Public Goods, Merit Goods, and the Relation Between Private and Government Consumption

In this paper, we investigate the relation between public and private consumption, by constructing a general government spending data set, by function, for twelve European Union countries. In particular, we split government consumption into two categories. The first category includes defense, public order, and justice ("public goods"). The second category includes health, education, and other services that could have been provided privately ("merit goods"). Equations from a relatively general theoretical model of household behavior are estimated by GMM. The estimates are fairly robust in showing that public goods substitute while merit goods complement private consumption, and, that the relation between merit goods and private goods is stronger than that between public goods and private goods. So that, in the aggregate government and private consumption are complements. It also suggests that the potential calibration/estimation bias by ignoring the composition of government consumption might be substantial.