Public ExPEnditurE and Economic Growth in india: VEcm Estimation of thE causal rElationshiP T. Lakshmanasamy* Abstract The relationship between public expenditure and economic growth is obvious, but the direction of causality is not clear. This paper analyses the relative impact of the different components of public expenditure on economic growth. Specifcally, this paper examines whether the level of government expenditure is managed to accelerate economic growth or whether government expenditure is used excessively, which may hurt domestic economy because of increased taxes and/or high government borrowing. The vector error correction method is applied to the annual time series data for India from 1983 to 2020 for testing the long- and short-run causality. The pair-wise Granger causality test indicates one-way causality moving from gross domestic product to total government expenditure, and from gross domestic product to government revenue showing that the growth of the economy leads to an increase in both government revenue and expenditure. The estimated error correction coeffcient is signifcantly negative, indicating that the speed of adjustment between the short-run dynamics and the long-run equilibrium is about 0.03%. The results show a stable long-run relationship between public expenditure and economic growth. Keywords Public Expenditure, Economic Growth, Causal Relationship, Vector Error Correction Model (VECM) INTRODUCTION Public expenditure plays a signifcant role in the functioning of an economy. The relationship between public expenditure and economic growth is obvious and has been extensively studied, both theoretically and empirically. The theoretical foundation of this relationship can be traced as far back as Wagner (1883) in his famous Wagner’s Law. Wagner advanced his ‘law of rising public expenditures’ by analysing trends in the growth of public expenditure and in the size of the public sector. Wagner’s law postulates that: (i) the extension of the functions of the states leads to an increase in public expenditure on administration and regulation of the economy; (ii) the development of modern industrial society would give rise to increasing political pressure for social progress and call for increased allowance for social consideration in the conduct of industry; and (iii) the rise in public expenditure will be more than a proportional increase in the national income, and thus result in a relative expansion of the public sector. Musgrave and Musgrave (1973), in support of Wagner’s law, argue that as progressive nations industrialise, the share of the public sector continues to grow in the national economy. The role of public expenditure in the economy is now well- grounded in the macroeconomic theory after the Keynesian revolution. The macroeconomic theory establishes that credit for public expenditure is not only in the determination of the level of income, but also in its distribution. Keynesian macroeconomics provides a theoretical basis for the developments in public expenditure programmes in developed economies. However, empirical studies on the relationship between government expenditure and economic growth arrive at different and even conficting results. The direction of causality between public expenditure and economic growth is not always clearly established. Whether public expenditure causes economic growth or whether economic growth necessitates more government expenditure is a moot question. Some studies suggest that an increase in government expenditure on socio-economic and physical infrastructure impacts the long-run growth rate of the economy. For instance, government expenditure on health and education raises the productivity of labour and increases the growth of national output. Similarly, public expenditure on infrastructure such as roads, power, and so on, reduces production costs and increases private sector investment and proftability of frms, thus ensuring economic growth (Barro, 1990; Barro & Salai-i-Martin, 1992). There is also overwhelming evidence that fast-growing economies have heavily expanded their public investments. Some studies even suggest bi-directional causality between government expenditure and economic growth. The main objective of this paper is to establish the direction of the causal relationship between public expenditure and economic growth. Specifcally, this paper aims to analyse * ICSSR Senior Fellow and Formerly Professor, Department of Econometrics, University of Madras, Chennai, Tamil Nadu, India. Email: tlsamy@yahoo.co.in International Journal of Business Ethics in Developing Economies 11 (1) 2022, 07-14 http://publishingindia.com/ijbede/