Government expenditure, informality, and economic growth: Evidence from Eastern and Southern African countries

Abstract

This study investigates the dynamic linkages among government expenditure, informality, and economic growth in 15 Eastern and Southern African countries over a 25‐year period during 1991–2015. The analysis exploits panel vector autoregressive models to construct the time path of one variable following an orthogonal shock to another variable using impulse response functions. The analysis is complemented by panel quantile regressions to investigate the potential role of informality in the expenditure–economic growth nexus. The findings are threefold. First, both government consumption and investment expenditure have positive and significant effects on real per capita GDP. Second, informality has a direct negative impact on real per capita GDP. Third, the informal sector dampens the impact of government expenditure on real per capita GDP. These results are robust to the inclusion of selected control variables and are unchanged across GDP quantiles. The study's findings suggest that government policies aimed at reducing informality can have direct impacts on economic growth and indirect impacts through improvements in the effectiveness of government expenditure.