The impact of government expenditure on economic growth-How sensitive to the level of development.pdf

Journal of Policy Modeling 32 (2010) 804–817 Available online at The impact of government expenditure on economic growth: How sensitive to the level of development? Shih-Ying Wu 1, Jenn-Hong Tang 2, Eric S. Lin ? Department of Economics, National Tsing Hua University, Hsin-chu 30013, Taiwan Received 1 January 2010; received in revised form 1 March 2010; accepted 1 April 2010 Available online 19 June 2010 Abstract Previous studies generally find mixed empirical evidence on the relationship between government spending and economic growth. In this paper, we re-examine the causal relationship between government expenditure and economic growth by conducting the panel Granger causality test recently developed by Hurlin (2004, 2005) and by utilizing a richer panel data set which includes 182 countries that cover the period from 1950 to 2004. Our empirical results strongly support both Wagner’s law and the hypothesis that government spending is helpful to economic growth regardless of how we measure the government size and economic growth. When the countries are disaggregated by income levels and the degree of corruption, our results also confirm the bi-directional causality between government activities and economic growth for the different subsamples of countries, with the exception of the low-income countries. It is suggested that the distinct feature of the low-income countries is likely owing to their inefficient governments and inferior institutions. ? 2010 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved. JEL classification: E24; E32; E52 Keywords: Government size; Economic growth; Wagner’s law; Panel Granger causality 1. Introduction and background The relationship between government expenditure and economic growth has been an ongoing issue in debates on economic development. The celebrated “Wagner’s ([1883] 1958) law” pos- tulates that government spending is income elastic and that the ratio of government spending to ? Corresponding auth