How Does Economic Freedom Influence The Relationship Between Government Size And Convergence?

In this paper we present some empirical results about absolute and conditional convergence of real GDP within 121 countries using cross-country data. We assume that there is an inverted U-shaped curve, which describes the relationship between economic growth and government spending. It is mainly because the institutional conditions of productivity do not exist at lower levels of government spending. At higher levels, the government needs to levy higher taxes to finance its expenditures, which hinders growth. So there can be somewhere an optimal government redistribution level that maximizes growth. This optimal level depends on institutional factors that can be grabbed by certain Economic Freedom and Worldwide Governance Indicators. It was not our aim necessarily to determine exactly the level of optimal government redistribution, it would be difficult because of the heterogeneity of the countries, only to make a comparison between free and less free countries, and draw some conclusions about how this level depends on these institutional variables. Summing up we can say that our aim was to compare free and less free, legally “good” and “bad”, as well as corrupt and less corrupt countries from the aspect of government redistribution level. If we divide countries into free and less free countries and assume that both groups have an inverted U-shaped curve, the optimal level of government spending share is larger in the richer countries because of their better institutional system. These results do not contradict those findings that declare positive or negative relationship between government spending and economic growth. One part of the literature presumes that there is only one optimal level of government spending, we point out that there can be at least two optimal levels, and they depend on the institutional quality.