Does government spending boost economic growth in Europe?

• Author: Boldeanu F.T., Ialomiteanu R.
• Pages: 213-228

Bulletin of the Transilvania University of Braşov

Series V: Economic Sciences • Vol. 9 (58) No. 1 - 2016

Does government spending boost

economic growth in Europe?

Florin Teodor BOLDEANU1, Răzvan IALOMIŢIANU2

Abstract: The article aims to analyse the evolution of budgetary expenditures and their

relationship with economic growth, especially in the EU countries and three non-EU

countries - Switzerland, Norway and Iceland during 1991 - 2012. To test the link between

government spending and economic growth the research used the United Nation

Classification of the Functions of Government and three econometrical regression methods –

ordinary least square, least squares dummy variable and the generalized method of

moments. Statistical results for the 10 categories of expenditure have shown that economic

affairs, environmental protection, recreation, culture and religion and social protection have

a significant impact on economic growth. Also the recent economic crisis and the EU

accession influenced the variation of GDP/capita.

Key-words: economic growth, COFOG, economic crisis, public spending, panel data,

GMM

1. Introduction

The study aims to analyse the evolution of budgetary expenditures and their

relationship with economic growth, especially in the EU countries and three non-EU

countries - Switzerland, Norway and Iceland during 1991 - 2012. For this

endeavour the article uses the United Nation division of government spending

(Classification of the Functions of Government) and three econometrical regression

methods – ordinary least square, least squares dummy variable and the generalized

method of moments.

Based on the developments of econometric theory proposed by Arellano and

Bover (1995), Blundell and Bond (1998) and Wooldridge (2002), we propose a

dynamic model estimated by using the GMM method.

Governments apply different strategies for sizing public spending depending

on the national and international context. Thus, in times of economic crisis the state

is forced to allocate funds for social and economic affairs necessary to support its

1 Lucian Blaga University of Sibiu, boldeanuflorinteodor@yahoo.com

2 Lucian Blaga University of Sibiu, ialomitianu.razvan@yahoo.com

Bulletin of the Transilvania University of Braşov • Series V • Vol. 9 (58) No. 1 - 2016

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development. The degree of economic development has a significant impact on the

structure and volume of public expenditure, as developing countries need a sustained

increase of their public spending so as to minimize the gap between them and the

developed ones.

In the economic research studies there are many conflicting views regarding

the effects of public expenditure on economic growth. In addition to providing

social protection and transfers to maintain an optimal level of social welfare, the

government invests in the economy both in the public sector (infrastructure,

allocation of budgetary resources) and in the private sector to so as to increase

productivity.

Short-term unproductive expenditures in education and health can facilitate

long-term growth of labour productivity. In addition, the government can provide

information for the economic environment, reduce financial risks and change the

incentives. But many economists believe that public goods provided by the state

may be ineffective. Also there are negative effects on economic growth by

amending tax that doesn’t stimulate economic development and by the somewhat

inefficient transfer mechanism between ministries. Raising taxes can cause a

misallocation of surplus funds and may also cause a constraint for private sector.

Based on the research of Laura Braşoveanu (2008), Holzner (2011),

Miyakoshi et al. (2010) and others, the paper continues their analysis using

functional classification of government expenditures by sectors.

We selected a sample of 30 European countries, both developed countries

and developing ones. Due to the economic crisis the European governments have

chosen to reduce part of their public expenditure to counter the economic and

financial contagion. In this paper we analysed whether public expenditure had a

significant effect on economic growth.

The remainder of the article is divided as follows: Section 2 addresses the

literature review. Section 3 presents the methodology and the data used for the

research. Section 4 the results obtained and Finally, Section 5 contains concluding

remarks.

2. Literature review

The recent empirical studies show that the structure of public spending is more

important than the overall level of expenditure, providing a clearer picture for policy

makers to intervene effectively in the economy and to achieve long-term growth.

After the 1990s research in this area is mainly based on the studies made by

Robert Barro and Sala-i-Martin (1991, 1995). In 1991 Barro (1991) examined the

empirical relationship between government investment and economic growth

forming a narrow econometric model and in 1995 along with Sala-i-Martin (1995)

examined the same theme in an article about growth. For that period, the