**1. Introduction**

On the 2nd of June 1932, history was made in Bahrain when oil was discovered in the first well in "Jebel Al Dukhan" making it the leading country among the Arabian Gulf countries in oil discovery. Since the establishment of the first refinery, oil and gas have played a significant part in the economic side of Bahrain. This is translated in the value of the share of oil and gas revenues to total revenues of Bahrain. The Ministry of Finance reports show that the share of oil and gas revenues formed 60.4% of total revenues in 1990 and continued to increase and reached 87.8% in the year 2011.

There were many trials since the seventies of the 20th century to shift the economy from oil sector to non-oil sectors such as manufacturing, finance and tourism. One of the Bahrain Government initiatives to set the foundation of the economic diversification was through its long-run strategy procedure "Bahrain 2030 Vision" that was established in October 2008. The main aim of this vision is to build a better life for every Bahraini. One of the guiding principles of this vision is the sustainability. Bahrain government is working on enabling the private sector to stimulate economic growth. By doing so, Bahrain Government will be able to employ its resources in the investment in its human capital through training and education specifically in the area of applied sciences.

The 2019–2022 Government Action Plan focuses on achieving number of objectives including the investment in citizens by developing and sustaining the government services in certain sectors such as education and health. Moreover, the action plan aims to support creativity, youth, gender equity and sports. As a subsequent of the collaboration parties of the society, the contribution of non-oil sectors to Bahrain GDP increased over time. **Figure 1** shows the contribution of the different economic sectors to the GDP of Bahrain. In the year 2019, the second largest contributor to Bahrain GDP after the oil sector is the Finance sector with 17% share. The manufacturing sector comes next with a stake of 15%.

With all of these attempts to achieve economic diversification, oil sector remains the highest contributor to Bahrain GDP. Since the drop in oil prices at the end of 2014, Bahrain is facing the largest budget deficit among the rest of the GCC countries. Number of initiatives were introduced between the years 2015 and 2017 managed to reduce the budget deficit from 13% to 10.1% of GDP over the same period.<sup>1</sup> The initiatives taken over this period includes i) decreasing operational expenditure, ii) establishing optional retirement program for the public sector employees, iii) Balancing the water and electricity revenues and expenditure, iv) assigning cash subsidies to the needy citizens, v) boosting the effectiveness of government spending, and vi) increasing non-oil revenues.

As an attempt to investigate the long and short run impacts of the oil revenues and government expenditure on the economic growth of Bahrain, this chapter

#### **Figure 1.**

*Economic sectors contribution to Bahrain GDP, 2019. [Source: Bahrain economic quarterly, Q3 2019 – Ministry of Finance and National Economy].*

<sup>1</sup> Fiscal Balance Program document https://www.mofne.gov.bh/fbp\_en.pdf.

#### *The Reform in Government Expenditure and the Standard of Living in Bahrain DOI: http://dx.doi.org/10.5772/intechopen.98249*

employs yearly data for oil and gas revenues, total government expenditure and GDP growth and estimates the relationship between them using vector error correction model (VECM). Moreover, the sectoral relationship with the economic growth is examined using the ministry of health and ministry of education expenditures. The results show that oil and gas revenues have a positive impact on economic growth while the government expenditure affects economic growth negatively. However, when looking at the individual impact of education and health expenditure on economic growth, the estimation results indicate that both have a positive impact on economic growth of Bahrain.

The chapter is constructed as follows: a brief of the literature review is reported in Section 2. The employed data and methodology are explained in Section 3. Section 4 demonstrates the results, and the conclusions of this chapter are stated in Section 5.

## **2. Literature review**

A considerable number of studies have concentrated on the relationship between natural resource wealth and economic growth. The motivation behind these studies is to investigate the potential benefit of this wealth in promoting economic growth. The results of most of these studies agree on the negative impact of the abundance natural resources. Using a large cross-country data, Sachs and Warner [1] conclude that the natural resource wealth has a harmful effect on the economic growth. Gylfason [2] interprets this harmful impact as the result of the false sense of security that these nations develop regarding their natural resources which may drive them to neglect human capital accumulation. But there is a great distinct between having natural resources and using it. Botswana is an obvious example for an African country whose 80% of its exports are diamonds, copper, nickel and gold could escape the natural resource curse. The reason behind this is that all the mineral revenues are spent on investment such as capital projects and recurrent spending on education and health [3, 4].

The literature proposes various channels through which gifted resources may obstruct economic growth. The first channel is the Dutch disease. The fluctuations in the prices of raw materials causes fluctuations in exports revenues which may cause variation in exchange rate. Volatile exchange rates lead to unpredictability that may harm the exports and foreign investments. Moreover, the natural resource-based industry may pay higher wages compared to other industries which makes it difficult for the other industries to compete. The second channel is through the massive natural resource rents accompanied by weak markets in most of the developing countries. The third channel is through decreasing the public and private motivation in human capital accumulation due to underestimating the longterm value of education. The fourth channel is through retarding the development of financial institutions which may dampen savings and investments that leads to reducing economic growth [5].

The relationship between the government spending and economic growth was investigated in an enormous number of studies with different types of economies. Different results were obtained from these studies due to the variable economic development levels, different periods of time and the use of distinct methodologies. For example, Barro [6] who employed a panel of 98 countries over 36 years found that growth is inversely related to the share of government expenditure. Using OECD sample, Agell et al. [7] found no conclusion about the effect of public sector spending on growth as the relation is easily tilted from negative to positive by introducing control variables. Devarajan et al. [8] who utilized data from 43

developing countries and conclude that an increase in the current expenditures affects growth positively whereas the capital expenditure has a negative impact on economic growth, which indicates that excess capital spending may become unproductive. In a study that used seven transition economies from South Eastern Europe, Alexiou [9] found that government spending on capital formation affects growth positively. The empirical evidence of Lamartina and Zaghini [10] paper provides evidence of structural positive correlation between GDP per capita and public expenditure in a sample of 23 OECD countries. Using data for EU-28 countries, Dudzevičiūtė et al. [11] investigated the government spending and economic growth nexus. Positive relationship has been detected in 4 countries, negative correlation in other 4 countries and insignificant relationship in the remaining countries.

A great number of empirical studies scrutinized the effect of the sectoral government expenditure on economic growth in different economies. For example, Baum and Lin [12] investigated the differential impact of the various types of government expenditures on economic growth using a sample of 58 countries. Their results show a positive impact of educational expenditures on economic growth but insignificant impact of welfare and defense expenditures on economic growth. In a study that used data from East Africa, Gisore et al. [13] found that expenditures on health and defense have positive impact on economic growth whereas educational expenditure has insignificant impact on growth.

At the level of GCC countries, Al-Yousif [14] applied a Granger-causality test to examine the relationship between education expenditure and economic growth in the six GCC countries and conclude that the nature of this relationship cannot be generalized across countries. Ghali [15] studied the relationship between economic growth and government expenditure in Saudi Arabia and found insignificant impact of government expenditure on economic growth. Hamdi and Sbia [16] applied the Toda and Yamamoto procedure to investigate the relationship between government revenues, expenditure and gross domestic product using data for the six GCC countries over the period 1990–2010. Their results show that there is a unidirectional causality from government expenditure to GDP in Bahrain only while GDP granger cause government expenditure in Qatar and Oman. Ahmad and Masan [17] found that there are positive long run relationship between oil revenues, government expenditure and economic growth of Oman.
