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CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND OF THE STUDY

The relationship between government expenditure and economic growth has continued to generate series of debate among scholars. Government performs two functions­-Protection (and security) and Provision of certain public goods (Abdullah, 2000) and (AI - Yousif, 2000). Protection function consists of the creation of rule of law and enforcement of property right. This helps to minimize risk of criminality, protect life and property, and the nation from external aggression. Under the provision of public goods are defenses, roads, education, health and power, to mention few. Some scholars argue that increase in government expenditure on socio - economic and physical infrastructure encourages economic growth. For example, government expenditure on health and education rises to productivity of labor and increase the growth of national output. Similarly, expenditure on infrastructure such as roads, communications, power, etc, reduces production, cost, increase private sector investment and profitability of firms, thus fostering economic growth. Supporting this view, scholar such as (Al - Yousif, 2000), (Abdullah HA, 2000), (Ranjan, Sharma, 2008), and (Cooray, 2000) concluded that expansion of government expenditure contributes positively to economic growth. However, some scholar did not support the claim that increasing government expenditure promotes economic growth, instead they are assert that higher government expenditure may slow down overall performance of the economy. For instance, in an attempt for finance rising expenditure, government may increase taxes and/or borrowing. Higher income tax discourages individual from working for long hours or even searching for jobs. This in turn reduces income and aggregate demand. In the same vein, higher profit tax tends to increase production costs and reduce investment expenditure as well as profitability of firms. Moreover, if government increases borrowing (especially from the banks) in order to finance its expenditure, it will compete (crowds - out) away the private sector, thus reducing private investment.

Furthermore, in a bid to score cheap popularity and ensure that they continue to remain in power, politicians and government officials sometime increase expenditure and investment in unproductive project or in goods that the private sector can produce more efficiently. Thus, government activity sometimes produces misallocation of resources and impedes the growth of national output. In fact, studies by (Laudau, 1986), (Barro, 1991), (Engen, Skinner, 1992), and (Foister, Henrekson, 2001) suggested that large government expenditure has negative impact on economic growth.

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