The Relationship between Government Size and Economic Growth in Iran; Bivariate and Trivariate Causality Testing

The aim of this study is to demonstrate the relationship between government size and economic growth in Iran within bivariate and trivariate causality framework. For this purpose, Vector Auto Regressive Model, Johansen Test and Auto Regressive Distributed Lag Model were used for analyzing the long run relationship, whereas Error Correction Model was considered for the short run. Moreover Wald Coefficient was used for bivariate and trivariate causality test. The results show that the relationship between government size and economic growth in Iran is negative. Furthermore there is a one-way causality relationship for the long run and the short run-from government size to economic growth. Inclusion of unemployment and oil revenue (separately) as the third variable causes the relationship to remain negative. However the direction of causality depends on the choice of the third variable. If unemployment rate is considered as the third variable instead, there will be no causality between the two variables in the long run. Although in the short run government size is still the cause of economic growth. However, consideration of oil revenue as the third variable results in a two-way causality relationship between the government size and the economic growth in the long run and the short run. Economic growth has been developing countries apprehension which is the required condition for economic development. Success or failure in achieving required economic growth can cause enhancement or falling the governments and non- developed nation's plans is evaluated based on their national income. It is a fact that no society throughout history has ever obtained a high level of economic affluence without a government. Where governments did not exist, anarchy reigned and little wealth was accumulated by productive economic activity. After governments took hold, the rule of law and the establishment of private property rights often contributed importantly to the economic development of Western civilization, and it has similarly impacted on other societies as well. Government is necessary, though by no means sufficient, condition for prosperity. It is also a fact, however, that where governments have monopolized the allocation of resources and other economic decisions, societies have not been successful in attaining relatively high levels of economic affluence. Economic progress is limited when government is zero percent of the economy, but also when it is at or near 100 percent. The experience of the old Soviet Union is revealing, as was the comparison of East and West Germany during the Cold War era, or that of North and South Korea today. Too much government stifles the spirit of enterprise and lowers the rate of economic growth. One of the most important issues which have been studied in different ways is the impact of government size on long run economic growth. Although the issue has a high level of importance, the empirical ideas about that have had adverse results. There are three overall points of views about the impact of government size on economic growth. According to the first group theory, larger government size is likely to be detrimental to efficiency and economic growth due to some inefficiencies existing in the government's presence and can be an obstacle for development in economy, the second group believe that the government existence is not a hindrance for economic growth, and the third group know the relationship between these two like an inverted U, and believe that increasing the government size to a special limit causes increasing the economic growth but results in its decrease by going beyond this limit.