while some are unproductive. Government expenditures on health and education raise the productivity of labour and increase the growth of national output. Education is one of the important factors that determine the quality of labour. Government expenditure on health could lead to economic growth in the sense that human capital is essential to growth. Good investment in the form of national defense is a necessity for safeguarding and protecting the nation from outside aggression, while agriculture, in the form of food security, is a necessity for human existence. But due to lack of sufficient revenue, there is need to categorise productive and non-productive government expenditure for East Africa in order to reduce the non- productive expenditure. 

An Overview of Macroeconomic Trends of East Africa 
The East African Community (EAC) was established in 2000 by Kenya, Tanzania and Uganda; Burundi and Rwanda joined in 2007. Its objectives are to deepen cooperation among member states in political, economic, and social fields - including establishment of a customs union (2005), common market (July 2010), monetary union and ultimately political federation of East African States. Burundi and Rwanda joined the customs union in 2009. While the current EAC has existed for more than a decade, there has been a long history of cooperation under successive regional integration arrangements in the region. Kenya, Tanzania and Uganda have participated in regional integration arrangements dating back to 1917, starting with a Customs Union between Kenya and Uganda in 1917, which the then Tanganyika joined in 1927; the East African Community (1967–1977) and the East African Co-operation (1993–2000) (EAC, 2011). 

EAC members nonetheless remain diverse in terms of incomes, industrial structures, and social indicators. The EAC has a population of about 127 million, a land area of 1.8 million square kilometers, and nominal GDP of $73.8 billion (2009). Kenya has the largest economy, with a nominal GDP of US$30.1 billion (41 percent of the region’s total). Measured in GDP per capita, Burundi is the poorest member, with an average nominal per capita GDP of US$164, less than one-third of the EAC average (US$560). Kenya has the highest per capita income of US$ 833.4, followed by Rwanda, Uganda, Tanzania, and Burundi in that order. Large shares of the population live in rural areas across the region. Uganda is landlocked, Tanzania is actively exploiting natural resources (gold), and two have resources on stream (Uganda, Kenya) (EAC, 2011).

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Item Type: Kenyan Postgraduate Material  |  Attribute: 77 pages  |  Chapters: 1-5
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