An Empirical investigation of wagner's law in Sri Lanka

Abstract

The relationship between economic growth and public expenditure has been debated in the literature of Macro Economics and Public Finance over the decades. When a country achieves a higher economic growth through the liberalization, modernization of economic policies it is crucial to understand the behavior of the relevant government activities. Therefore, the relationship between economic growth and public expenditure is analyzed through this study with respect to the Wagner’s Law (1883) using annual real and nominal terms of public expenditure and GDP (Gross Domestic Product) data from the period of 1960 – 2011 in the Sri Lankan context. Series are tested for co-integration using the Engle Granger method (EG Method). With the evidence of the long run relationship between GDP and various definitions of public expenditure, the Error Correction Method (ECM) is employed in order to check for short run dynamics of the relationship. Furthermore, Granger causality test is applied to check for the direction of causal relationship. The Granger causality test results of real terms of series show that there is no existence of Wagner’s Law becoming consistent with earlier findings while results of nominal terms of series provide that out of six versions of Wagner’s law four of them are showing a causal relationship from GDP to public expenditure which is an evidence of existence of Wagner’s Law in Sri Lanka. The evidence of the study with the aggregate data in real terms from the period 1960 -2011 is proved that, although country leads to economic growth, government activities are not stimulated by the economic growth in Sri Lanka. Further, there is no validity of Wagner’s Law which is positive causal relationship from GDP to public expenditure. However, the evidence of the study with the usage of nominal terms of series shows a positive causal relationship from GDP to public expenditure for the period of 1960 – 2011 showing that the scope of government activities are stimulated by economic growth of country.