Description

CHAPTER ONE: INTRODUCTION

1.1 Background of the study

“The role of government in economic growth is an issue of debate since the time of Adam Smith”(Gisore et al., 2014). According to Hasnul (2015), "an inclusive and long-term economic growth has become a concern for many policymakers for decades and government spending has been debated whether it can accelerate economic growth". The key question is whether government spending improves the economy's long-term steady-state growth rate. It is hypothesized that government spending can be growth-enhancing, especially on physical infrastructure and human resources, although the source of funding for such spending can be growth-retarding.

According to Barro (1990), "government spending on investment and productive activities are expected to make a positive contribution to economic development, while government spending on consumption is expected to slow growth." In turn, "public services are considered as an input to private production in creating a potentially positive linkage between government spending and economic growth"(Dereje, 2012).

Economic growth is the most significant macroeconomic variable representing a society's overall output, resulting from more goods and services generated “which require improvement in productivity and growth in the labor supply”(Dereje, 2012). Growth in productivity requires a combination of a more skilled and productive workforce; more private physical resources such as plants and equipment; increased use of modern technology; more public services such as highways and other utilities; competitive pricing markets; and the rule of law to implement contracts. Therefore, “government needs to improve contracts and sustain national security and also to provide essential public goods to improve a well-organized market which will arouse economic growth"(Oladele et al., 2017).

An analysis of the various studies that have been performed on the effect of government spending on economic growth provides contradictory evidence of the influence of government spending on economic growth. However, “it is imperative to examine this unique relationship because public expenditure is necessary for governments’ management of the economy”(Miah, 2017).

There are two contrasting views in the economic literature on the relationship between economic development and the size of the public sector.  According to the Keynesian view, increasing government spending results in rising production. The Keynesian theory “suggests that a constructive fiscal policy is an effective weapon at the disposal of governments to promote economic development and economic growth”(Shafuda, 2015). “The idea is that when there is an increase in government spending, it can cause stagnation in aggregate demand in the economy and as a result it will affect crowd–in for private business”(Oladele et al., 2017). Another group of economists who argue in this regard that high government spending is likely to be detrimental to economic development as a result of government agencies' inefficiencies. Therefore, “it crowds out private investment that leads to slow down growth and reduction in capital accumulation”(Shumaila & Abdul, 2014).

 On the other hand, the Wagner hypothesis suggested that that government spending is either an endogenous factor or consequence but not a source of economic growth. However, "several studies have empirically examined the Wagner's Law and found conflicting results for different countries"(Rana, 2014).