Government Spending and Economic Growth in a Context of Market Imperfections

This paper identifies a key feature of the structure of government spending as a determinant of economic growth: the public goods/ private goods expenditure ratio, where public goods are broadly defined as expenditures that mitigate market failure. The paper develops a theoretical and empirical analysis which corroborates the hypothesis that shifting government expenditures from private goods to public goods, promotes economic efficiency and growth. The empirical analysis using data for 87 countries from 1980-2004, shows that increasing the share of public goods by one half of a standard deviation induces a one percentage point increase in the annual per capita growth rate of GDP for the average country in the sample. This result is robust to stringent sensitivity checks