The Johansen theory of public expenditure, also known as the Johansen equation, is an economic theory that seeks to explain the relationship between government spending and economic growth. This theory was developed by the Norwegian economist Finn E. Kydland and Bengt Holmstrom in the late 1970s.

According to the Johansen theory, government spending can affect economic growth through two channels: the reallocation effect and the crowding-out effect.

The reallocation effect suggests that government spending can promote economic growth by reallocating resources from less productive sectors to more productive sectors. For example, investing in infrastructure projects can improve transportation and communication networks, which can boost productivity and overall economic performance.

On the other hand, the crowding-out effect argues that excessive government spending can crowd out private investment and reduce economic growth. When the government borrows money to finance its spending, it increases the demand for credit, leading to higher interest rates. This can discourage private sector investment since borrowing becomes more expensive, thus slowing down economic growth.

The Johansen equation mathematically models the relationship between public expenditure, economic growth, and other relevant variables. It takes into account factors such as government debt, tax rates, productivity, and inflation. By estimating the parameters of the equation, economists can analyze the impact of government spending on the economy and make policy recommendations.

However, it is important to note that the Johansen theory is just one of many theories that seek to explain the relationship between government spending and economic growth. There are other theories, such as Keynesian economics, that may offer different perspectives on the topic.

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