Causal relationship between government expenditure and economic growth in Ethiopia: an econometrics analysis

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.