What is the optimum level of public spending in Ukraine? (press release)

Ukraine is in the top-10 countries with the highest share of public sector spending as a proportion of GDP. At the same time, the state’s institutional capacity to efficiently spend the country’s economic resources is low. A non-optimal level of public spending can annually reduce economic growth by 2.1-4.2 percentage points if the share of public spending in GDP stays at the level of 2010-14.

In the research “What is the optimum level of public spending in Ukraine?” experts from the Centre for Economic Strategy answer the question if the share of public spending in GDP is too high in Ukraine, provide quantitative indicators of optimum level of public spending in Ukraine, and analyze its effects on economic growth. This research will help to focus on more nuanced analysis of the categories of public spending and alternative policy proposals in further work.

The current level of public spending in Ukraine is high compared with other countries. Among 180 countries covered by the International Monetary Fund, Ukraine has the 9^th highest share of public sector spending in GDP.

The share of public sector spending in GDP in Ukraine compared with peer regions in 2014, %

Institutional capacity to effectively deploy economic resources through the public sector in Ukraine is limited. According to the World Governance Indicators by the World Bank Ukrainian standards of government effectiveness are 2.5-10 times behind developed economies, which have comparable level with Ukraine redistribution of GDP through public sector. The share of public spending in GDP is high in Ukraine, even though the share of the shadow economy in GDP is higher than in most other countries.

Economic theory shows that there is an optimum level of public spending in GDP. If public spending is above this level, it harms economic development and a low level of institutional capacity enhances this harm. According to econometric analysis by the Centre for Economic Strategy, an optimum level of public spending for Ukraine is 37 percent of GDP. 10 percentage points of deviation from this level can reduce economic growth by 2.1-4.2 percentage points. It is higher than the same effect for other European countries since the negative effect of high public spending in Ukraine on economic growth is enhanced by low institutional capacity.

The analysis of alternative approaches to public spending cuts and their influence on economic growth projections in 2016-2020 shows that the quickest possible reduction in public spending to 37 percent of GDP is the best approach. For example, immediate reduction of public spending to this level in 2016 would allow to accelerate average annual GDP growth in 2016-2020 by 1.2-1.8 percentage points compared with the current International Monetary Fund assessment. A more gradual approach, which provides a reduction of public spending to 37 percent of GDP over the period to 2020 can accelerate average annual growth by 0.5-0.9 percentage points. In other words, not implementing fast cuts of public spending will lead to a loss of additional 0.3-0.5 percentage points of real GDP growth per year.

“Blanket rejection of public spending cuts would act as an even more severe break on economic growth. In a one-year perspective a dramatic decrease in public sector spending as a share of GDP can have either negative or neutral impact on the economy depending on whether tax income and expenditures decrease simultaneously as well as on the effect on the aggregate demand of a decrease in particular categories of expenditures and taxes. At the same time, in a five-year timeframe we see a significant positive effect”, commented Pavlo Kukhta, adviser to the Centre for Economic Strategy.

For more detailed information about CES research on “What is the optimum level of public spending in Ukraine?” please contact Maria Repko, CES deputy director (tel.: +380 44 492-7970, office@ces.org.ua).