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).
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