Economic growth and government size in developed European countries: A panel threshold approach

Based on the literature on economic growth, there is a non-linear relationship between government size and economic growth, which is usually similar to an inverted U-shaped curve and is used to determine the optimum share of government expenditure. The present study aims to investigate the non-linear relationship among 14 developed European countries during 1995–2014. Final consumption expenditure to gross domestic product (FCE), current expenditure other than final consumption to gross domestic product (OCE), and government gross fixed capital formation to gross domestic product (GFCF) were considered for measuring government size. The results indicate an asymmetric effect of FCE and GFCF on economic growth when they are above and below the optimal level. The optimum values of FEC and GFCF were estimated to be 16.63 and 2.31%, respectively. However, it is noted that OCE always has a negative effect on economic growth. In terms of policy prescriptions, governments of developed countries should be aware that misallocation of public expenditure can occur given it may likely become unproductive after passing an optimal size.