Heterogeneity in the effects of government size and governance on economic growth

Abstract

This paper explores whether there exist nonlinear threshold effects of government size and governance on output growth and whether the effect is mainly mediated through the productivity growth channel. Using the panel smooth transition regression (PSTR) approach to a sample of developed and developing countries, it finds that (i) better governance helps government size increase productivity and hence output growth, and bigger government size helps governance raise productivity and then output growth; (ii) government size turns harmful to growth above some threshold level of government size; (iii) governance becomes beneficial to growth above some threshold level of governance; and (iv) the evidence is more pronounced in countries with abundant natural resources. The findings are robust and provide circumstantial support for government size and governance to promote economic growth.