INTRODUCTION
Objectives
Basedo n d i f f e r e n t r e s u l t s o f p r e v i o u s s t u d i e s , t h i s p a p e r m a i n l y foc uses o n exploringt h e n a t u r e ofther e l a t i o n s h i p b e t w e e n g o v e r n m e n t s i z e a n d e c o n o m i c g r o w t h w i t h anon-lineartechnique Next,myobjective is to examine whethertherearedifferences inresultsbetweena developedcountryanda dev elopingcountry, h e n c e IinvolveChinaandJapanassubjects.
1.Whichmodelshouldt he relationshipbetween governmentsize( p r o x i e d as g e n e r a l governmentfinalconsumptionexpenditureinGDP)andeconomicgr owthb e betterexplained?Alinearornon-linearmodel(withSTARmodelimplication)?
Overallmethodology
Int hi s p a p e r, a n e o c l a s s i c a l p ro du ct io n f u n c t i o n modelis em pl oye d I nthismodel,g o v e r n m e n t e x p e n d i t u r e a n d o p e n n e s s a r e a s s u m e d t o a f f e c t
T o t a l F a c t o r P r o d u c t i v i t y (TFP).Therefore,economicgrowthisafunctionofca pitala c c u m u l a t i o n , governmentsizeandopenness.Usingdescriptivestati sticshelpsush av e preliminaryevaluationsfortwovariables‟relation.Process totestlinearandnon- linearr e l a t i o n s h i p a n d s e l e c t t h e a p p r o p r i a t e modelf o r ea c h c o u n t r y wi ll b e c a r r i e d o u t a f t e r t h a t T h e n I a p p l y p r o p e r S T A R modelt o d e s c r i b e t h e r e l a t i o n b e t w e en g o v e r n m e n t s i z e a n d e c o n o m i c g r o w t h f o r e a c h c o u n t r y I assumet h a t governments i z e i s t h e t h r e s h o l d v a r i a b l e c a u s i n g t h e s m o o t h t r a n s i t i o n b e t w e e n regimesingrowth.Basedonresults obtained,Iwillestimateparameters‟valuesfore a c h explanatoryvariableandthethresholdvalueforg overnmentsize.
Subjects
Chinaisadevelopingcountrywiththelargestpopulationintheworld.Chinar e a l i z e d thecommand economywasnolongerproper inexpectinghighereconomicdevelopment andlivingstandardforitscitizens.Therefore,in 1979,Chinastartedtoc a r r y o u t a h u g e r e f o r m , s w i t c h i n g t o f r e e - m a r k e t e c o n o m y A f t e r t h a t , i t e x p e r i e n c e d higheconomicgrowthforma nyyearsimpressively.In2010,ito f f i c i a l l y o v e r t o o k J a p a n t o becomet h e s e c o n d l a r g e s t e c o n o m y ( m e a s u r e d byGDP).Wecannotrejectthatgover nmentspendingisanimportantcontributiontoi t s g r o w t h Particularly,investmentininfrastructurehasbeengrowingfastestinthe
General government total expenditure (% GDP) GDP growth (%) world.F i s c a l policys e e m s t o h a v e p o s i t i v e e f f e c t s o n g r o w t h S o m e empiricalstudiesshowthatgovernmentexpenditureisanincrementalfactortogrowt h(Shinha,1998),Wagner‟slawdoesnotholdinChina(Huang,2006).Largefiscalm ultiplier(morethan2)helpsChinapreventingfromeconomicslowdowns.H o w e v e r , governmentspendinga lso causesinflation andinvestmentbooms,t h e n damagesgrowth(WangandWen,2013).Figure1.3presentsGDPgrowthandtotalgo vernmentexpenditureinChinafrom1982-
2014.Governmentspendingtendstoe x t e n d toomuch,meanwhilegrowthtends toreduce.Chinesegovernmentise x p a n d i n g spending,particularlyininfrastructurei nvestmentsinattemptingtor e v i v e s l o w i n g e c o n o m y H e n c e , d i s p u t e o v e r g o v e r n m e n t e x p e n d i t u r e s inC h i n a h a s beenraisedagain.
JapanisadevelopedcountrywiththethirdlargestGDPintheworld.Aft erWorldWarII,Japanexperiencedrapideconomicgrowth.Especially,in1960s,thea v e r a g e annualgrowthisapproximately12%,muchmorethanotherG7countries,h o w e v e r , itdroppedquitequicklyin1970s.Sincetheassetpricebubbleinearlie r1 9 9 0 s , Japanhasbeenfacingdifficultiesandeconomicgrowthhasbeenatoneo ft h e lowest(Figure1.4).Incontrast,generalgovernmenttotalexpenditurehasbeen increased,f a l l i n g i n t h e r a n g e from3 0 % to4 0 % s i n c e 1 9 9 0 Tostimulatet h e
General government total expenditure (% GDP) GDP growth (%)
-10 demanda n d r e m a i n t h e g r o w t h r a t e , J a p a n r a n a h u g e b u d g e t onp u b l i c w o r k programs.NationaldebtisaproblemthatJapanisfacing.Somestudies attempttoinvestigatet h e relationshipb e t w e e n g o v e r n m e n t s p e n d i n g a n d g r o w t h i n J a p a n Ter asawa andGates(1998)showthatgovernmentspendingh asdecrementaleffecto n growth.Theyarguethat“governmentprogramstypicallylackcomp etition,profitincentives,quantitativeoutputmeasures,andalinkbetweenproductio ncostsandconsumervalues”(p.217).Ontheotherhand,GuerreroandParker(201
0)indicatethatg o v e r n m e n t s p e n d i n g reallyh a s a positive effecto n r e a l G D P a n d “ e x p an si o n a ry fiscalpolicy mayhaveplayedther o l e ofavo id in g adeep ereconomicdepressionthantheoneobservedduringJapan‟slostdecades”(p.2).
Therestofthis paperis organizedas follows.Section2 summarizes rela tedtheoriesandpreviousempiricalstudies.Next,Section3outlinesmethodologyan dd e s c r i b e s dataandvariablemeasurements.Section4providesempiricalresultsan dconclusionisgiveninSection5.
LITERATURE REVIEW
Governmentsizeandeconomicgrowth
Economicgrowthisgenerallydefinedasanincreaseintheamountofgoodsa n d servicesproducedbyaneconomyoveraperiodoftime.AccordingtoWorldBa nk,thisconceptis“quantitativechangeorexpansioninacountry‟seconomy”. Economicg r o w t h i s u s u a l l y measuredast h e p e r c e n t a g e i n c r e a s e i n ( r e a l ) G r o s s DomesticProduct(GDP)or(real)GrossNationalProduct(GNP).
According to the World Bank, Gross Domestic Product (GDP) represents the total value of all final goods and services produced within a country over a specific period This includes contributions from both residents and foreigners GDP can be measured in two ways: first, as the sum of all incomes generated in an economy, including wages, interest, profits, and rents; second, as the total of consumption, investment, government purchases, and net exports (exports minus imports) Both methods yield the same result, and Real GDP refers to GDP adjusted for inflation.
Gross National Product (GNP) measures the total value of all final goods and services produced within a country in one year, along with the income residents earn from abroad, minus the income claimed by non-residents In cases where income from non-residents exceeds that of residents, GNP may be lower than Gross Domestic Product (GDP) Conversely, GNP can surpass GDP when income from residents abroad is significantly higher Real GNP is the inflation-adjusted version of GNP.
Inaddition,economicgrowth isalsomeasuredasthepercentagerateof percap it a GDPorpercapitaGNP.PercapitaGDP(GNP)isGDP(GNP)divided bypo pu lation
Intermsofgovernmentsize,infact,itisavagueconcept.“Itcanrefertothenumbe ri f e x i s t i n g f u n c t i o n s o f g o v e r n m e n t , t h e numbero f p u b l i c a g e n c i e s , t h e numberofpublicemployeesorthegovernmentbudgetsize”(SuDinhThanh,2015,p.2).FacchiniandMelki(2013)definegovernmentsizeastheproportionofpublic spendingtothevalueofnationaloutputorrealGDP.Governmentsizecanbep r o x i e d bydi fferentvariablessuchasgovernmentconsumption,transfersandsubsidies,thenumbero fgovernmententerprisesorgovernmentdebt…
(AfonsoandJalles,2011).However,thisnotioninboththeoreticaland empirica lstudiesregardinge c o n o m i c g r o w t h f r e q u e n t l y r e f e r s t o governmente x p e n d i t u r e s o r governmentrevenues,especiallygovernmentconsumptionexpenditures.
Totalgeneralgovernmentexpendituresincludeallkindsofoutlaysincurredbyg e n e r a l governmentunits.AccordingtoSystemofNationalAccounts(SNA)2008,“governm entunitsareuniquekindsoflegalentitiesestablishedbypoliticalp r o c e s s e s th athavelegislativejudicialorexecutiveauthorityoverotherinstitutionalu n i t s w i t h i n a g i v e n a r e a ”.“ Generalg o v e r n m e n t u n i t s i n c l u d e s o m e n o n - p r o f i t institutions(NPIs)andpublicenterprisesnottreatedascorporations”.
FollowingChobanovetal.(2009),the generalgovernmentexpenditurecanbed i v i d e d intothreesub-categoriesasfollows:
1 Thefinalconsumptionexpenditures:“expendituresonawiderangeofconsum ptiong o o d s a n d s e r v i c e s a r e i n c u r r e d byg e n e r a l g o v e r n m e n t , e i t h e r o n collectiveservicesoronselectedindividualgoodsorservices”.“Finalgovern mentc o n s u m p t i o n e x p e n d i t u r e s c o n s i s t o f t h e v a l u e o f a l l typeso f o u t p u t o f g e n e r a l governmentlessthevalueofoutputforownaccountcapitalformation andthevalueo f s a l e s o f g o o d s a n d servicesatbotheconomicallyinsignificantprices andate c o n o m i c a l l y significantpricesplusthevalueofgoodsandservicespurchasedfro mmarketproducers fordelivery tohouseholds f r e e orateconomically insig nificantp r i c e s ” (SNA,2008).Inotherwords,thefinalconsumptionexpenditu resbygovernmentaregoodsandserviceseitherpurchasedfromprivatesectororproducedbyg overnment.Theyareprovidedfreeorateconomicallyinsignificantprices.
2 Governmentinvestmentexpenditures:consistofgovernmentcapitalform ation,purchasesofland andintangible assetsas wellas capitaltransfertonon- governmentsectors(Chobanovetal.,2009).
Inaddition,governmentrevenueisalsousedasproxyforgovernmentsizeinsom estudies.AccordingtoSNA2008,“governmentrevenueisusuallydominatedbycom pulsoryleviesintheformoftaxesandsocialcontributions.Forsomelevelso f g o v e r n m e n t , g r a n t s ( t r a n s f e r s f r o m o t h e r g o v e r n m e n t u n i t s a n d intern ationalo r g a n i z a t i o n s ) areamajorsourceofrevenue.Othergeneralcategori esofrevenueincludepr op er ty income,sa l es o f g o o ds andservicesandmiscellan eoustransferso t h e r thangrants”.
Regardingt h e r o l e o f i n s t i t u t i o n s , noo n e c a n r e j e c t t h e i m p o r t a n t r o l e o f governmentsectorindevelopingeconomyandsociety.VedderandGallaw ay( 1 9 9 8 ) i n t h e i r studye x p l a i n e d q u i t e fullyt h i s r o l e H o w w o u l d o u r s o c i e t y b e withoutg o v e r n m e n t ?
Assets produced by society are often vulnerable to theft by bullies and those with greater power Anarchy creates an unsafe environment for living and production, which discourages savings and investment The accumulation of assets is hindered at the lowest levels without proper institutions Establishing laws and private property rights significantly impacts societal and economic development by protecting private wealth When individuals know their assets are safeguarded from theft, it encourages a safer environment for living and production Consequently, this leads to higher incentives for asset accumulation and fosters economic growth.
Anotherr e a s o n s u p p o r t i n g f o r g o v e r n m e n t e x i s t e n c e isa b i l i t y o f p r o v i d i n g g o o d s andserviceswhichareaproductivecontributiontoprivateproducti onsucha s education,nationdefense,infrastructure,areliablemediumofexchang e…
Forexample,t r a n s p o r t a t i o n d e v e l o p m e n t h e l p s t o c o n n e c t notonl ys t a t e s w i t h i n a c o u n t r y butalsoregionsintheworld;nationdefensepreventsacount ryfromothers‟ invasion;a reliablem ed iu m ofexchangeenhancestrading…
I n t he early stateo f governments i z e , theya l l c o n t r i b u t e t o l o w e r t r a n s a c t i o n c o s t s , e x p a n d b u s i n e s s activitiesandofcourseincreaseincomeandgrowth.
When government grows beyond a certain point, the law of diminishing returns comes into play, meaning that each additional unit of goods and services provided yields less output than before This growth often results in higher taxes, which serve as an incremental burden on society, altering consumption and investment behaviors Additionally, as government size increases, transfer payments also expand, potentially harming economic growth by diminishing the working incentives for lower-income individuals Ultimately, taxes and transfer payments can distort economic activities, leading to a slowdown in growth.
Besidest h a t , o t h e r i s s u e s r e g a r d i n g t h e e f f i c i e n c y o f p u b l i c s e c t o r w h i c h a f f e c t s outputandgrowthisalsomentionedinmanytheorie s.AccordingtoBu ch an an ‟ s andTullock‟stheory,self- interestgroupswouldobtainbiggerbenefitsw h e n thegovernmentsizeislarger.Decision smadetendtofavorof asmallinterestg r o u p insteadofbenefitsofthewholesociety.Particularly,rent- seekingactivitiesofself- interestgroupsfrustrategrowthbytwoways:unproductiveallocationofr e s o u r c e s a n d i n e f f i c i e n c y fromt h e u s e o f t h e marketp o w e r B u r e a u c r a t i c governme ntdecidesthesizeofthebudgetwhichmaximizeshisutilityratherthant h e e f f i c i e n t s i z e f o l l o w i n g N i s k a n e n ( 1 9 7 1 ) Theya r e a l l d e e m e d t o d i s c o u r a g e p r i v a t e sector‟sincentivesandthereforetheyhavenegativeeffectstogrowth. (SeeGrossman(1988)foradetailedexposition).
Asw e c a n s e e t h a t , a s o c i e t y w i t h b o t h n o governmenta n d d o m i n a t e d t o o muchbyg o v e r n m e n t a r e n o t o p t i m a l t o e c o n o m i c g r o w t h Thatm i g h t s u g g e s t a p oi nta t w h i c h m a x i m i z e s t h e g r o w t h Next,w e w i l l d i s c u s s o n e o f e n d o g e n o u s frameworksd e v e l o p e d byBa r r o ( 1 9 9 0 ) T h i s m o d e l s h o w s h o w p r o d u c t i v e governmentspendingaffectseconomicgrowth.
Barro’smodel
Barro(1990)inhisstudy“Governmentspendinginasimplemodelofendogen ousg ro wt h” d e v e lopeda t h e o r e t i ca l frameworkinwh ich th e n e x u s b e t w e e n g overnmentsizeandeconomicgrowthistheinvertedU-shaped.Inshort,heasserts that thereexistsathresholdatwhichdifferentgovernmentsizeshavetwod i f f e r e n t effectst ogrowth.Whenthegovernmentissmall,belowthethreshold,anincreaseingovernme ntsizewillfostergrowthandtheoppositeeffectwillhappeni n c a s e s whichgovernment sizeisabovethethreshold.Hismodelwillbe explainedi n moredetailed.
Barroassumesthatpublicservicesisaproductivefactor toprivateproduction,h e n c e hemodifiesthesimpleproductionfunctioninwhichou tputisafunctionofp r i v a t e capital,thenewprivateproductionfunctionisgiven:
Whereassumingthatconstantreturnsonscale;satisfiesconditionsofb o t h p ositivea n d d im i n is h i n g m ar g i n al p ro d u c t s; k i st h e r e p r e s e n t a t i v e house hold‟samountofcapital;gispercapitaamountofgovernmentpurchases.gisn o w treatedasanin putthatwouldhavepositiveeffect ongrowth.Ba rro considers( 2 3 ) asCob b-Doughlasproductionfunction,therefore:
WhereTisgovernmentrevenue.Equation(2.5)alsoimpliesthattheagenthasa balan cedbudget.Hespendsallrevenuestofinanceproductivepurchaseswhichen terintothe p ro du ct io n function In this m o d e l , Barro assumesthatg ove rn me nt doesn o t o w n h is o w n c a p i t a l an d d o p r o d u c t i o n l i k e p r i v a t e se c t o r a s we l l T h i s makesthemodelmoreeasilyunderstoodbutdoesnotchangebasicresults.
Barroa r g u e s t h a t i n c a s e s w h i c h andg/ ya r e c o n s t a n t , t h e n g , T,k a n d ywouldgrowatthesamerateof,“theeconomyhas notransitionaldynamicsandi t alwaysinapositionofsteady- stategrowth”(Barro,1990,p.S108).Howeverw h e n
andg/ yarenotconstant,therearetwoeffectsongrowthrate,.Heassertsthata n increaseinflat- ratetaxwouldlowerwhereasanincreaseing/ ywouldi n c r e a s e themarginalproductofcapitaly/
k(thenincrease).Theseconde f f e c t wouldbestrongerthanthefirstonewhenthegovern mentsize,g/yissmall.
Therearethreeoutcomes.Wheng/ kissmallenoughinorderthat‟>1,t h e n theright- handside of(2.8)>0, growthrate i n c r e as es w i t h g/y.Andwheng/ ki s largeenoughinorderthat‟