Testing threshold cointegration in Wagner's Law: The role of military spending

This paper analyses historical data since the mid-19th century to find support for Wagner's Law in the Italian economy. Unlike previous studies, we accommodate possible nonlinear asymmetric effects of government spending and GDP towards their long-run equilibrium. The results reveal a threshold cointegrating relationship between the two variables with significantly different error correction adjustments in normal and extreme regimes. A long-run tendency for the public sector to grow relative to GDP from 1862 to 2009 is observed only when nonlinearities generated by temporary higher military spending during wars are take into account. •We study Wagner's law using new historical Italian data from 1862 to 2009.•Threshold VECM is applied to model total government spending and real GDP relationship.•Nonlinear asymmetric effects are found between the variables.•We find support for Wagner's law in the considered sample.•Nonlinearities are driven by temporary higher military spending during wars.