Government Consumption and Growth

By Evans, Paul | Economic Inquiry, April 1997 | Go to article overview

Government Consumption and Growth


Evans, Paul, Economic Inquiry


I. INTRODUCTION

Interest in formulating and testing growth models has surged in recent years. Following the seminal articles of Romer [1986] and Lucas [1988], the theoretical growth literature has primarily sought to endogenize the trend growth rate, which had been treated as an exogenous parameter in the earlier vintage of growth models formulated by Solow [1956] and Cass [1965] inter alia. Although the goal of endogenizing trend growth rates is surely desirable, it is still important to test whether trend growth rates are indeed better characterized as exogenous or endogenous.

Many papers have attempted to do so. Unfortunately, virtually all of them have used ordinary least squares to fit cross-sectional regressions relating the average growth rate of per capita output over some period to its initial value and other country characteristics.(1) My 1996a paper shows that this method produces seriously biased estimates and unreliable inferences.

This paper makes two contributions. First, using a simple stochastic growth model that nests both exogenous and endogenous growth, it shows that the growth rate of output per capita should be mean stationary if growth is exogenous, and should be difference stationary if growth is endogenous and any difference-stationary variable affects investment. Specifically, if the share of output devoted to government consumption is difference stationary, the growth rate should be mean stationary or difference stationary depending on whether growth is exogenous or endogenous. Furthermore, the growth rate should be negatively related to the share of output devoted to exhaustive government consumption if, and only if, growth is endogenous.

The second contribution is to test whether growth is exogenous or endogenous. Data for 92 countries over the period 1960 to 1989 strongly support the mean stationarity of the growth rate of per capita output and are consistent with the difference stationarity of the share of output devoted to government consumption. Moreover, the growth rate is not significantly related to the government share. These two findings support the exogeneity of growth. Finally, the relationship is precisely estimated to be weak if not nonexistent. Hence, even if growth is endogenous, the degree of endogeneity is likely to be small.(2)

The rest of the paper is organized as follows. Section II formulates a simple stochastic growth model for demonstrating the basic theoretical results. Section III investigates whether growth rates are mean stationary and whether shares of output devoted to government consumption are difference stationary. Section IV examines whether and how growth rates and government shares are related to each other. Finally, section V summarizes the paper and offers a few conclusions.

II. THEORETICAL DISCUSSION

This section lays out a simple and tractable stochastic growth model that nests both exogenous and endogenous growth. The model is special in many ways because several restrictive assumptions are made for the sake of tractability. Nevertheless, results similar to the ones derived below should hold in a wide class of models.

Consider a closed economy inhabited by a government and a household that lives in periods t = 0, 1, 2, .... The sole activity of the government is exhaustively consuming G, which is financed by a proportional tax on gross output Y at the rate [Tau]. Its budget constraint is therefore

(1) [G.sub.t] = [[Tau].sub.t] [Y.sub.t].

I assume that government consumption is set so that

(2) [g.sub.t] = - ln[1 - ([G.sub.t] / [Y.sub.t])]

is a driftless difference-stationary process.

The household is endowed with one unit of labor, which it supplies completely inelastically each period; a positive initial capital stock; and a technology

(3) [Mathematical Expression Omitted]

0 [less than] [Alpha] [less than or equal to] 1, t = 0, 1, 2, . …

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