Relationship between government spending and private consumption in Kenya

Abstract

Over the past years, the relationship between government spending and private consumption remains one of the contentious issues in macroeconomics literature. The question of whether public expenditure is neutral or crowds in or out private consumption has dominated theoretical and empirical debate. Three major schools of thought on the issue are observed in the literature, these are the Ricardian equivalence theorem, the Keynesian framework and the Substitutability hypothesis each with a distinct set of explanations. These contrasting schools of thought have triggered several empirical studies attempting to investigate the relationship between government spending and private consumption. However, conclusions from the empirical studies are inconclusive. Most of the empirical studies, on the subject have mainly focused on the high-income countries which have different structural properties in their economic structure and government spending patterns. There is scanty literature on the relationship between government spending and private consumption in the less developed economies. In Kenya, most of the studies focus on the relationship between government expenditure and economic growth. The government expenditure in Kenya, has been increasing gradually over the years. The average value of government expenditure was 9.96 billion U.S. dollars with a minimum of 0.56 billion U.S. dollars in 1961 and a maximum of 50.29 billion U.S. dollars in 2015. On the other hand, the private consumption, average increment was 2.06 billion U.S. dollars with a minimum of 0.09 billion U.S. dollars in 1960 and a maximum of 9.19 billion U.S. dollars in 2015. Though there is an upward trend of both private consumption and public spending in Kenya, the relationship between the variables is not clear. This study sought to investigate the relationship between government spending and private consumption in Kenya. The specific objectives of this study were to; determine the correlation between government spending and private consumption, establish the long run equilibrium linkage between government spending and private consumption and determine the causality link between government spending and private consumption in Kenya. This study used annual data from 1970 to 2014 sourced from World Bank Database. The study was based on correlational research design and used the Autoregressive Distributed Lag (ARDL) estimation technique. The model was subjected to several diagnostic tests, Breusch- Godfrey serial correlation LM test, CUSUM test and Bound test to ensure validity and reliability. The results of the study revealed that government spending has a significant positive effect on private consumption ( = 0.27, p= 0.0000). The results also indicated that the variables had a positive trend with a strong, statistically significant positive association (0.987, ). The Granger causality test results indicate that there is long run unidirectional causal relationship running from government consumption to private consumption. Based on the results, this study recommends the enhanced use of public spending to stimulate the private consumption.