Government health spending and growth in a model of endogenous longevity

Rosa Aísa*

Fernando Pueyo

Economic Analysis Department.

University of Zaragoza (Spain)

Abstract: We present a model of endogenous longevity that results in a non-

monotonic effect of government spending on economic growth. The key element is the

effectiveness of publicly provided health care in enhancing life expectancy.

Keywords: Endogenous growth, endogenous longevity, government spending

JEL codes: 041, I18.

*Corresponding author: Rosa Aísa. Address: Dpto. de Análisis Económico. Facultad de Ciencias Económicas y

Empresariales, C/ Gran Vía 2, 50005 Zaragoza (Spain). Phone number: 34976761000 ext. 4650. E-mail address:

raisa@unizar.es.

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 1.- Introduction

Reinhart (1999) provided an interesting study of the effects of life expectancy and

government spending on economic growth. Reinhart’s analysis leads to the result that

longer lives are associated with faster economic growth whereas higher government

spending lowers growth for any life expectancy. This letter shows an alternative

discussion which captures the non-monotonic relationship between government size and

growth, according to Barro (1990), and furthermore, the non-monotonic relationship

between life expectancy and economic growth, in line with the recent empirical

evidence (e.g., Kelley and Schmidt, 1995 and Bhargava et al., 2001). We consider

government spending to be productive and, in particular, we focus on the role of public

expenditure devoted to health. More public health services can enhance life expectancy

levels (e.g., Lichtenberg, 2004), which can establish a positive linkage between

government spending and economic growth by affecting agents’ willingness to save.

This link may offset the negative effect of government spending on investment captured

in Reinhart’s model.

2. The model

Population. Let us assume that N individuals are born at time s, forming cohort s.

We introduce a cohort-specific mortality assuming that all the members of each cohort

face an identical instantaneous probability of dying at any moment ps, a probability

which remains constant throughout their lives (Blanchard, 1985), so the life expectancy

of any individual of cohort s is given by ps −1 . In such a context, the aggregate

population in t is given by:

Lt = −t ∞ Ne − p s ( t − s )ds . (1)

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 Consumers. Assuming that the instantaneous utility derived from consumption is

logarithmic, the expected utility of a member of cohort s can be represented as:

EU ( s ) = s∞ ln( c s ,t )e −( θ + ps )( t − s ) dt , (2)

where cs,t is the goods consumption in t of an individual born in s and ρ is the

intertemporal discount rate of the utility.

Since the probability of being alive in any future period diminishes, individuals

will then want to protect themselves against the risk of dying without having spent their

whole wealth. We assume, as in Blanchard (1985), a system in which competitive

insurance firms receive the wealth of individuals if they die in exchange for paying

them a rate ps on their wealth throughout their life span. This implies the following

budget constraint:

v s ,t = (rt + p s )v s ,t + wt − c s ,t − τ t , (3)

where vs,t denotes the wealth of each member of cohort s at time t, rt is the interest rate,

wt the wage rate and τt the lump-sum taxes levied by the government. A dot over any

variable indicates its variation in time: v = dv / dt .

Production. Following Reinhart (1999), we assume a simple AK technology:

Yt = AK t . (4)

The government purchases an amount Gt of final goods and the rest of the

production is devoted to consumption Ct and physical capital accumulation K t :

K t = Yt − Ct − Gt − δK t , (5)

where δ is the depreciation rate.

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Government. To emphasize the consideration of government spending as productive, we

focus on its role as a provider of health services. Furthermore, these public health

services influence the level of cohort-specific mortality. The higher the ratio of

government health expenditure over GDP, the lower the instantaneous probability of

death, so we assume that the instantaneous probability of dying is negatively related to

public expenditure in health as a percentage of the GDP, that is to say,

p s = f (G s / Ys ) = f ( g s / A) = p s ( g s ) , where g s = G / K , with dp s / dg s < 0 .

The government issues new debt at any moment in time as the difference between

expenditure plus interest on previous debt Bt , and taxes, Tt :

Bt = rBt + Gt − Tt . (6)

3. Long-run equilibrium

In the steady state C, K, Y, G, T and B grow at a common rate σ, whereas the

probability of dying, p, is constant over cohorts. Following Reinhart (1999), the optimal

choice of individual consumption determines the subsequent path of aggregate

consumption over time1:

C = [ A − δ − θ ] C − p( θ + p )W . (7)

where individuals’ wealth includes both physical capital and public bonds: W = K + B .

The system formed by equations (5), (6) and (7) determines the long-run dynamics of

the economy. If we define additional normalized variables c = C / K , b = B / K and

τ~ = T / K , the long-run equilibrium can then be characterized by the following

equations, equivalent to (7), (5) and (6), respectively:

1
We drop the time index in what follows.
3
Note that expressions (8) and (9) require the term A-δ to be higher than both θ and g in order to

have a positive growth rate.

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 C 1+b
σ= = A − δ − θ − p( g )[θ + p( g )] , (8)
C c

K
σ= = A − c − g −δ , (9)
K

B g τ~
σ= = A−δ + − , (10)
B b b

where p is given by p = p( g ) , with p´<0 .

We assume that the volume of debt and of public expenditures are the result of political

decisions on the part of the government. Equation (10) simply determines the evolution

required on taxes to sustain the desired volume of debt, whereas the first two equations

determine the ratio of consumption over capital c and the growth rate σ in the long run.

From (8) and (9) we can deduce the growth rate as a solution to the following equation:

ϕ ( σ ) = σ 2 − ( 2 A − 2δ − θ − g )σ + ( A − δ − θ )( A − δ − g ) − p( p + θ )( 1 + b ) = 0 .(11)

Function ϕ is a concave parabola that has a minimum at the point

σ = A − δ − ( θ + g ) / 2 > 0 3 . Although it has two positive roots, the higher root

exceeds A-δ, which is inconsistent with (9). Thus, the steady state growth rate is the

lower root of (11).

4. Effects of an increase in government spending

Given the politically determined amount of debt, the impact on function ϕ of an

increase in government spending is given by:

∂ϕ / ∂g = σ − ( A − δ − θ ) − (2 p + θ ) p ′( g ) . (12)

The effect of government spending is indeterminate because

σ − ( A − δ − θ ) = − p( p + θ )( 1 + b ) / c < 0 (from 8), whereas the last term in (12) is

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positive. We find that an increase in g moves the parabola up when the condition

− p ′( g ) > (σ − A + δ + θ ) /(2 p + θ ) holds, and down when it is verified with the

opposite sign. This result shows that government spending does not have a monotonic

relationship with economic growth, the sign depending on the degree of response of the

probability of dying to an increase in public health services. When the response is high

enough, a higher ratio of government spending leads to faster economic growth. In the

converse circumstances, government spending and growth rate are inversely related.

The explanation is that public expenditure has two opposite effects: on one hand,

by lengthening life (decreasing p), it reduces the impatience of consumers which, in

turn, promotes saving and thus encourages growth; on the other, the resources devoted

to health are to the detriment of capital accumulation, which reduces growth. The first

effect is probably predominant in developing countries, where life expectancy is short

and public spending is very effective against death4. So, an increase in government

health spending not only leads to a longer life but also to faster economic growth5.

Conversely, in developed countries, where life expectancy is high and hard to

increase with additional spending, further efforts in public health spending can have a

negative effect on growth. Logically, this last outcome coincides with the conclusion of

Reinhart6 (1999), who focuses on wasteful government spending without taking into

4
Bidani and Ravallion (1997) find that public health spending affects longevity more for the poor

than for the non-poor countries.

5
As discussed in Aísa and Pueyo (2004), this result is reinforced by the fact that a longer life

implies a larger workforce, which can also drive faster growth.

6
In Reinhart’s model, longer lives are always positively associated with economic growth rates.

However, in our model, longer lives could be associated negatively with growth rates.

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account the positive effect of productive public expenditure on enlarging life

expectancy.

4. Conclusions

Although, in general, the relationship between government spending and growth

is considered to be negative, we find a non-monotonic relationship when considering

public health spending specifically. The positive effect of public health expenditure on

life expectancy, saving and growth, when it is sufficiently intense, could offset the

effect of taking away resources from investment. This could be the situation in

developing countries and, in such a context, higher government health spending would

lead to faster growth. However, the standard negative relationship probably still holds in

developed countries.

References

Aísa, R. and F. Pueyo, 2004, Endogenous longevity, health and economic growth: a

slow growth for a longer life?, Economics Bulletin 9, 1-10.

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Barro, R. J., 1990, Government spending in a simple model of endogenous growth,

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Bhargava, A., D. T. Jamison, L .J. Lawrence and C. J. L. Murray, 2001, Modelling the

effects of health on economic growth, Journal of Health Economics 20, 423-440.

Bidani, B. and M. Ravallion, 1997, Decomposing social indicators using distributional

data, Journal of Econometrics 77, 125-139.

Blanchard, O., 1985, Debt, deficits and finite horizon, Journal of Political Economy 93,

223-247.

Kelley, A. and R. Schmidt, 1995, Aggregate population and economic growth

correlations: the role of components of demographic change, Demography 32,

543-555.

Lichtenberg, F. R., 2004, Sources of U.S. longevity increase, 1960-2001, The Quaterly

Review of Economics and Finance 44, 369-389.

Reinhart, V.R., 1999, Death and taxes: their implications for endogenous growth,

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