Estimating the optimal size of public expenditures within the context of an endogenous growth model

The goal of this dissertation is to estimate the optimal size of government using a measure of government size that incorporates public capital expenditures as well as government consumption expenditure. The estimation is based on the Barro Rule of Public Finance according to which government services are optimally provided when their marginal product equals unity and is carried out on a panel of 65 countries for the period 1970--1999. The measure of government size employed is more comprehensive than past studies on the growth of government because my compilation includes both consumption expenditure and investment expenditure components of public expenditures. It is clear from the results of this study that the optimal size of public expenditures varies across regions and countries in their respective output quantiles, with higher income countries typically having a smaller than optimal size of government compared to lower income countries. In developing countries, the actual size of government tends to exceed the estimated optimal size more so than in their more developed counterparts and this may perhaps be justified by the need for the government to take on a greater role in enabling investment and growth, and forcing industrialization in these economies. Furthermore, the findings show that the democracy ranking of a country is important for its size of government, as the estimated optimal size of government is larger for less democratic countries and decreases with the level of democracy.; I conclude that the deviation between the actual size of government and estimated optimal size of government is related to the functions and roles of governments in developing and developed countries. Furthermore, the large variations between actual government size and estimated optimal government size observed in developing countries can only be justified if a relatively larger share of public expenditures is directed towards public investment expenditures which are found to be more productive than public consumption expenditures.