The Effect of Government Size on the Steady-State Unemployment Rate: An Error Correction Model
The relationship between government size and the unemployment rate is investigated using an error-correction model that describes both the short-run dynamics and long-run determination of the unemployment rate. Using data from twenty OECD countries from 1970 to 1999 and after correcting for simultaneity bias, we find that government size, measured as total government outlays as a percentage of GDP, plays a significant role in affecting the steady-state unemployment rate. Importantly, when government outlays are disaggregated, transfers and subsidies are found to significantly affect the steady-state unemployment rate while government purchases of goods and services play no significant role.
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