The Relationship between Government Size and Economic Growth in Iran: Bounds Testing Approaches and Toda and Yamamoto's Causality

There are Two important approaches about the relationship between government size and economic growth. According to Keynesian approach the economic growth is determined by government size. According to Wagner law, on the other hand, the government expenditures are results of economic activities. Thus, if the society's real incomes increase, the public expenditures grow and the government size increase too. Recently, some empirical studies showed that there are bilateral causality between economic growth and the size of government. Our study tests Wagner’s law (using various specifications proposed by Huang) and compares it to Keynesian view, for the case of Iranian economy during 1965-2010. To analyze, we use annual time series including unit root test and two methods: casual bounds test approaches based on unrestricted error correction model (UECM) (Pesaran, Shin and Smith (2001)) as well as Toda and Yamamoto's Granger non-causality test (1995). Findings show a one-way causality from government size to economic growth (Verified Keynesian view). Some reasons are non-optimal management of government and the structure of the Iranian oil-dependent economy