14
Government Expenditure and Economic Growth

Does government expenditure have a positive or negative effect on economic growth? A priori, we do not know. Arguments can be made in both directions.

To the extent that the well-known effects of the existence of collective goods, externalities and natural monopolies are important impediments to growth, the types of government expenditure that rectify these problems can be expected to have growth-enhancing effects. Following Barro ( 1990) we may label this 'productive' government spending.

Another problem is that the valuation of government output may lead to an overestimation of measured growth. In the different accounts, government goods and services are valued at their cost of production. This procedure gives rise to a number of difficulties which bias the researcher to find that increased government spending results in increased economic growth. This is due to the implicit assumption that government output is produced with a constant returns to scale technology, that all government production can be classified as final output rather than intermediate inputs lowering private sector production costs, and that the market value of government output is equal to the cost of production ( Carr, 1989; Koskela and Virén, 1992).

Government expenditure is also part of GDP. Since both government consumption and investment are part of GDP when measured from the expenditure side, explaining GDP growth by changes in government spending involves explaining something partly by itself. In particular during periods when the government spending share has been increasing, this problem lends an upward bias to the estimated effect.

Kaldor ( 1966) claimed that a high rate of utilization has a beneficial effect on long-run productivity growth. In so far as an expansion of the public sector results in a higher utilization rate,

-106-

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