The effect of government expenditure on economic growth: an empirical analysis in Liberia

Abstract

The Liberian government expenditure is largely composed of recurrent spending which reduces growth according to economic theory. Thus, the objective of this study is to analyze the effect of government expenditure on economic growth in Liberia using time series data. To achieve this objective, the study employs secondary annual time series data for Liberia for the period 1970 to 2007. The neoclassical aggregate production function is used as the methodology to analyze the relationship between government expenditure and growth. Government expenditure was disaggregated into consumption and total investment expenditures. The Johansen Maximum Likelihood approach is used to test for long-run relationship between the dependent and independent variables. The results indicated that, such a long-run equilibrium relationship exists. Therefore, an error correction model is used to determine the relationship between government expenditure and economic growth.

The empirical findings show that government consumption expenditure, private consumption and exports are positively related to growth in Liberia but foreign aid has negative impact. However, total domestic investment, foreign direct investment and population growth rates are insignificant. Thus, the main policy recommendation is that, improving economic growth in Liberia requires improving expenditures which have positive impacts. However, the impact of government expenditure is modest compared to private sector expenditure. Thus to maximize economic growth, more resources should be directed into the private rather than into the public sector. The caveat to this policy recommendation is that, government expenditure cannot be increased to the point where deficits will result. Financing such a deficit is most likely to result into increase in interest rate or inflation that may harm rather than improve growth.