IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Tracing the Link between Government Size and Growth: The Role of Public Sector Quality

Listed author(s):
  • Daniel Oto Peralías
  • Daniel Oto-Peralías
  • Diego Romero-Ávila
Registered author(s):

    The influence of government size on per capita GDP growth has attracted much interest from scholars during the past two decades. However, despite all the work conducted, there is no consensus among researchers on the importance of government size in affecting economic growth. Some authors find negative effects (Barro, 1991, De la Fuente, 1997, or Fölster and Henrekson, 2001) while others point out that the relationship is positive or not significant (Caselli et al., 1996, or Agell et al., 1997 and 2006). Another strand of the growth literature underlines the importance of economic and political institutions, where there is widespread agreement that good institutions are a precondition for economic growth (Hall and Jones, 1999, Acemoglu et al., 2001, or Rodrik et al., 2004). By taking into consideration both branches of the literature, this paper focuses on the empirical link between government size and growth and assesses whether this relationship depends on the quality of public sector institutions. There are good reasons to expect the presence of heterogeneity in the effect of public sector on economic growth. One could suppose that public spending is negative for the real economy when the public administration is inefficient, corrupt or pursues the private interests of politicians and officials. By contrast, when quality standards in the public administration are high (government responds to citizen demands, works diligently and satisfactorily fulfils its functions), government size does not necessarily hinder economic growth. We believe that the lack of consensus about the effect of government size may result –among other things- from the presence of heterogeneity in its relationship with economic growth. Consequently, we try to contribute to this literature by showing that the effect of government size on growth depends on the quality of public sector institutions.In first place, we estimate cross-section growth regressions for the period 1981-2005 using ordinary least squares (OLS) to analyze the effect of government size on long-term growth. To investigate the presence of heterogeneity, we estimate an interaction model where we include as regressors –along with other common variables in growth models- government size, bureaucratic quality and the product of both variables. In order to make a correct specification, we include all constitutive terms of the interaction in the equation. In addition, following the advice of Brambor et al. (2006), we conduct a conditional interpretation of the coefficient of government size, reporting the coefficients and standard errors of the marginal effect of government size for each value of bureaucratic quality. The results are subjected to several robustness checks, such as a wide range of control variables, the presence of outliers, the use of an alternative indicator of institutional quality and the use of two-stage least squares (2SLS). In second place, with the aim of overcoming the shortcomings of the cross-section approach as well as exploiting the time variation of the data, we estimate panel regressions with the system GMM estimator developed by Arellano and Bover (1995) and Blundell and Bond (1998). Likewise, we pay particular attention to the marginal effects of government size for each value of bureaucratic quality and carry out several robustness checks.This paper shows evidence of strong heterogeneity in the relationship between government size and growth, depending on the quality of public sector institutions. Government size affects growth negatively when the quality of the public sector is low, but not when public sector quality is high. In the latter case the evidence shows that there is no significant effect (either positive or negative). This finding holds both in cross-section and panel data analyses and is robust to a large number of robustness checks. The observed heterogeneity in the effect of government size on the real economy appears in line with previous work by Angelopoulos et al. (2008) and Rajkumar and Swaroop (2008). Our results contribute to shed light on the debate over whether government size is an obstacle to growth. In conclusion, the central message of this paper is that government size can be an obstacle to economic growth when public sector institutions are weak, but is neutral when bureaucratic quality is high.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://ecomod.net/system/files/Oto-Peralias%20and%20Romero-Avila%202012.pdf
    Download Restriction: no

    Paper provided by EcoMod in its series EcoMod2012 with number 4015.

    as
    in new window

    Length:
    Date of creation: 01 Jul 2012
    Handle: RePEc:ekd:002672:4015
    Contact details of provider: Postal:
    351 Pleasant Street, #357, Northampton MA 01060-3900 USA

    Phone: +1 413 586 3203
    Fax: +1 413 517 0900
    Web page: http://www.ecomod.net

    More information through EDIRC

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as
    in new window


    1. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-1037, October.
    2. La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert, 1999. "The Quality of Government," Journal of Law, Economics and Organization, Oxford University Press, vol. 15(1), pages 222-279, April.
    3. Tavares, Jose & Wacziarg, Romain, 2001. "How democracy affects growth," European Economic Review, Elsevier, vol. 45(8), pages 1341-1378, August.
    4. Robert E. Hall & Charles I. Jones, 1999. "Why do Some Countries Produce So Much More Output Per Worker than Others?," The Quarterly Journal of Economics, Oxford University Press, vol. 114(1), pages 83-116.
    5. Easterly, William & Rebelo, Sergio, 1993. "Fiscal policy and economic growth: An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 32(3), pages 417-458, December.
    6. Andrei Shleifer & Florencio Lopez-de-Silanes & Rafael La Porta, 2008. "The Economic Consequences of Legal Origins," Journal of Economic Literature, American Economic Association, vol. 46(2), pages 285-332, June.
    7. Guseh, James S., 1997. "Government Size and Economic Growth in Developing Countries: A Political-Economy Framework," Journal of Macroeconomics, Elsevier, vol. 19(1), pages 175-192, January.
    8. Agell, Jonas & Ohlsson, Henry & Thoursie, Peter Skogman, 2006. "Growth effects of government expenditure and taxation in rich countries: A comment," European Economic Review, Elsevier, vol. 50(1), pages 211-218, January.
    9. Edward L. Glaeser & Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer, 2004. "Do Institutions Cause Growth?," Journal of Economic Growth, Springer, vol. 9(3), pages 271-303, 09.
    10. Daron Acemoglu & Simon Johnson, 2005. "Unbundling Institutions," Journal of Political Economy, University of Chicago Press, vol. 113(5), pages 949-995, October.
    11. Caselli, Francesco & Esquivel, Gerardo & Lefort, Fernando, 1996. "Reopening the Convergence Debate: A New Look at Cross-Country Growth Empirics," Journal of Economic Growth, Springer, vol. 1(3), pages 363-389, September.
    12. Daron Acemoglu & Simon Johnson & James A. Robinson, 2001. "The Colonial Origins of Comparative Development: An Empirical Investigation," American Economic Review, American Economic Association, vol. 91(5), pages 1369-1401, December.
    13. Agell, Jonas & Lindh, Thomas & Ohlsson, Henry, 1997. "Growth and the public sector: A critical review essay," European Journal of Political Economy, Elsevier, vol. 13(1), pages 33-52, February.
    14. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, vol. 68(1), pages 29-51, July.
    15. Dani Rodrik & Arvind Subramanian & Francesco Trebbi, 2004. "Institutions Rule: The Primacy of Institutions Over Geography and Integration in Economic Development," Journal of Economic Growth, Springer, vol. 9(2), pages 131-165, 06.
    16. Charles Oman & Christiane Arndt, 2006. "Governance Indicators for Development," OECD Development Centre Policy Insights 33, OECD Publishing.
    17. David Roodman, 2009. "How to do xtabond2: An introduction to difference and system GMM in Stata," Stata Journal, StataCorp LP, vol. 9(1), pages 86-136, March.
    18. Robert J. Barro, 1991. "Economic Growth in a Cross Section of Countries," The Quarterly Journal of Economics, Oxford University Press, vol. 106(2), pages 407-443.
    19. Knack, Stephen & Keefer, Philip, 1995. "Institutions and Economic Performance: Cross-Country Tests Using Alternative Institutional Indicators," MPRA Paper 23118, University Library of Munich, Germany.
    20. Folster, Stefan & Henrekson, Magnus, 2001. "Growth effects of government expenditure and taxation in rich countries," European Economic Review, Elsevier, vol. 45(8), pages 1501-1520, August.
    21. repec:hhs:iuiwop:492 is not listed on IDEAS
    22. John Luke Gallup & Jeffrey D. Sachs & Andrew Mellinger, 1999. "Geography and Economic Development," CID Working Papers 1, Center for International Development at Harvard University.
    23. Andreas Bergh & Martin Karlsson, 2010. "Government size and growth: Accounting for economic freedom and globalization," Public Choice, Springer, vol. 142(1), pages 195-213, January.
    24. Brambor, Thomas & Clark, William Roberts & Golder, Matt, 2006. "Understanding Interaction Models: Improving Empirical Analyses," Political Analysis, Cambridge University Press, vol. 14(01), pages 63-82, December.
    25. Ahlerup, Pelle & Olsson, Ola & Yanagizawa, David, 2007. "Social Capital vs Institutions in the Growth Process," Working Papers in Economics 248, University of Gothenburg, Department of Economics.
    26. repec:hrv:faseco:30747160 is not listed on IDEAS
    27. Jeffrey D. Sachs, 2003. "Institutions Don't Rule: Direct Effects of Geography on Per Capita Income," NBER Working Papers 9490, National Bureau of Economic Research, Inc.
    28. Rebelo, Sergio, 1991. "Long-Run Policy Analysis and Long-Run Growth," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 500-521, June.
    29. Adam Przeworski & Fernando Limongi, 1993. "Political Regimes and Economic Growth," Journal of Economic Perspectives, American Economic Association, vol. 7(3), pages 51-69, Summer.
    30. Rajkumar, Andrew Sunil & Swaroop, Vinaya, 2008. "Public spending and outcomes: Does governance matter?," Journal of Development Economics, Elsevier, vol. 86(1), pages 96-111, April.
    31. Jeffrey D. Sachs & Andrew Warner, 1995. "Economic Reform and the Process of Global Integration," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(1, 25th A), pages 1-118.
    32. Manuel Arellano & Stephen Bond, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Oxford University Press, vol. 58(2), pages 277-297.
    33. André Varella Mollick & René Cabral, 2011. "Government Size and Output Growth: the Effects of “Averaging out”," Kyklos, Wiley Blackwell, vol. 64(1), pages 122-137, 02.
    34. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 87(1), pages 115-143, August.
    35. Stephen Knack & Philip Keefer, 1995. "Institutions And Economic Performance: Cross-Country Tests Using Alternative Institutional Measures," Economics and Politics, Wiley Blackwell, vol. 7(3), pages 207-227, November.
    36. Gallup, J.L. & Sachs, J.D. & Mullinger, A., 1999. "Geography and Economic Development," Papers 1, Chicago - Graduate School of Business.
    37. Paolo Mauro, 1995. "Corruption and Growth," The Quarterly Journal of Economics, Oxford University Press, vol. 110(3), pages 681-712.
    38. David H. Romer & Jeffrey A. Frankel, 1999. "Does Trade Cause Growth?," American Economic Review, American Economic Association, vol. 89(3), pages 379-399, June.
    39. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 103-126, October.
    40. Daron Acemoglu & Simon Johnson & James A. Robinson, 2002. "Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1231-1294.
    41. Nickell, Stephen J, 1981. "Biases in Dynamic Models with Fixed Effects," Econometrica, Econometric Society, vol. 49(6), pages 1417-1426, November.
    42. Ben R. Craig & William E. Jackson & James B. Thomson, 2004. "On SBA-guaranteed lending and economic growth," Working Paper 0403, Federal Reserve Bank of Cleveland.
    43. Kaufmann, Daniel & Kraay, Aart & Mastruzzi, Massimo, 2010. "The worldwide governance indicators : methodology and analytical issues," Policy Research Working Paper Series 5430, The World Bank.
    44. Romero-Ávila, Diego & Strauch, Rolf, 2008. "Public finances and long-term growth in Europe: Evidence from a panel data analysis," European Journal of Political Economy, Elsevier, vol. 24(1), pages 172-191, March.
    45. Sachs, Jeffrey D. & Warner, Andrew M., 2001. "The curse of natural resources," European Economic Review, Elsevier, vol. 45(4-6), pages 827-838, May.
    46. Acemoglu, Daron & Johnson, Simon & Robinson, James A., 2005. "Institutions as a Fundamental Cause of Long-Run Growth," Handbook of Economic Growth,in: Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 6, pages 385-472 Elsevier.
    47. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:ekd:002672:4015. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Theresa Leary)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.