We consider whether there is statistical evidence for a causal relationship between federal government expenditures and growth in real GDP in the United States, using available data going back to 1791. After studying the time-series properties of these variables for stationarity and cointegration, we investigate Granger causality in detail in the context of a Vector Error Correction Model. While we find causal evidence that faster GDP growth leads to faster growth in government spending, we find no evidence supporting the common assertion that a larger government sector leads to slower economic growth.
KeywordsLong-Term Economic GrowthFederal Government SizeWagner’s LawUnited StatesCointegrationGranger CausalityVector AutoregressionVector Error Correction Model
J. Poot, “A Synthesis of Empirical Research on the Impact of Government on Long-Run Growth,” Growth and Change, Vol. 31, No. 4, 2000, pp. 516-546. doi:10.1111/0017-4815.00143
R. J. Barro, “Government Spending in a Simple Model of Endogenous Growth,” Journal of Political Economy, Vol. 95, No. 5, 1990, pp. S103-S125. doi:10.1086/261726
D. Landau, “Government Expenditure and Economic Growth: A Cross-Country Study,” Southern Economic Journal, Vol. 49, No. 3, 1983, pp. 783-792. doi:10.2307/1058716
D. Landau, “Government and Economic Growth in the less Developed Countries: An Empirical Study for 1960-80,” Economic Development and Cultural Change, Vol. 35, No. 1, 1986, pp. 35-75. doi:10.1086/451572
R. Ram, “Government Size and Economic Growth: A New Framework and Some Evidence from Cross-Section and Time-Series Data,” American Economic Review, Vol. 76, No. 1, 1986, pp. 191-203.
B. S. Lee and S. Lin, “Government Size, Demographic Changes, and Economic Growth,” International Economic Journal, Vol. 8, No. 1, 1994, pp. 91-108.
J. Slemrod, “What Do Cross-Country Studies Teach about Government Involvement, Prosperity, and Economic Growth?” Brookings Papers on Economic Activity, Vol. 1995, No. 2, 1995, pp. 373-431.
E. M. Engen and J. Skinner, “Taxation and Economic Growth,” National Tax Journal, Vol. 49, No. 4, 1996, pp. 617-642.
T. Plümper and C.W. Martin, “Democracy, Government Spending, and Economic Growth: A Political-Economic Explanation of the Barro-Effect,” Public Choice, Vol. 117, No. 1-2, 2003, pp. 27-50. doi:10.1023/A:1026112530744
J. S. Guseh, “Government Size and Economic Growth in Developing Countries: A Political-Economy Framework,” Journal of Macroeconomics, Vol. 19, No. 1, 1997, pp. 175-192. doi:10.1016/S0164-0704(97)00010-4
G. W. Scully, “Economic Freedom, Government Policy and the Trade-Off between Equity and Economic Growth,” Public Choice, Vol. 113, No. 1-2, 2002, pp. 77-96. doi:10.1023/A:1020308831424
A. Wagner, “Grundlegung der Politischen ?konomie,” 3rd Edition, Winter’sche Verlagshandlung, Leipzig, 1892.
W. J. Baumol and W. G. Bowen, “On the Performing Arts: The Anatomy of Their Economic Problems,” American Economic Review, Vol. 55, No. 1-2, 1965, pp. 495-502.
A. Peacock and A. Scott, “The Curious Attraction of Wagner’s Law,” Public Choice, Vol. 102, No. 1-2, 2000, pp. 1-17. doi:10.1023/A:1005032817804
P. M. Jackson, M. D. Fehti and S. Fehti, “Cointegration, Causality and Wagner’s Law: A Test for Northern Cyprus, 1977-1996,” 2nd International Congress on Cyprus Stud- ies, Gazima?usa, 24-27 November, 1998, pp. 1-24.
S. Demirbas, “Cointegration Analysis-Causality Testing and Wagner’s law: The Case of Turkey, 1950-90,” European Public Choice Society, Lisbon, 1999.
A.M. Islam, “Wagner’s Law Revisited: Cointegration and Exogeneity Tests for the USA,” Applied Economics Letters, Vol. 8, No. 8, 2001, pp. 509-515. doi:10.1080/13504850010018743
F. Halicioglu, “Testing Wagner’s Law for Turkey, 1960-2000,” Review of Middle East Economics and Finance, Vol. 1, No. 2, 2003, pp. 129-140. doi:10.2202/1475-3693.1007
J. D. Jones and D. Joulfaian, “Federal Government Ex- penditures and Revenues in the Early Years of the Ameri- can Republic: Evidence from 1791-1860,” Journal of Macroeconomics, Vol. 13, No. 1, 1991, pp. 133-155. doi:10.1016/0164-0704(91)90035-S
K. H. Ghali, “Government Size and Economic Growth: Evidence from a Multivariate Cointegration Analysis,” Applied Economics, Vol. 31, No. 8, 1998, pp. 975-987. doi:10.1080/000368499323698
C. W. J. Granger, “Some Recent Developments in a Concept of Causality,” Journal of Econometrics, Vol. 39, No. 1-2, 1988, pp. 199-211. doi:10.1016/0304-4076(88)90045-0
S. Johansen and K. Juselius, “Maximum Likelihood Estimation and Inference on Cointegration with Applications to the Demand for Money,” Oxford Bulletin of Economics and Statistics, Vol. 52, No. 2, 1990, pp. 169-210. doi:10.1111/j.1468-0084.1990.mp52002003.x
J. J. M. Kremers, “U.S. Federal Indebtedness and the Conduct of Fiscal Policy,” Journal of Monetary Economics, Vol. 23, No. 2, 1989, pp. 219-238. doi:10.1016/0304-3932(89)90049-4
J. Gwartney, R. Lawson and R. Holcombe, “The Size and Functions of Government and Economic Growth,” Joint Economic Committee, U.S. Congress, Washington DC, 1998.
S. B. Carter, S. S. Gartner, M. R. Haines, A. L. Olmstead, R. Sutch and G. Wright, Eds., “Historical Statistics of the United States: Earliest Times to the Present,” Cambridge University Press, New York, 2006.
U.S. Department of Commerce: Bureau of Economic Analysis, “Bureau of Economic Analysis,” 2011. http://www.bea.gov
M. A. Conte and A. F. Darrat, “Economic Growth and the Expanding Public Sector: A Reexamination,” The Review of Economics and Statistics, Vol. 70, No. 2, 1988, pp. 322-330. doi:10.2307/1928317
D. Kwiatkowski, P. C. B. Phillips, P. Schmidt and Y. Shin, “Testing the Null Hypothesis of Stationarity against the Alternative of a Unit Root,” Journal of Econometrics, Vol. 54, No. 1-3, 1992, pp. 159-178. doi:10.1016/0304-4076(92)90104-Y
R. F. Engle and C. W. J. Granger, “Co-Integration and Error Correction: Representation, Estimation, and Testing,” Econometrica, Vol. 55, No. 2, 1987, pp. 251-276. doi:10.2307/1913236