Iranian Economic Review, Vol.15, No.

27, Fall 2010

The Impact of Government Expenditure on GDP,

Employment and Private Investment a CGE Model
Approach
∗
Masoome Fouladi

Abstract

T he interaction of government expenditures with economic variables

has been the subject of long debates between pros and cons in all
major schools of Economics. According to Classical extremists,
government expenditure has no effect on GDP due to complete
crowding out between government expenditure and investment. This is
vehemently rejected by radical Keynesians that assert a fiscal expansion
policy affects GDP in full. In this paper we will study government
expenditure effects on GDP and employment by a CGE model. It will be
shown efficiency of government expenditure depends on kind of
expenditure. The present paper divides government expenditures into
two categories, consumption and investment expenditure. Also
investment expenditure has been studied in five sectors: agricultural, gas
and oil, construction, industry and mineral and service. The results
confirm that government expenditure influences on economy in different
ways, depends on types of costs. Increasing the government
consumption expenditure causes reduction in production, employment
and investment. Government investment expenditure has different
effects on economy that depends on which area they will be spent.
Keywords: Government expenditure, GDP, Employment, Investment,
CGE model.

1- Introduction
The government expenditures are amongst the most significant
instruments of fiscal policies. For this reason, the interaction of government
expenditures with economic variables has been the subject of long debates
between pros and cons in all major schools of Economics.

∗ Faculty of Economics, University of Tehran.

54/ The Impact of Government Expenditure On GDP, Employment….

According to Classical extremists, government expenditure has no

effect on GDP due to complete crowding out between government
expenditure and investment. This is vehemently rejected by radical
Keynesians that assert a fiscal expansion policy affects GDP in full.
Totally it expects an increase in government expenditure raises
aggregate demand. So when demand is more than supply in economy, prices
will increase and it makes a force for decreasing demand until economy
stand on equilibrium point.
On the other way, in labor market if labor demand depends on nominal
wags, demand function for labor is depend on nominal value of marginal
product of labor. So if prices increase, demand for labor will rise and we will
have an increase in nominal wages because of demand surplus. At least we
will be in new equilibrium point in labor market.
In addition, there is an other viewpoint about government expenditure
effects. If government expenditure acts as a complementary effect for private
investment, we can expect an increase in government expenditure will make
a growth in production and employment.
In this paper we will study government expenditure effects on GDP and
employment. The new opinion that will be studied here is efficiency of
government expenditure depends on kind of expenditure. The present
dissertation divides government expenditures into two categories,
consumption and investment expenditure, where the latter has been studied
in five sectors: agricultural, gas and oil, construction, industry and mineral
and service.

2-Methodology
We use a CGE models approach for studying government expenditure
effects.
Whereas variation of aggregate demand and labor demand are in
different markets, it seems using a systemic model that can show variation
and adjustment of applying a policy through a system, is more suitable.
Computable General Equilibrium Models (CGE) has been used
extensively since late 1970s as policy analyzing models. These models
which are so flexible, are deterministic and regarding Walras rule in
markets have great ability to include different economic issues .These
models are used in expansive range of policy concepts such as
 Fouladi, M. /55

choosing developing strategy, income distribution, trade policies,

structural changes, foreign shocks, tax policies and long run growth in
developed and developing countries.
The great advantage of the approach is that it lets economists to
investigate and analyze the effects of policy changes or exogenous
factors changes through the system which is connected to entire
economic sectors and the whole world. In comparison with
econometric models, the remarkable advantage of computable general
equilibrium models is their independence to time series data. In
addition, strong microeconomic frame work of computable general
equilibrium models which describes the optimization behavior of
economic factors completely lets these models have more powerful
analyzing bases; hence, not only are they preferred to econometric
models, but they are also preferred to input-output models.
In computable general equilibrium models ,different economic
sectors are being investigated .The expansion of range which includes
sectors , is referred to type of study and analyzing policy effects .In
order to evaluate economic sectors , we are able to investigate the
impacts of projects and different policies in an area ,or in a country or
in the whole world.
Computable general equilibrium models define a set of
institutions (households, firms, sectors, government or the whole
world) and a set of markets, and then, assured of considering
definitions of macroeconomic standard, a set of supply and demand
relationships for each market are defined.
It is necessary to attend that generating relationships in CGE models is
based on the assumption of consumer and producer optimizing behavior.
Consumer is following the way maximizes his or her utility or satisfaction
and producer is also trying to maximize his or her benefit or to minimize his
or her cost. In a single period CGE model, we would have a list of defined
sectors for labor force, goods and investment markets which considering an
open economy, import and export enter the model, too. Import commodity
might be considered as perfect or imperfect substitute for domestic product.
Base of the computable general equilibrium models is Walras
equilibrium thesis. Regarding perfect competition assumption which is one
of the basic assumptions for generating general equilibrium models, theory
56/ The Impact of Government Expenditure On GDP, Employment….

bases of these models are observable in competitive equilibrium theories.

Policy variables in these models can be explained in various types such as
tax rates, subside, supply and demand functions shifts, pricing regulations,
government expenditure components, etc.
Organizing data for using general equilibrium models is one of the
initial significant steps to generate these models. General equilibrium
models' required data are gathered in a matrix, called Social Accounting
Matrix (SAM) which commodity and service motilities, payment between
sectors and economic classes and other accounts enter it. In a technical view,
SAM is a square matrix in which each account is related to a single row and
the same single column.
Each cell of this matrix is indicating payment from related column to
the related row. Hence, each account's revenue is revealed in row and its
expenditure appears in related column. The significant principal in
computing social accounting matrix is equality between expenditure and
revenue.
The providing model in this paper is one of the comparative static
models which make the possibility of simulating in enforcing policies or
changing exogenous variables. Consequently it is possible to study the
effects of these changes on economy.

3-Model Details
We use the model that has been made by Dr Lofgren1 as a base and
extend and adjust it for Iran economy.
Table 1 indicates details of institutions, production factors, activities
and commodities in model. Model details follow data of computed SAM.

1- Hans Lofgren. (2003), “Exercises in General Equilibrium Modeling Using GAMS”,

.IFPRI. Washington D.C.
 Fouladi, M. /57

Table 1: Model Details

Set Elements
Agricultural, Industry and Mining, Oil and Gas, Service,
Activities
Construction
Agricultural, Industry and Mining, Oil and Gas, Service,
Goods
Construction and Trade commodities
Factors Labor force and Capital
Households Rural and Civic
Other
Government, Enterprises and Rest of The World
Institutions

In this model it is assumed that each sector maximizes its own profit
subject to the neoclassical production function with constant substitution
elasticity for factors and fixed coefficients for intermediate inputs.
QAa = ad a ∏ Q F fa fa
α

QINTca = icaca . QAa

Each activity is able to produce other sectors products. Only oil and gas
sector products only one output (oil and gas). Diagram 1 illustrates
production technology in economy.
In the goods market prices are flexible and change for cleaning markets
in the competitive condition. Thus demanders and suppliers are price taker in
this model.
The factor incomes generated in the production process, are paid in
fixes shares to the enterprises. These incomes are distributed between
enterprises (for capital factor) and household (for capital and worker factor)
in constant ratio. Enterprises spend their income on paying tax, purchasing
consumption goods or saving. The residue of enterprises’ income transfers to
households (as capital gain) or other economic enterprises (transfer between
enterprises).
Households also earn from their own primary production factors stock
(directly from labor force and directly and indirectly from capital through
firms).
Y Fhf = shry hf (∑ WF f .WFDISTfa . QF fa + tr f .row . EXR)
f
58/ The Impact of Government Expenditure On GDP, Employment….

Productio
n

Value added Intermediate goods

Cobb-daglas ( leontief)

Capital Labor
Sectors inputs
(CES)

Import Domestic
intermediate intermediate
inputs inputs

Diagram 1: Production Technology

Furthermore total income of households contains transfer payments

from other economic institutions (government, enterprises and income of
labor force who work out of country).

Y H h = ∑ YFhf . + ∑ trhi
f i

Households spend their income on paying tax, consumption and saving.

They also transfer some of their own income to enterprises (for investment).
The household consumption is shown by demand function results from
maximizing the utility function.

β ch (1 − MPS h ) (1 − ty h ) YH h
QH ch =
PQc
The government income results from the direct tax (income tax) and
indirect tax (tax on sale, import, export and economic activities) and foreign
loans.
 Fouladi, M. /59

Tax bases include constant ratio of tax rates. This income is spent on
government fixed consumption expenditure or transfer payments to other
domestic institutions. Some of government income may be used for paying
back the foreign loans. What remains from government income will be
saved. If the government saving is positive it specifies the budget surplus
and if it is negative, it specifies budget deficit. Considering the government
budget deficit in a specific year, government investment expenditure is
provided by financial resources of monetary system of the country.
Other countries, on the one hand , communicate with domestic
economy by giving financial payments in the form of loan or investment, to
government or financial market ;and on the other hand ,by receiving loans '
payback, taking loan from domestic government or absorbing financial
payments from financial market .In addition, the other aspect of foreign
countries cooperation with domestic economy occurs by importing
commodities or exporting .The assumption considered in this model is that
in comparison with world economy , the economy of country is small scaled
.So, export and import are done under price circumstances, determined
globally .Transferring the income of labor force ,working out of country,
towards country, and on the opposite side , transferring the income of
foreign labor force , working inside country, to out of country ,is another
aspect of domestic economy cooperation with global economy.
In this model, the assumption of qualitative difference between
domestic products and import commodities is considered. On domestic
demand side, this qualitative difference is taken into consideration under the
assumption of imperfect substitution between import and domestic products
which are supplied in domestic market. It means that if a specific good has
an import equivalent, aggregate domestic demand –for households ,
government consumption, investment and intermediate demand – is prepared
by combination of import goods and domestic products (in another word it is
called composite commodity).
1
−
− ρq −ρq ρq
QQc = aq c (δ . QM
q
c c + (1 − δ ) . QD
q
c c ) c ∈CM

The optimum demand quantity of these two groups of commodities

depends on their relative price.
60/ The Impact of Government Expenditure On GDP, Employment….

1
QM c PDDc δ cq 1+ ρ q
=( . )
QDc PM c 1 − δ cq

Similarly it is also assumed that there is an imperfect transfer for selling

domestic products domestically and for their external selling (export) It
means that domestic producer is able to supply his or her own product in
domestic markets or export them.
1
ρt ρt ρt
QX c = at c (δ . Q E c + (1 − δ ) . QDc )
t
c
t
c c ∈CE

The optimum supplied quantities of these two markets are also

determined by their relative prices.
1
QEc PEc 1 − δ ct ρt −1
=( . )
QDc PDSc δ ct

Considered assumptions on both demand side and supply side of the

economy, lead to make domestic price system independent from
international prices and also makes export and import response to relative
prices changes .The quantity of supply and demand responses to occurred
changes in relative prices depend on elasticity's, which are defined for
equations.
The institution residual income after expenditure deduction is its
accumulation. In this study, it is assumed that economic factors don't invest
their entire saving, but they keep some in the form of financial funds .These
funds contain money and deposited loans, foreign assets and other financial
assets .Therefore, total accumulation of each institution, equals sum of the
institution's saving and its funds in the last period. Economic institutions
allocate some of their accumulation for investment and financial funds .In
this model; demand for financial funds is accounted as an equivalent for
money transactional demand. Hence, the amount of financial funds is a ratio
of each institution's income. After allocating accumulation of each institution
to investment and financial funds, investment begins in various economic
sectors.
 Fouladi, M. /61

Sum of investment, done by institutions in each economic sector, show

the total investment in that specific sector; which is prepared by capital,
produced by different sectors. In money market, there is complete movement
of financial funds. It means that some of funds can be attained from foreign
country and similarly some of funds are transferred to out of country.
The relationships, explained the production, consumption and labor
force market, are achieved considering of economic factors behaviors. But
all in all, constraints which face economy in reality should be considered.
These constraints might not be revealed in economic factors behaviors. Real
constraints, remarked in model, are constraints, related to commodity and
production factor markets; and nominal constraints, refer to current account,
saving-investment account and financial account.
Supply in composite commodity market, is a combination of domestic
products, sold in domestic markets, and import commodities. Also, demand
contains final demand for consumption and investment, demand for
intermediate inputs and demand for transactional commodities. Changes in
domestic products, supplied in domestic markets, establish equilibrium in
domestic output market. However, variation in the amount of import
commodities, establish equilibrium in import commodities market.
In primary factor market, we achieve to factors demand function by
maximizing profit function for every activities:
α fa . PVAa .Q Aa
WF F .WFDIST fa =
QF fa
In labor market, it is assumed that there is unemployment in this
market, and according to the assumption of labor force complete movement,
wages are fixed but number of labors, used in each sector, is variable. As a
result, variation in number of labors, used in each sector, assures equilibrium
in that sector. But in capital market, the amount of capital, used for each
sector, is fixed and there is full employment of capital. Variation in rental
price of capital assures equilibrium in this factor’s market.
Regarding the assumption of fixed foreign saving, current account,
considering the rest of the world, will be balanced by import variation. But
in saving-investment account, it is assumed that balance in each institution’s
investment assures equilibrium in that institution .In financial account,
62/ The Impact of Government Expenditure On GDP, Employment….

regarding fixed primary asset and foreign saving, capital outcome would
assure equilibrium in this market.
This model is used for comparative static analysis and doesn’t contain
any dynamic aspect. For the reason that the capital stock is fixed, this model
can be called a short run model. Since the model is computed under the
assumption of existence of general equilibrium in economy, for policy
analysis, it is assumed that economy moves from one single point to another
one. (Model equations are provided in enclosure)
Diagram 2 shows the model structure.

Rest of the

Production sectors Factors

market

Goods market Household

Accumulation Government

Finance market
Enterprises

Investment

Diagram 2: Model Structure

 Fouladi, M. /63

3 – Accounting the Required Sam table

Required social accounting matrix in present paper, has resulted
from social accounting table, accounted for Iran by Dr. Banooei and
Dr. Asgari1 (1) for the year 2001.It consists of 22 types of
commodities, 21 production sectors and 7 types of production factors,
first and second income allocation account, income and capital
expense of civic and rural households, enterprises and government,
financial account with 4 sub-accounts and the rest of the world
account. Fixed capital formation account is also computed for 21
production sectors.
In the present study, using mentioned social accounting matrix,
MACRO SOCIAL ACCOUNTING MATRIX (MACRO SAM) and MICRO
SOCIAL ACCOUNTING MATRIX (MICRO SAM) have been computed in
proportion to represented general equilibrium model in this paper.
As a result, commodity and service; and activity accounts are
summarized in five sectors: agricultural, oil and gas, industry and mining,
service and construction. Two types of production factors - labor force and
capital- have been considered, too. First and second income allocation
account and income expense account have been also summarized in just one
account for civic and rural households , enterprises and government.
Financial account is used as just one account, too. Moreover, fixed capital
formation account has been prepared and summarized for five given sectors.

4- Determining Model Parameters

The model has been specified and solved by GAMS program .It
contains 2 types of parameters. Share parameters are accounted directly from
SAM data and behavioral parameters are accounted by data, out of SAM.
These parameters results from previous studies in Iran or similar countries;
or estimations, used for similar general equilibrium models.

1- Ali Asghar Banooei and Manoochehr Asgari , “Iran’s social accounting table for the year 2001” .
Institution of economic research of Iran, Bank of data and papers of Iran’s economy
64/ The Impact of Government Expenditure On GDP, Employment….

5- Discussing Scenarios
Using represented general equilibrium model, the impacts of variation
in government expenditure on production, private investment and
employment in different economic sectors are going to be studied as follows.
In this model it is assumed that government expenditure is an
exogenous variable which is not dependent on other economic variables. In
other words, if government expenditure is not dependent on other economic
variables, the scenarios will indicate the effects of this expenditure on
economy1. Thus, 2 scenarios are going to be considered, gather below.

1– 15% increase in government consumption expenditure

In economic issues, and its effect on gross domestic products (GDP) is
studied given to multiplier. In other word, in the concept of government
expenditure increase, substituting this expenditure with private investment,
determines positive, negative or neutral effects on GDP and employment.
The advantage of using represented general equilibrium model in order
to study the effects of government expenditure on economic variables, is
that, although the results of enforcing this policy is observable on GDP, you
are able to recognize them on labor force market, too .To examine the effects
of increasing the government consumption expenditure, using a general
equilibrium model frame work; income effect and substitution effect, result
from enforcing this policy, would be discussed.

Income Effect:
Government expenditure increase leads to demand increase for
commodities and service. This demand increase is prepared by domestic
products and import commodities. Therefore, demand for domestic products
and import increases. Consequently, domestic products increase leads to an
increase in primary production factors, thus, the income of households and
firms, results from production factors’ income, will rise. Furthermore, while
production is increasing, demand for intermediate inputs and transactional
commodities increase too.

1- It is necessary to note that government expenditure in Iran is dependent on oil revenue

severely. But the aim of this paper is studying the impacts of government expenditure on
economy, provided that this expenditure would be independent on oil revenue.
 Fouladi, M. /65

A raise in household’s income causes increase in their consumption

expenditure and money transactional demand. To assure the equilibrium in
stock account, on the one hand, as government expenditure and transactional
demand for money increase, investment will decrease. On the other hand, as
transactional demand for money increases in financial markets, given to
fixed foreign saving; exchange rate and capital
Outcome will increase. In this situation, export should increase to
assure equilibrium in current account.
Increase in production, will raise demand for labor and increase in
production, import and household income, lead to increase government
income through tax on sale, activity and income.
In brief , income effect , results from government expenditure are
increase in domestic demand , import , income of households and firms ,
taxes , demand for intermediate and trade commodities , transaction demand
for money , capital output , exchange rate and domestic price, employment
;and decrease in investment . But the effect on export is not defined.

Price Effect:
As demand for domestic products increases, domestic price of
commodity will increase, and it will cause export decrease and import
increase. On the one hand, raising the price of domestic products, decreases
domestic demand; on the other hand, this price increases decreases
households’ consumption expenditure. Hence, domestic production will
decreases, as export and demand decrease, thus, use of production factors
will decrease, resulting in a decrease in employment and household’s income
and firm’s income.
While exchange rate is increasing, the price of import commodities,
increase; consequently demand for import commodities will decrease. In
another point of view, raising the export price, results in export increase.
As a result, substitution effect of government expenditure increase
leads to deduction in demand, production, employment, income of
households and firms, import and money transactional demand. The price
effect of government expenditure increase on export is dependent on both
export and import elasticities to exchange rate and domestic prices.
Total effect of government expenditure increase on demand, domestic
production, employment, and households’ income and expenditure, depends
66/ The Impact of Government Expenditure On GDP, Employment….

on income elasticity and price elasticity. If price elasticity is more than

income elasticity, it will be expectable that demand, domestic production
and consequently employment and households income, are going to reduce.
Total effect of government expenditure increase on investment is
negative but the mentioned effect on trade balance depends on import and
export elastisities to exchange rate and domestic prices .If import and export
elasticities to exchange rate are more than import elasticity to domestic
prices , import will reduce and export will increase ; therefore , trade balance
will increase.

2- 15 % increase in government total investment expenditure

The effects of government investment expenditure are different from
government consumption expenditure .This expenditure , used for generating
infrastructures , prepares sufficient situation for private investment .Thus , it
would be expectable to encourage private investors to invest and increase
their investment incentives. In another point of view, about the mentioned
expenditure, the issue of substitution effect is notable. Hence, final effect on
GDP refers to the strength of these effects. Also, according to general
equilibrium models frame work, it is feasible to study the impact of
government investment expenditure increase in two sides: income effect and
price effect.

Income Effect:
Raising in government expenditure, leads to an increase in investment,
consequently demand for commodities and service will increase, and this
demand increase will be prepared by increase in demand for import and
domestic products .Domestic production increase , not only increases
demand for transactional commodities, but it also causes demand for
intermediate inputs and primary production factors. Raising the use of
production inputs, results in an increase in labor force employment,
consequently households’ income increase too. Hence, households’
consumption expenditure and their money transactional demand will rise. As
a result, money transactional demand increases. Increase in capital outcome
and exchange rate come along money transactional demand increase. In
foreign trade balance, export increase covers increase in capital outcome and
exchange rate.
 Fouladi, M. /67

In brief, income effect of increase in investment expenditure on

production, employment and household’s income is positive.

Price Effect:
While demand is increasing, domestic price increases. Domestic price
increase, leads to decrease both demand and export. Thus, domestic
production will reduce and consequently it will cause reduction in
households’ income.
Exchange rate increase leads to raise domestic price of import and
export, resulting in import reduction and export increase.
Total effect of government investment expenditure, will be dependent
on income elasticity and price elasticity of domestic demand. If income
elasticity is more than price elasticity, production, employment and
households’ income will increase. The impact of this policy on trade balance
depends on import and export elasticities to exchange rate and domestic
prices. If import and export elasticities to exchange rate are more than import
elasticity to domestic prices, import will decrease and export will increase,
therefore, trade balance will increase.
The effect of increase in investment expenditure in one sector, on total
investment, depends on the effect of enforcing this policy on investment in
other sectors. Increasing the investment in one sector, considering this
sector’s use of other sectors’ intermediate inputs, and marginal variation in
production in each production sector, shows investment variations in each
sector and consequently it specifies final effect on total investment.
In order to study this scenario, it is considered that government
investment expenditure in various economic sectors has increased 15 % of
total government investment expenditure. Hence, it is possible to compare
the impacts of government investment expenditure increase on different
economic sectors.
Also we are going to study effect of 3% increase government
investment expenditure in all economic sectors simultaneously on GDP and
employment too.
68/ The Impact of Government Expenditure On GDP, Employment….

Policy Analysis:
A) 15% increase in government consumption and investment
expenditure.
In the first we study results from 15% increase in government
consumption expenditure (scenario 1) and government investment
expenditure (scenario 2). We increase 3% government investment
expenditure in all economics sectors that will raise total government
investment expenditure to 15%.
The results of model simulation according to enforcing these two
scenarios, have been shown in table 2.As you see, nominal GDP (market
price), has decreased resulting from enforcing both of scenarios. But in the
second scenario it is little (0.14%). We can see the same result about private
investment. In other words, there is crowding out between government
consumption expenditure and private investment but this effect is almost
slightly for government investment expenditure and private investment.
As it is shown in table 2, while government expenditure is increasing,
labor force employment decreases, but the effect of this policy on
employment in different economic sectors is different. The only positive
effect on labor force employment belongs to service sector. The negative
effect on employment in construction sector is more than other sectors.
Increasing government investment expenditure has a positive effect on
total employment (0.49%) that it relates to increase employment in
agricultural and construction sectors although results show decreasing in
employment in industry and service sectors.

Table 2: Result of Model Simulation (Increasing Government Consumption

and Investment Expenditure)
Index Results of Model Simulation
scenario1 scenario2
GDP (Market Price) -8.26 -0.14
Investment -15.09 -0.14
Labor force Employment -1.38 0.45
Agricul Tural -0.72 1.55
Oil and Gas -3.31 0.0
Industry and Mining -3.7 -0.84
Construction -17.06 0.6
Service 3.81 -0.13
 Fouladi, M. /69

B) A 15% increase in government investment expenditure in different

economic sectors
In this scenario government investment expenditure has increased 15%.
.Hence, discussing scenarios in this section are mentioned below:
1- Increase in government investment expenditure in ‘agricultural’
sector to 15% of government total investment expenditure
2- Increase in government investment expenditure in ‘oil and gas’
sector to 15% of government total investment expenditure
3- Increase in government investment expenditure in ‘industry and
mining’ sector to 15% of government total investment expenditure
4- Increase in government investment expenditure in ‘construction’
sector to 15% of government total investment expenditure
5- Increase in government investment expenditure in ‘service’ sector to
15% of government total investment expenditure
Government investment in oil and gas, and service sectors leads to
increase GDP and private investment. Employment will increase by
increasing government investment in all sectors expect investment in
industry and mining sector. Government investment in agricultural sector
increases employment than the other three sectors.

Table 3: Results of Model Simulation (Increasing in Government Investment in

Different Economic Sectors)
Index Results of Model Simulation
Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5
GDP (Market Price) -0.51 0.03 -0.21 -0.1 0.09
Investment -0.25 0.02 -0.23 -0.29 0.09
Labor force Employment 1.97 0.39 -0.97 0.98 0.16
Agricultural 8.93 -0.19 -0.55 -0.03 -0.26
Oil and Gas -0.97 0.96 -0.07 -0.24 0.03
Industry and Mining -3.6 -0.53 0.36 -0.51 0.11
Construction -1.05 2.91 -5.07 4.96 1.34
Sevice -1.05 -0.06 0.06 0.38 0.03

The results of enforcing each scenario that we can see in table 3 are as
follows:
1- Government investment increase in agricultural sector:
Government investment in this sector will decrease GDP and private
investment. But total employment increase because of arising employment in
70/ The Impact of Government Expenditure On GDP, Employment….

agricultural sector (8.93%). though it is with decreasing at employment in

other sectors. With other sectors, deduction in employment in industry and
mining sector is more than others. Despite the decrease in labor force
employment in other sectors, employment increase in agricultural sector will
cause increase in total employment.
2- Government investment increase in oil and gas sector:
Raising the investment in oil and gas sector will cause a little increase
in GDP, and private investment. It will increase employment in ‘oil and gas’
and ‘construction’ sectors. Consequently, despite employment decrease in
‘agricultural’, ‘industry and mining’ and ‘service’ sectors, total employment
will increase (0.39%).
3- Government investment increase in industry and mining sector:
GDP and investment decrease as a result of increase in government
investment in ‘industry and mining’ sector. Despite employment increase in
‘industry and mining’ and ‘service’ sectors, labor force employment
decreases as a result of employment decrease in other three sectors (0.97%).
4-Government investment increase in construction sector:
However government investment in construction sector increases, GDP
and private investment decrease. Enforcing this policy results in employment
increase in ‘construction’ and ‘ service’ sectors and decrease in employment
in other sectors, consequently total employment will increase , too(0.98%).
5- Government investment increase in service sector:
Though government investment increase in service sector has positive
effect on GDP and private investment, but these effects are weak. Labor
force employment in all sectors except agricultural sector, has increased
slightly; thus, total employment has increased, too.
Comparing the results of enforcing scenario 5 ,makes it clear that in
comparison with other sectors , investment increase in ‘service’ sector,
increases GDP and investment more than other sectors . But if the aim of
enforcing a fiscal policy (to increase government expenditure) is increasing
total employment, investment in ‘agricultural’ sector is better than
investment in other economic sectors. And if the target of increasing
government expenditure is raising employment in special sector we can give
advices as a fellow:
For increasing in employment in all sectors expect ‘service’ sector,
government investment expenditure should be increase in the same sector.
 Fouladi, M. /71

But for raising employment in ‘service’ sector, increasing in ‘construction’

sector is the best advice.

6- Conclusion
Before observing the results of enforcing scenarios, notice that general
equilibrium models analyze the policies according to the assumed economic
structure frame work .Thus, for policy analysis, using the model presented
before, remembers that this model is accounted considering accounted SAM
table for the year 2001.Hence, base of analysis is economic structure of Iran
in 2001.
Increase in government expenditure influences on economy in different
ways, depends on types of costs. Increasing the government consumption
expenditure causes reduction in production, employment and investment.
Government investment expenditure has different effects on economy
which depends on their nature and area they spent. Increasing the
government investment expenditure in ‘oil and gas’, and ‘service’ sectors,
makes an increase in GDP, and investment. In other words, government
investment expenditure in mentioned sectors can be counted as private
investment complementary and investment incentive .But government
investment in ‘agricultural’, ‘construction’ and ‘industry and mining’ sectors
has negative effects on economy. An increase in government investment in
these sectors leads to decrease in production and investment.
But government investment in all sectors expect ‘industry and mining’
sector, will increase employment. More effect on employment in different
economic sectors is depended to the sector that government invests on.
As a whole, we can result the effect of enforcing a fiscal policy as
an increase in government expenditure is depend on which sector it
will increase. So it can be an efficiency policy for increasing GDP or
employment and it can have a negative effect on them.
72/ The Impact of Government Expenditure On GDP, Employment….

Enclosure A:
Equation
1- PM c = pwm . (1 + tmc ) . EXR
2- PEc = pwe . (1 − tec ) . EXR
3- PDDc = PDS c + ∑ PQc′
c′ . icd c′,c

4- PQc .QQc = ( PDDc .QDc + PM c .QM c ) (1+ tqc )

5- PX c .QX c = PDSc .QDc + PEc .QEc
6- PAa = ∑ PX
c
c .θ ac

7- PVAa = PAa (1 + ta a ) − ∑ PQ
c
c . ica ca

∏Q F
α fa
8- QAa = ad a fa
f

α fa . PVAa .Q Aa
9- WF F .WFDIST fa =
QF fa
10- QINTca = icaca . QAa
11- Q Tc = ∑ icd . QD
c
c , c′ c c ∈CT

12- QX c = ∑θ .QA ac a
a
1
−
− ρq −ρq ρq
13- QQc = aq c (δ cq . QM c + (1 − δ cq ) . QDc ) c ∈CM
1
QM c PDDc δ cq 1+ ρ q
14- =( . )
QDc PM c 1 − δ cq
15- QQc = Q Dc c ∈CNM
1
ρ ρ ρt
16- QX c = at c (δ ct . Q E c t + (1 − δ ct ) . QDc t ) c ∈CE
1
QEc PEc 1 − δ ct ρt −1
17- =( . )
QDc PDSc δ ct
18- QX c = Q Dc c ∈ CNE
19- QFIN s = ifi s .YI i
20- QACU s = ∑ qinvbar .IADJ + QFIN
v
v,s s

21- QINVv = ∑ qinvbar .IADJ v,s

s
 Fouladi, M. /73

22- QDINVc = ∑ iiv

V
cv . QINVv
23- Y F hf = shry hf ( ∑ WF f . WFDIST fa . QF fa + tr f . row . EXR )
f

24- Y H h = ∑ YFf
hf . + ∑ trhi
i

25- QH β ch (1 − MPS h ) (1 − ty h ) YH
ch = h

PQ c
⎛ ⎞
26- YF ins . f = shry ins . f ⎜ ∑ WF f .WF f .WFDIST . QF fa + tr f . row . EXR ⎟⎟
⎜ fa
⎝ f ⎠
27- Y I = ∑f
YFins . f + trins ,i ∑ i

28- E I =∑ PQc . qic + ∑ tr i ,ins

c i

YG = ∑h
ty h . YH h + ∑ tq c . ( PDD c . QD c + PM c . QM c )
c
29- + ∑ tm c . EXR . pwm c QM c + ∑ te c . EXR . pwe c . QE c
cM cE

+ ∑ ta a . PA a . QA a + ty ins . YI + tr gov .row . EXR

a
30- E G = ∑ c
P Qc . qg c + ∑ tri , gov
i
31- ∑
f
Q F fa = Q FS f

32- QQc = ∑ QINTca + ∑ QH ch + qg c + qic + QTc + QDINVc

a h

33-Saving- Investment Balances

∑ QINV + ∑
v
v
s
QFIN s + WALRAS = ∑ MPS
h
h .(1 − ty h ).YH h +

(YG − EG − trrow . gor . EXR ) + (YI − EI − tyins . yI p ) + ∑ qfinbar s .

s
34-Fund Balance
∑s
QFIN s + FSAV . EXR = ∑
s
qfinbars + OCAP . EXR
35-Foreign Balance
∑cE
pwe c . QE c + ∑ tri .row + FSAV +
i
∑ tr
f
f .row =

∑
cM
pwm c . QM c + ∑ trrow. f + trrow. gov + OCAP
f
 74/ The Impact of Government Expenditure On GDP, Employment….

Iranian Economic Review, Vol.15, No.27, Fall 2010

Million
Enclosure B: Macro SAM Table for Iran(2001)
dollar

Financial Rest of the Total

Activity Good Factors Household Government Enterprise Accumulation Investment
sector World Income

Activity 1149108.151 1149108.2

Good 417436.337 0 397375.679 104733.108 0 28620.912 177593.418 157720.338 1283479.8

Factors 722717.463 4209 726926.46

Household
439332.435 356707614 32654 13773 52 357193425

Government 8964.999 9385.989 151050 37040 13740 0 1,715 221895.99

Enterprise 133339.8 5623847 -4720 0 1 5752467.8

Accumulation 0 51357.733 74792.892 114846 115,541 356537.63

Investment 177592.526 177592.53
Financial
19393 4075 173794
sector 150326
Rest of the
124975.706 3206 37 696 38860 167774.71
world
Total
1149118.8 1283469.846 726928.235 362817271 221896 128619 356539.438 177593.418 173794 167772.338
Expenditure
 Fouladi, M. /75

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