Journal of the Knowledge Economy

https://doi.org/10.1007/s13132-022-01038-2

Public Sector Efficiency and Economic Growth

in Developing Countries

Nahed Trabelsi1 · Younes Boujelbene1

Received: 16 December 2020 / Accepted: 13 September 2022

© The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature
2022

Abstract
Our main contribution to this paper consists of analyzing the impact of public sector
efficiency on economic growth. For this purpose, we based on a sample of seventy-
five developing countries during the period 2000–2018. In the first step, we have
estimated the countries’ efficiency scores of public spending using data envelop-
ment analysis (DEA). In the second step, we have incorporated them into a simple
model of growth through government expenditure by applying a generalized method
of moments (GMM). The results demonstrate that increasing government expendi-
ture reduces economic growth in developing countries. However, when government
expenditure is interacted with public sector efficiency, we find evidence for effi-
ciency to boost the impacts of public spending on economic growth. Moreover, the
empirical results show that above a critical threshold, efficiency lowers the optimal
size of government expenditure required to maximize growth. Our findings can be
useful for policymakers in order to set out a structural adjustment plan to improve
the efficiency level of the public sector.

Keywords Government expenditure · Public sector efficiency · Data envelopment

analysis · Growth

Introduction

The debate concerning government involvement in the economic system and its
outcome has a long history since the Keynesian and Neo-Classical eras (Chirwa &
Odhiambo, 2016), and this involvement is justified by the nature of the market econ-
omy. There is a contention that the market is not perfect; thus, government interven-
tion is required to minimize the distortions which result from market failure. The

* Nahed Trabelsi
nahedtrabelsi2020@gmail.com
1
Faculty of Economics and Management, University of Sfax, Street of Airport, km 4.5, LP 1088,
Sfax 3018, Tunisia

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aim of superseding the economic system is to achieve efficiency and thus economic
growth (Parker & Kirkpatrick, 2012).
While the government intends to achieve better efficiency through superseding
the workings system of the economy, there is further contention that government
intervention may result in inefficiency rather than efficiency in resource allocation.
This is because government tends to displace private sector performance through the
effects of crowding out (Okoye et al., 2019). In most cases, increasing government
expenditure in developing countries causes crowding out of the private investment.
Consequently, the whole process reduces economic growth (Chang et al., 2011).
Despite all these debates, the argument of whether government expenditure con-
tributes positively to economic growth has become an accepted premise in most
economies worldwide (Deepti & Deepak, 2020). Along this hypothesis, for gov-
ernment expenditure to have a significant contribution to the country’s economic
growth, efficiency in resource allocation is essential. The relationships between
government expenditure and economic growth tend to vary, and these variations
are influenced by the level of efficiency (Rahmayanti & Horn, 2011). Government
expenditure is an input which requires maximum efficiency in allocation so as to
accelerate economic growth (Therkildsen, 2010).
The public sector efficiency is measured as a relative term, i.e., whether a particu-
lar economic entity is more efficient compared to other economic entities (OECD,
2004). The efficiency of the public sector is measured as the ratio between costs
(inputs) and results (outputs) compared to the same variables in other countries. If
the results are better, with the same or lower costs, it is considered that the public
sector of that country is more efficient.
Efficiency analysis has its precedent in the literature quantifying the productive
efficiency of firms or decision-making units of diverse nature. Cherchye and Post
(2001) address the efficiency of electricity generating plants, Burgess and Wilson
(1998) evaluate the efficiency of hospitals, and Wheelock and Wilson (2003) of
banking institutions. Afonso and Santos (2008) address the efficiency of Portuguese
Universities and Agasisti (2011) of Universities in the European Union. Other exam-
ples are Eugène (2008) for the relative efficiency of the Belgian general government
as a provider of public order and safety, while Aubyn (2008) offers a review of the
literature on law and order efficiency measurement.
In the case of public spending efficiency, the wide majority of the related literature
has focused on the analysis of efficiency in education and health sectors across coun-
tries (Fonchamnyo & Sama, 2016; Herrera & Ouedraogo, 2018; Ozana & Margareta,
2018; Richard & Patrizio, 2020; Lilia & Kristina, 2017). A smaller strand of the lit-
erature has centered on the analysis of efficiency of public expendiure at the subna-
tional or aggregate level. Notable examples are Afonso and Fernandes (2008) for the
assessment of efficiency of public spending in Belgian local governments, Afonso and
Scaglioni (2007) for Italian regions, and D’inverno et al. (2018) for Tuscan munici-
palities. To the best of our knowledge, this is the first attempt in the literature to quan-
tify the efficiency of the public sector at the aggregate level in the context of devel-
oping countries. For this purpose, this study uses a non-parametric approach to data
envelopment analysis (DEA) to estimate the efficiency scores of the public sector. This
technique is a competing methodology to the stochastic frontier approach (SFA) and

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reveals many advantages compared with SFA, such that (i) DEA can be applied eas-
ily and no distributional assumptions are required; (ii) unlike SFA, the main feature of
DEA is that it does not require specifying a functional form for production technology;
(iii) in the case of the production function, the DEA approach can be used in the case
of multi-inputs multi-outputs. This is the main advantage vis-à-vis the SFA approach
that can only be used when we have one output or aggregate output. Therefore, in this
kind of research, aggregate outputs in one output inevitably lead to misleading results.
Many studies have attempted to establish an identifiable link between government
expenditure and economic growth since the 1990s. Barro (1990) laid down the theo-
retical framework for examining this relationship, adding government spending to
the list of growth determinants which include capital and labor. Meanwhile, other
empirical studies have produced mixed results. Although both positive and negative
relationships between expenditure and growth were found, negative findings such
as those by Fölster and Henrekson (2001) dominated. Another significant finding
of these studies is that government size matters to growth, as was observed by Chao
and Grubel (1998). However, Scully (1994) described the relationship between gov-
ernment expenditure and growth as an inverted U curve, indicating the existence of
an optimal point for government size. There are, however, limited contributions to
the analysis of the impact of government expenditure efficiency on economic growth
with the prominent exceptions of Rahmayanti and Horn (2011). We incorporate
efficiency scores into an estimation model to find the optimal size of government
expenditure that maximizes economic growth. For this objective, this study applies
a generalized method of moments (GMM). The remainder of the paper is organized
as follows: The “A Review of Existing Literature” section discusses the literature
review focusing on government expenditure, efficiency, and economic growth rela-
tionships. The empirical methodology which is used in this paper is presented in
the “Empirical Methodology” section. While the “Results and Discussion” section
presents, discusses, and interprets the empirical results. The “Conclusions” section
offers conclusions and policy implications.

A Review of Existing Literature

Government Spending Efficiency

We shall make a brief discussion about papers that have emphasized the importance
of gauging the efficiency of public spending. It may be noted from the below review
of existing literature that there is no such study in the case of developing countries.
Yi-Chang Hsu (2013) gauges the health expenditure efficiency for 46 European
and Central Asia countries by applying DEA. He found that these countries could
produce more quantity of outputs by about 2.1% while maintaining the same level
of inputs.
Rouselle and Gabriel (2015) assess the efficiency of health and education
expenditure in Asian countries during the period 1995–2012. Using DEA meth-
odology, they reveal that countries could achieve higher health and education out-
comes given their expenditures.

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Dutu and Sicari (2016) evaluate the efficiency of health care, secondary edu-
cation, and general public services in a sample of OECD countries for the year
2012. The study finds a wide dispersion in efficiency levels across OECD coun-
tries and suggested that improvements could be possible for both output and input
efficiency.
Fonchamnyo and Sama (2016) analyze the efficiency of public expenditure on
education and health in three CEMAC countries (Cameroon, Chad, and Cen-
tral African Republic) using the non-parametric DEA method over the period
2000–2012. The empirical results show that Cameroon is the best in terms of effi-
ciency in spending on education and health, and Chad is the worst regarding public
spending on education, despite it spends more on education than the others. The
Central African Republic is the least efficient in public spending on health.
Afonso and Kazemi (2017) measure the public sector efficiency of 20 OECD
countries for the period 2009–2013. The main objective of their work is to evaluate
performance and efficiency on the basis of inputs and outputs. In the first step, they
have constructed two indicators, public sector performance (PSP) and public sector
efficiency (PSE). In the second step, they used the non-parametric approach (DEA)
by considering six different models. The first two models assess the efficiency of
government at the aggregate level, but the other four models measure the efficiency
of public spending in four main sectors: administration, education, health, and infra-
structure. The authors raised that countries that spend more are less efficient and
vice versa.
Antonelli and Bonis (2019) assess the efficiency of government spending in the
case of 22 European countries. First, they measure efficiency by means of the free
disposable hull and data envelopment analysis techniques. Second, the authors per-
form an econometric analysis to identify the factors that can be associated with cross-
country differences. Their findings stress that, on average, a 20 percent cut in expend-
iture is feasible to maintain the existing output. Moreover, they show that countries
scoring higher efficiency have higher education and GDP levels, a smaller population
size, a lower degree of selectivity of their welfare systems, and a lower corruption
level.
Michael et al. (2020) analyze the public sector efficiency in a sample of 23 Euro-
pean countries over the period from 1995 to 2015 using several efficiency techniques,
e.g., free disposal hull and order‐m, and investigate input- and output‐oriented effi-
ciency. They construct a measure of public sector performance consisting of nine dis-
tinct indices for each area of public policy, such as administration, health education,
economic performance, and infrastructure. They also investigate the determinants
of public‐sector efficiency, in particular, the role of fiscal decentralization and fiscal
rules. The authors conclude that, whereas decentralization fosters efficiency, fiscal
rules have no effect. In addition, fiscal rules, when combined with decentralization,
may harm efficiency, which is consistent with the ratchet effect.
Sijuola Orioye et al. (2020) examine the public sector efficiency in the design of a
Euro area-wide social benefit scheme. Their results reveal large-scale inefficiencies
in the use of funds allocated to the scheme during the great recession and Euro area
sovereign debt crisis that followed, with member states wasting, on average, 34.6%
of funds allocated to it.

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Journal of the Knowledge Economy

Government Spending Efficiency and Economic Growth

There have been quite a few works that examine the relationships between govern-
ment expenditure and economic growth. However, the number of works involving
expenditure efficiency with economic growth has been very few. This study tries to
provide some leads on how to boost the impact of public expenditures on economic
growth.
Ndambiri et al. (2012) examined the determinants of economic growth in a panel
of 19 sub-Saharan African countries in the period from 1982 to 2000. Among the
variables incorporated in the model was a public expenditure. Using the general-
ized method of moments (GMM), the results of the study indicated that government
expenditure leads to negative economic growth in the sample study countries.
Asghari and Heidari (2016) revisited the government spending-economic growth
nexus as they empirically examined the impact of government size on economic
growth. The study was based on a sample of selected Organization for Economic
Cooperation and Development – Nuclear Energy Agency (OECD-NEA) countries
based on data stretching from 1990 to 2011. Using the panel smooth transition regres-
sion (PSTR) model in the form of a Cobb–Douglas equation function, the results of
the study rejected the linearity hypothesis.
Chirwa and Odhiambo (2016) carried out a study to empirically determine the
long-run drivers of economic growth in South Africa over a period from 1970 to
2013. Using the ARDL technique, the results of the study indicated that government
spending had a significant negative impact on economic growth in South Africa,
both in the short run and in the long run.
Sáez et al. (2017) studied the relationship between government spending and
economic growth in European Union countries using data stretching from 1994 to
2012. Using panel data techniques, the results of the study revealed that, while the
relationship between government spending and economic growth can be positive or
negative, depending on the countries included in the sample, the period of estima-
tion and the variables used to proxy the public sector size, government spending has
a negative impact on economic growth in European Union countries.
Lupu et al. (2018) examined the impact of public expenditure on economic
growth in 10 selected Central and Eastern European countries during 1995–2015.
Public expenditure was disaggregated into 10 different categories. The results, based
on ARDL estimation techniques, showed that model public expenditures on defense,
economic affairs, general public services, and social welfare have a negative impact
on economic growth in the study countries.
Okoye et al. (2019) examined the relationship between government expenditure
and economic growth in an effort to determine the extent to which output growth in
Nigeria is affected by government spending during the period from 1981 to 2017.
They found that in Nigeria, public expenditure has a negative impact on economic
growth.
With regard to the significance of government efficiency in boosting the impacts of
government expenditure on economic growth, Angelopoulos et al. (2008) demonstrate
that what matters to growth is not the magnitude of government expenditure parse but
the expenditure-efficiency mix. Angelopoulos et al. (2008) put forward that obtaining

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a robust impact of the overall government expenditure on economic growth without

expenditure efficiency is tedious. This argument is consistent with the hypothesis of
Avkiran (2006) and Hauner and Kyobe (2010). Additionally, Butkiewicz and Yanikkaya
(2011) reveal that if the government is less efficient, government expenditure tends to
reduce economic growth. Consistent results which support the significance of efficiency
to accelerate the effects of government expenditure on economic growth are reported by
Rahmayanti and Horn (2011) who employ the endogenous growth model and incorpo-
rate government efficiency to examine the relationships between government expendi-
ture, efficiency, and economic growth. The study uses panel data from 63 countries, both
developed and developing. Empirical results show that government efficiency matters
up to a certain level of spending for government expenditure to boost economic growth.
Beyond that, level expenditure reduces economic growth.

Empirical Methodology

Econometric Model
Crit = 𝛼i + 𝛽 GEXPit + 𝛾PEFF it ∗ GEXPit + vXit + 𝜀it (1)
where Grit is the growth rate of a country i at time t; GEXPit is a measure of govern-
ment expenditure as a ratio of GDP; PEFFit is a measure of public efficiency calcu-
lated through DEA; and Xit represents control variables.

Critical Value of Efficiency and Optimal Size of Government

We extended the growth regression and efficiency equation used:

Grit = 𝛼i + 𝛼1 GEXPit + 𝛼2 PEFF it ∗ GEXPit + B1 GEXP2it

(2)
+ B2 (PEFF it ∗ iGEXPt )2 + Xit + 𝜀it

Equation (3) can be rewritten as follows:

GRit = 𝛼i + (𝛼1 + 𝛼2 PEFF it )GEXPit + (𝛽1 + 𝛽2 PEFFit2 ) GEXP2it + Xit + 𝜀it (3)

GEXP is measured as a ratio of government expenditure to GDP and can be any

number from 0 to 1. However, in reality, it is uncommon for this ratio to equal 0 or
1. Therefore, the optimal size of government is represented as GEXP ∈ (0, 1).
The quadratic function exhibits a parabolic form in which the vertex of the
inverted U-shaped curve represents the optimal solution. Based on Eq. (3), for the
parabolic curve to have an inverted U shape, it must satisfy the following condition:

𝛽1 + 𝛽2 PEFF 2it < 0 or 𝛽1 < −𝛽2 PEFF 2it (4)

Therefore, the critical value of efficiency is as follows:

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√
PEFF ∗it = 𝛽1 ∕(𝛽2 ) (5)

The optimal government size to maximize growth is then:

𝛼1 + 𝛼2 PEFFit
GEXP∗it = (6)
−2(𝛽1 + 𝛽2 PEFFit2 )
Therefore, we conclude that optimal government expenditure is conditional on
efficiency.

Data Description

This paper employs panel data from 75 developing countries covering the period
from 2000 to 2018. Developing countries here refer to those classified by the World
Bank as low-income, lower-middle-income, and upper-middle-income countries. We
focused on developing countries for several reasons. First, the income similarities
among sample countries make the comparison more reasonable. Second, not enough
attention has been paid to developing countries in the literature on the optimal size
of government expenditure. (See Appendix 1). The paper uses panel data because
they are able to surmount the problem of endogeneity which is the outcome of unob-
served information (Baltagi, 2005; Hsiao, 2003). This advantage ensures unbiased
results. All data series are taken from the Human Development Index of the United
Nations Development Project and the World Bank Development Indicator.

Variables and Measures

Inputs and Outputs: DEA Analysis

It is prominent in the frontier approach literature that the specification and definition
of inputs and outputs represent the keystone of this kind of research. According to
some recent studies (Afonso & Kazemi, 2017; Antonelli & Bonis, 2019), we adopt
the final consumption of government to GDP as input. In the production process,
the input is mobilized to produce a given amount of outputs. The performance of
the government as a supplier of public goods and services is limited to the provi-
sion of education, health, and public infrastructure. As for education, we focus on
literacy rate and secondary school enrolment rate. For health, we consider the tra-
ditional output indicators of infant mortality and life expectancy. As for the provi-
sion of infrastructure, we center our attention on electricity usage and telephone per
100 habits. Education and health indicators have been used as output indicators in
many studies measuring government efficiency (Afonso & Kazemi, 2017; Cetin &
Bahce, 2016; Hsu, 2013; Jacob, 2015). Many studies also found a long-term effect
of infrastructure on growth. Infrastructure development is also an important goal of
governments in developing countries, as shown in empirical studies including that
of Angelopoulos et al. (2008) and Lavado and Domingo (2015).

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Table 1  Descriptive statistics

Variables Descriptions Mean Standard Min Max
deviation

Input Final consumption of government 13.39 5.42 9.80 32.40

to GDP
Outputs Literacy rate 88 45.8 26.0 95
Secondary school enrolment 23.56 11.21 5.34 38.45
Infant mortality 79 44.2 2.7 89.6
Life expectancy 68 35.1 38.8 82
Electricity usage 8,98 823.09 3,63 9,25
Telephone per 100 habits 16.32 17.51 8.36 39.89

Source: Own elaboration

Table 1 displays the main statistics of the structure of the different inputs used
and outputs produced over the period 2000–2018. It offers a simple but useful look
at the main inputs and the main outputs that we will use here in the estimation of the
efficiency scores.

Determinants of Economic Growth

For growth regression, the dependent variable, economic growth was measured as
annual real GDP per capita. For the choice of the variables introduced as explana-
tory determinants of economic growth, government expenditure was measured by
final consumption of government as a ratio of GDP, public sector efficiency was
measured by efficiency scores calculated through DEA methodology, public invest-
ment was measured as gross fixed capital formation, inflation rate was measured by
a consumer price index, trade openness was measured by the sum of exports and
imports of goods and services as a percentage of GDP, and demographic growth was
measured by the population growth rate, domestic credit to the private sector as a
ratio of GDP, political stability, and corruption perception index. The measurement
for all the variables was based on empirical literature and has been widely employed
in the growth literature.
Table 2 summarizes the description of the explanatory variables used in this
study.
Table 3 displays the main statistics of the structure of the different variables dur-
ing the period 2000–2018.

Empirical Method

Fixed and random-effect models could satisfy the analysis of government expenditure,
efficiency, and economic growth. However, the two models exhibit methodological
weaknesses as follows: Fixed effects model which relies on the assumption of different

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Table 2  Description of explanatory variables used

Variables Descriptions Expected signs

GEXP/GDP Final consumption of government to GDP +/−

PEFF Efficiency scores of the public sector +
INVEST Public investment +
INFL Inflation rate −
OPEN Trade openness as a percentage of GDP +
DEMG Demographic growth −
CRED Domestic credit +
PS Political stability +
CPI Corruption perception index −

Source: Own elaboration

intercepts for different individuals (Gopalan & Rajan, 2016; Gujarati & Porter, 2005)
employs ordinary least squares (OLS) in its estimations. The applications of OLS may
result in spurious estimates because it is unable to surmount the possible simultaneity
relationship (Gopalan & Rajan, 2016; Himmelberg et al., 1999) which exists between
government expenditure and economic growth. If the simultaneity relationship
between government expenditure and economic growth remains unsolved, the results
will be in a risk of endogeneity problems (Baltagi, 2005; Hsiao, 2003).
Similarly, the random-effects model which relies on individuals’ intercept and
error term assumption employs the generalized least squares (GLS) method in its
estimations. GLS is also proven to experience an inability to overcome the problem
of endogeneity (Gujarati & Porter, 2005). Therefore, premised on these methodolog-
ical shortcomings, fixed and random-effect models are unable to solve the problem
of endogeneity. The most excellent solution to overcome the problem of endoge-
neity which guarantees consistent and efficient estimates is to employ generalized

Table 3  Descriptive statistics Variable Mean Standard Min Max

deviation

GDP/capita 2.28 7.16 − 10.22 14.13

PEFF 0.871 0.301 0.473 1.000
GEXP/GDP 13.39 5.42 9.80 32.40
INVEST 20.73 8.12 − 11.17 111.37
INFL 7.39 12.63 − 100 100
OPEN 22.30 15.26 0.13 88.68
DEMG 1.79 1.75 − 5.18 8.87
CRED 21.45 14.23 1.817 56.22
PS − 0.27 0.83 − 2.23 1.30
CPI 1.4 1.2 0.000 6.7

Source: Own elaboration

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methods of moments (GMM) (Chen et al., 2014; Clark & Linzer, 2012; Gopalan &
Rajan, 2016).

Results and Discussion

Public Sector Efficiency, Government Expenditure, and Economic Growth

Results in Table 4 below demonstrate a negative relationship between government

expenditure and long-run growth. This unfavorable effect of government expendi-
ture on economic growth can be attributed to the fact that government expenditure
is not used efficiently in developing countries (Ouattara, 2013). These findings are
consistent with Yogi and Theara (2011) who conclude that increasing government

Table 4  Public sector efficiency Dependent variable Growth Growth

and economic growth
GEXP − 0.387* − 0.340**
(0.001) (0.029)
GEXP*PEFF 0.267*
(0.004)
INVEST 0.131* 0.123*
(0.001) (0.001)
INFL − 0.013 − 0.015
(0.454) (0.436)
HC 0.538 0.624
(0.951) (0.865)
OPEN 0.042** 0.044**
(0.022) (0.034)
DEMG − 1.132 − 1.201
(0.003)* (0.045)**
CRED 0.042 0.054
(0.116) (0.144)
CPI − 0.051* − 0.064
(0.000) (0.000)
PS 0.168* 0.166*
(0.002) (0.004)
Constant − 12.101* − 11.302**
(0.007) (0.017)
P-value AR1 0.000 0.000
R squared 0.63 0.65
Hansen J statistic 10.16 10.059
P-value J 0.110 0.237
Fisher statistic 13.73 14.07

Source: Own elaboration. Asterisks indicate variables whose coeffi-

cients are significant at 10 percent (***), 5 percent (**), and 1 per-
cent (*), respectively

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expenditure reduces the economic growth of developing countries. However, when

government expenditure is combined with public sector efficiency, we find that gov-
ernment efficiency accelerates the impacts of government expenditure on economic
growth. The findings of positive relationships between expenditure efficiency and
economic growth are consistent with Gupta et al. (2014) who conclude that public
sector efficiency boosts the impacts of government expenditure on economic growth.
Regarding the control variables that enter significantly, the ratio of investment in
GDP has a positive effect on economic growth (Knight et al., 1993). Trade openness
as a percentage of GDP positively affects the growth rate of developing countries in
this study (Romero & Strauch, 2003). Political stability also has a positive influence
on economic growth (Fosu, 1992; Strauch & Hagen, 2000). However, demographic
growth has a negative relationship with economic growth. The corruption percep-
tion index also has a negative impact on economic growth (Mauro, 1997; Tanzi,
1998).

The Effect of Efficiency on the Growth Maximizing Optimal Size of Government

Table 5 shows that the optimal size for government expenditure exists for a coun-
try only when its efficiency score is higher than 0.86. Out of the 75 countries in
our sample, 43 had efficiency scores below the critical value, for which no optimal
government expenditure size could be determined. For the 32 countries for which
we were able to determine the optimal expenditure sizes, we simulated these sizes
with their corresponding average efficiency scores for the period 2000 to 2018. The
results are presented in Fig. 1. We found that the optimal government size decreases
when the efficiency of government spending increases.
We also observed that more countries were overspending than under-spending.
Some countries, such as Argentine, Afrique du sud, Malaysia, and Peru, lie very
close to the optimal line, implying that their governments, with respect to their effi-
ciency levels, are spending optimally to maximize their economic growth. Mean-
while, countries that lie above the optimal level should reduce their spending to
achieve their optimal size, a crucial step, especially for countries running budget
deficits. Guyana, Korea, Mexique, and Myanmar, for example, may cut their spend-
ing to sustain their budgets without forgoing their growth targets. However, if these
countries are utilizing their own revenues as opposed to other funding sources,
expenditure can be directed toward projects other than growth promotion, such as
improving social security and public welfare.
Finally, countries that lie closely under the optimal line may achieve their opti-
mal size simply by improving their efficiency scores. Countries which lie far below
the optimal line, such as Buthan, Dominica, Ecuador, Honduras, and Tunisia, imply
that their governments may be spending too little and, as such, can get closer to the
optimal line significantly by increasing their expenditure. However, by improving
efficiency, the amount required to achieve the optimal size would be less. Increas-
ing government spending using loans creates interest liability and reduces budget

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Table 5  The Effect of efficiency Dependent variable Growth

on optimal government size
GEXP − 0.351**
(0.021)
PEFF*GEXP 0.408*
(0.001)
GEXPit2 0.006**
(0.020)
PEFFit2* ­GEXPit2 − 0.008*
(0.004)
INVEST 0.142*
(0.002)
INFL − 0.019
(0.740)
HC 0.633
(0.631)
OPEN 0.087**
(0.041)
DEMG − 1.193
(0.005)*
CRED 0.062
(0.112)
PS 0.301*
(0.002)
CPI − 0.081*
(0.003)
Constant 3.088*
(0.000)
P-value AR1 0.000
R squared 0.66
Hansen J statistic 4.365
P-value J 0.257
Fisher statistic 13.60
Critical value of efficiency 0.86

Source: Own elaboration. Asterisks indicate variables whose coeffi-

cients are significant at 10 percent (***), 5 percent (**), and 1 per-
cent (*), respectively

flexibility. Hence, improving efficiency would not only help to achieve optimal
government size but also support budget sustainability. Improving efficiency may
take various forms, such as choosing more productive spending and improving
governance, that is, carefully considering what to spend resources on and how to
spend them. Focusing on expenditures that directly impact economic growth, such
as education, health, and infrastructure, will improve the efficiency level. On the
other hand, efficiency can also be improved through better budget disbursement by
streamlining the bureaucratic chain and increasing accountability.

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Fig. 1  Decreasing function of the optimal size of government with respect to efficiency

Conclusions

International Monetary Fund (IMF) fiscal adjustment programs, which are in

place in many developing countries, have created a heated debate in the field of
fiscal policy. These programs often rely heavily on public investment cuts that
may improve current government cash flows but at the expense of future eco-
nomic growth (Ley, 2009). Another important issue related to the government
budget is the efficiency of government expenditure. Small changes in the efficient
use of resources can have major impacts on developing countries’ gross domes-
tic product (GDP) and attainment of government objectives (Gupta et al., 2014).
There have been many studies on the relationship between public expenditure and
economic growth, but only a few of them explicitly link government efficiency
to macroeconomic performance. The present study aims to contribute to the cur-
rent body of literature by considering both efficiency and optimal size in examin-
ing the relationship between government expenditure and economic growth. First,
we assess public sector efficiency over the period 2000–2018 using data envelop-
ment analysis (DEA). Second, we examine the impact of public sector efficiency
on economic growth by applying a generalized method of moments (GMM). The
empirical results show that rising government expenditure has a negative impact
on economic growth. Nevertheless, the combined effect of government expendi-
ture and public sector efficiency enhances economic growth significantly. Moreo-
ver, the results indicate that the optimal government size exists only above a cer-
tain efficiency threshold for which the optimal size is a decreasing function of the
efficiency scores.

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 Journal of the Knowledge Economy

Our findings suggest that improving efficiency will reduce the optimal govern-
ment size required to maximize growth. Understandably, when a government spends
its resources toward the right purposes and in an efficient manner, the amount
required to maximize growth will be smaller. Thus, as policy implications, it seems
important that governments of developing countries, when considering economic
growth, pay attention not only to their budget sizes but also to what to spend their
budgets and how to spend them. Improving expenditure efficiency can help alleviate
the fiscal deficit that is often experienced by developing countries.
We would like to note, however, that the results of this study should be taken as
indicative rather than definitive, owing to the limitation arising from the method of
developing the efficiency scores. Using a non-parametrical approach provides little
choice in terms of statistical assessment. Furthermore, as sample choice may differ
from one study to another, the efficiency score should only be considered as a rela-
tive measurement.

Appendix 1. List of countries

Pays Code

Afghanistan AFG
Afrique du sud AFS
Argentine ARG​
Bahamas BHM
Belize BLZ
Benin BNN
Bangladesh BAG
Barbados BAD
Botswana BTS
Bolivia BLV
Bhutan BHT
Brazil BZL
Burkina Faso BFS
Cambodia CMD
Cameroun CRN
Chile CHL
Chine CHN
Congo CGO
Comoros CMR
Colombie CLB
Cote d’ivoire CIV
Costa Rica CRC​
Dominican Rep DRP
Domonica DMC
Ecuador EDR

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Journal of the Knowledge Economy

Pays Code
El Salvador SLV
Equatorial Guinea EGN
Ethiopie ETH
Fiji FJI
Gambie GBE
Guatemala GTM
Guinea GNA
Guyana GYN
Honduras HDR
Inde IND
Jamaique JMQ
Indonesie IND
Korea KRA
Kenya KNY
Lesotho LSO
Liberia LBR
Madagascar MDG
Malawi MWI
Malaysia MYS
Maldives MDV
Mexique MXQ
Mauritus MTS
Mali MLI
Mongolia MNG
Myanmar MYR
Mozambique MZM
Népal NPL
Niger NGR
Nicaragua NIG
Nigeria NGA
Peru PER
Panama PNM
Paraguay PRG
Pakistan PKT
Philippines PHL
Rwanda RWD
Singapore SIN
Sénégal SNG
Soloman Island SLD
Sri-Lanka SLK
Swaziland SZD
Tunisie TUN
Thailand TLD

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 Journal of the Knowledge Economy

Pays Code
Tonga TNG
Trinid and Tobaggo TTG​
Togo TGO
Uruguay URG​
Venezuela VNZ
Vietnam VNM
Zimbabwe ZWE

Appendix 2. Efficiency and optimal size in developing countries

during the period 2000‑2018

Pays Efficiency score Government size (%GDP) Opti-

mal size
(%GDP)

BHM 1 10,576 13,5

BEL 1 11,586 13,5
SLV 1 15,054 13,5
GYN 1 22,107 13,5
KOR 1 17,439 13,5
MEX 1 19,605 13,5
MNG 1 15,97 13,5
MYR 1 20,7 13,5
PER 1 12,76 13,5
SLD 1 18,411 13,5
SLK 1 14,065 13,5
PNM 1 13,413 13,5
DRP 1 16,36 13,5
MLD 1 13,437 13,5
BZL 0,961 19,965 14,932
AFG 0,958 16,025 14,813
DRP 0,984 16,213 13,997
AFG 0,963 16,36 14,599
BZL 0,961 19,965 14,682
MLD 0,958 16,025 14,813
FJI 0,954 16,865 15,003
AFS 0,949 14,74 15,267
ARG​ 0,942 14,957 15,703
IND 0,94 17,51 15,844
BHT 0,935 13,091 16,288
BAD 0,917 20,391 18,529

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Journal of the Knowledge Economy

Pays Efficiency score Government size (%GDP) Opti-

mal size
(%GDP)
MYS 0,923 16,791 17,288
EDR 0,905 15,7 20,204
NPL 0,9 16,805 21,524
TUN 0,88 18,677 25,811
DMC 0,874 13,065 25,297
HDR 0,864 14,713 23,7
SNG 0,648 10,015
TNG 0,743 17,616
ZWE 0,740 5,948
CHN 0,736 14,895
JMQ 0,726 13,018
URG​ 0,726 11,850
PHL 0,624 10,895
IND 0,622 11,543
GBE 0,616 14,057
BTS 0,613 24,912
MZM 0,604 9,729
VNZ 0,601 10,628
MDG 0,600 8,157
NIG 0,697 14,479
TTG​ 0,597 11,208
CMR 0,594 18,169
PKT 0,589 19,178
LBR 0,486 15,259
CRC​ 0,477 13,610
LSO 0,465 35,181
CHL 0,460 11,225
MLI 0,459 11,378
CMD 0,455 5,092
TGO 0,455 11,751
CIV 0,444 10,406
SNG 0,438 14,109
NGR 0,420 13,694
MTS 0,420 14,052
SZD 0,410 16,992
GNA 0,400 7,870
HDR 0,399 12,075
EGN 0,398 15,822
MWI 0,394 15,604
BLV 0,391 14,278
CRN 0,386 10,384
NGR 0,386 17,000

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 Journal of the Knowledge Economy

Pays Efficiency score Government size (%GDP) Opti-

mal size
(%GDP)
GTM 0,374 6,970
TLD 0,273 15,529
RWD 0,279 12,522
BFS 0,275 19,444
PRG 0,261 9,969
BNN 0,250 11,379
CGO 0,247 16,904

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