Public Expenditure and Economic Growth in India: VECM Estimation of the Causal Relationship

Abstract

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The relationship between public expenditure and economic growth is obvious, but the direction of causality is not clear. This paper analyses the relative impact of the different components of public expenditure on economic growth. Specifically, this paper examines whether the level of government expenditure is managed to accelerate economic growth or whether government expenditure is used excessively, which may hurt domestic economy because of increased taxes and/or high government borrowing. The vector error correction method is applied to the annual time series data for India from 1983 to 2020 for testing the long- and short-run causality. The pair-wise Granger causality test indicates one-way causality moving from gross domestic product to total government expenditure, and from gross domestic product to government revenue showing that the growth of the economy leads to an increase in both government revenue and expenditure. The estimated error correction coefficient is significantly negative, indicating that the speed of adjustment between the short-run dynamics and the long-run equilibrium is about 0.03%. The results show a stable long-run relationship between public expenditure and economic growth.

Keywords: Public Expenditure, Economic Growth, Causal Relationship, Vector Error Correction Model (VECM)

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