Government size and economic growth: evidence from a multivariate cointegration analysis

This study uses multivariate cointegration techniques and attempts to model the dynamic interactions between government size and economic growth in a five variable system consisting of the growth rates of GDP, total government spending, investment, exports, and imports. Using data on ten OECD countries the analysis shows: (i) Government size Granger-causes growth in all the countries with some disparities concerning the proportion by which government size contributes to explaining future changes in the growth rates. An innovation shock at the growth rate of government size generates a permanent effect on the growth rate of GDP that, for some countries, reaches from 26% to 60% of the total change in growth: (ii) Government size also Granger-causes investment and international trade and, for some countries government size Granger-causes growth indirectly either through investment or the trade variables; and (iii) In almost all countries, international trade and investment generate permanent effects on growth. In particular we found that exports and imports do not have the same effects on growth as is the case in cross-country growth models.