Economic Analysis and Policy 58 (2018) 1–13 Contents lists available at ScienceDirect Economic Analysis and Policy journal homepage: www.elsevier.com/locate/eap Full length article Economic growth and government size in developed European countries: A panel threshold approach Mehdi Hajamini a, *, Mohammad Ali Falahi b a Department of Economics, Yazd University, Yazd, Iran b Department of Economics, Ferdowsi University of Mashhad, Mashhad, Iran article info Article history: Received 29 September 2016 Received in revised form 31 December 2017 Accepted 31 December 2017 Available online 4 January 2018 JEL classification: H50 H54 H60 O40 Keywords: Economic growth Government expenditure Government size European countries abstract Based on the literature on economic growth, there is a non-linear relationship between government size and economic growth, which is usually similar to an inverted U-shaped curve and is used to determine the optimum share of government expenditure. The present study aims to investigate the non-linear relationship among 14 developed European countries during 1995–2014. Final consumption expenditure to gross domestic product (FCE), current expenditure other than final consumption to gross domestic product (OCE), and government gross fixed capital formation to gross domestic product (GFCF) were considered for measuring government size. The results indicate an asymmetric effect of FCE and GFCF on economic growth when they are above and below the optimal level. The optimum values of FEC and GFCF were estimated to be 16.63 and 2.31%, respectively. However, it is noted that OCE always has a negative effect on economic growth. In terms of policy prescriptions, governments of developed countries should be aware that misallocation of public expenditure can occur given it may likely become unproductive after passing an optimal size. © 2018 Economic Society of Australia, Queensland. Published by Elsevier B.V. All rights reserved. 1. Introduction Sustainable economic growth is regarded as a discovery process which is generally guaranteed by the market mechanism. However, the effect of government size on economic growth is a controversial issue. Obviously, government should play a role in different areas such as the security of property rights and providing the proper environment for private activities. Accordingly, a decrease in transaction costs leads to an increase in investment and production. Government can also provide infrastructure, public health, and education since the private sector cannot implement them sufficiently for the whole community. Hence, government efforts lead to higher economic growth through entering those sectors in which the market mechanism fails or are more efficient, compared to the private sector. In this regard, some empirical studies have indicated a positive effect of government size on economic growth (Ram, 1986; Bose et al., 2007; Romero-Ávila and Strauch, 2008; Ghose and Das, 2013). Government, on the other hand, cannot allocate very large sums to expenditure given its corresponding need to finance expenditure by borrowing and taxes. However, borrowing may increase the financial costs of investment, displace private investment and increase taxes in the future. Taxes may distort resource allocation which results in discouraging economic agents. In addition, centralization and bureaucracy decrease creativity in both public and private sectors. Thus, the trend * Corresponding author. E-mail addresses: hajamini.mehdi@yazd.ac.ir (M. Hajamini), falahi@um.ac.ir (M.A. Falahi). https://doi.org/10.1016/j.eap.2017.12.002 0313-5926/© 2018 Economic Society of Australia, Queensland. Published by Elsevier B.V. All rights reserved.