Displacement Effect and Ratchet Effect: Testing of Two Alternative Hypotheses

Abstract

This article empirically tests the displacement effect of Peacock and Wiseman (PW) and the ratchet effect of Bird, both of which are alternatives to Wagner’s law on the growth of public expenditure. The displacement effect explains why the (horizontal) trend line moves upward in discrete steps over time, whereas the ratchet effect affirms that public expenditure “ratchets” during drops in the economy and remains at a higher level after the economy stabilizes. The following innovations are introduced in the present study: (a) empirical testing was conducted for Spain and an extensive time period, 1880–2016; (b) the relationship between PR and expenditure was considered, introducing Gross Domestic Product (GDP) as a control variable; and (c) testing was performed using two differentiated methodologies. More specifically, the two methodologies employed were unit roots and cointegration with structural breakpoints and the more recent wavelet methodology. Given that PW refer to situations of social upheaval and its consequences, this study places its focus on analyzing the changes produced in Spain’s public expenditure with respect to the Spanish Civil War of 1936–1939 and to other disruptions both before and after this date. It was concluded that the displacement effect explains the development of Spanish public expenditure for the crises of 1982 and 1998. Meanwhile, wavelet methodology explains growth that took place in 1920 and 1980. In contrast, the ratchet effect does not explain the development of Spanish public expenditure over the study period.