Abstract:
The main objective of this study is to investigate causality relationship between government
expenditures and economic growth in Ethiopia. To achieve the objective of the study, time series
data for the period 1974/75 to 2013/14 was collected for various macroeconomic variables. Unit
root tests were conducted to test the stationarity level of the data which was found to be
integrated of order one. The data was also tested for Johansson Cointegration test approach
found government expenditure components and economic growth to be cointegrated and found
that there exists long run relationship between economic growth and its independent variables.
Granger causality test shows unidirectional causality running from economic growth to
government expenditure in validation of Wagner’s Law. The study showed that government
expenditure on total capital expenditure, trade openness and school of enrollment has positive
and significant on economic growth while government expenditure on recurrent expenditure has
negative and significant impact in the long run. The study also tried to explore the short run
effect of components of government expenditure on economic growth using vector error
correction model and found that capital expenditure has positive and significant impact on
economic growth and recurrent expenditure has positive sign but insignificant in short run. On
other hand, private investment has positive and significant impact on economic growth in short
run. Hence, the government should increase its capital expenditure in areas that are beneficial to
the private sector and eschew from those that compete with or crowd it out. It should increase its
expenditures on those items that enter private production functions as productive public
inputs that enhance economic growth. Such productive government capital expenditure
includes expenditure on infrastructures, plant and machinery all of which generate positive
externalities that raise private investment and thus economic growth. The increase in
investment would increase economic growth.
