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Public Investment, Economic Performance and Budgetary Consolidation: VAR Evidence for the 12 Euro Countries

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  • Alfredo M. Pereira

    () (Department of Economics, College of William and Mary)

  • Maria de F�tima Pinho

    () (Instituto Superior de Contabilidade e Administra��o)

Abstract

In a period of heightened concern about fiscal consolidation in the euro area a politically expedient way of controlling the public budget is to cut public investment. A critical question, however, is whether or not political expediency comes at a cost, in terms of both long-term economic performance and future budgetary contention efforts. First, common wisdom suggests that public investments have positive effects on economic performance although the empirical evidence is less clear. Second, it is conceivable that public investment has such strong effects on output, that over time it generates enough additional tax revenues to pay for itself. Obviously, it is equally plausible that the effects on output although positive are not strong enough for the public investment to pay for itself. In this paper we investigate these issues empirically for the twelve countries in the euro area using a vector auto-regressive approach. We conclude that the euro countries can be gathered in four groups according to the nature of the economic and budgetary impact of public investment. The first group includes Austria, Belgium, Luxembourg, and Netherlands, where the economic effects are either negative or positive but very small and, therefore, cuts will be harmless for the economy and effective from a budgetary perspective. The second group includes Finland, Portugal, and Spain, where public investment does not pay for itself and, therefore, cuts are an effective tool of budgetary consolidation although they are harmful for the economy. The third group includes France, Greece, and Ireland where public investment just pays for itself and therefore cuts are not an effective way of achieving long-term budgetary consolidation and are harmful for the economy. Finally, the fourth group includes Germany and Italy, where public investment more than pays for itself and, therefore, cuts are not only harmful for the economy but also counterproductive from a budgetary perspective.

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Bibliographic Info

Paper provided by Department of Economics, College of William and Mary in its series Working Papers with number 40.

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Length: 18 pages
Date of creation: 23 Aug 2006
Date of revision:
Handle: RePEc:cwm:wpaper:40

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Keywords: public investment; economic performance; budgetary consolidation; euro area;

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References

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Cited by:
  1. Alfredo Pereira & Maria Pinho, 2008. "Public investment and budgetary consolidation in Portugal," Portuguese Economic Journal, Springer, vol. 7(3), pages 183-203, December.
  2. Alfredo Marvão Pereira & Jorge M. Andraz, 2010. "On The Economic Effects Of Investment In Railroad Infrastructures In Portugal," Working Papers 96, Department of Economics, College of William and Mary, revised 03 Apr 2012.
  3. Shaun K. Roache, 2007. "Public Investment and Growth in the Eastern Caribbean," IMF Working Papers 07/124, International Monetary Fund.
  4. Ulrich Klüh & Wolfgang Wiegard & Karl-Hans Hartwig & Thomas Bauer & Busso Grabow, 2009. "Konjunkturpaket II: Was bringen Investitionen in Infrastruktur?," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 62(02), pages 03-15, 01.
  5. Guillermo Perry & Luis Servén & Rodrigo Suescún, 2008. "Fiscal Policy, Stabilization, and Growth : Prudence or Abstinence," World Bank Publications, The World Bank, number 6818, May.

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