Causality between Public Expenditure and National Income in India: A Reexamination

P Sakthivel and Inder Sekhar Yadav

The IUP Journal of Public Finance, 2007, vol. V, issue 4, 36-51

Abstract: As India tries to maintain a healthy balance between its social welfare obligations and its economic policies contrary to Wagner and Keynes propositions concerning the causal relationship between national income and public expenditure, it becomes important to understand the causal relationship between the two macroeconomic variables especially in the case of a developing country like India. Thus, the present paper tries to examine, firstly, the growth trend of Gross Domestic Product (GDP), public expenditure and its various selected components. Secondly, it tests and investigates the short run nature and the direction of causality between national income, public expenditure and its various components in India. For the purpose, the necessary annual data on macroeconomic variables viz., total public expenditure, GDP, expenditure on social and economic services, defense services and interest payments are collected from Handbook of Statistics on Indian Economy, 2006, RBI and Centre for Monitoring Indian Economy (CMIE), and various issues on public finance from 1980-81 to 2005-06. To examine the growth rate of selected macroeconomic variables, a semi-log model and a linear trend model have been employed. Granger Causality Test has been employed to test the direction of causality between national income, public expenditure and its various selected components. The results showed that the public expenditure has registered a higher growth rate than the national income. And among the various selected components of public expenditure, debt obligations in the form of interest payments registered a higher growth than others. The Granger Causality Tests confirm a bidirectional relationship between national income and public expenditure and economic services. The causality between national income and India’s expenditure on social and defense services are found to be independent. Finally, a unidirectional realtionship between GDP and interest payments is found.

Date: 2007
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