Unproductive Public Expenditures
A Pragmatic Approach To Policy Analysis

Public Expenditure Productivity: Illustrative Analyses

Increasing public expenditure productivity can yield large returns in terms of budgetary savings, reduced negative externalities, and increased direct benefits. Although difficult, it is possible for governments to take steps to this end. Governments can improve the data base and use more systematic--but pragmatic--analysis to increase public expenditure productivity.

This section discusses a practical approach for assessing public expenditure productivity and illustrates the analysis of public expenditure productivity for major expenditure categories. The list of expenditure components is not meant to be exhaustive but to illustrate the range of issues that might arise. With each example, plausible primary objectives of public programs are identified; possible criteria to assess the feasibility of achieving the objectives are suggested; the feasibility of alternative ways to achieve the objectives is assessed; and finally, possible ways to identify inefficient programs are indicated.

The discussion is intended to illustrate a framework that can be helpful for assessing public expenditure policy within each country's process of choosing expenditure priorities.8

Overview of an Approach

Cost-effectiveness

Economic policymakers can and should examine the cost-effectiveness of major programs or projects. At times, glaring inefficiencies, such as ghost employees or vastly underutilized infrastructure requiring large operational costs, can be easily recognized without elaborate analysis.

Unproductive expenditures may emerge because of the ambiguity and multiplicity of outputs and objectives. It is necessary, therefore, to identify each program's primary--separate from its less important--outputs or objectives. For example, the primary objective of college education programs is the provision of higher education rather than providing a sort of employment for college-age youths. The primary objective of military research is improving national security rather than discovering new technologies for industrial use. Secondary objectives may be important, but aiming at the cost-effective fulfillment of the primary objective may yield more than enough savings to achieve secondary objectives in a similar manner.

The appropriate mix of inputs is a technical as well as an economic issue. The analysis of this issue often involves key technical relationships. For instance, a shortage of medicine or nurses relative to doctors may imply inefficient health expenditures. A shortage of textbooks relative to teachers is an indication of ineffective education programs. Generals without adequate numbers of enlisted soldiers are an indication of ineffective military expenditures; and roads without adequate provision of operations and maintenance are an indication of inefficient infrastructure expenditure.

The performance of the private sector in providing certain goods and services can suggest a useful benchmark for assessing the efficiency of public expenditures. Public programs that could be implemented more efficiently by the private sector in a competitive environment, such as the production, processing, and distribution of many consumer goods currently controlled by the state in the former Soviet Union countries and some Middle Eastern countries, would be obvious candidates for privatization.9

In assessing the efficiency of expenditures, it is often useful to analyze the empirical data comparing main output indicators or their proxies with certain input or cost indicators. Educational attainment indicators, such as literacy rates, standardized test scores of students, and school enrollment ratios, can be compared with relevant measures of expenditure on education. Studies analyzing these data demonstrate that certain inputs (for example, teacher experience, textbooks, homework, and length of school year) have a positive effect on student achievement; however, these studies have not been able to identify the relative productivity of different inputs.10 High teacher-student ratios, in the absence of high educational attainment, can also indicate inefficiency.11 Similarly, the infant mortality rate or life expectancy may be compared with health expenditures, and linkages between health indicators and certain types of health outlays can be assessed. For example, utilization of community and family-planning clinics appears to promote infant health.12 Indicators are also compiled in some countries for such output indicators as military capabilities or crime prevention, which can be compared with expenditures on defense or public order to assess the productivity of these outlays. Gore (1993) describes the efforts of a U.S. city to make public sector objectives transparent and to quantify public sector outputs.

Prices of inputs should be correctly valued. When input prices are administratively controlled, proper shadow prices reflecting opportunity costs should be used. Government guarantees, including those for lending, borrowing, and exchange rates, should also be priced on an economically sound basis to avoid distorting the pattern of private sector risk taking and placing an undue burden on future budgets.13

Appropriate mix of outputs and level of aggregate expenditure

Cost-benefit analysis often provides a basis on which policymakers can determine the mix of outputs or benefits. For those expenditures for which benefits can be quantified and compared with one another, reallocating expenditures from those programs yielding smaller additional benefits to those yielding larger additional benefits will increase total benefits. In designing an investment program, it is important to rank possible investment projects in accordance with their discounted net present values and to choose the highest-yielding projects. At times, however, even where adequate data are available, appropriate analytical tools--for example, social cost-benefit analysis--are not systematically applied. In other circumstances, available information is not collected or made use of in formulating policy advice.14

In some cases, an inappropriate output mix can be identified (for example, high-technology urban hospitals in the absence of rural clinics, or high levels of expenditure on university education in the presence of increasing illiteracy rates). In many cases, however, the benefits associated with various expenditures can be neither quantified nor compared. Value judgments are unavoidable, and the domestic political process inevitably plays a paramount role.

To be successful, the political process that determines the mix of public sector outputs should be supported by the economic analysis of policy options and their implications. A clear assessment of opportunity costs is essential. For example, in determining the appropriate size of military expenditure, it is essential to analyze not only the level of benefits that such expenditure brings about but also possible trade-offs of benefits resulting from reallocating a certain amount of military expenditure to a development project, a social program, or deficit reduction.

An analysis of the macroeconomic and structural implications of expenditure policies is necessary to assess trade-offs properly. In particular, it is useful to assess the short- and longer-run effects of public expenditure programs on aggregate demand, resource allocation, and external balances, because the analysis of expenditure programs for each sector does not usually take into account the implications of the overall resource envelope under which a country is likely to operate over the medium term. It is difficult for a sector-oriented analysis to assess the "appropriateness" of a project in isolation--even if its efficiency is assured.

The aggregate resource constraint that a country faces may require it to reduce the level of public expenditure when government revenue falls or when available financing dwindles or becomes more expensive. In this case, efficient and sustainable expenditure adjustment will likely require differential reductions in various expenditure categories. If, for example, a fall in revenue occurs that was not fully anticipated at the time that a public expenditure review was made, the desired expenditure pattern indicated in that review may need to be revised. Cutting obvious waste should be the first step in reducing expenditure. Public expenditure cuts are often more sustainable when public sector employment is reduced than when pay is compressed (Tanzi (1990)). In Tanzania, for example, a decline in the average purchasing power of civil service salaries to one fifth of their 1970 level by the end-1980s was reported to have resulted in a serious fall in public service morale, motivation, and discipline. This, in turn, led to high levels of absenteeism, frustration, and corruption, compromising the quality of public services (World Bank (1994b)). To be sustainable, expenditure cuts need to emphasize the protection of key public investment programs, in particular, those aimed at promoting external adjustment and growth, as well as social expenditures targeted to the poor. In fact, when available resources fall, the targeting may have to become more pointed, that is, the definition of the target group or the beneficiaries of government social programs may have to become more restrictive.

Output mix, expenditure composition, and value judgments

Because of the difficulties involved in valuing public sector outputs and measuring the efficiency of their production, the empirical analysis of public expenditures often assumes that changes in the composition of functional expenditure suggest changes in the public sector output mix. Moreover, there is a tendency to characterize changes in the composition of expenditure as solely a normative issue.

This tendency is detrimental to the analysis of public expenditure productivity. A change in expenditure composition is not synonymous with a change in the output mix if an increase in the productivity of a public program brings about a reduction in cost, but not output. In this case, a change in expenditure composition is an efficiency issue that does not necessarily involve value judgments.

Institutional and political considerations

In some cases, institutional arrangements can point, indirectly, to inefficient programs--for example, when budgetary control, the procurement system, project management, or auditing procedures are deficient.15 Also, state enterprises often can exercise considerable influence on budgetary allocations for enterprise transfers; many transition economies maintain budgetary transfers or subsidized credit to loss-making enterprises. These shortcomings can facilitate the emergence of unproductive expenditures, but their removal may be far from easy for political reasons. Frequently, powerful vested interest groups profit from such expenditures and lobby strongly against their elimination.16 It is therefore much more difficult politically (although more efficient economically) to reduce overemployment in the public sector than to reduce spending on textbooks or hospital supplies. A careful identification of the winners and losers of an expenditure reallocation, coupled with the implementation of a well-targeted compensation scheme, can significantly enhance the political feasibility of reducing unproductive expenditures.

The expenditures of central banks (through their quasi-fiscal activities) or extrabudgetary funds can be a source of unproductive outlays that is often less than transparent to policymakers. Such expenditures can take the form of inefficient and inequitable social security programs, the allocation of below-market credit to certain enterprises, or the provision of foreign exchange at below-market rates to certain users, which generate not only huge implicit subsidies but also, in some instances, large financial losses for central banks. Every effort should be made to make these expenditures and activities transparent, so that the costs and benefits of these activities can be readily assessed.

In a democratic political process with institutions promoting good governance, a well-informed public may help set appropriate public expenditure priorities by fostering public participation in the assessment of alternative goals and the exploration of cost-effective strategies to achieve established goals, as well as by maintaining the accountability of the government.

Importance of data

Proper analysis, policy design, and policy implementation require extensive data. Proper expenditure data should include data on detailed functional expenditure components, including the administration of justice, national defense, and major economic and social services, such as agricultural services, primary education, and primary health care, with each of these components broken down to show their major economic components, such as wages, other current expenditures, and capital outlays. These data should cover all public entities, including central and local governments and other public sector institutions, and should be collected in a timely fashion.

Analyses of Economic Components

Public sector employment and wages

During 198390, the central government wage bill in a sample of high-income, middle-income, and low-income countries accounted for, on average, 3.7 percent, 5.5 percent, and 2.5 percent of GDP, respectively, and 11.9 percent, 21.2 percent, and 11.5 percent of central government expenditure (see Appendix, Table A1).17 The policy implications of public sector employment and wages depend upon the particular circumstances of individual countries; however, several general issues may be considered.

Public employment represents only one input into the production of public goods and services. While in some cases a high degree of capital intensity in the face of abundant labor and high unemployment may be a sign of inefficiency, in others high public sector employment may be indicative of overstaffing. Maintaining a large number of public sector employees on the grounds of social protection can result in a low (or even negative) marginal product of labor for a large portion of the public sector work force. In these cases, it may be more efficient to utilize the least-cost input mix at appropriate input prices and implement a separate social protection program.18 In some circumstances, employment can become relatively excessive because of increasing shortages of other inputs (for example, medicine or textbooks), resulting in low labor productivity in the public sector. Additional public sector employment will not necessarily substitute for other inputs--it can, for instance, imply additional expenses for office space, vehicles, and support staff. Moreover, it is often easy to underestimate labor costs when wages are supplemented by in-kind entitlements, such as travel and housing allowances and privileged access to free or subsidized goods or services.

The use of a blanket prescription to reduce expenditures, such as an across-the-board reduction in public sector wage rates, may not always be appropriate. It is also often unproductive to maintain, for the sake of equity, uncompetitively low public sector wages, particularly for skilled managerial and professional staff, and inadequate wage differentials in the public sector. The results could be absenteeism, low morale, corruption, or the inability to attract qualified personnel, thus contributing to an inefficient provision of public goods. In Peru, for example, two major factors have contributed to the decline in the quality of education--a fall in real salaries of teachers and a reduction in the salary gap between professional teachers (those with a degree in education) and nonprofessional teachers to only about 20 percent. As a result of these factors, the percentage of professional teachers in public schools fell from 80 percent in 1980 to only 49 percent in 1990 (World Bank (1994e)). However, it should also be noted that wage differentials, in the absence of good governance, can be a strong incentive for nepotism and thus inefficiency. Reform in this area could include cuts in unproductive employment, coupled with a rise in real wages for the remaining productive employees.

The experience in Ghana provides a good example of the benefits of streamlining public sector employment and improving the competitiveness of compensation while increasing public sector productivity. The 1970s and early 1980s in Ghana were characterized by the rapid growth of public employment and dramatic declines in productivity and real wages; by 1983, real monthly earnings were less than 11 percent of their 1975 level. The result was an overstaffed, poorly trained, and unmotivated civil service. Civil service reform, in the context of a program supported by the IMF's enhanced structural adjustment facility and a World Bank structural adjustment loan, was aimed at reducing overall staff levels while improving the competitiveness of civil service pay, particularly at higher levels, and providing training and incentives for increased productivity (see Kapur and others (1991) and Mackenzie and Schiff (1991)).19 While reforms such as these may not greatly reduce a government's wage bill, they can lead to efficiency gains and productivity spillovers. In fact, public sector retrenchment with severance pay and other social safety nets can increase public expenditures in the short run, while reducing public expenditure in the long run.

Subsidies and transfers

Central government subsidies and transfers include those to local governments, public and private enterprises, and households. Social security payments and producer and consumer subsidies, in particular for high-income countries, account for the bulk of the subsidies and transfers. During 198390, central government subsidy and transfer payments accounted for a large share of GDP and total government expenditure--17.1 percent, 7.2 percent, and 5.5 percent of GDP; and 54.5 percent, 27.1 percent, and 25.2 percent of total expenditure, respectively, in a sample of high-income, middle-income, and low-income countries (Appendix, Table A1).20 Subsidies and transfers are prevalent in all countries.

Subsidies and transfers are justified on a number of grounds: to offset market failure, exploit economies of scale in production, redistribute income, and alleviate poverty. In many countries, however, subsidies and transfers do not achieve their objectives efficiently. Only a small part of the subsidies and transfers aimed at alleviating poverty actually benefit the poor. For some transfers, this is inevitable--pensions, for example, are usually designed to benefit those who have joined the scheme regardless of their preretirement incomes. To a significant degree, however, there is unintended waste. Producer subsidies on tradable goods not only raise questions about both their efficiency and equity implications but also have negative international externalities, as they might induce retaliatory actions by competitor countries. In many cases, the analysis of subsidies is difficult because their provision is not transparent; subsidies are sometimes financed by the implicit taxation of producers (for example, through controlled producer prices) or by the banking system (for example, through low-interest-rate loans to producers).

In the case of generalized food subsidies, the stated primary objective is often to enhance the nutritional status of the poor. Therefore, it is not unreasonable to expect that food subsidies would be targeted to the poorest segment of the population, for example, the poorest 20 percent. A typical open-ended general subsidy, however, tends to provide greater absolute benefits to the rich than to the poor, as the former usually consume more than the latter do for most goods.

Moreover, low food prices encourage wasteful consumption (for example, the use of food to feed livestock). Where general subsidies are supported by low producer prices in order to minimize budgetary outlays, these prices discourage domestic production, thus adversely affecting the external balance. In several countries in the Middle East and North Africa, for example, the incidence of food subsidies to the poorest quintile is as low as 3 percent of total food subsidy expenditure, and it rarely exceeds 20 percent. A study of the incidence of bread, mutton, rice, and sugar subsidies in Jordan suggests that in 1987 the ratio of the benefits for the richest quintile to those for the poorest ranged between 1.5 and 17.4, while the share of total benefits going to the poorest quintile was between 3 percent and 16 percent. The Jordanian authorities have been making efforts to improve the efficiency of food subsidies and have successfully introduced a number of measures to improve targeting (Ahmad (1991)).

Subsidy reforms should go hand in hand with pricing reforms. Both producer and consumer prices should be liberalized. Providing higher producer prices while maintaining low consumer prices may lead to a positive producer response, but it would imply a larger budgetary expenditure on consumer subsidies.

Enhanced targeting would allow the government to support the poor at the same level at lower cost, thus freeing resources for other programs for the poor or for other public or private uses. Unfortunately, attempting to reform subsidies through excessive targeting may be counterproductive in the short run in many countries--not only because such targeting is not feasible administratively but also because reducing or eliminating the benefits for middle-income groups may elicit strong political opposition to the subsidy reform and even to overall economic reform.

It may be possible to improve benefit incidence in a number of more limited ways. For example, in the absence of sufficient administrative capacity for means testing, countries could limit commodity subsidies by restricting the level of subsidized consumption of essential commodities to particular groups of households regardless of their income, such as pensioners, unemployed workers, and families with children. Administratively, such a system could be designed to operate without interfering significantly with a competitive market for the relevant commodity. A key question is whether such systems are feasible at a reasonable cost. While attractive as a transitory measure when relative price changes are large, these arrangements entail significant administrative costs. Therefore, it is important to phase them out as the transition to market arrangements proceeds and as permanent social protection mechanisms, including pensions, child allowances, unemployment insurance, and local social assistance, are introduced.

Another attractive option for protecting low-income groups at minimal administrative cost is public works programs, in which low wages act as a self-targeting mechanism. In any event, there are often alternatives that protect the poor at a lower cost than generalized subsidies and are consistent with sustainable economic reform.

Political opposition to targeting may be reduced by designing a reform program that enlists broad public support by spreading the burden of adjustment widely while protecting the poor, rather than requiring any one social group, even if it is a high-income group, to bear a large burden of adjustment. Recent experiences suggest that the elimination of severe shortages following the liberalization of prices mitigates the adverse effects of higher prices. Again, the immediate removal of all subsidies may prove counterproductive in many environments, and it is important to be aware of alternative adjustment patterns and social safety nets that might be essential to underpin economic reform efforts.

Producer subsidies for competing countries' traded goods can increase the aggregate amount of such subsidies globally above the level that would prevail in the absence of trade. In this case, as in the case of military expenditure, a coordinated reduction in subsidies may result in no loss of global welfare, and even in gains in efficiency.

In many countries, there is a need for permanent insurance-based social security programs, including pensions and unemployment benefits. When such programs are introduced, substantial surpluses are often generated in early years. This promotes the proliferation of benefits and the "backdoor" financing of the budget deficit by requiring the funds to hold government paper at below-market prices, as well as other forms of inefficient investment. However, growing expenditures on the contingent liabilities have to be met in the future--for example, in connection with the aging of the population. As the value of reserves has in many countries dwindled and vanished, there is often a substantial call on budgetary resources (for example, in several Latin American countries).

Public investment

In many developing countries, public investment accounts for a large proportion of total expenditure, reflecting the role of the government in providing infrastructure--for example, in transportation, communications, and energy. During 198390, central government capital outlays accounted for 1.8 percent, 3.8 percent, and 4.3 percent of GDP, respectively, for a sample of high-income, middle-income, and low-income countries, and for 5.7 percent, 14.5 percent, and 19.9 percent of total expenditure, respectively, for the same three country groups (Appendix, Table A1).21 To the extent that such projects increase the supply of public goods, the involvement of the government may be worthwhile. However, some public investment is commercial in nature and may directly compete with, or crowd out, more efficient private sector activity. Other investments by the government may provide a low social rate of return.

In evaluating investment activities, governments should follow sound economic analysis, including, where feasible, the principles of cost-benefit analysis, and undertake only those projects with a positive net social present value. The experience of Madagascar illustrates the possibility of using economic analysis to increase the efficiency of public investment. A three-year public investment program stressing an improvement in infrastructure and overall project quality was put in place in 1989. A task force was established to monitor public investment systematically, and a trigger mechanism was put in place to reduce the public investment program in midstream should expenditures lag behind expectations. This mechanism led to a downscaling of the original program after six months, with the core projects maintained (Miranda (1991)).

Cost-benefit analysis may also be useful in evaluating public expenditure policy more generally.22 However, using cost-benefit analysis will often raise complex measurement and valuation problems. Owing to these difficulties, it is perhaps wise to employ cost-benefit analysis systematically for selected public programs and for the broad expenditure composition only as a framework for informed debate on policy alternatives, rather than as a mechanical tool for providing precise answers.

Public investment is an area in which, even without careful cost-benefit analyses, one can find extreme examples of white elephants. Moreover, in countries where aggregate public investment does not seem to contribute significantly to economic growth, inefficiency may be widespread.23 While public investment is often undertaken to meet legitimate objectives, such as the provision of infrastructure, it is sometimes implemented in costly and inefficient ways. Other seemingly viable investments may turn out to be inefficient, owing to poor coordination between projects (for example, a road leading to an industrial complex that is never developed). In some other cases, the productivity of existing public capital deteriorates either because of insufficient maintenance or because qualified manpower does not exist for public operations.24 The allocation for recurrent expenditures in the 1993/94 road budget for Ethiopia, for example, was less than half of what would be needed for regular maintenance and rehabilitation. Partly as a result of poor maintenance in the past, approximately 65 percent of the road network in Ethiopia can be classified as poor, and only 10 percent as good (World Bank (1994d)).

Analyses of Functional Components

Nutrition, health, and education

The resource implications of nutrition, health, and education programs are large. During 198390, central government expenditures on health and education accounted for 3.3 percent and 1.7 percent of GDP, respectively, for a sample of 80 countries (Appendix, Table A1). Combined outlays of the general government on health and education for a smaller number of sample countries were almost 10 percent of GDP (Appendix, Table A2).

It is conventional wisdom that public expenditure on nutrition, health, and education is relatively productive not only because of its direct impact on well-being but also because of its investment aspect, that is, its beneficial effect on the development of human capital. These outlays provide direct benefits to individual recipients and may provide indirect benefits to society as a whole.25 The efficiency of government nutrition, health, and education programs, which is a universally critical issue, varies widely across countries. From an economic perspective, a primary objective of these programs is to enhance the productive capacity of human resources. Low-income countries, in particular, have a large need for expenditures on health.26 The efficiency of these programs requires a proper mix, taking into account the complementarity of, as well as substitutability between, nutrition, health, and education programs. For example, enhanced nutrition and health can complement education programs by ensuring that students are healthy enough to attend class. At the same time, enhanced hygienic education can to some extent reduce the need for nutrition and health programs.27

The intrasectoral program mix should also be examined. In general, costly university education programs in the presence of very low primary and secondary school enrollment ratios are relatively unproductive. While such a situation may indicate that a reallocation of education expenditures is in order, it should be recognized that the expansion of primary or secondary education will increase the demand for some of the products of university education, such as qualified teachers. A recent World Bank study of Tanzania noted that the opportunity cost of sending 1 student to university was not sending 238 students to primary school. A reallocation of expenditures from university education to primary education could therefore yield vastly increased benefits and prevent a further increase in the illiteracy rate. According to official estimates, illiteracy rates in Tanzania increased from 10 percent in 1986 to 16 percent in 1992 (World Bank (1994b)).

In some cases, user charges, judiciously applied, can improve the efficiency of public programs. The recent experience of Kenya illustrates this point. Higher education has been highly subsidized through interest-free loans and low tuition and charges. As a result, the higher-education sector has deprived other levels of education of needed funds. Beginning in 1991/92, in the context of a program supported by the IMF's enhanced structural adjustment facility, tuition and fees were raised and student loans were reduced; in addition, enrollment was to be limited to 10,000, compared with 21,500 in the previous year, and was to increase by no more than 3 percent a year. The Government sought to mitigate the impact on the poor of the higher user charges by granting targeted scholarships and loans.

Similarly, research has shown that the rate of return on preventive health care is particularly high and that the costs incurred per patient are typically low. By definition, per patient costs of large hospitals are higher than per patient costs for primary health care. This points to the need to assess carefully the needs of preventive health care relative to available curative facilities, and the mix of both types of facilities.28

Several indicators can provide useful clues of inefficiency in social programs. For example, imbalances between categories of current expenditures, such as a declining share for school books or operations and maintenance relative to historical or international averages, may indicate inefficiencies. In Sierra Leone, for instance, the eightfold reduction in recurrent health expenditures per capita in real terms between 1980/81 and 1992/93-causing a near breakdown of essential government health services--was cited as an indicator of inefficient expenditure allocations (see World Bank (1994a)). In Sierra Leone, during the 1980s, the imbalance between expenditures on wages and salaries and other goods and services resulted in a lack of supplies for clinics, and over 80 percent of the education sector budget for recurrent expenditures was allocated for staff salaries and allowances, leaving hardly anything for textbooks or other instructional materials (World Bank (1994a)). In Ethiopia, many health care facilities would have had no drugs to dispense in 1991/92, in the absence of support from the international community, and 98.9 percent of the budget for primary education was allocated for salaries (World Bank (1994d)).

Underutilization of existing facilities often points to inefficiency. In Ethiopia, government health facilities in the late 1980s and early 1990s recorded only about 0.25 visits per person a year, compared with 2.5 to 3 visits per person a year in Tanzania, Kenya, and Zimbabwe (World Bank (1994d)). In Lithuania, many schools are operating below capacity; the number of vocational and college students per schools fell from an average of 460 and 720, respectively, in 1990, to 280 and 330 in 1993 (World Bank (1994c)).

Military expenditure

Military expenditure that is excessive--in the sense that the marginal improvement in national security associated with this expenditure is less than its economic cost--imposes burdens on both the spending country and other countries that believe their own security may be jeopardized by such expenditure. The issue is sensitive and difficult because it involves national security and because the measurement of national security is problematic.

From the perspective of an individual country, national security is a public good. However, considerable gains for both individual countries and the world community at large could emerge from a coordinated multilateral reduction in resources devoted to the military. No loss of national or international security need occur, provided, of course, that the uniformity of implementation could--which does not necessarily imply equal spending cuts--be defined and verified. This is in sharp contrast to the global impact of many other types of public sector expenditures, for example, health care and education.

The importance of these issues is highlighted by the scale of global resources devoted to military spending. Estimates of world military spending in 1988, for example, range from $850 billion to $1,000 billion, some 4.5 percent to 5 percent of world GDP.29 Of the total, industrial countries accounted for about 60 percent, equivalent to almost 4 percent of their GDP; and Eastern Europe (including the former Soviet Union) accounted for almost 25 percent, equivalent to some 10 percent of its GDP. There are considerable regional variations among developing countries; Middle Eastern and North African countries are estimated to have devoted some $66 billion to military spending in 1988 (8.1 percent of GDP), whereas Western Hemisphere countries spent $17 billion (2.1 percent of GDP). On average, the proportion of national income devoted to the military by sub-Saharan African and Asian countries was broadly comparable to that of industrial countries, although here, too, there was considerable variation among individual countries.

While military expenditure is a unique category because national defense, or national security, is difficult to evaluate objectively, an explicit analysis of the economic implications of alternative levels of military expenditure would be an important input to the political process involved in determining the composition of public expenditure. Some aspects of the production of national defense can be subjected to economic analysis. For instance, a decline in the ratio of material expenses to the wage bill could indicate an increasing number of soldiers without proper equipment. Alternatively, such a decline could indicate a reduction in underutilized equipment.


8 For a discussion of specific steps suggested for improving public expenditure productivity in the United States, see Gore (1993). In particular, Chapter 4 suggests specific actions to eliminate unnecessary programs, to invest in greater productivity, and to cut costs by redesigning programs, as well as to price public services appropriately.
9 Empirical studies have confirmed, in particular, the importance of competition in ensuring efficiency. For a recent summary of empirical evidence on ownership, competition, and efficiency, see Vickers and Yarrow (1991).
10 See Summers and Wolfe (1977), Alexander and Simmons (1978), Heyneman and Loxley (1983), Fuller (1987), and Haddad and others (1990).
11 See the World Bank public expenditure reviews for Tanzania (World Bank (1994b)) and Ethiopia (World Bank (1994d)).
12 See Corman, Joyce, and Grossman (1987).
13 Such outlays are widespread in all economies. The savings and loans crisis in the United States provides an example of the possible consequences of government guarantees.
14 While household data sets are increasingly available, including those generated by the World Bank's social dimensions of adjustment program, as well as by living-standard measurement surveys and national household surveys, very few studies utilize this information to assess distributional concerns.
15 It is an open question whether federal systems are more efficient with respect to unproductive expenditure than more centralized systems. In principle, a federal system can be more efficient if local governments are (1) better able to identify (than the central government) the appropriate level of local expenditures, for example, through their better knowledge of local conditions; and (2) subject to financial discipline through political checks and balances of central government regulations.
16 Examples of the way in which political pressure slowed down the reform of cost-ineffective social security systems in Poland are discussed in Chapter 7 of Graham (1994).
17 General government data, while likely to show different patterns, are very limited in their coverage. See Appendix, Table A2.
18 Wage drift, owing to the use of public sector employment for social protection, was a major problem in many countries implementing programs supported by the IMF's structural adjustment and enhanced structural adjustment facilities (Nashashibi and others (1992)).
19 Sri Lanka and The Gambia have also achieved a major reduction in the size of the civil service (see Nashashibi and others (1992)).
20 The IMF's government finance statistics data for a sample of 68 countries indicate that subsidies and transfers increased between 1975 and 1990; this increase was most pronounced in industrial countries, where these expenditures increased from 18 percent to 22 percent of GDP.
21 Government capital outlays and public investment overlap but are not identical. The former include outlays on purchases of existing capital assets, which are not part of public investment.
22 For further discussions, see Posner (1977) and Drze and Stern (1987).
23 See, for example, Tanzi (1991) for a discussion of the experience in Asian countries, and IMF (1992) for a related discussion.
24 See Miranda (1991) for a discussion of cost-benefit analysis in general and Heller (1991) for a discussion of operations and maintenance expenditure.
25 For a recent discussion of the role of the public sector in human capital formation, macroeconomic adjustment, and growth, see Otani and Villanueva (1990), Blejer and Chu (1990), the World Bank (1990), and Tanzi and Chu (1992).
26 A sample of 18 low-income countries spent a relatively small amount on health at the central government level. For example, during 198390, health expenditure in low-income countries was only 0.4 percent of GDP and 2.2 percent of total central government expenditure--far less than military expenditure. This share is substantially lower than that of middle-income countries (Appendix, Table A1). By contrast, life expectancy is substantially shorter and mortality rates for children under the age of 5 are substantially higher in low-income than in middle-income countries. Limited general government data for a sample of 3 low-income countries do not alter the picture (Appendix, Table A2).
27 The positive correlation between schooling and good health is well documented. See Kenkel (1991) for a discussion of these linkages. The 1993 World Bank World Development Report also stresses the importance of the complementarity of health and education, in particular, the education of females in developing countries (World Bank (1993a)).
28 The World Health Organization's strategy for assuring health for all by the year 2000 is based on expanding primary health care, including adequate safe water and sanitary facilities, immunization, local health care, and care for pregnancy and childbirth (see World Health Organization (1986)). Comprehensive data on preventive and curative health care expenditure are unavailable; a survey of available data by the authors indicates, however, that, during 198390, in a sample of eight low-income countries with large rural populations, 62 percent of the central government health care budget was allocated for hospital services, compared with 38 percent for other public health services, including outlays on small clinics and preventive health care. This share is even lower than the share (45 percent) for middle-income countries surveyed.
29 Based on data compiled by the Stockholm International Peace Research Institute and the U.S. Arms Control and Disarmament Agency; comprehensive data from official sources are not available. The data for Eastern Europe (including the former Soviet Union) should be interpreted with particular caution, as the structure of relative prices differed markedly from that prevailing in western countries. See Hewitt (1991a) and (1991b) for more details. The data on which the analysis is based in this section differ from those reported in the appendix. For those countries included in the sample shown in the appendix, defense expenditures accounted for 4.4 percent, 2.0 percent, and 2.8 percent of GDP in high-income, middle-income, and low-income countries, respectively (Appendix, Table A1).

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