Does Government Spending Cause Investment?: A Panel Data Analysis

Abstract

Government spending has increased recently in almost all countries to ease the severely negative economic impacts of the current health crisis. Similar expansionary fiscal and monetary policies were observed during other economic downturns too. The effectiveness of expansionary policies, especially in terms of their effects on investment, has been discussed widely. Thanks to the possible multiplier effect of higher government expenditures, it is expected that government spending would generate a higher amount of income and therefore consumption in economies. At some point, this higher government spending with glowing economic activities is expected to increase private investment—an important item to promote job creations and improvements in production. Although one of the direct or indirect expected outcome of higher government spending is larger investment, many empirical studies in the literature cannot observe this positive expected effect of government spending on investment. As a result, even the necessity of increased government expenditures during economic crisis has been questioned. In this paper, the causal and correlation relationship between government spending and investment is investigated in a panel data setting to better evaluate the importance of higher government spending during economic downturns. The findings show that country classifications based on income, time periods covered in the analysis, measures of government spending and investment, and the time lag of government policies can make a difference. There are cases where government spending highly significantly causes private investment, and high correlations between two variables are observed. Therefore, accurate evaluations of the impacts of government spending on investment may require detailed data analysis.

Appendix: List of Countries

Low income	Middle income		High income
Afghanistan	Albania	Jordan	Australia	Singapore
Benin	Algeria	Kenya	Austria	Slovak Republic
Burkina Faso	Angola	Malaysia	Belgium	Slovenia
Burundi	Argentina	Mauritania	Canada	Spain
Central Afr. Rep.	Armenia	Mexico	Chile	Sweden
Chad	Azerbaijan	Moldova	Croatia	Switzer land
Congo, Dem. Rep	Bangladesh	Morocco	Cyprus	United Kingdom
Eritrea	Bolivia	Myanmar	Czech Rep.	United States
Ethiopia	Botswana	Namibia	Denmark	Uruguay
Gambia	Brazil	Nicaragua	Estonia
Guinea	Bulgaria	Nigeria	Finland
Guinea-Bissau	Cabo Verde	Pakistan	France
Haiti	Cambodia	Paraguay	Germany
Liberia	Cameroon	Peru	Greece
Madagascar	China	Philippines	Hungary
Malawi	Colombia	Romania	Iceland
Mali	Comoros	Russia	Ireland
Mozambique	Congo, Rep.	Senegal	Israel
Nepal	Costa Rica	South Africa	Italy
Niger	Cote d’Ivoire	Sri Lanka	Japan
Rwanda	Dominican Rep.	Sudan	Korea, South
Sierra Leone	Ecuador	Thailand	Kuwait
Somalia	Egypt	Tunisia	Latvia
South Sudan	El Salvador	Turkey	Lithuania
Syria	Equatorial Guinea	Ukraine	Netherlands
Tajikistan	Fiji	Uzbekistan	New Zealand
Tanzania	Gabon	Vietnam	Norway
Togo	Georgia	Zambia	Panama
Uganda	India	Zimbabwe	Poland
Yemen	Indonesia		Portugal