The Government Size and Economic Growth in Iran: Markov-Switching Granger Causality Approach

For more than a century, the causal relationship between government size and economic growth has been a challenging issue in the public sector economics. However, there is no theoretical or empirical consensus among economists on this issue. Accordingly, it seems that the best way to resolve these theoretical and empirical contradictions is experimentally investigation the causal relationship between government size and economic growth in each country. Therefore, this paper investigates the causal relationship between government size and economic growth using the Markov-Switching Granger Causality Approach in Iran over the period 1967-2017. The findings confirmed the existence of a non-linear causal relationship between government size and economic growth and showed that government size had a significant negative effect on economic growth in the form of a two-regime structure (regime Zero: 1966-2002 and regime one:1983-1987), although this negative effect was greater in regime one than in regime zero. This larger negative effect can be rooted in the fact that the share of current expenditure in total government expenditure was significantly larger in the years related to regime one (compared to regime zero). Finally, contrary to Wagner's law, Findings did not confirm the positive and significant effect of economic growth on government size in Iranian economy.