Impact of Government Consumption on Household Consumption in Sri Lanka

Abstract

Government consumption expenditure can either have a positive or a negative impact on household consumption expenditure. When both variables are positively related, they are complements, but if they are negatively related they are substitutes. Government may choose to increase aggregate demand in order to stimulate economic growth, so, it becomes important to know if increasing government consumption is the right channel to achieve this. This study examined the impact of general government final consumption on household consumption in Sri Lanka. Real per capita income and gross capital formation were among the explanatory variables. Using annual data from 1961 – 2018, an ARDL model was estimated. Results showed that the variables had no long run equilibrium relationship, as they were not co-integrated. Government consumption expenditure was not statistically significant in the explanation of changes in household consumption. Rather, Gross capital formation was significant in the explanation of changes in household consumption. Meanwhile a 1% increase in per capita income leads to a 1.37% increase in household consumption on average, while all other factors are held constant, Granger causality test result showed that there is a unidirectional causality from gross capital formation to household consumption, but there is no evidence of causality between government consumption and household consumption. These findings have the following policy implications: household consumption has very high income elasticity, so, in order to raise aggregate demand, Sri Lankan government should raise per capita income. Also, priority should be given to government investment and capital expenditure, as this will create an atmosphere for the private sector to thrive and boost income and economic growth.