Effect of Government Expenditure on Economic Growth of the USA - Research Proposal Example

Effect of government expenditure on economic growth of USA Thesis: Government expenditure is a positive enhancement towards the economic growth a nation Table of Contents Introduction 3 Research question and objectives 4 Definitions of government expenditure and economic growth 4 Government expenditure 4 Economic growth 5 Literature review 5 USA’s economic history 5 USA’s current economy 6 Keynesian theory 6 Rahn Curve theory 7 Relationship between economic growth and government expenditure 7 Research methodology 8 Data collection 8 Tools 9 Graphs 10 Correlation coefficient analysis 12 Regression Analysis 13 Conclusion 14 References 14 Introduction Policy makers always contemplate on whether government expansion is a positive move or negative towards economic growth of a nation. In most cases, advocates of larger governments always put forward the argument that; government programs result in valuable public goods such as infrastructure and schools (Daniel). Their argument mostly implies that an increase in government spending it is an indication that more money is going to the people’s pockets which is a good boost towards economic growth. This view however is a complete opposite when it comes to smaller governments. The argument in this section implies that government is too big and the more it spends it ends up undermining the economic growth of the nation. This can be explained in such a way that the more the government spends it ends up transferring supplementary resources from the more successful sector to government where they will most likely be misappropriated. In such a small economy there is likely to be more resistance towards expansion of the public sector. This is because when implementing pro-growth policies for example personal retirement accounts and fundamental tax reforms, an expansion to the public sector would inhibit such a process. In most economies, the question that most philosophers and economists keep on contemplating on is which side is right. This because as much as the explanation distinguishes it as being between a large economy and a small economy, the reality is that either could apply to any economy (Daniel). There are many studies have been and are still being carried out in this sector. In the article by Shih-Ying, Jenn-Hong, and Eric (810) generally the same argument arises stating that on matters of government spending and economic growth there is always a mixed reaction across many sectors. However, after conducting a comprehensive study using the “panel Granger causal test” on a richer panel of data comprising 182 countries within the period of 1959 to 2004, the results are clear and educative (Shih-Ying, Jenn-Hong and Eric 815). The results from the study come out in favor of Wagner’s law and the assumption that government expenditure is a positive move towards economic growth despite the size and economic growth. Basing from the above explanations this essay tries to explore on a more definite explanation of how government expenditure affects the economic growth of a nation in this case basing on the government and economy of United States. Research question and objectives The objectives of this research are to find out the level of government expenditure in the US and to determine how this spending relates to its overall economic growth. The research questions that will be addressed in this study include level the United States government spending, if there is a relationship between the government spending and the nation’s economic outcome and if there how is this relationship. The final question the study will answer is the differences and similarities that exist between the US and other developed nations. Definitions of government expenditure and economic growth Government expenditure According to Grilli and Baro, Government expenditure refers to the investment and consumption by a government excluding transfer payments by the state. This involves the government acquiring goods and services that it uses to satisfy current needs of its citizens. The final consumption expenditure by a government and its gross capital accumulation is what constitutes towards a nation’s gross domestic product GDP (237). Economic growth On the other hand, economic growth is a reflection of the increase in amount of services and goods an economy is producing over a certain period (Lucas 37). It is normally measured as a percentage rate of increase in a nation’s GDP. According to economists, economic growth is characterized by long run economic changes and short term economic changes, which are referred to as business cycle (Helpman 76). However, economic growth focuses mostly on production in the long-run trend; this is because of the associated factor accumulation and technological growth. Literature review USA’s economic history In the 16th,17th, and 18th century the United States was under the colony of Europe and it is from this period that its economic has revolved from to what it is today (Johnson 194). After the colonization, the thirteen marginal economies joined in 1776 and formed the United States of America (195). Since independence, the US economy has grown to a huge, industrialized, and integrated economy that contributes to almost a quarter of the world’s economy (Wood 115). Key contributors to this economic growth include a large unified market, vast number of natural resources, supportive political legal system, entrepreneurial spirit, highly productive farmland, and major investments in material and human capital (Johnson 190). Some of the important statics in the US economy include increase in national debt up to 75% and a rise in GDP by 69% which happened in the 90s (Hudson 117). The historical transition into globalization in the 90s saw the US rise into a World superpower. Starting 1994 to 2000, the nation’s inflation was manageable, output rose, and unemployment levels went down to 5% (Helpman 34). However, things did not go so well for US starting March 2000. During this period, the market results were ranging from 50% to 75% of the growth achieved in 1990s. Things worsened in 2001 when the economy only grew by 0.3% and a rise in unemployment (Daniel 375). USA’s current economy The US remains to be a world superpower with a huge economy on its shoulders. However, in the recent economic times the US has experienced a number of setbacks. The major setback is the financial crisis that started in 2007, which not only hit the US but the entire world as well (Hudson 111). The other major setback on the US economy includes the 2008-2010 Automotive industry crisis. However, the financial crisis tends to be haunting the US to date especially after the major events that happened following this crisis. A series of banks in the US all the way to Europe collapsed, while some went bankrupt and the government bailed out a few such as AIG insurance company (310). Currently it has been noted that the economy is starting to give positive feedback following the signing of American Recovery and Reinvestment Act of 2009 by President Barack Obama (Shih-Ying, Jenn-Hong and Eric 67). The bill is modeled on the Keynesian theory, which indicates that government spending should offset the collapse in private spending, which mostly happens when there is an economic downturn. Keynesian theory The Keynesian theory was a substantial argument in public policy starting early 1930s to late 1970s but is no longer favored in the current economics (Daniel). Few years later after President Obama signed the bill he is now on the receiving end being accused of destroying the economy and capitalism for being a socialist (Chtaini). Many scholars are advancing theories that seek to explain why the Keynesian theory best works as a theory but not in practical and they are using the US as key area for study (Ramey 679). Rahn Curve theory Rahn curve is an economics theory that tries to explain the optimum point where government spending should be in order to maximize on economic growth (Pettinger). According to various academic studies that have been carried out in the recent years, most of them indicate that the US is on the sloping section of the Rahn curve (Daniel). In terms of the Rahn curve theory “size of government” matters when it comes to economic performance of a nation (McKeever). Size in this matter refers to the government expenditure and economic performance referring to the annual progression in GDP. According to the Rahn theory, economic performance is at best when the government’s expenditure is in the range of 15-25% of the nation’s GDP. This however is not the case in the US and there is a very large disparity as the US government expenditure is around 35-40% of its GDP, which ends up reducing the prosperity of the nation (McKeever). Relationship between economic growth and government expenditure Over the years, economists continue to carry out several studies on economic growth and its relationship with government expenditure. There are several theories that arise from these studies some agreeing with each other and other totally contradicting. One of the recent studies by The Organization for Economic Co-operation and Development stated, “Government expenditure and Taxes both affect the economic growth of a nation directly or indirectly in terms of investment (Bassanini and Scarpeta). In another study, Lee explains that government expenditure directly associates to slower economic growth of a nation with coefficients ranging from 0.0602 to 0.0945 measured using four separate regressions (106). Research methodology Data collection In carrying out the research, I utilized secondary sources such as government database to collect data on the economic growth of US since 1970 to 2000. The data from 1970 to 1991 comprised of data that has been interpolated between the actual reported values and the real values. From 1992 to 2000 contains data from the actual values represented by treasury. Total Spending Year GDP-US $ billion nominal Population-US million Total Spending-total percent GDP 1970 1038.3 203.302 31 i 1971 1126.8 205.515 31.49 i 1972 1237.9 207.752 31.36 i 1973 1382.3 210.013 29.74 i 1974 1499.5 212.299 30.23 i 1975 1637.7 214.609 33.62 i 1976 1824.6 216.945 34 i 1977 2030.1 219.307 32.91 i 1978 2293.8 221.694 32.02 i 1979 2562.2 224.107 31.48 i 1980 2788.1 226.546 33.72 i 1981 3126.8 228.67 34.32 i 1982 3253.2 230.815 36.25 i 1983 3534.6 232.979 36.31 i 1984 3930.9 235.164 34.44 i 1985 4217.5 237.369 35.48 i 1986 4460.1 239.595 35.71 i 1987 4736.4 241.842 35.09 i 1988 5100.4 244.11 34.73 i 1989 5482.1 246.399 34.74 i 1990 5800.5 248.71 36.01 i 1991 5992.1 251.802 37.22 i 1992 6342.3 254.933 37.04 a 1993 6667.4 258.103 36.31 a 1994 7085.2 261.312 35.38 a 1995 7414.7 264.561 35.53 a 1996 7838.5 267.85 34.69 a 1997 8332.4 271.18 33.76 a 1998 8793.5 274.552 33.24 a 1999 9353.5 277.966 32.64 a 2000 9951.5 282.172 32.56 a Legend: a - actual reported i - interpolated between actual reported values Tools All the data was analyzed with the help of Microsoft excel. The correlation coefficient and the regression analysis was done using the help of Excel which is a statistical tool that is mostly used in research to analyze data by grouping, structuring and analyzing. The graphs, were generated using relevant command lines in the excel workbook and transferred to this final document. This was also the case with the analysis section where all the analysis regarding regression analysis and correlation coefficient was done in an excel spreadsheet and the results exported to this paper. Graphs I generated two graphs from to have pictorial view of what the data represented in terms of the GDP and US spending within the selected years. The first graph represents a table-indicating the US total percentage GDP which reflects the country’s economic growth . The second graph below illustrates the US total spending over the selected time period. It is clear from the Graph that the country’s spending has been on the constant rise over the years. The third graph below shows a combination of the annual percentage GDP over the selected period against the total government spending over the years. Correlation coefficient analysis The first analysis to carry on the data was determining the correlation coefficient. The coefficient will determine the relationship between the government spending data and the percentage GDP or economic growth. The formula for correlation coefficient is as below The results from the analysis gave the correlation coefficient between array X as the government spending and array Y as the annual economic growth in terms of percentage GDP = 0.432893 Regression Analysis Regression Statistics Multiple R 0.393046948 R Square 0.154485903 Adjusted R Square 0.124288971 Standard Error 2481.17034 Observations 30   df SS MS F Significance F Regression 1 31494824.82 31494824.82 5.115946983 0.031661704 Residual 28 172373775.2 6156206.256 Total 29 203868600         Intercept 31 Coefficients -13284.2405 526.7253228 Standard Error 7946.322 232.8740951 t Stat -1.67174707 2.261845924 P-value 0.10571479 0.031661704 Lower 95% -29561.5432 49.70436323 Upper 95% 2993.06225 1003.746282 Lower 95.0% -29561.5432 49.70436323 Upper 95.0% 2993.06225 1003.746282 Conclusion Starting from the graphs to the data, analysis using statistical formulas such as regression analysis and correlation coefficient all the results agree that government spending has a positive relation to economic growth. From the data on USA we can clearly see that the positive value of 0.432893 resulting from a correlation coefficient analysis. The graphs the combined graphs also show this trend apart from the period beginning 1994 to 2000. It is also evident from the results given by the regression analysis that there is a linear relationship between the two variable. Drawing conclusion from these results, it is now evident that the government spending of USA directly relates to its economic wellbeing. In addition, one other analysis we can draw from the study is that the graph work between the percentage economic growth and total government spending relates tends to agree with the Rahn Curve theory. Looking at the graph it is clear that the maximum government spending should have been maintained at 7085.2 billion, which are the values in 1994. From this point onwards, any more additional government expenditure results to a negative change in the overall GDP. 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