The Direct and Indirect (Spillover) Effects of Productive Government Spending on State Economic Growth ANDREW OJEDE, BEBONCHU ATEMS, AND STEVEN YAMARIK ABSTRACT Using data on 48 contiguous U.S. states and a spatial econometric approach, this paper examines short- and long-run effects of productive higher education and highway infrastructure spending financed by different revenue sources on state economic growth. Following the Lagrange Multiplier, Wald, and Likelihood Ratio tests, the data are found to be characterized by both spatial lag and spatial error processes, leading to the estimation of a dynamic spatial Durbin model. By decomposing results of the dynamic spatial Durbin model into short- and long-run direct as well as indirect (spillover) effects, we show that accounting for spillover effects provides a more comprehensive approach to uncovering the effects of productive government spending on growth. We find that, regardless of the financing source, productive higher education and highway spending have statistically significant short- and long-run direct as well as spill- over effects on state income growth. Introduction A key motivation for the long-run growth effect of fiscal policy implemented at the state level or in subnational economies can be attributed to theoretical endogenous growth models. These models predict that productive government expenditures such as spending on infrastructure and edu- cation typically lead to long-run economic growth. In particular, Barro (1990: S118, figure 3) shows that productive government expenditures financed by income taxes have non-linear effects on growth. In other words, growth initially increases with increased in government spending but decreases later. Romer (1987, 1990) predicts that distortionary taxation that influences the allocation of resources by different economic agents can affect long-run economic growth. Simulating an endogenous growth model, King and Rebelo (1990) find that a twenty percent increase in income taxes leads to a four percentage point decrease in economic growth. Extending the work of Barro (1990), many theoretical papers, including King and Rebelo (1990), Devereux and Love (1994), Sto- key and Rebelo (1995), among others, have attempted to explain the different channels through which public spending and taxation policies affect growth. Several empirical studies that use aggregate fiscal policy variables in the government budget con- straint have arrived at mixed results when looking at the effects of fiscal policy on growth. Mendoza, Milesi-Ferretti, and Asea (1997) and Agell, Lindh, and Ohlsson (1999), for example, argue that no significant correlation exists between tax revenues and economic growth. On the other hand, Folster and Henrekson (1999) and Romer and Romer (2010) find significant contractionary effects of taxes Dr. Andrew Ojede is an Assistant Professor of economics in the Department of Finance and Economics, McCoy Col- lege of Business Administration, Texas State University, San Marcos, TX 78666, USA. His e-mail address is: Andrew. Ojede@txstate.edu. Dr. Bebonchu Atems is an Associate Professor of Economics in the School of Business, Clarkson Uni- versity, Potsdam, NY 13699, USA. His e-mail address is: batems@clarkson.edu. Dr. Steven Yamarik is a Professor in the Department of Economics, California State University, Long Beach, Long Beach, CA 90840, USA. His e-mail address is: Steve.Yamarik@csulb.edu. The authors would like to thank James LeSage and Yao-Yu Chih and two other anonymous referees for valuable comments on earlier drafts. All other errors of course remain our own. Submitted August 2017; accepted August 2017. V C 2017 Wiley Periodicals, Inc Growth and Change DOI: 10.1111/grow.12231 Vol. 00 No. 00 (Month 2017), pp. 00–00