Public Expenditure, Human Capital Formation and Economic Growth in Modified Lucas Framework: A Study in the Indian Context

This paper examines the effect of social expenditure of the government on economic growth via its effect on human capital formation using the theoretical framework of Lucas (J Monet Econ 22:3–42, 1988) in modified form and analyzing the empirical results on the theoretical arguments in the Indian context. The Lucas model has been modified to incorporate the role of public expenditure in human capital formation. The theoretical results suggest that the growth rate will be higher if production elasticity of human capital is higher and social expenditure has significant impact on human capital formation. The results of time series analysis based on Indian data at the national level show that social expenditure has significant positive effect on GDP along with other factors like physical capital and economic expenditure of the government. The increasing export of services and extensive migration of skilled workers from India resulting in huge remittances from abroad are found to be related with social expenditure of the government. Panel regressions using state level data and considering literacy rate as a rough proxy for human capital show that higher social expenditure results in higher literacy rate and literacy rate has significant positive effect on per capita income. The poverty has negative impact on literacy rate and it suggests that higher social expenditure of the government is necessary for human capital formation and growth in the states where poverty is high. The infrastructure and physical capital are also found to play significant role in accelerating growth in the Indian states.