Does the Wagner’s hypothesis hold for China? Evidence from static and dynamic analyses

Abstract

China witnessed an admirable growth performance over the last three decades. It is claimed that such success was achieved by strong support from government expenditures. This study examines the relationship between government expenditures and GDP growth for China within the context of Adolph Wagner?s Hypothesis. It covers the most recent time period between 1982 and 2011 and use advanced static and dynamic econometric models to test validity of the Hypothesis for Chinese economy. After determining the stationarity of the series and confirm the existence of the long term relationship between the variables by using the Bounds test approach, we examine the long and short run relationship between government expenditures and GDP using an ARDL model. The ARDL (1, 2) model suggests that 1 percentage point increase in GDP will lead to 1.63 percentage points surge in government expenditures. Finally, we use the Kalman filter to investigate the dynamic relationship between government expenditures and GDP. According to the Kalman filter model, the income elasticity of government expenditures remains between 1.32 and 1.38. Since the elasticity is found larger than 1 in both static and dynamic models, we conclude that Wagner?s Hypothesis is valid for China during the 1982-2011 period.