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In this article, we survey the existing literature on the causal relationship between government size and economic growth, highlighting the theoretical and empirical evidence from topical work. To our knowledge, this study may well be the first study of its kind to survey, in detail, the existing literature on the causal relationship between government size and economic growth—in all the countries, whether developing or developed. By and large, our study shows that direction of causality between these two variables has four possible outcomes, and that all the outcomes have found empirical support, based on variations in the country or region under study, methodology, proxies, data set used, and time frame considered. However, of the four, the most prominent is the second view, which validates unidirectional Granger-causality from economic growth to government size, followed by the bidirectional Granger-causality category. The study, therefore, concludes that the causal relationship between government size and economic growth is far from being clear-cut. Keywords government size, government expenditure, economic growth, Granger-causality Wagner (1883/1958) termed this as Wagner’s Law. Of the Introduction Wagner’s Law and the Keynesian view, it is debatable which The relationship between government size and economic one of the two is the most widely favored view. growth has been a topic of discussion more than a century The middle ground is the third view, known as the “bidi- ago, when Wagner (1883/1958) came up with Wagner’s Law, rectional causality view” or the “feedback response,” which which places importance on economic growth as a driver of places importance on both the government size and the eco- government size. Recent decades have seen the escalation of nomic growth as they are deemed to mutually cause each this debate as increased government size and low economic other in a feedback response fashion (see Abu-Bader & Abu- growth rates have become a prominent feature of today’s Qarn, 2003; Abu-Eideh, 2015; Singh & Sahni, 1984; Wu, economies. The thrust of the discussion is on whether it is Tang, & Lin, 2010). Then, there is the fourth and unpopular government expenditure that drives economic growth or it is strand, known as the “neutrality view” or the “independent economic growth that causes government expenditure. view.” This view places importance neither on the govern- To date four views exist. The first view is the “govern- ment size nor on economic growth as the two are seen to be ment size-led economic growth view,” or the “supply-lead- independent of each other and therefore do not cause each ing response,” also known as the “Keynesian view.” This other (see Afxentiou & Serletis, 1996; Ansari, Gordon, & view places importance on the size of the government and Akuamoah, 1997; Taban, 2010). argues that it is the government size that causes economic On the empirical front, each of these views has found sup- growth, and not the other way round (see Ebaidalla, 2013; port in one study or the other, giving rise to a far from con- Ghali, 1998; Loizides & Vamvoukas, 2005). On the extreme clusive debate, yet the outcome has perilous policy continuum of this view is the “growth-led government size,” implications. A review of literature shows that various stud- alternatively known as the “demand-following response” or ies that explored the government size–economic growth “Wagner’s Law,” as it is also popularly known. According to this view, government is inefficient in providing services; hence, it cannot drive economic growth. Instead, it is eco- University of South Africa, Pretoria, South Africa nomic growth that propels government size increases as the Corresponding Author: government responds to the demand placed on it by the Sheilla Nyasha, Department of Economics, University of South Africa, P.O. growing economy (see Bohl, 1996; Islam, 2001; Samudram, Box 392, Pretoria 0003, South Africa. Nair, & Vaithilingam, 2009; Thabane & Lebina, 2016). Email: sheillanyasha@gmail.com Creative Commons CC BY: This article is distributed under the terms of the Creative Commons Attribution 4.0 License (http://www.creativecommons.org/licenses/by/4.0/) which permits any use, reproduction and distribution of the work without further permission provided the original work is attributed as specified on the SAGE and Open Access pages (https://us.sagepub.com/en-us/nam/open-access-at-sage). 2 SAGE Open causal nexus had different study country/region coverage expenditure is derived from the national accounts. On an over varied time periods, using varied variables and proxies aggregate basis, total government expenditure is often used and varied econometric techniques. The outcomes were, to signify the size of the government. The less the govern- therefore, also varied, inconsistent, and inconclusive in pro- ment spends, the smaller its size, and the more the govern- viding any policy recommendations that can be applied uni- ment spends in aggregate terms, the larger its size. Although formly across countries. this measure is commonly used, it can be argued that it is an The objective of this study is to take stock of what has appropriate measure of government size in some instances been scientifically produced on the government size–eco- but not in others, due to impact differentials associated with nomic growth causality space, highlighting both the theoreti- the components of government expenditure (Cusack & cal frameworks and empirical evidence on the subject. The Fuchs, 2002; Sedrakyan & Varela-Candamio, 2019). review is fundamentally different from previous reviews. It Cusack and Fuchs (2002) further split government expen- has dedicated focus on the causality between government diture into five components—investment and consumption size and economic growth, unlike isolated reviews that are expenditure, as well as subsidies, social transfers, and inter- more generalized and focus on several aspects of govern- est payments. Some studies have gone beyond the overall ment expenditure and economic growth, which tend to end government spending when analyzing the relationship up scratching the surface of various issues. The confined between government size and various macroeconomic vari- focus of this study allows it to have a deep review and analy- ables. The consideration of various components of govern- sis of previous works, leading to a rich study. ment expenditure by various researchers is premised on the The rest of this article is organized into four sections. understanding that different government expenditure catego- “The Causal Relationship Between Government Size and ries may have a different impact on various macroeconomic Economic Growth: A Theoretical Framework” section variables. Even when components of government expendi- reviews the theoretical literature on the causal relationship ture are considered, the more expenditure on the considered between government size and economic growth, whereas category, the larger the government size, and the opposite “The Causal Relationship Between Government Size and holds. Economic Growth: Empirical Evidence” section reviews the A small government is considered advantageous based on empirical evidence on the causal relationship between gov- the crowding-out effect principle. On the consumption front, ernment size and economic growth. The “Conclusion” sec- governments can only spend what they have taken out of the tion presents some concluding remarks. real economy via taxes or they can alternately finance their spending through borrowing. An increase in tax revenue means reduced private consumption by the same amount of The Causal Relationship Between tax increase. The result is stagnation in overall demand and Government Size and Economic subsequently no wealth creation. From the investment angle, Growth: A Theoretical Framework the same principle applies. Government borrowing from pri- vate lenders makes resources available for lending to private Government Size in a Nutshell investors decline by the same amount lent to the government Following Lane (2000) and Häge (2003), government can be by the private lender. Thus, by and large, if government defined as a state’s body for general decision making and its spending and borrowing go up, private spending and borrow- outcomes. A government, thus, imparts direction to its soci- ing go down by the same margin, its government counterpart ety through various collective decision-making means, and it has gone up. However, on the flipside are the pro-big govern- exercises the state’s authority on a daily basis. The govern- ment size proponents who argue that a big government is ment usually has two arms, the direct arm and the indirect good for the economy as it provides jobs and financial secu- arm. Through the direct arm, the government raises revenue rity to a number of people—to the tune of millions in most through collection of taxes, allocates and redistributes cases. Big governments are also known to create economies resources through subsidies and welfare grants, and produces of scale and to provide infrastructural development, which is and consumes goods and services (Häge, 2003). All these a precursor to private investment. activities performed by the direct arm can be narrowed down to a monetary value. However, the indirect arm of the gov- Government Size and Economic Growth ernment—that is responsible for costs and benefits associ- ated with regulations, indirect taxes, and subsidies in the The relationship between government size—as measured by form of tax allowances—allows the government substantial the level of government expenditure—and economic growth power over national resources, nonetheless, with little reflec- has brought widespread debate, not only empirically but also tion on expenditure and employment data. theoretically. Dominating the theoretical platform are the Government size can be measured in terms of expendi- Keynesians and the Classicals. The Keynesian school of ture, revenue, or employment. However, the expenditure thought places importance on the size of the government measure is the most commonly used indicator. This through fiscal policies. According to this school of thought, Nyasha and Odhiambo 3 fiscal policies boost economic activity, especially during economic growth. While the Keynesian view postulates that recession, when the self-regulatory mechanisms in the econ- the causality runs from government spending to economic omy fail to drive the economy back to equilibrium as a result growth, Wagner’s Law suggests that causality runs from eco- of rigidities in the labor market. The Keynesians are, there- nomic growth to government spending. Both contentions fore, ardent supporters of expansionary fiscal policies for could, however, be correct in their own right, depending on economies to shy away from long and economy-crippling the nature of the particular economy under scrutiny. In econ- recessions. omies dominated by monopolies and where product and fac- With the entrance of new growth theories on the debate tor markets are underdeveloped, the first view may be platform, the Keynesian argument for fiscal policies as eco- applicable. On the contrary, in economies where key prod- nomic growth enhancers has gained traction and additional ucts and services are provided by the government at subsi- support. In contrast to the Neoclassical growth models (see dized rates, and where inefficient public corporations are Solow, 1956) that did not prescribe the transmission chan- abundant, private investment and long-run economic growth nels through which government expenditure could affect are likely to be significantly reduced. Hence, on this premise, long-run economic growth, the new growth theorists argue government size impedes economic growth, thereby validat- that there is both a short-term (temporary) impact and a long- ing the second view. term impact of government intervention through fiscal stim- Some recent theoretical literature has attempted to recon- ulation on economic growth during the transition to cile the two conflicting views—Keynesian view and equilibrium (see Lucas, 1988; Romer, 1986). It is, therefore, Wagner’s Law—by proposing a non-linear relationship that the Keynesian view that even causality runs from increased is positive when the share of government in economic activ- government expenditure to increased economic growth ity is low but negative when the relative size of the govern- through an expansionary fiscal policy. ment grows (Barro, 1989; Easterly, 1999). It is through the On the other side are the Classicals and the Neoclassicals reconciliation of the two prominent views that gave birth to that consider fiscal policies to be futile as a result of the the other two causality views—bidirectional view and the crowding-out effect, directly and indirectly. Directly, these neutrality view, where the former postulates that government two groups of theorists believe increasing public spending size and economic growth are mutually causal while the lat- leads to the substitution of private goods by public goods, ter sees no causality between the two variables, and deem giving rise to lower private expenditure even on key goods them independent. and services. Indirectly, government, as a way of financing its spending, exerts pressure on the market for credit, thereby The Causal Relationship Between pushing up interest rates. When interest rates rise, they do not Government Size and Economic rise for the government only but for everyone, including the private sector—which tends to suppress private investment Growth: Empirical Evidence and overall hamper economic growth. The relationship between government size and economic Furthermore, according to the Classicals and the growth has been on center stage for some time now as econo- Neoclassicals, government may choose to finance its mists and politicians debate on whether it is government increased expenditure by increasing taxes—an act which can expenditure that drives economic growth or vice versa. distort market prices and resource allocation, and may even Empirical literature on the four views, aforementioned in the attract tax evasions and avoidance. The ultimate outcome is “Introduction” section, is systematically and chronologically a negative impact on economic growth. reviewed in the subsections that follow. Unlike the Keynesian view, the Classicals and the Neoclassicals are consistent with Wagner’s (1883/1958) Law, which advocates that the direction of causality runs The Supply-Leading Response/The Government from economic growth to government expenditure for three Expenditure-Led Growth/The Keynesian View reasons: first, the administrative and protective public func- tions of the state substituting for private activity; second, A number of studies on the causal relationship between gov- economic development results in the expansion of cultural ernment size and economic growth lend support to the and welfare expenditures; and third, government interven- “Keynesian view”—alternatively known as the government tion is required to manage and finance natural monopolies. size-led growth. The view has increasingly been referred to Therefore, in Wagner’s view, an expansion in government as the supply-leading response—where economic growth is expenditure is a function of economic development, and not deemed as a mere response to the growth of the government. vice versa. Ghali’s (1998) results confirmed the predominance of the In sum, the Keynesian view and Wagner’s Law present Keynesian view in the case for 10 Organisation for Economic two different positions, placed at each end of the continuum, Co-Operation and Development (OECD) countries. The concerning the relationship in general, and the causal rela- objective of the study was to assess the direction of causality tionship in particular, between government spending and between government expenditure and economic growth in 4 SAGE Open Table 1. Studies in Favor of Unidirectional Causality From Government Size to Economic Growth. Author(s) Region/country Methodology Direction of causality Ghali (1998) OECD countries VECM Size → Growth Loizides and Vamvoukas Greece, the United Kingdom, and Bivariate and trivariate error- Size → Growth (2005) Ireland correction models within a In the short run Granger causality Dogan and Tang (2006) Five South East Asian countries—The Granger-causality test Size → Growth Philippines, Indonesia, Malaysia, In the case of the Philippines Singapore, and Thailand Blankenau, Simpson, and Developed and developing countries Causality tests Size → Growth Tomljanovich (2007) Chandran, Rao, and Anwar Malaysia ARDL approach Size → Growth (2011) Bivariate and the multivariate models Ebaidalla (2013) Sudan Granger-causality test and Size → Growth error-correction model Note. OECD = Organisation for Economic Co-Operation and Development; VECM = vector error-correction model; Size = government size; Growth = economic growth; → = direction of flow; ARDL = autoregressive distributed lag. these countries. Based on a vector error-correction model between real government spending and real gross domestic (VECM), developed through multivariate co-integration product (GDP). Two models were used—a bivariate and a techniques, Ghali concluded that it is the government size multivariate. In addition, the study considered aggregate that Granger-causes economic growth in all the study government expenditure and economic growth, on one hand, countries. and government expenditure on education and economic Loizides and Vamvoukas (2005) examined the causal growth, on the other hand. Using the autoregressive distrib- relationship between government size and economic growth uted lag (ARDL) approach, the results of both the bivariate in three countries—Greece, the United Kingdom, and and the multivariate models, on the whole, revealed that in Ireland—using bivariate and trivariate error-correction mod- Malaysia, aggregate government expenditure was the driver els (ECMs) within a Granger-causality framework. The of economic growth—thereby confirming the Keynesian results of the study showed that government size Granger- view. causes economic growth in all the study countries in the Ebaidalla (2013) investigated the causality between gov- short run while the same outcome for Ireland and the United ernment expenditure and national income in Sudan during Kingdom was realized only in the long run. These results the period from 1970 to 2008. Using the Granger-causality applied irrespective of the model used—bivariate or test and the ECM, the results were consistent with the trivariate. Keynesian view, where causality was found running from Dogan and Tang (2006) revisited the government size– government expenditure to national income, irrespective of growth nexus as they examined the causality between gov- whether the analysis was in the short or in the long run (see ernment expenditure and economic growth in five South Table 1). East Asian countries. The countries were the Philippines, Indonesia, Malaysia, Singapore, and Thailand. Based on the The Demand-Following Response/The Growth- Granger-causality test methodology, a unidirectional causal- Led Government Expenditure View/Wagner’s Law ity running from government expenditures to national income was found, but only in the case of the Philippines. Bohl (1996) put the causal nexus between government Thus, the Keynesian view was supported in the Philippines. expenditure and economic growth under examination in the Another year later, Blankenau, Simpson, and Tomljanovich G7 countries. The results revealed that in the United Kingdom (2007) examined the relationship between government and Canada, it is Wagner’s Law that predominates, where expenditure and economic growth in developed and develop- unidirectional causality was confirmed to run from economic ing countries. Based on the developed country sample, the growth to government expenditure. results of the study were consistent with the Keynesian view. Ansari et al. (1997) put the causal relationship between Chandran, Rao, and Anwar (2011) utilized annual data government expenditure and national income for three covering the 1970-2006 period to examine the causality African countries (Ghana, Kenya, and South Africa) to the between government expenditure and economic growth in test, using data from 1957 to 1990, and using the standard Malaysia. The thrust of the study was to examine Wagner’s Granger causality test. Although the study found no evidence Law and the Keynesian hypothesis concerning the link of causality between government expenditure and national Nyasha and Odhiambo 5 income in Kenya and South Africa, in the short run, it vali- in support of Wagner’s Law, where economic growth was dated Wagner’s Law in the case of Ghana. found to Granger-cause increases in the relative size of gov- Abizadeh and Yousefi (1988) empirically tested the valid- ernment in Greece, irrespective of the model used, and in the ity of Wagner’s Law in the case of South Korea over the United Kingdom when a trivariate model with inflation was period from 1961 to 1992. Using the Granger-type causality considered. tests, their results attested to the existence of unidirectional The direction of causality between government expendi- causality from economic growth to government expendi- ture and economic growth was also empirically examined by ture—thereby certifying the validity of Wagner’s Law. Akitoby, Clements, Gupta, and Inchauste (2006) using a Islam (2001), in the same vein, examined the causal rela- sample of developing countries. They found evidence of the tionship between government expenditures and economic growth-led government expenditure, where unidirectional growth, proxied by real GDP per capita, for the United Granger causality ran from economic growth to government States. Using annual data for the period from 1929 to 1996 expenditure, thus confirming that Wagner’s Law holds in the and the error-correction approach, the results of the study developing countries studied. were consistent with the demand-following response, satis- Sideris (2007) carried out a similar empirical study with fying Wagner’s Law—where economic growth was found to an objective of testing the validity of Wagner’s Law in Granger-cause government expenditure. Greece during the 1833-1938 period. According to Sideris, In the case of Malaysia, T. C. Tang (2001) empirically the study period consideration was well calculated as it rep- tested the direction of causality between government expen- resented a period of growth, industrialization, and modern- diture and economic growth, proxied by national income in ization of the economy—conditions which should be Malaysia during the period from 1960 to 1998. Using conducive to Wagner’s Law. Using Granger-causality tests, Johansen’s multivariate co-integration tests and Granger- the results of the study found causality to run from income causality methodology, the study concluded that in the short to government expenditure, validating Wagner’s Law in run, it is national income that Granger-causes government Greece. expenditure, confirming the relevance of Wagner’s Law in Narayan, Nielsen, and Smyth (2008) empirically tested the study country. Wagner’s Law in Chinese provinces. Using a panel unit root, A year later, Al-Faris (2002) also revisited the causal co-integration, and Granger-causality approach, the results nexus between government expenditure and economic of the study confirmed the presence of Wagner’s Law but growth for Gulf Cooperation Council (GCC) countries using only for the central and western provinces, and not the east- multivariate co-integration and Granger-causality tests. The ern provinces. results indicated the presence of unidirectional Granger cau- In the same year, Mohammadi, Cak, and Cak (2008) also sality from economic growth to government expenditure in examined empirically the causal relationship between gov- the majority of the gulf countries—leading to the acceptance ernment expenditure and economic growth in the case of of Wagner’s Law and the rejection of the Keynesian view in Turkey. The results were consistent with Wagner’s Law, con- the study countries. firming that, in Turkey, it is economic growth that drives Abu-Bader and Abu-Qarn (2003) investigated the direc- government expenditure. tion of causal flow between government expenditure and Samudram et al. (2009) assessed the direction of causality economic growth in three countries—Egypt, Israel, and between government expenditure and economic growth in Syria—covering a period of 30 years. Using multivariate co- the case of Malaysia. Unidirectional Granger causality was integration and variance decomposition techniques, they found flowing from economic growth to various categories found a unidirectional causal flow from economic growth to of government expenditure—defense, education, develop- government expenditure only in the short run and only for ment, and agriculture, in the long run. one study country, Egypt, thereby lending support to C. F. Tang (2009) re-examined the causality between Wagner’s Law. various components of government spending and eco- A year later, Dritsakis (2004) also investigated the direc- nomic growth for Malaysia—with government expendi- tion of causality between government expenditure and eco- ture disaggregated. The study covered the period from nomic growth in Greece and Turkey. The results of the study 1960 to 2007. Using the bounds testing for co-integration were consistent with the growth-led government expenditure and the leveraged bootstrap simulation approaches, hypothesis that places importance on the economic growth together with the Modified Wald (MWALD) causality test, as a driver of government expenditure. the results showed strong evidence of unidirectional causal Loizides and Vamvoukas (2005) examined the causal relationship running from national income to the three relationship between government size and economic growth major government spending in Malaysia (health, educa- in three countries—Greece, the United Kingdom, and tion, and defense)—thereby confirming the validity of Ireland—using bivariate and trivariate ECM within a Wagner’s Law when certain pockets of government expen- Granger-causality framework. The results of the study were diture were considered. 6 SAGE Open A year later, Taban (2010) re-investigated the government confirming that the government expenditure in the study expenditure–economic growth nexus for the Turkish econ- country is real sector-led. Thus, the results validate Wagner’s omy using quarterly data covering the period from 1987:Q1 Law in Lesotho (see Table 2). to 2006:Q4. Various proxies were used to capture govern- ment expenditure—total government expenditure, the share The Bidirectional Causality/Feedback Response of the government consumption spending to GDP, govern- ment investment expenditure to GDP, and government con- Singh and Sahni (1984) examined the causal link between sumption spending to GDP ratio. Based on the bounds testing provincial government expenditure and income for India. approach and MWALD Granger-causality test, unidirec- The thrust of the study was on whether it is public expendi- tional causality was found running from the per capita output ture growth that stimulates income or it is the increase in growth to the ratio of the government investment to GDP, provincial income, which causes government spending to thereby confirming Wagner’s Law in Turkey when govern- rise. The results of the study showed that just as in the cases ment spending was proxied by government investment of national variables, the provincial variable in the study expenditure to GDP ratio. exhibited neither Wagnerian Law nor the Keynesian view Lamartina and Zaghini (2011) also revisited the causal but a feedback relationship. The authors, therefore, con- nexus between government expenditure and economic cluded that increases in public expenditure and provincial growth in 23 OECD countries. Granger causality was found income in one of India’s provinces reinforce each other, in to flow from economic growth to government expenditure in spite of exogenous forces. the sample countries—thereby validating Wagner’s Law. In Cheng and Lai (1997) empirically examined the direction the same vein, Kumar, Webber, and Fargher (2012) also of causality between government expenditure and economic examined empirically the direction of causality between growth in South Korea, during the period from 1954 to 1994, government size and economic growth, this time in New using vector autoregressive (VAR) techniques within a tri- Zealand. Based on the results of the study, they established variate framework. Unlike most studies that had confirmed that in New Zealand, it is economic growth that drives gov- the direction of causality between government expenditure ernment expenditure in the long run. and economic growth to be consistent with either the Using data over the period from 1973 to 2012 for India, Keynesian view or Wagner’s Law, the study found that in Srinivasan (2013) also tested the causality between public South Korea, there exists bidirectional Granger causality expenditure and economic growth. Based on the co-integra- between government expenditures and economic growth. tion approach and ECM, the empirical results showed that Abu-Bader and Abu-Qarn (2003) investigated the direc- causality was one way, flowing from economic growth to tion of causal flow between government expenditure and public expenditure, irrespective of whether the analysis was economic growth in three countries—namely, Egypt, Israel, done in the short run or in the long run. The study, therefore, and Syria—covering a period of 30 years, using multivariate lent support to Wagner’s Law. co-integration and variance decomposition techniques. Akinlo (2013) revisited the causality between govern- When causality was examined within a bivariate framework, ment spending and national income in Nigeria during the the Keynesian view and Wagner’s Law were found to coexist period from 1961 to 2009. The main objective was to assess in Israel and Syria, strongly suggesting the feedback hypoth- the applicability of Wagner’s Law in the study country. Using esis where government expenditure and economic growth a multivariate framework incorporating population size vari- caused each other. able, the study found Wagner’s Law to hold. Ahmad and Ahmad (2005) examined the causality Biyase and Zwane (2015) investigated whether Wagner’s between government expenditure and per capita income Law holds in African countries, using panel data techniques for D-8 member countries. Using standard Granger proce- and for a sample of 30 African countries during the period dure, the results of the study revealed that of all the study from 1990 to 2005. The causality results confirmed the exis- countries, it is only in Iran where short-run bidirectional tence of unidirectional causality from economic growth to causality between government size and per capita income government expenditure in the study countries, irrespective existed. of different panel data techniques used. Thus, the study lent Huang (2006) empirically tested Wagner’s Law in China support to Wagner’s Law. and Taiwan using annual time-series data stretching from One of the most recent studies on the government expen- 1979 to 2002. Based on Pesaran et al.’s (2001) bounds test on diture–growth nexus subject is by Thabane and Lebina unrestricted error-correction model (UECM) estimation and (2016). They empirically examined the causal relationship Toda and Yamamoto’s (1995) Granger non-causality test, the between government spending and economic growth in empirical results of the study showed that Wagner’s Law Lesotho for the period from 1980 to 2012, using the ARDL does not apply in the study countries. Instead, the results bounds testing procedure. The results of the Granger- found bidirectional causality to dominate, implying that in causality test show the existence of unidirectional causal China and Taiwan, government expenditure and economic flow from economic growth to government expenditure, growth are mutually causal. Nyasha and Odhiambo 7 Table 2. Studies in Favor of Unidirectional Causality From Economic Growth to Government Size. Author(s) Region/country Methodology Direction of causality Bohl (1996) G7 countries Causality tests Growth → Size UK and Canada Ansari, Gordon, and Akuamoah Three African countries— Granger test and the Holmes- Growth → Size Ghana (1997) Ghana, Kenya, and South Hutton (1990) causality test Africa Abizadeh and Yousefi (1988) South Korea Granger-type causality tests Growth → Size Islam (2001) The United States The Engle-Granger (1987) Growth → Size error-correction T. C. Tang (2001) Malaysia Johansen’s multivariate Growth → Size co-integration tests and Granger-causality methodology Al-Faris (2002) GCC countries Multivariate co-integration and Growth → Size majority of the Granger-causality tests gulf countries Abu-Bader and Abu-Qarn (2003) Three countries—Egypt, Multivariate co-integration and Growth → Size Israel, and Syria variance decomposition techniques Dritsakis (2004) Greece and Turkey Causality tests Growth → Size Loizides and Vamvoukas (2005) Greece, the United Bivariate and trivariate ECMs Growth → Size Kingdom, and Ireland within a Granger causality Greece and UK Akitoby, Clements, Gupta, and Developing countries Causality tests Growth → Size Inchauste (2006) Sideris (2007) Greece Granger-causality tests Growth → Size Narayan, Nielsen, and Smyth Chinese provinces Panel unit root, co-integration, Growth → Size only for the (2008) and Granger-causality approach central and western provinces Mohammadi, Cak, and Cak (2008) Turkey ARDL bounds tests Growth → Size Samudram, Nair, and Vaithilingam Malaysia ARDL bounds testing approach Growth → Size (2009) C. F. Tang (2009) Malaysia Bounds testing for co-integration Growth → Size when and the leveraged bootstrap government expenditure on simulation approaches, together health, education. and defense with the MWALD causality test was considered Taban (2010) Turkey Bounds testing approach and Growth →Size when MWALD Granger-causality test government spending was proxied by government investment expenditure to GDP ratio Lamartina and Zaghini 23 OECD countries Causality tests Growth →Size (2011) Kumar, Webber, and New Zealand ARDL bounds test, General to Growth →Size Fargher (2012) Specific, Engle and Granger, Phillip Hansen’s Fully Modified Ordinary Least Squares, and Johansen’s time-series techniques Srinivasan (2013) India Co-integration approach and Growth →Size error-correction mode Akinlo (2013) Nigeria Multivariate framework Growth → Size Biyase and Zwane (2015) 30 African countries Various panel data techniques Growth → Size Thabane and Lebina (2016) Lesotho ARDL bounds testing procedure Growth → Size Note. Growth = economic growth; Size = government size; → = direction of flow; GCC = Gulf Cooperation Council; ARDL = autoregressive distributed lag; GDP = gross domestic product; OECD = Organisation for Economic Co-Operation and Development; MWALD = Modified Wald. Samudram et al. (2009) put the Keynesian view and C. F. Tang (2009) re-examined the causality between gov- Wagner’s Law under test for Malaysia during the period ernment spending and economic growth for Malaysia—with from 1970 to 2004. Using the ARDL bounds testing approach, government expenditure disaggregated. The study covered the results revealed the existence of bidirectional causality the period from 1960 to 2007. Using the bounds testing for between GNP and government expenditures on administra- co-integration and the leveraged bootstrap simulation tion and health in the long run. approaches, together with the MWALD causality test, the 8 SAGE Open Table 3. Studies in Favor of Bidirectional Causality Between Government Size and Economic Growth. Author(s) Region/country Methodology Direction of causality Singh and Sahni (1984) India Granger’s causality test Size ↔ Growth in one of India’s provinces Cheng and Lai (1997) South Korea VAR techniques within a Size ↔ Growth trivariate framework Abu-Bader and Abu-Qarn Three countries—Egypt, Multivariate co-integration Size ↔ Growth in Israel and Syria (2003) Israel, and Syria and variance decomposition techniques Ahmad and Ahmad (2005) D-8 member countries Standard Granger procedure Size ↔ Growth only in Iran Huang (2006) China and Taiwan Pesaran et al.’s (2001) Bounds Size ↔ Growth Test on UECM estimation and Toda and Yamamoto’s (1995) Granger non-causality test Samudram, Nair, and Malaysia ARDL bounds testing approach Size ↔ Growth Vaithilingam (2009) Government expenditures on administration and health in the long run C. F. Tang (2009) Malaysia Bounds testing for co-integration Size ↔ Growth when government and the leveraged bootstrap expenditure on health was simulation approaches, together considered with the MWALD causality test Wu, Tang, and Lin (2010) 182 countries Panel Granger-causality test Size ↔ Growth Taban (2010) Turkey Bounds testing approach and Size ↔ Growth total government MWALD Granger-causality test spending Abu-Eideh (2015) Palestinian territories Granger-causality tests Size ↔ Growth Note. Size = government size; ↔ = direction of flow; Growth = economic growth; UECM = unrestricted error-correction model; ARDL = autoregressive distributed lag; MWALD = Modified Wald. results found bidirectional causality to exist between national Abu-Eideh (2015) explored the causal relationship income and government spending on health. between public expenditure and the GDP growth in the Wu et al. (2010) re-examined the Granger causality Palestinian territories during the period from 1994 to 2013. between government expenditure and economic growth The validity of the six versions of Wagner’s Law in the study using a 182-country panel data set covering the period from country was also tested. On the basis of the Granger-causality 1950 to 2004. This was one of the studies with the largest tests, the results showed the existence of bidirectional cau- sample and longest time period. Using the panel Granger- sality, where government expenditure and economic growth causality test, the results of the study strongly supported both were mutually causal (see Table 3). the Keynesian view and Wagner’s Law—thereby confirming that the direction of causality between government expendi- No Causality/The Independent ture and economic growth is bidirectional. The results were View/The Neutrality View found to hold regardless of how the government size/spend- ing and economic growth were measured. Using annual data covering the 1950-1981 period, Singh and In the same year, Taban (2010) re-investigated the gov- Sahni (1984) examined the direction of causality between ernment expenditure–economic growth nexus for the national income and public expenditures in India. Based on Turkish economy using quarterly data covering the period the Granger’s causality test, they found no evidence of cau- from 1987:Q1 to 2006:Q4. Various proxies were used to sality between government spending and national income in capture government expenditure—total government expen- most provinces. Therefore, their finding neither confirmed diture, the share of the government consumption spending the Wagner’s Law nor the Keynesian view. to GDP, government investment expenditure to GDP, and Afxentiou and Serletis (1996) examined government government consumption spending to GDP ratio. Based on expenditure convergence within the expanded European the bounds testing approach and MWALD Granger-causality Union and also tested the validity of Wagner’s Law in the test, the study found strong evidence of bidirectional causal- study countries. Government expenditure was further disag- ity between total government spending and economic gregated into government consumption, transfers, and subsi- growth. dies. Causality tests failed to validate Wagner’s Law; neither Nyasha and Odhiambo 9 did they confirm the reverse causality, irrespective of the Verma and Arora (2010) put to the test the validity of proxy used for government expenditure. Wagner’s Law and all (six) its versions in India over the Ansari et al. (1997) put the causal relationship between period 1950/1951 to 2007/2008. Two phases were identi- government expenditure and national income for three fied—the mild liberalization phase and the intensive liberal- African countries (Ghana, Kenya, and South Africa) to the ization phase. Although the results confirmed the validity of test, using data from 1957 to 1990, and using the standard Wagner’s Law during the intensive phase of liberalization Granger test and its modified version, the Holmes-Hutton given a significant fall in the elasticity, short-run empirical (1990) causality test. The study found no evidence of causal- evidence rejected the validity of the law. Instead, it con- ity between government expenditure and national income for firmed the neutrality hypothesis, where no relationship was Kenya and South Africa, in the short run. found to exist between economic growth and the size of the Bagdigen and Cetintas (2003) also put Wagner’s Law to government expenditure in India. the test in Turkey, using data from 1965 to 2000. Based on In the same year, Taban (2010) re-investigated the gov- the co-integration test and the Granger-causality test, the ernment expenditure–economic growth nexus for the Turkish study found no evidence of any causal relationship between economy using quarterly data covering the period from government expenditure and economic growth in the study 1987:Q1 to 2006:Q4. Various proxies were used to capture country—lending support to the neutrality hypothesis. government expenditure—total government expenditure, the Ahmad and Ahmad (2005) examined the causality share of the government consumption spending to GDP, gov- between government expenditure and per capita income for ernment investment expenditure to GDP, and government D-8 member countries. Using the standard Granger proce- consumption spending to GDP ratio. Based on the bounds dure, the results of the study revealed that in the short run, testing approach and MWALD Granger-causality test, no there is no causality between government expenditure and causality was found to exist between government expendi- per capita income in all D-8 member countries except for ture, as measured by the government consumption spending Iran. This led the authors to conclude that, in these study to GDP ratio, and economic growth. countries, prudent policies, with or without government Using traditional and time-series econometric techniques, intervention, are conducive for economic growth. Afzal and Abbas (2010) re-investigated the application of the Dogan and Tang (2006) tested the causal relationship Wagner’s Law to Pakistan during the period from 1960 to between national income and government expenditure for 2007. The study found no causality between income and five South East Asian Countries—Indonesia, Malaysia, The public spending. Philippines, Singapore, and Thailand. Based on the Granger- Rauf, Qayum, and Zaman (2012) empirically examined causality test methodology, neither the Keynesian view nor the applicability of Wagner’s Law—national income-led Wagner’s Law was confirmed in Indonesia, Malaysia, public expenditure growth—in the case of Pakistan for the Singapore, and Thailand. Thus, no causal relationship was period from 1979 to 2009. Using the ARDL approach to co- found to exist between government expenditure and eco- integration and Todo and Yamamoto’s approach to causality, nomic growth in these four countries. the results confirmed the neutrality of government expendi- Frimpong and Oteng-Abayie (2009) empirically exam- ture and economic growth as there was no causality found ined the Granger-causal relationship between government between the two. expenditure and economic growth proxied by per capita In the same vein, Ray and Ray (2012) examined the GDP growth for three of the five West African Monetary Granger causality between economic growth and various Zone (WAMZ) countries comprising the Gambia, Ghana, components of government expenditure in India. The results and Nigeria. The main objective was to test Wagner’s Law confirmed the absence of short-run causality between eco- and the Keynesian view in the study countries. The study nomic growth and developmental expenditure of govern- was prompted by the issue of whether increasing govern- ment, thereby dispelling both the Keynesian view and ment expenditure is the cause of economic growth or eco- Wagner’s Law in India (see Table 4). nomic growth is the cause of growth in government expenditure—as the issue has policy implications for the Conclusion WAMZ economies, among other economies. Using the co- integration test and Granger-causality test, the results of the In this article, theoretical and the empirical literature on the study confirmed that neither Wagner’s Law nor the Keynesian causal relationship between government size and economic view was valid, as they lent support to the neutrality view, growth has been reviewed, providing coverage for both where no causality was found to exist between government developed and developing countries. The academic literature expenditure and economic growth in the study counties. on the relationship between government size and economic Based on the findings of the study, the authors then con- growth dates back to as early as the late 19th century (Wagner, cluded that noneconomic factors could be playing an impor- 1883/1958), as the researchers battle to establish the impact tant role in influencing government spending in these of government size on economic growth. However, as the countries. research intensified, the causality aspect of the relationship 10 SAGE Open Table 4. Studies in Favor of Neutrality Between Government Size and Economic Growth. Author(s) Region/country Methodology Direction of causality Singh and Sahni (1984) India Granger’s causality test Size ≠ Growth in most provinces Afxentiou and Serletis (1996) Expanded European Union Causality tests Size ≠ Growth Ansari, Gordon, and Akuamoah Three African countries— Standard Granger test and its Size ≠ Growth for Kenya and (1997) Ghana, Kenya, and South modified version—The South Africa, in the short run Africa Holmes-Hutton (1990) Bagdigen and Cetintas (2003) Turkey Co-integration test and the Size ≠ Growth Granger-causality test Ahmad and Ahmad (2005) D-8 member countries Standard Granger procedure Size ≠ Growth in all D-8 member countries except for Iran Dogan and Tang (2006) Five South East Asian Granger-causality test Size ≠ Growth in Indonesia, Countries—Indonesia, Malaysia, Singapore, and Malaysia, The Philippines, Thailand Singapore, and Thailand Frimpong and Oteng-Abayie Three WAMZ countries—The Co-integration test and Size ≠ Growth (2009) Gambia, Ghana, and Nigeria Granger-causality test Verma and Arora (2010) India ECM Size ≠ Growth in the short run Taban (2010) Turkey Bounds testing approach and Size ≠ Growth when government MWALD Granger-causality expenditure is measured by test the government consumption spending to GDP ratio Afzal and Abbas (2010) Pakistan Standard Granger or Sims test Size ≠ Growth Rauf, Qayum, and Zaman Pakistan ARDL approach to co-integration Size ≠ Growth (2012) and Todo and Yamamoto’s approach to causality Ray and Ray (2012) India Causality tests Size ≠ Growth Note. Size = government size; Growth = economic growth; ≠ = not causality related. WAMZ = West African Monetary Zone; ECM = error- correction model; GDP = gross domestic product; ARDL = autoregressive distributed lag; MWALD = Modified Wald. gained traction, leading to the intensification of the debate on proxies, data set used, and time frame considered. Also whether it is government size that drives economic growth or revealed by this study is that of the four views on the causal- it is economic growth that propels government size. To date, ity between government size and economic growth, the most there is little consensus on the exact direction of causality prominent one is the second view, the Wagner’s Law, which between these two key macroeconomic variables. Previous validates unidirectional Granger-causality from economic literature on the subject can be divided into four categories. growth to government size, followed by the bidirectional The first category is the government size-led growth, which Granger-causality category. Notwithstanding this outcome, consists of studies that support the Keynesian view. the study also finds empirical literature in favor of govern- According to this group, it is the government size that pro- ment size-led growth and no causality to be increasing. The pels the real sector. The second category is the growth-led study, therefore, concludes that the causal relationship government size, which is based on the premise that it is eco- between government size and economic growth is not nomic growth that leads to government size increase. This clear-cut. category supports the famous Wagner’s Law. Then, there is the third view, which is a middle ground. This category con- Declaration of Conflicting Interests sists of studies that validate both the Keynesian view and The author(s) declared no potential conflicts of interest with respect Wagner’s Law, and therefore concluded that government size to the research, authorship, and/or publication of this article. and economic growth are mutually causal—thereby confirm- ing the bidirectional causality between the two variables. Funding The fourth and less popular category is made up of studies The author(s) received no financial support for the research, author- that support the neutrality or the independent view, where ship, and/or publication of this article. government size and economic growth are independent of each other and, therefore, do not cause each other. 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Quarterly Journal of Economics, 70, 65-94. Author Biographies Srinivasan, P. (2013). Causality between public expenditure and Sheilla Nyasha holds a doctoral degree in Economics from the economic growth: The Indian case. International Journal of University of South Africa (UNISA) and is currently a senior Economics and Management, 7, 335-347. research fellow in the Macroeconomic Policy Analysis (MPA) Taban, S. (2010). An examination of the government spending research programme at the University of South Africa. She is also and economic growth nexus for Turkey using the bound test with the Department of Trade and Industry as a director. Sheilla approach. International Research Journal of Finance and Nyasha has done extensive research covering the financial sector Economics, 48, 184-193. development, public sector and economic growth, among other Tang, C. F. (2009). An examination of the government spending areas, in a number of countries; and her research has been published and economic growth nexus for Malaysia using the leveraged in a number of internationally recognised journals. bootstrap simulation approach. Global Economic Review, 38, 215-227. Nicholas M. Odhiambo holds a PhD in Economics from the Tang, T. C. (2001). Testing the relationship between govern- University of Stellenbosch, South Africa and is currently the ment expenditure and national income in Malaysia. Analisis, research chair of the Macroeconomic Policy Analysis (MPA) pro- 8(1&2), 37-51. gramme at the University of South Africa (UNISA). His research Thabane, K., & Lebina, S. (2016). Economic growth and gov- profile is broad, rich and multifaceted. During the past 17 years, he ernment spending nexus: Empirical evidence from Lesotho. has published more than 150 articles in 60 internationally recognised African Journal of Economic Review, IV(1), 86-100. journals.
SAGE Open – SAGE
Published: Sep 20, 2019
Keywords: government size; government expenditure; economic growth; Granger-causality
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