Effect of Institutional Quality on the Size of Stat e: A Dynamic Panel Data Study

* * ** * Abstract. There has been a steady increase in the size of sta te, defined as the share of total government expenditure to gross domestic p roduct, over time. Although there are many factors affecting the size of state, institutional quality is also expected to have an effect on the size of state in recent years. The purpose of this study is to test empirically long run relation betw een institutional quality and the size of state, using static and dynamic panel data analysis of advanced economies for the period 1984-2007. To deal with the problems of autocorrelation and endogeneity that exist with static panel analysis, the Arellano -Bond GMM dynamic model as instrumental variable approach is used. It is found that existence of institutional quality reduces the size of state towards small but better government.