The paper investigates the validity of a long-run relationship between public expenditure and income (Wagner's Law) in the case of India over the period 1970-2004. The study, by using the modern time series econometric technique, finds evidence of long-run relationship between public expenditure and income but rules out the validity of Wagner's Law. This is because there is no unidirectional causality from income to public expenditure. However, the study finds evidence of a unidirectional causality from public expenditure to income. It eventually suggests that public expenditure is an important policy tool to influence income level in the economy.
The
substantial growth of the size of government expenditure in
both the developed and developing nations since the World
War II, and its affect on long-run economic growth (or vice
versa), has been an outstanding issue in the public finance
literature (Demirbas, 1999; Olomola, 2004; and Loizides and
Vamvoukas, 2005). There are two set of beliefs: first, during
the course of economic development, government spending tends
to expand relative to national income and represented as Wagnerian
school of thought; second, government spending tends to determine
the relative size of national income in the economy and represented
as Keynesian school of thought. Therefore, the obvious question
is what causes what; that means whether government spending
causes economic growth or vice versa. The former follows Wagnerian
hypothesis (causality runs from economic growth to government
expenditure), while the latter follows Keynesian hypothesis
(causality runs from government expenditure to economic growth)
(Singh and Sahni, 1984; Ram, 1986; Barro, 1991; Devarajan
et al., 1996; Arghyrou, 2000; and AbuBader
and Abu-Qarm, 2003).
Usually
there are three possible reasons to justify the Wagnerian
hypothesis: first, industrialization and modernization lead
to a substitution of public functions for private activity;
second, economic development results in the expansion of cultural
and welfare expenditures, where collective producers were
more efficient than private ones; third, government intervention
is needed to manage and finance natural monopolies, which
occur due to change in technology (Bird, 1971; and Henrekson,
1993). Similarly, there are five different reasons to justify
the Keynesian hypothesis: first, government supplies pure
public goods that constitute a sizeable component of the aggregate
demand; second, government may own or operate enterprises
and institutions that provide quasi-public or private goods;
third, regulations and controls imposed by the government
can facilitate the protection of property rights and enhance
allocative efficiency in the presence of externalities; fourth,
income taxes and transfer payments affect income distribution
and may create a more equitable society; fifth, governments
often act as facilitators in markets with asymmetric and imperfect
information (Poot, 2000). |
