The effect of federal government size on private economic performance in Canada: 1870–2011

Abstract

This paper asks whether government size is complementary to or a substitute for private economic activity and whether that effect is a function of its size. It does so by testing the hypothesis that the growth of federal government size in Canada over the long 1870–2011 period has had an inverted U shape with a tipping point in relation to private output. Its contribution is three fold: first it argues that historical size should be linked to the level rather than the growth rate of private performance; second it incorporates formal controls for endogeneity; and third, nonparametric techniques assess whether the quadratic form most often used to test this hypothesis is appropriate. The empirical work finds the inverted U shape to be consistent with the data for Canada, but only for the 1870–1936 time period. In the post WW2 time period when federal size is above peak size, the data suggest that increases have imposed constant rather than increasing cost. The policy implication is that while government size complemented the growth of the Canadian private economy in its early stages, recent experience is more consistent with the hypothesis that increases in government size have decreased rather than increased private per capita output.