Local Government Investment and Long-Run Economic Growth

There has been an international trend towards shifting the provision of public services down to lower levels of government. That decentralization has increased the relative importance of local governments. This paper examines the relationship between spending by those local governments and long-run economic growth. Using a comprehensive data set of all U.S. metropolitan areas, the overall level of local government spending was found to have no significant relationship with economic growth. However, local government investment (capital outlay) and the percent of spending devoted to highways both had a statistically significant positive relationship with growth. Key Words: economic growth, public investment, government spending, metropolitan areas. 1. Introduction Because government spending removes resources from private use, all else being equal, higher levels of spending in general would be expected to have a negative impact on economic growth. On the other hand, because some government spending is used to provide valuable public goods (such as roads or police protection), higher levels of some categories of local government spending may be expected to have a positive impact on growth. As the body of empirical work on economic growth has expanded, researchers have begun to examine the impact of various measures of the size of government, such as government spending and revenue. For example, Barro (1991) examined a cross-section of 98 countries and found a statistically significant negative relationship between government consumption spending as a share of GDP and per capita GDP growth. Levine and Renelt (1992) "could not find a robust cross-country relationship between a diverse collection of fiscal-policy indicators and growth. Specifically, although there are econometric specifications that yield significant coefficient estimates between specific fiscal-policy indicators and growth, the coefficients on these same variables become insignificant when the right-hand-side variables are slightly altered." (952) Most of this work has focused on a cross-section of countries. The choice of nations as the unit of analysis creates several problems that are often acknowledged. There are numerous important differences (e.g., cultural and institutional) between countries that are very difficult to quantify, and thus difficult to incorporate into an econometric test. In addition, national and state boundaries can be relatively arbitrary, and substantial variation can occur amongst local economies within those boundaries. Furthermore, reliable historical data can sometimes be difficult to obtain for more than a relatively small number of countries. One way to get around those problems is to examine smaller political units within a single nation. Another advantage of that approach is that in recent years there has been a trend towards the devolution of responsibility to lower levels of government, which has thereby increased the relative importance of state and local governments. Using pooled time series and cross section data for 48 U.S. states, Helms (1985) examined the relationship between state and local taxes and state economic growth. He finds that tax increases used to fund increased transfers have a significant negative relationship with income growth but tax increases used to finance higher spending on public services may have a positive relationship. More recently, Holcombe and Lacombe (2004) examined the impact of state income tax rate changes on income growth. The authors employ a matching technique to compare every border county in the 48 contiguous states with the county or counties they touch in neighboring states. They found that higher marginal state income tax rates (relative to their neighbors) and higher average taxes were both associated with lower per capita income growth. Reed and Rogers (2004) examined the impact of tax cuts on employment growth in New Jersey. …