Government expenditures and economic growth: The supply and demand sides

This paper uses a new approach to estimate how government expenditures affect the growth rate of real GDP. They affect the growth rate through three channels - total factor productivity, investment and aggregate demand. We find that apart from government investment, all government expenditures have negative marginal effects on productivity and GDP growth. In particular, a 1 percentage point increase in the share of government consumption in GDP reduces the equilibrium GDP growth rate by 0.216 percentage points, while the same increase in government investment raises the growth rate by 0.167 percentage points. This suggests that a reallocation of 1 percentage point of government consumption to government investment can raise the growth rate by 0.38 percentage points.