The long-run relationship between public consumption and output in developing countries: Evidence from panel data

Abstract

This paper uses heterogeneous panel cointegration techniques to examine the long-run effect of public consumption on output for 33 low- and lower-middle-income developing countries from 1972 to 2014. We include total investment in the cointegration relation and explicitly deal with cross-sectional dependence in the data that arises due to unobserved common factors. We find that on average, government consumption has a negative impact on output in the long-run — a result driven by non-sub-Saharan African countries in our sample. In contrast, investment has a consistent positive effect on output. The results suggest that fiscal adjustments that cut government consumption while maintaining investment spending will have a potential expansionary effect on long-run output.