An examination of the Impact of Economic Policy on long-run Economic Growth: An application of a VECM structure to a middle-income context

This paper examines the impact of two indicators of government policy, government consumption expenditure and inflation, on per capita GDP in South Africa over the period 1935-1992. The paper draws from both the theoretical literature on growth as well as the international empirical findings. We highlight two possible effects of government consumption expenditure: government consumption expenditure may potentially have an optimal level with respect to the growth rate of output; and there may be both direct and indirect impacts from government spending through the introduction of an investment equation. We employ the Johansen VECM structure in order to show that policy does indeed have an impact on GDP, consistent with the international literature. In a replication of specifications employed in international growth studies, we find that the direct impact on GDP is indeed negative. However, we also find evidence in favour of a non-linearity in the relation between policy and GDP.