Available online at www.sciencedirect.

com

Journal of Policy Modeling 32 (2010) 804817

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 Wagners 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 classication: E24; E32; E52

Keywords: Government size; Economic growth; Wagners 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 Wagners ([1883] 1958) law pos-
tulates that government spending is income elastic and that the ratio of government spending to

Corresponding author. Tel.: +886 3 574 2729; fax: +886 3 562 9805.
E-mail addresses: wus@mx.nthu.edu.tw (S.-Y. Wu), jhtang@mx.nthu.edu.tw (J.-H. Tang),
slin@mx.nthu.edu.tw (E.S. Lin).
1 Tel.: +886 3 516 2031; fax: +886 3 562 9805.
2 Tel.: +886 3 516 2149; fax: +886 3 562 9805.

0161-8938/$ see front matter 2010 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.
doi:10.1016/j.jpolmod.2010.05.011
 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817 805

income tends to grow with economic development. Moreover, the public goods and services pro-
vided by the government for non-military purposes, such as education, infrastructure, and laws,
are often regarded as important factors for economic growth.
The effects of economic growth on government expenditure have been examined by many
empirical studies using various testing procedures and different measures of government spending
(e.g., Peacock & Scott, 2000). Since the 1990s, it has become a common practice to test Wagners
law using times-series techniques such as unit-root and co-integration tests (Narayan, Nielsen, &
Smyth, 2008). Using the Swedish data, Henrekson (1993) finds no support for Wagners law; he
also notes that earlier findings from time-series studies may be spurious because they did not pre-
test the stationarity properties of the data. In contrast, Akitoby, Clements, Gupta, and Inchauste
(2006) find support for Wagners law by applying the co-integration method to a sample of 51
developing countries.
On the other hand, a number of studies have tested for the influence of government activity on
economic growth assuming that an inverted-U relationship exists between the scale of government
and economic growth (e.g., Ram, 1986; Dar & AmirKhalkhali, 2002). Hansson and Henrekson
(1994) utilize disaggregated data and find that government transfers, consumption and total out-
lays have negative effects, while educational expenditure has a positive effect, and government
investment has no effect on private productivity growth. In a framework of endogenous growth,
Barro (1990) predicts that the unproductive governmental spending will lower the growth rate of
GDP, while the the effect of productive government expenditure on the growth rate of GDP is
ambiguous, depending on how the government behaves and on whether the expenditure ratio is
too little or too much. Some subsequent research also confirms the detrimental effect of the public
sector on economic growth (e.g., Barro, 1991).
The existing empirical studies in general suggest that Wagners law may hold for developed
countries, but less likely so for developing countries (Akitoby et al., 2006). On the other hand,
another strand of literature suggests that government spending could have a positive effect on
economic growth if it involves public investment in infrastructure, but could have a negative effect
if it involves only government consumption. Yet, previous studies have not reached a consensus on
the relationship between government spending and economic growth, owing to their differences
in the specification of econometric models, the measurement of government expenditures, and
the selection of samples (e.g., Agell, Lindh, & Ohlsson, 1997).
As pointed out by Abu-Bader and Abu-Quar (2003), typical regressions for explaining gov-
ernment spending or economic growth generally focus on the associations between government
spending and economic growth, rather than providing insight into the direction of causality.
One popular approach to investigating the causal relationships between the two variables has
been using the tests la Granger (1969). Over the past decades many studies have applied the
Granger causality tests to test the causal relationship between government spending and economic
growth.
Halicioglu (2003) applies the Granger causality tests to the Turkish data over 19602000
and finds neither co-integrated nor causal relationships between per capita GDP and government
spending shares. In contrast, several studies find evidence on the Granger causality running from
national income to government expenditure, and thus provide support for Wagners law (e.g.,
Abu-Bader & Abu-Quar, 2003). In particular, Dritsakis (2004) provides evidence on such a causal
relationship for Greece and Turkey. By applying the unit-root, co-integration, and the Granger
causality tests to panel data, Narayan et al. (2008) find that Wagners law is supported by the
panel of sub-national data on Chinas central and western provinces, but is rejected by the full
panel consisting of all Chineses provinces. Using the U.S. data since 1792, Guerrero and Parker
806 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817

(2007) find evidence supporting Wagners law but not supporting the hypothesis that the size of
the public sector Granger causes economic growth.
As most of the literature employs the techniques from time-series econometrics and uses the
data on a small number of countries, the empirical findings are thus usually sample-specific and not
robust. Consequently, previous studies may not provide consistent evidence on the relationships
between government size and economic growth. In this paper, we re-examine the causal relation-
ships between government expenditure and economic growth by undertaking the test procedure
recently developed by Hurlin (2004, 2005). In contrast to the literature, this new test procedure
is implemented on panel data; thus, as argued by Hurlin, it is more efficient than those solely
based on time-series data for they may perform poorly in small samples. We collect a richer panel
data set which includes 182 countries, with the sample covering the period from 1950 to 2004.
To investigate whether country heterogeneities affect the regression results, we also carry out the
Granger causality tests on the subsamples based on income levels and the degree of corruption,
and on whether they are OECD countries or not. This paper contributes to the literature by uti-
lizing more efficient econometric methods to a large data set with more countries over a longer
period. Furthermore, the regression results based on subsamples with similar levels of income or
corruption are able to provide broader implications for economic development.
The panel Granger causality tests in this study generally support both Wagners law and the
hypothesis that the government spending plays a role in economic growth, regardless of how we
measure government size and economic growth. Unlike those using cross-country or time-series
data, this study applies more efficient panel Granger tests to panel data over 19502004 for 182
countries. Besides the introduction, the remainder of this paper is organized as follows. Section
2 examines the econometric foundations for the Granger causality test applied to panel data.
Section 3 discusses the regression results and evaluates their policy implications. Section 4 then
concludes.

2. Econometric methodology and data sources

To empirically verify the Wagners law hypothesis is equivalent to investigating the relationship
between the GDP and government spending based on the concept of Granger causality (1969). The
government spending causes the GDP growth rate in the Granger sense if the lagged government
spending does in fact help the forecast for the GDP growth rate. The Granger causality test for
time-series data is well developed. However, a better way to test for causality is to combine both
the cross-sectional and time-series data, and perform the so-called panel Granger causality test.
It turns out to be more efficient than using the time-series data only (Hurlin & Venet, 2003).

2.1. Panel unit-root tests

Like the standard Granger causality test, the panel causality test developed by Hurlin (2004,
2005) also requires the variables under investigation be covariance-stationary. The tools used here
for detecting non-stationarity of the data are the panel unit-root tests developed by Levin, Lin,
and Chu (2002; LLC, hereafter), and other researchers. The more traditional unit-root tests, such
as the Dickey-Fuller, Augmented Dickey-Fuller (ADF), Phillips-Perron, and KPSS tests, may
also be applied to serve the same purpose. However, those univariate/single-equation methods
are well known for their low power in small samples. By contrast, the panel unit-root tests can be
more powerful than the conventional tests for they combine the information from the time-series
dimension with that from the cross-sectional dimesion.
 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817 807

Since the pioneering work of LLC, several panel unit-root tests have become available. Here
we use the tests developed by LLC, Breitung (2000), Maddala and Wu (1999; MW, hereafter),
Choi (2001), and Im, Pesaran, and Shin (2003; IPS, hereafter). As in the literature, the tests are
based on estimating the model:


Ki
(k)
yit = i + i yit1 + i t + i yitk + it ,
k=1

it iid N(0, 2 ), i = 1, . . . , N, t = 1, . . . , T,

where yit denotes the variable y observed for the ith of N entities in the tth of T periods, and  is
the difference operator. The LLC test involves the null hypothesis Ho : i = 0 for all i against the
alternative HA : i = < 0 for all i. The Breitung test does not employ a bias adjustment, which
results in a substantially higher power than that of the LLC test. The IPS test involves the same
null hypothesis as the last test, but its alternative hypothesis allows for non-stationarity for some
individuals. The idea of IPS is simply to compute the average of the individual ADF test statistics.
MW and Choi utilize the heterogeneous alternative and propose the Fisher type test statistics by
combining the p-values from unit-root tests across individual i.

2.2. Panel Granger tests

Once stationarity of the variables has been verified, one can test the causal relationships between
two variables in the spirit of Granger (1969). The panel Granger test is pioneered by Holtz-Eakin,
Newey, and Rosen (1988), who consider the following fixed-effect model:


K 
K
yit = i + (k) yitk + (k) xitk + it , i = 1, . . . , N, t = 1, . . . T, (1)
k=1 k=1

where i represents the fixed individual effect, and coefficients (k) and (k) are implicitly assumed
to be identical for all individuals. The proposed Granger test has the null hypothesis:

Ho : (1) = (2) = = (K) = 0. (2)

As pointed out by Hurlin (2004), this approach may suffer from several shortcomings. First,
this test involves estimators for (k) and (k) , but the fixed-effect estimators in dynamic models
tend to be biased and inconsistent if N is large while T is relatively short (Nickell, 1981). Second,
when T is short, the Wald-type statistic associated with the null hypothesis may not have a standard
distribution (Hurlin & Venet, 2003). Finally, the alternative hypothesis against the null hypothesis
in (2) is that (k) =
/ 0, for some k {1, . . . , K}, i.e., x causes y for all individuals. This is quite
strong (Granger, 2003).
Given the above discussions, here we conduct Granger causality tests by following Hurlins
(2004, 2005) approach, which considers the following model:


K
(k)

K
(k)
yit = i + i yitk + i xitk + it , i = 1, . . . , N, t = 1, . . . T. (3)
k=1 k=1
808 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817

(k) (k)
The last specification is more general than (1) in that coefficients i and i admit hetero-
geneity among individuals. The null hypothesis to be tested is
(1) (2) (K)
Ho : i = i = = i = 0, for all i = 1, . . . , N. (4)
This is called the homogeneous non-causality (HNC) hypothesis, and it is different from (2)
in that the alternative hypothesis against it allows for the causality from x to y for some but not
all individuals. This approach is undertaken in two steps. In the first step, we compute for each
(1) (K)
individual i the Wald statistic under the null that i = = i = 0, denoted by Wi,T . Then,
we compute the average of the Wald statistics from the previous step:

1
N
HNC
WN,T = Wi,T . (5)
N
i=1
HNC
As shown by Hurlin (2004), the average Wald statistic WN,T converges in distribution to a
standard normal if T is sufficiently large (or T ). More specifically,

N d
ZN,T =
HNC
(W HNC K)N(0, 1). (6)
2K N,T
If T is small, the last result does not hold.3 Nevertheless, Hurlin shows that if T > 5 + 2K, we
can still have the following useful result:
  
N T 2K 5 T 2K 3 HNC d
ZN,T =
HNC
WN,T K N(0, 1). (7)
2K T K 3 T 2K 1
Hurlin (2005) further shows that the causality test can also be applied to unbalanced panel
data, which are often encountered in empirical studies. Specifically, suppose individual i has the
number of observations Ti > 5 + 2K, where i = 1, . . . , N. The result displayed in (7) should be
modified as follows4 :
 
K  Ti 2K 1
N
ZN,T = N WN,T
HNC HNC
N Ti 2K 3
i=1
 1/2
2K  (Ti 2K 1)2 (Ti K 3)
N
d
N(0, 1), (8)
N (Ti 2K 3)2 (Ti 2K 5)
i=1

where again we can appropriately scale the average of the individual Wald statistic to obey the
standard normal distribution asymptotically to deal with the unbalanced panel data set.

2.3. Variables and data sources

In previous studies on the relationships between government expenditure and economic devel-
opment, different measurements for the two variables of interest have been proposed. The

3 If T is small, the individual Wald statistic W

i,T does not converge to a chi-squared distribution. Consequently, the
HNC
average Wald statistic WN,T in (5) no longer has the asymptotic property such that (6) holds.
N
4 HNC
Of course, the definition of WN,T in (5) should be modified accordingly: WN,THNC
= W /N, where Wi,Ti
i=1 i,Ti
represents the individual Wald statistics associated with the Granger HNC tests for individual i.
 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817 809

differences in the measurements might lead to different conclusions. To address this issue, we
measure the variables using the methods that often appear in the literature (e.g., Peacock & Scott,
2000). Specifically we consider the following five sets of measurements and conduct Granger
causality tests on each set:

I. real GDP vs. real government spending;

II. real GDP/population vs. real government spending;
III. real GDP/population vs. real government spending/population;
IV. real GDP vs. real government spending/real GDP;
V. real GDP/population vs. real government spending/real GDP.

The data on population, real GDP, and the government expenditure to GDP ratio are taken
from Penn World Table 6.2, compiled by Heston et al. (2006). A total amount of 182 countries
are included; the sampling period is from 1950 to 2004.

2.4. Tests on subgroups of countries

To control for country heterogeneity owing to various stages of development, we first divide the
sample countries into OECD and non-OECD groups. As the OECD included 30 member countries
in 2005, the OECD and non-OECD subsamples consist of 30 and 152 countries, respectively.5
To further investigate the influence of income level on the relationship between government size
and economic development, the countries are also classified into high-, middle-, and low-income
groups, according to their GNI per capita in 2007 (calculated by the World Bank Atlas method).
As defined by the World Bank, the low-income countries are those having a per capita GNI less
than $936; the middle-income countries are those having a per capita GNI between $936 and
$11,455; and the high-income countries are those having a per capita GNI greater than $11,455.
The low-, middle-, and high-income groups consist of 47, 84, and 51 countries, respectively.
A number of studies have documented the impacts of corruption on government efficiency, the
composition of government expenditure, and economic growth (e.g., Mauro, 1998). To examine
whether the relationship between government spending and economic growth hinges on cor-
ruption, we classify the sample countries into low- and high-corruption countries. Transparency
International publishes annually for most countries the Corruption Perceptions Index (CPI), which
is defined as the degree to which corruption is perceived to exist among public officials and politi-
cians. A higher score implies less (perceived) corruption. The mean CPI for all countries in the
Transparency International data set equals 4.03 in 2004, so we classify the countries with a CPI
greater than 4.03 as the low-corruption countries (64 countries) while the others are classified as
the high-corruption countries (118 countries).

3. Results

HNC
For all the cases considered, we compute the standardized statistic ZN,T based on the asymp-
HNC
totic moments and the standardized ZN,T based on the approximation of finite sample moments.

5 The countries in our subsample based on different groupings are listed in the supplementary Appendix, which can be

found at authors website.

810 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817

Table 1
Panel unit-root tests level and first difference.
Variables LLC Breitung IPS MW Choi

Y 12.314 4.132 3.282 442.212 546.148

[0.000] [1.000] [1.000] [0.004] [0.000]
sG 2.955 0.838 6.741 567.361 619.826
[0.002] [0.201] [0.000] [0.000] [0.000]
y 7.308 2.390 1.064 462.026 462.078
[0.000] [0.992] [0.856] [0.001] [0.001]
g 9.876 3.271 3.239 508.142 613.034
[0.000] [1.000] [0.001] [0.000] [0.000]
G 15.024 4.856 3.572 547.989 700.088
[0.000] [1.000] [0.000] [0.000] [0.000]
Y 19.652 24.008 43.387 2717.920 3585.640
[0.000] [0.000] [0.000] [0.000] [0.000]
sG 32.559 24.908 54.927 3418.980 4674.610
[0.000] [0.000] [0.000] [0.000] [0.000]
y 20.606 24.541 44.669 2799.750 3694.760
[0.000] [0.000] [0.000] [0.000] [0.000]
g 33.270 21.935 50.227 3058.490 4190.860
[0.000] [0.000] [0.000] [0.000] [0.000]
G 31.703 21.627 48.341 2926.010 4123.320
[0.000] [0.000] [0.000] [0.000] [0.000]

Notes: (1) Y, sG , y, g, and G denote real GDP, government share, real GDP per capita, real government expenditure
per capita, and real government expenditure, respectively. (2) All variables are logged before testing. (3)  denotes the
first-difference operator. (4) p-values are given in parentheses.

To address the sensitivity of the results to the selection of the lag order K in (3), we compute all
the statistics for K = 1, 2, and 3.

3.1. Panel unit-root tests

Before implementing the panel Granger causality tests, panel unit-root tests are conducted
to investigate whether the variables of interest exhibit stationarity. Five versions of panel unit-
root tests with the same null hypothesis, viz., the LLC, IPS MW, Choi, and Breitung tests, are
employed.6
Table 1 summarizes the results, where Y, sG , y, g, and G denote real GDP, government share,
real GDP per capita, real government expenditure per capita, and real government expenditure,
respectively. The results indicate that the variables of interest are likely to be non-stationary.
For all the cases considered, the IPS and Breitung tests suggest that five variables are non-
stationary, whereas the LLC, MW and Choi tests suggest otherwise. The unit-root tests on the
first-differenced variables in Table 1 suggest that the first-difference transformation will remove

6 While the panel unit-root tests can increase the power of time-series unit-root tests for each single country by increasing

the sample size, it should be noted that the asymptotic theory for the panel unit-root tests is built upon the assumption
of large T and N. As it is often encountered in empirical research, the time dimension in our sample is not that large.
Nevertheless, Im et al. (2003) show that the finite-sample properties of the IPS test perform reasonably well. In particular,
even when T = 10, the empirical sizes are very close to the nominal sizes for all cross-sectional sample sizes (say, for
N = 10, 25, 50 and 100).
 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817 811

the potential non-stationarity. Thus, the first-differenced variables will be used in the analysis
below.7

3.2. Panel causality tests

The results from the full sample are reported in Panel (A) of Table 2. For the full sample, both
the causality running from government expenditure to economic growth and the reverse causality
are strongly supported by the panel Granger causality tests. These results are robust to the five
versions of Wagners law and the lag lengths varying from 1 to 3.
To address the sensitivity of the results to country selection and to compare the results with the
literature, the sample is split based on various criteria and the tests are re-examined based on the
subsamples. First, the sample is categorized into OECD and non-OECD countries, and the results
are reported in Panels (B) and (C) of Table 2. The tests on OECD countries are consistent with
previous studies using OECD countries (e.g., Ghali, 1998).8 The causality tests on non-OECD
countries also support bi-directional causality between government size and economic growth. By
contrast, Granger causality tests in previous studies on non-OECD countries are generally based
on a small number of countries and their results are mixed. For example, Iyare and Lorde (2004)
find a causal effect of national income on government expenditure for Caribbean countries, but
Halicioglu (2003) does not find a similar effect for Turkey.
The sample is further grouped into the low-, middle-, and high-income countries. The causality
tests are conducted for each group, and the results are summarized in Table 3. For both the middle-
and high-income countries, the bi-directional causal relationships between government spending
and economic growth are quite robust. In contrast, the results from the low-income countries
appear to depend on the measure of government spending. As shown in the bottom panel of
Table 3, the data on the low-income countries support the hypothesis that economic growth leads
to a larger government if the government spending is measured in aggregate or per capita levels
(versions I, II, and III in Section 2.3), but not so if government spending is measured by GDP
shares (versions IV and V in Section 2.3). The results suggest that the public sector expands
as the economy grows, but it does not grow faster than the economy. When per capita income
is as low as $935 and most people live below the subsistence level,9 it is less feasible for the
public sector to take the limited economic resources away from the private sector. Thus, while
the public sector of a low-income country may grow along with the economy, its GDP share is
less likely to increase significantly. Akitoby et al. (2006) note that the existing empirical evidence
on Wagners law is generally supported for developed countries, but there is somewhat weaker
support for developing countries. Thus, the above findings from different income groups are
largely consistent with previous studies.
Notably, the bottom panel of Table 3 also indicate that the homogeneous non-causality from
government spending to economic growth cannot be rejected, suggesting that the growth effect
of government spending is insignificant for the low-income countries. The results appear to go

7 The non-stationarity of the key variables under consideration has been confirmed or treated in the literature, for

instance, see Halicioglu (2003), etc. Another motive for using the first-differenced variables is that our main interest is
to explore the effect of the government size on economic growth so that there is a strong reason to adopt the growth rate
rather than the level of variables.
8 Ghali (1998) utilizes the Granger causality test to show that government size causes economic growth in a sample of

10 OECD countries.
9 Recall that the low-income countries are those with a per capita GNI less than $935 in 2007 dollars.
812 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817

Table 2
Panel Granger causality tests (Part I).
I II III IV V

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

(A) Full sample (N = 182)

K=1
Z 16.46* 6.86* 16.30* 6.00* 15.88* 5.84* 8.24* 6.30* 8.59* 5.33*
Z 12.46* 4.78* 12.33* 4.09* 11.9* 3.96* 5.46* 3.98* 5.73* 3.24*
K=2
Z 15.01* 7.87* 14.32* 7.19* 14.28* 6.88* 8.68* 8.54* 8.50* 6.96*
Z 9.99* 4.76* 9.48* 4.26* 9.45* 4.04* 4.82* 4.73* 4.70* 3.65*
K=3
Z 24.86* 11.30* 36.00* 9.78* 38.77* 11.01* 9.71* 11.05* 16.58* 10.36*
Z 16.22* 6.74* 24.01* 5.68* 25.94* 6.54* 5.47* 6.40* 10.23* 5.92*
(B) OECD countries (N = 30)
K=1
Z 11.88* 1.71* 10.72* 1.36 10.38* 1.52 4.53* 2.07* 4.77* 1.91*
Z 10.55 * 1.35 9.50* 1.04 9.20* 1.18 3.76* 1.59 3.97* 1.44
K=2
Z 11.94* 4.77* 10.99* 4.47* 10.25* 4.40* 8.25* 4.76* 7.91* 4.08*
Z 10.20* 3.90* 9.36* 3.63* 8.71* 3.57* 6.66* 3.69* 6.36* 3.11*
K=3
Z 12.74* 2.21* 11.58* 2.13* 10.32* 2.10* 6.74* 2.87* 6.12* 2.19*
Z 10.26 * 1.47 9.29* 1.40 8.23* 1.37 4.93* 1.83* 4.44* 1.28
(C) Non-OECD countries (N = 152)
K=1
Z 12.70* 6.76* 13.05* 5.97* 12.74* 5.72* 6.99* 5.97* 7.28* 4.98*
Z 9.25* 4.60* 9.53* 3.98* 9.28* 3.78* 4.41* 3.65* 4.62* 2.92*
K=2
Z 11.05* 6.48* 10.72* 5.86* 11.02* 5.56* 5.76* 7.21* 5.72* 5.79*
Z 6.88* 3.64* 6.65* 3.20* 6.86* 2.99* 2.75* 3.71* 2.72* 2.77*
K=3
Z 21.49* 11.43* 34.32* 9.80* 37.97* 11.17* 7.55* 10.87* 15.44* 10.43*
Z 13.46* 6.65 * 22.16* 5.54* 24.62* 6.48* 3.92* 6.16* 9.24* 5.86*

Notes: (1) Y, sG , y, g, and G denote real GDP, government share, real GDP per capita, real government expenditure per
capita, and real government expenditure, respectively. (2) The formulae for Z and Z are displayed in Eqs. (6) and (8). (3)
The symbol K denotes the autoregressive lags. (4) All variables are logged and first-differenced before testing.
* Significance at 5% level.

against the Keynesian hypothesis. This may be explained by the growth literature (see, e.g.,
Barro, 1990), which postulates that the growth effect of government spending depends on how
the government spending is allocated and executed. As compared to the developed countries, the
low-income countries generally have poorer institutional quality and more corrupt governments;
consequently, their government budgets are more likely to be embezzled for private uses or spent
on unproductive projects (see, e.g., La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1999). Thus,
the growth effect of government spending tends to be insignificant for those countries.
While the relationships between government spending and economic growth have been dis-
cussed at length, the literature focuses mainly on how the relationships are influenced by the
stage of economic development, but rarely on how the relationships are influenced by the degree
 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817 813

Table 3
Panel Granger causality tests (Part II).
I II III IV V

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

(A) High-income countries (N = 51)

K=1
Z 12.63* 4.72* 11.27* 3.26* 12.16* 3.08* 7.46* 4.10* 7.36* 2.66*
Z 10.91* 3.89* 9.71* 2.60* 10.50* 2.44* 6.01* 3.15* 5.93* 1.92*
K=2
Z 13.45* 5.93* 12.82* 4.46* 12.70* 4.34* 8.40* 5.54* 8.08* 3.94*
Z 11.04* 4.62* 10.51* 3.36* 10.40* 3.27* 5.94* 3.73* 5.70* 2.51*
K=3
Z 14.70* 3.53* 13.86* 2.82* 12.74* 2.43* 6.78* 3.95* 5.75* 2.47*
Z 11.16* 2.24* 10.49* 1.67* 9.59* 1.36* 4.59* 2.40* 3.80* 1.25
(B) Middle-income countries (N = 84)
K=1
Z 11.69* 6.25* 12.38* 5.92* 10.86* 5.82* 5.26* 6.20* 5.41* 5.79*
Z 8.17* 4.11 * 8.69* 3.86* 7.55* 3.79* 3.16* 3.83* 3.26* 3.53*
K=2
Z 9.68* 7.80* 9.00* 7.68* 8.77* 7.45* 5.66* 8.94* 5.42* 7.85*
Z 5.69* 4.45* 5.24* 4.36* 5.09* 4.21* 2.84* 4.93* 2.68* 4.24*
K=3
Z 20.30* 14.70* 19.25* 12.66* 19.09* 14.66* 6.27* 13.75* 5.93* 13.69*
Z 12.29* 8.67 * 11.61* 7.36* 11.51* 8.65* 3.28* 8.19* 3.06* 8.15*
(C) Low-income countries (N = 47)
K=1
Z 3.57* 0.25 3.77* 0.52 4.02* 0.53 1.36 0.16 1.99* 0.01
Z 2.58* 0.16 2.75* 0.07 2.96* 0.08 0.61 0.57 1.09 0.45
K=2
Z 2.46* 1.11 2.65* 0.72 3.01* 0.89 0.63 0.90 0.93 0.87
Z 1.36 1.34 1.51 1.04 1.78* 1.17 0.14 1.19 0.06 1.17
K=3
Z 6.60* 0.66 30.63* 0.24 37.45* 0.02 3.59* 0.42 18.66* 0.09
Z 4.07* 1.06 21.03* 0.76 25.85* 0.58 1.76* 0.95 11.97* 0.74

Notes: (1) Y, sG , y, g, and G denote real GDP, government share, real GDP per capita, real government expenditure per
capita, and real government expenditure, respectively. (2) The formulae for Z and Z are displayed in Eqs. (6) and (8). (3)
The symbol K denotes the autoregressive lags. (4) All variables are logged and first-differenced before testing.
* Significance at 5% level.

of government corruption. As noted above, corruption not only affects government efficiency
and spending composition, but also hinders economic development. Consequently, the effect
of government spending on economic growth would be lessened in a more corrupt environment.
Moreover, corruption may induce more government spending on military spending (Mauro, 1998)
and hence the effect of economic growth on government spending is likely to be larger in a more
corrupt country.
Corruption is often related to regulation; both of them are in general found to be detrimental
to institutional efficiency. While a number of studies have found a positive relationship between
institutional efficiency and economic growth, the direction of causality and the underlying mech-
anism are still in debate. For example, Dawson (2003) utilizes the Granger causality tests to assess
814 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817

Table 4
Panel Granger causality tests (Part III).
I II III IV V

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

(A) High-corruption countries (N = 118)

K=1
Z 9.77* 3.93* 11.12* 4.02* 10.13* 3.78* 3.79* 3.59* 4.28* 3.36*
Z 6.77* 2.35* 7.79* 2.42* 7.04* 2.23* 2.02* 1.88* 2.37* 1.71*
K=2
Z 7.73* 4.76* 8.11* 5.05* 8.00* 4.62* 4.69* 5.95* 4.58* 5.05*
Z 4.41* 2.40* 4.66* 2.59* 4.59* 2.30* 2.11* 2.91* 2.03* 2.33*
K=3
Z 18.94* 8.94* 35.26* 8.49* 39.09* 8.77* 7.00* 8.30* 16.93* 7.88*
Z 11.30* 4.84* 21.84* 4.55* 24.32* 4.73* 3.59* 4.44* 10.07* 4.17*
(B) Low-corruption countries (N = 64)
K=1
Z 14.56* 4.99* 12.60* 3.41* 13.10* 3.47* 9.21* 5.04* 9.16* 3.65*
Z 12.49 * 4.06* 10.76* 2.66* 11.20* 2.72* 7.52* 3.94* 7.47* 2.74*
K=2
Z 13.39* 6.29* 11.78* 4.77* 11.76* 4.81* 8.27* 6.31* 8.04* 4.79*
Z 10.62* 4.72* 9.28* 3.45* 9.27* 3.49* 6.05* 4.47* 5.86* 3.25*
K=3
Z 15.44* 6.72* 13.45* 4.71* 13.09* 6.39* 7.26* 7.48* 6.20* 6.84*
Z 11.62 * 4.70* 10.05* 3.11* 9.76* 4.44* 4.73* 4.90* 3.93* 4.42*

Notes: (1) Y, sG , y, g, and G denote real GDP, government share, real GDP per capita, real government expenditure per
capita, and real government expenditure, respectively. (2) The formulae for Z and Z are displayed in Eqs. (6) and (8). (3)
The symbol K denotes the autoregressive lags. (4) All variables are logged and first-differenced before testing.
* Significance at 5% level.

the causal relationships between economic freedom and economic growth. He finds that aspects
of freedom are more crucial for economic growth than the degree of freedom. In this paper, we
do not directly test the causal relationships between corruption and other variables. Nevertheless,
we assess the influence of corruption on the causal relationship between government spending
and economic growth by testing the Granger causality between them for countries with different
corruption levels.
The causality tests on the subsamples of the high- and low-corruption countries are summarized
in Table 4. Regardless of how the variables are measured, the results indicate that the causality
running from economic growth to government spending is significant for both subsamples, as the
corresponding HNC hypotheses are rejected. This finding suggests that Wagners law may hold
regardless of the degree of government corruption. Governments tendency to expand their budgets
has been documented for a wide range of countries. For example, democratic countries tend to
pursue inefficient goals because of the influence from the interest groups and budget-maximizing
bureaucrats. In contrast, less developed countries usually exhibit inferior government performance
in public sector efficiency and public good provision.
Table 4 also indicates that the causality running from government spending to economic growth
is significant for both low- and high-corruption countries. The result for the latter group may seem
to be at odds with the result that government spending does not Granger cause economic growth
 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817 815

for the low-income countries (see Panel C of Table 3). It should be noted that the high-corruption
group consists of not only the low-income countries but also 63 middle-income and 8 high-income
countries (see the supplementary Appendix). As noted above, the causal relationship is significant
for the richer countries. Thus, the result here indicates that within the high-corruption group, the
richer countries take more weights than the low-income countries in accounting for the causality.

3.3. Policy implications

The results above indicate that there is strong evidence on the validity of Wagners law for all
countries, regardless of their differences in income and in the degree of corruption. In contrast,
the tests on the causality running from government spending to economic growth indicate that
such a causal relationship is significant for the middle- and high-income countries, but not for the
low-income countries.
The last result suggests that role of government in the process of economic growth may differ
among countries. One possible explanation for such difference is that as compared to the richer
countries, the low-income countries are often characterized by poorer institutional quality and
more severe corruption. Thus, one policy implication from this result is that institutional quality
and corruption are key determinants for government performance, which in turn affects the growth
effects of government spending. Moreover, as suggesed by recent studies (e.g., Easterly, 2006),
poor institutional quality is to blame for the poverty trap for developing countries. That view and
our result seem to have one common implication that improving insitutional quality could be
crucial for the developing countries to escape from poverty.
Our findings from the low-income countries are also consistent with the studies showing that
the governments of those countries in general fail to provide basic services like electricity power
supply, roads, public health services, etc. (see, e.g., Easterly, 2001). As the governments do
little public service provision, their expenditures cannot be expected to help economic growth.
A common view in the political economy literature is that a large government is harmful to the
economy, as the efficiency loss arising from rent-seeking activities and redistributional policies
would be great. However, as implied by the above discussions, the efficiency and content of
government services seem to deserve much more concerns than the government size.

4. Conclusion

Wagners law of increasing government activities has been subjected to various econometric
tests in the past few decades. In particular, a number of studies utilize the Granger causality
test to examine the causal relationship. On the other hand, the critical role of governments for
economic growth has also been gaining increasing attention in the past half century. For instance,
the institutional role of government in economic growth has especially been widely confirmed
in various studies. While this body of evidence adds to our understanding of the relationship
between government activities and economic growth, the evidence on the causal relationship is
less conclusive.
This study utilizes a large sample of 182 countries over a long period of time ranging from
1950 to 2004 and a more recent panel Granger causality test to examine the relationship between
government spending and economic growth. Our results from the whole sample show that gov-
ernment expenditure and economic growth Granger cause each other; thus, the results support the
hypotheses that Wagners law holds and that the government plays a role in economic growth.
We can largely draw the same conclusions even if the countries are categorized by income levels
816 S.-Y. Wu et al. / Journal of Policy Modeling 32 (2010) 804817

and by the degrees of corruption, except that for the low-income countries, government spending
does not Granger cause economic growth. One possible explanation for the last result is that the
low-income countries generally have poor institutions and corrupt governments, which cause the
government expenditures to be irrelevant or destructive to economic growth.
Government expenditures consist of various activities. The diverse relationships between those
government activities and economic growth have been examined by previous studies (e.g., Barro,
1991; Dakurah, Davies, & Sampath, 2001). While the present study takes various government
activities as a whole and does not distinguish the differences among them, it may still complement
previous studies by providing more robust results on the causal relationships between the overall
government spending and economic growth.

Acknowledgements

We thank Antonio Maria Costa (Editor-in-Chief), and four anonymous referees for their
valuable comments on earlier drafts of this article.

Appendix A. Supplementary data

Supplementary data associated with this article can be found, in the online version, at
doi:10.1016/j.jpolmod.2010.05.011.

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