Causality between Public Expenditure and Economic Growth in Sri Lanka: A Time Series Analysis

Abstract

This paper examines the causality between public expenditure and economic growth in Sri Lanka using time series annual data over the period of 1977-2009. In particular, this study keeps a special focused on various selected components of public expenditure by applying a multivariate cointegration and Vector Error Correction Modeling (VECM) techniques. The empirical evidence suggests, in long run, public expenditure on education, agriculture, health and transport and communication have positive and statistically significant effects on economic growth while defense expenditure shows a negative but a statistically significant effect on economic growth. Granger causality analysis confirms that there is a unidirectional causality running from education expenditure to economic growth, defense expenditure to economic growth, and agriculture expenditure to economic growth, which supports the existence of Keynesian hypothesis in Sri Lanka. Analysis also indicates that existence of bidirectional causality between health expenditure and economic growth, transport and communication expenditure and economic growth. Therefore, the findings of this study provide an important implication to policy makers to improve the efficiency of public expenditure by reallocating among sectors in a growth context.