Proceedings of 5th Annual American Business Research Conference
6 - 7 June, 2013, Sheraton LaGuardia East Hotel, NY, USA, ISBN: 978-1-922069-24-5
Government Expenditure and Economic growth in South
Africa: An Empirical Investigation
Nicholas M. Odhiambo
The relationship between government expenditure and economic growth has been a
subject of intense debate for many decades. This debate has been renewed subsequent
to the recent debt crisis in some EU countries. The thrust of this debate has been whether
the causality between the two variables runs from government expenditure to economic
growth, or whether the causality runs from economic growth to government expenditure.
While the former view is associated with the Keynesian theory, the latter view is
associated with Wagner’s law – which is also known as the law of increasing government
spending.
According to the Keynesian theory, an increase in government expenditure leads to an
increase in economic growth via an expansionary fiscal policy. When government
spending increases, production also increases; and this leads to an increase in aggregate
demand, which ultimately leads to an increase in GDP. However, according to Wagner’s
law, there is a propensity for government expenditure to increase – as the national
income increases. In other words, as the economy progresses, because of
industrialization, the share of the government expenditure in total expenditure also
increases.
This could be mainly attributed to: (i) The increased administrative functions of the State;
ii) increased welfare spending; and iii) the increased social functions of the State (see
Wagner, 1912; 1883). Consequently, according to Wagner’s law, the causality runs from
national income to government expenditure, and not in the opposite direction.
Although a number of studies have attempted to examine the linkage between
government expenditure and economic growth, the majority of these studies are mainly
based on European, Asian and Latin American countries. Very few studies have been
conducted in African countries, especially in sub-Saharan Africa. Moreover, previous
studies on this subject suffer from a number of weaknesses. Firstly, the majority of the
previous studies used either the residual-based cointegration test associated with Engle
and Granger (1987), or the maximum-likelihood test, based on the work of Johansen
(1988) and Johansen and Juselius (1990). However, these techniques have been found
to be inappropriate, especially when the sample size is too small. Secondly, many of the
previous studies relied on a bivariate model, which can produce biased results – due to
the omission-of-the-variable bias. In fact, studies have shown that the introduction of a
third variable into a bivariate setting would not only change the direction of causality, but it
could also change the magnitude of the results. Thirdly, some of the previous studies
typically relied on the cross-sectional data, which do not satisfactorily address the
country-specific issues.
In this study, the dynamic causal relationship between government expenditure and
economic growth is examined – using data from South Africa, the largest economy in
Africa. The study aims to answer one critical question: Does government expenditure
Granger-cause economic growth? The study uses the newly developed ARDL-bounds
testing approach to examine this linkage. In order to address the omission of variable
bias, the study incorporates unemployment as an intermittent variable between economic
growth and government spending – thereby creating a simple multivariate model. The
empirical findings of this study show that, although both government expenditure and
economic growth Granger-cases each other in the short run, in the long run, it is
economic growth that Granger-causes government expenditure.Other results show that
there is a short-run unidirectional causality from both economic growth and government
expenditure to unemployment.
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Prof. Nicholas M. Odhiambo, University of South Africa (UNISA), South Africa.
Email:odhianm@unisa.ac.za, nmbaya99@yahoo.com
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