GOVERNMENT EXPENDITURE AND ECONOMIC GROWTH IN THE EU: LONG-RUN TENDENCIES AND SHORT-TERM ADJUSTMENT

This paper analyses the both the long and the short-run relation between government expenditure and potential output in EU countries. Having a satisfactory measurement of these relations has relevant implications for policy. From a long-term perspective, it improves the understanding of the links between output growth and public finances sustainability. Over a medium- to short-run horizon, it provides a benchmark to evaluate the stance of expenditure policy. In the analysis, the panel dimension of the data set is exploited in such a way: (i) to improve the power of statistical tests for the analysis of the dynamic properties of macroeconomic series through panel unit root and panel cointegration tests; (ii) to obtain country-specific information on adjustment dynamics by means of pooled mean group estimation (Pesaran, Shin and Smith, 1999). Results show that, over a sample comprising EU-15 countries over the 1970-2003 period, it cannot be rejected the hypothesis of a common long-term elasticity between cyclically-adjusted primary expenditure and potential output close to unity. The long-run elasticity is however not stable over time (it decreased considerably over the decades) and is significantly higher than unity in catching-up countries, in fast-ageing countries, in low-debt countries, and in countries with weak numerical rules for the control of government spending. The average speed of adjustment of government expenditure to its long-tem relation is 3 years, but there are significant differences across countries. Anglo-saxon and Nordic countries exhibit in general a faster adjustment process, while adjustment in Southern European countries appears somehow slower.