Wagner's law and Peacock and Wiseman's effect in EMU countries: A panel data study

Wagner’s law is the first model of public spending in the history of public finance. It suggests that during the process of economic development the share of public spending in national income tends to expand (Wagner, 1883). Nevertheless, Peacock and Scott in 2000 wrote a paper entitled “The curious attraction of Wagner’s law”, explaining the reasons for why this (apparently) outworn theory is still studied by modern economists. On the other hand, Keynes (1936) considered public spending as an exogenous factor to be used as a policy instrument to influence growth. Moreover, Peacock and Wiseman (1961) presented the displacement effect, according to which during times of war tax rates are increased to generate more revenues, sustaining the increase in defense spending. Peacock and Wiseman (1979), surveying the literature on public expenditure growth, suggest a new approach in which to the displacement effect new elements are added to explain the public expenditure dynamics. In particular, the public bureaucracy, because of its monopolistic position is inefficient and the political and bureaucratic apparatus manipulate the demand of public services, inflating its size to increase their rents and power. This paper aims to analyze the relationship between public expenditure and aggregate income in European Monetary Union (EMU) countries, for the period 1970-2013, using panel data methodologies. After a brief introduction, a survey of the economic literature on this issue is discussed. Then, panel data tests are performed on stationarity, cross-dependence, co-integration, and causality, for public expenditure in relation to GDP for the considered countries. Finally, the paper concludes with policy implications.