changes. In such scenario, it is possible to envisage that public spending may change the growth path, by affecting the production factors and/or TFP.

Empirically, the relationship between public spending and growth in support of either neoclassical or endogenous models has been difficult to establish for several reasons. A large part of the recent empirical literature on growth has examined the impact on growth of both the level and composition of government expenditures. Overall the evidence on the nature of this relationship is mixed. First of all, not all the public funds that appear in government budgets as having been spent were actually used according to budget allocations; any leakages or deviations from the original budget plan diminish the impact of public spending and distort its relationship with growth<sup>22</sup> .

Second, efficiency constraints affect the share of the public spending flows actually used in creating new capital (physical and human) stocks, which affect growth directly<sup>23</sup> . Thus, by considering the total amounts of public spending financed, without any efficiency considerations, we may anticipate a higher impact on growth than what can be realistically expected.

Third, while some public spending may be, by itself, growth-promoting, the way through which the government chooses to finance it (inflationary financing, distortionary taxes, public debt leading to high interest rates resulting in crowding out of private investment, etc.) may have the opposite influence on growth. Since the two effects are difficult to disentangle, the impact of public spending on growth depends on its source of financing<sup>24</sup> . Yet, many empirical studies fail to include the implicit financial assumptions, or revenue side of the equation, when testing for the impact of public spending on growth.

Fourth, since not all categories of public spending are expected to have the same growth impact, classifying them according to different criteria may be essential to differentiate those items that are truly “productive” from those whose growth impact is negligible. However, data availability does not always allow for such classification<sup>25</sup> .

> 22 Quantitative techniques such as Public Expenditure Tracking Surveys (PETS) that are being currently conducted in many developing countries show that the percentage of spending actually reaching the population is much lower than what was recorded in the budget as being spent, due to leakages and inadequate budget implementation.

> 23 This issue was raised by Pritchet in 1996 who reckoned that only about 50% of public investments flows in developing countries contribute to creating new capital stock (see Pritchet, 2000).  The idea has been further developed and tested by Hurlin and Arestoff, 2006.

> 24 In Barro’s (1990) model, growth increases with expenditures and taxation at low levels, and then decreases as the distortionary effects of taxation exceed the beneficial effects of public spending.  In addition, at higher levels of public spending inefficiency may increase.  That is the main conclusion of Afonso, Schuknecht, and Tanzi in reference to new EU members (forthcoming 2008).

25 While aggregated expenditures are easier to find on an annual basis for a relatively long period of time, not all the sectors report data every year and therefore functional classifications are not always possible. In addition, some countries have introduced recent changes in the budget nomenclature, which make sectoral comparisons less meaningful.

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