Analyzing Growth and Welfare Effects of Public Policies in Models of Endogenous Growth with Human Capital: Evidence from South Africa

Since the abolition of its Apartheid regime in 1994, South Africa has launched a massive program of education, which has been financed through resources representing on average 21% of the national budget or 7% of GDP. Today, the GDP share of public spending on education is 1.3 times the average of industrialized countries (5.4%) and almost twice that of developing countries (3.9%). In this paper, we simulate fiscal policy experiments to analyze the growth and welfare effects of a shift in the allocation of government expenditures between public spending on education and transfers as well as those of a change in the tax rate in a model of endogenous growth with human capital accumulation for the South African economy. The results of simulations demonstrate that a shift in the allocation of fiscal resources between educational spending and transfers does not affect the long run allocation decisions. In the transition, however, this shift generates a negative effect on the rate of growth of GDP. In fact, a reallocation of expenditures shifts resources away from saving and toward consumption, and translate into lower rate of growth but higher welfare. Nonetheless, these growth and welfare effects are very small. On the other hand, a tax cut generates growth effects in the long run as well as in transition. In fact, reducing or cutting the tax rate in the long run lowers the interest rate, which in turn creates disincentives for saving and results in low rate of growth of GDP. However, in the transition, it reduces or removes distortions and translates into high work effort, high accumulation of human capital, and thus high rate of growth of GDP. Nonetheless, its welfare effect is negative.