The Futile Quest for a Grand Explanation of Long-Run Government Expenditure

47 Pages Posted: 22 Jan 2010 Last revised: 13 Apr 2019

See all articles by Dick Durevall

Dick Durevall

Göteborg University - School of Business, Economics and Law

Magnus Henrekson

Research Institute of Industrial Economics (IFN)

Date Written: March 1, 2011

Abstract

This paper carries out a critical reappraisal of the two contending theories purporting to explain long-run government spending: Wagner’s Law and different variants of the ratchet effect. We analyze data spanning from the early 19th century until the present day in Sweden and the United Kingdom. Hence, in contrast to previous studies, we evaluate the validity of Wagner’s Law and the ratchet effect hypothesis over a very long time period, starting at the beginning of industrialization. Cointegration analysis is used to investigate the long-run relationships between government expenditure and GDP, focusing on sub-periods and parameter stability. Moreover, we test the ratchet effect hypothesis by estimating models which allow for asymmetric adjustment. According to our main results, Wagner’s Law does not hold in the long run, although the data are consistent with Wagner’s Law between roughly 1860 and the late 1960s in Sweden, and the 1970s in the UK. This can be traced to the formation of the modern public sector, including the introduction of public education, health care, and so forth. Yet Wagner’s Law did not hold during the initial industrialization phase (before 1860), or during recent periods. Finally, we find some evidence of asymmetric adjustment, particularly in the post WWII period in the UK: Public expenditure grows more during bad times than it decreases during good times. However, the ratchet effect is only a short to medium-term phenomenon.

Keywords: Displacement effect, Government expenditure, Growth of government, Public sector, Ratchet effect, Wagner’s Law

JEL Classification: H1, H55, I38

Suggested Citation

Durevall, Dick Johnny and Henrekson, Magnus, The Futile Quest for a Grand Explanation of Long-Run Government Expenditure (March 1, 2011). IFN Working Paper No. 818. Available at SSRN: https://ssrn.com/abstract=1539425 or http://dx.doi.org/10.2139/ssrn.1539425

Dick Johnny Durevall

Göteborg University - School of Business, Economics and Law ( email )

Box 605
Goteborg, 40530
Sweden

Magnus Henrekson (Contact Author)

Research Institute of Industrial Economics (IFN) ( email )

P.O. Box 55665
Grevgatan 34
Stockholm, SE-10215
Sweden
+46-8-6654502 (Phone)
+46-8-6654599 (Fax)

HOME PAGE: http://www.ifn.se/mh

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