The aim of this paper is to estimate the relationship between public sector expenditure and public sector output. The literature in this field is relatively scarce due to difficulties in measuring public sector output. In this study we construct an index for public sector performance based on the structure presented by Afonso et al. (2005), for a panel of OECD countries between the years 2000-2010. We then estimate the effect of general government expenditure, as well as other variables, such as public debt and demographic structure, on public sector performance. We find that public sector expenditure is characterized by diminishing returns. Maximal public sector performance is achieved when the general government share of GDP is at 52%-60%, dependent on the control variables used. However, this range represents only an upper bound for optimal government size as it does not consider the opportunity cost of public expenditure. Moreover, increasing public expenditure beyond this range leads to lower public sector performance.

Keywords: Public Sector Output, Government Expenditure, Indexation.

JEL Classification: H11, H5.

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