Government expenditure in the euro area during the pandemic crisis – insights from the Classification of the Functions of Government data

Prepared by Marta Rodríguez-Vives and Hans Olsson

Published as part of the ECB Economic Bulletin, Issue 3/2023.

On 22 February 2023 Eurostat released the 2021 data on general government expenditure according to the Classification of the Functions of the Government (COFOG). This dataset covers all EU Member States over the period from 1995 to 2021. The data are published annually with a time lag of around 14 months, and provide insights into the composition of public expenditure in the EU and the euro area. Notably, the COFOG data regroup national accounts spending data according to similar economic government objectives, thus improving its comparability across countries.^[1] The ratio of euro area public expenditure to GDP increased substantially in recent years, from 46.9% in 2019 – the pre-pandemic baseline – to 52.6% in 2021 and to 50.7% in 2022. In the light of the high magnitude of public expenditure in the euro area, as well as the multiplicity of organisational and institutional settings in public administration, COFOG data provide valuable information on common and divergent trends in governmental actions across countries. Against this background, this box provides an overview of the functional composition of government spending in the euro area and across euro area countries in 2021. The effect of the COVID-19 pandemic on government spending is also discussed.^[2]

Although expenditure on different government functions is heterogeneous across countries, some common trends emerge. Based on COFOG data, Chart A shows how the governments of euro area countries spent their budgets on different economic functions in 2021. The main function is re-distribution, with social protection being the largest component of public expenditure in all euro area countries, amounting to 21.2% of GDP on average. Pension payments represent around 60% of this expenditure on average. The second most important category is health expenditure, which accounts for 8.3% of GDP. Other key functions include (i) economic affairs, which covers energy, transport infrastructure and communication, among others; (ii) education; and (iii) general public services, which covers foreign aid, embassies, debt and tax office, among others, and is included in Chart A under the category of “other”. Government expenditure on defence accounted for around 1.3% of GDP in the euro area in 2021.

Chart A

Composition of public expenditure in euro area countries in 2021

(percentage of GDP)

The main shifts in the composition of public finances during the COVID-19 pandemic crisis occurred in the categories of economic affairs, social protection and health. Chart B provides an indication of the changes in government expenditure on key functions across the euro area and in the four largest euro area economies in 2021 compared with 2019. It is important to note that changes in the composition of public finances in this period were affected by the policies implemented by individual governments to stabilise their respective economies following the COVID-19 shock. Governments adopted substantial fiscal packages in 2020 and 2021 to support households and firms,^[3] and such interventions are reflected in the COFOG data. Compared with 2019, government expenditure on economic affairs increased by 2.3 percentage points of GDP in 2021, mainly due to furlough schemes and other support offered to firms. These support measures fall under general economic, commercial and labour affairs – a subcategory of economic affairs – which increased by 1.4 percentage points of GDP.^[4] Chart B also illustrates that expenditure on social protection and public health increased remarkably in euro area countries, primarily as a direct consequence of the COVID-19 crisis. In fact, the ratio for public health services in 2021 is the highest in the available data series.^[5] In the case of social protection, part of its recent growth in expenditure is due to unemployment benefits, although there are differences in their shares across countries due to accounting reasons.^[6] Although not directly related to the COVID-19 crisis, expenditure on pensions, which falls under social protection, increased by an average of around 0.8 percentage points of GDP, with strong differences across countries. Importantly, shares in education and environmental protection generally remained stable from 2019 to 2021. This is of particular importance given the relative economic growth-friendly nature of these expenditure categories.^[7] These developments from 2019 to 2021 differ from those during the global financial crisis, when governments reduced expenditure on education and health through cuts to employee compensation, especially in the period from 2011 to 2013.

Chart B

Changes in the functional composition of government expenditure 2019-21 (euro area and the euro area big four: Germany, France, Italy, and Spain)

(cumulative changes, percentage points of 2019 GDP)

In view of strains on public finances, choices on how to better allocate public resources are becoming even more important in the making of fiscal policy, and the availability of data remains fundamental. At the current juncture, some governments are facing more constraints (e.g. a higher stock of public indebtedness, the growing effects of ageing populations on public finances) and new economic challenges are weighing on public finances (e.g. digitalisation trends, climate change, deglobalisation trends, increasing allocations for defence expenditure). This will increase the importance of improving the growth-friendliness of public finances.^[8]