Does Government Spending Cause Investment?: A Panel Data Analysis

Government spending has increased recently in almost all countries to ease the severely negative economic impacts of the current health crisis. Similar expansionary fiscal and monetary policies were observed during other economic downturns too. The effectiveness of expansionary policies, especially in terms of their effects on investment, has been discussed widely. Thanks to the possible multiplier effect of higher government expenditures, it is expected that government spending would generate a higher amount of income and therefore consumption in economies. At some point, this higher government spending with glowing economic activities is expected to increase private investment—an important item to promote job creations and improvements in production. Although one of the direct or indirect expected outcome of higher government spending is larger investment, many empirical studies in the literature cannot observe this positive expected effect of government spending on investment. As a result, even the necessity of increased government expenditures during economic crisis has been questioned. In this paper, the causal and correlation relationship between government spending and investment is investigated in a panel data setting to better evaluate the importance of higher government spending during economic downturns. The findings show that country classifications based on income, time periods covered in the analysis, measures of government spending and investment, and the time lag of government policies can make a difference. There are cases where government spending highly significantly causes private investment, and high correlations between two variables are observed. Therefore, accurate evaluations of the impacts of government spending on investment may require detailed data analysis.