Validation of Wagner’s Law in the context of the Bhutanese Economy

Abstract

Over the years, the public spending, along with the GDP has been rising in Bhutan. For instance, the public expenditure in Bhutan rose to Nu. 56331.357 million in the Fiscal Year 2018/19 from Nu. 49,966.611 million in the previous year (AFS 2017-18). This paper attempts to validate Wagner’s law against the Keynesian hypothesis in the context of the Bhutanese economy from 1991 to 2019. Wagner’s law of government expenditure and real income is opposite to the Keynesian hypothesis. In Wagner’s postulation, the causal relationship runs from real income to real government expenditure and it is reversed in the case of the Keynesian hypothesis. The two-way granger causality test result indicated that Wagner’s law does not hold and the evidence supports the Keynesian proposition. This is because Bhutan is more of a public-led welfare state and with its sluggish private sector growth, the economy requires the substantial support of the government. To assess the association of government expenditure with other macroeconomic variables such as inflation and unemployment, correlation and regression tests was conducted. The result showed that both consumption and capital expenditure positively influence inflation. The rising consumption expenditure has a positive relationship with unemployment; however, the capital expenditure can reduce unemployment.