An Empirical investigation of wagner's law: the case of 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 impact of the movement of government participation in the economy. Therefore, the relationship between economic growth and public expenditure is analyzed in this study, the Wagner’s Law (1883) using annual real terms of public expenditure and GDP (Gross Domestic Product) data for the period of 1960-2011 in the Sri Lankan context. The time series properties of each series are tested using the unit root test procedure. Then the series are tested for the long run relationship (Cointegration) 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 Model (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. 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.