The long-run effects of government expenditure on private investments: a panel CS-ARDL approach

Abstract

We re-explore the link between government expenditure and private investments within a modern econometric framework. Performing a dynamic analysis on a panel of 28 OECD countries over 1990–2019, we account for nonstationarity, country-heterogeneity, and cross-sectional dependence. By estimating an ECM version of the novel CS-ARDL model, we find robust evidence of both short-run and long-run adverse effects of aggregate government expenditure on private investments. Increases in productive expenditure have no significant effect on the long-run dynamics of private investments, whereas reallocating public resources towards productive expenditure enhances them. By contrast, both level increases and shifts of resources towards unproductive expenditure discourage capital formation in the private sector. Using the government budget constraint (GBC) system, we observe that the effects of government expenditure depend on how it is financed. In most cases, the short-run fall in private investments is mainly associated with tax-financed expenditure, while debt-financed expenditure appears to be the most detrimental in the long-run.