The Direct and Indirect (Spillover) Effects of Productive Government Spending on State Economic Growth

Using data on 48 contiguous U.S. states and a spatial econometric approach, this paper examines short‐ and long‐run effects of productive higher education and highway infrastructure spending financed by different revenue sources on state economic growth. Following the Lagrange Multiplier, Wald, and Likelihood Ratio tests, the data are found to be characterized by both spatial lag and spatial error processes, leading to the estimation of a dynamic spatial Durbin model. By decomposing results of the dynamic spatial Durbin model into short‐ and long‐run direct as well as indirect (spillover) effects, we show that accounting for spillover effects provides a more comprehensive approach to uncovering the effects of productive government spending on growth. We find that, regardless of the financing source, productive higher education and highway spending have statistically significant short‐ and long‐run direct as well as spillover effects on state income growth.