Government size and economic freedom as determinants of growth: Evidence based on the Heritage Foundation data

Abstract

The objective of this paper was to find out if government size is detrimental to economic growth as it is often claimed. This issue was investigated by using extreme bounds analysis to overcome the problem of model uncertainty and the sensitivity of the results to the selected set of explanatory variables. By also using non-nested model selection tests as applied to data obtained from the Heritage Foundation (an American conservative think tank based in Washington, D.C. that is primarily geared toward public policy), cross-sectional evidence was presented in support of the proposition that government size is detrimental to economic growth. In particular, government spending turns out to be the most important determinant of economic growth, dominating the rule of law, regulatory efficiency and market openness. Two caveats must be borne in mind when these results are interpreted: (i) what matters is the quality, not the quantity, of government spending; and (ii) a big government can be good for business. The results presented in this study provide further evidence on a controversial issue and some guidelines for policy makers concerned with economic growth.