Government Spending, Income Distribution, and Productivity Growth

Abstract

This paper examines the distributional and innovation effects of fiscal spending. Using data for 154 countries from 1980 to 2023, I show that expansionary government spending persistently raises output and total factor productivity for more than 10 years while compressing income inequality. Under sanctions, the productivity effect of government spending is stronger when private sector resources are constrained. The innovation response is further strengthened in countries with a higher share of government investment, indicating that productive public spending is central to the transmission of our findings. Countries with a higher share of inclusive spending further intensify the inequality-reducing impact. A standard two-agent New Keynesian model with endogenous growth and productive public investment rationalizes the evidence and matches the dynamic responses, linking innovation-driven TFP gains to persistent output effects and distributional improvements.

Keywords: Fiscal policy, Income inequality, Income distribution, Productivity enhancement D63, D72, E02, E12, E42, E44, E52