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Public Investment, Growth, and Debt Sustainability

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  • Andrew Berg
  • Rafael Portillo
  • Edward F. Buffie
  • Catherine A. Pattillo
  • Luis-Felipe Zanna

Abstract

We develop a model to study the macroeconomic effects of public investment surges in low-income countries, making explicit: (i) the investment-growth linkages; (ii) public external and domestic debt accumulation; (iii) the fiscal policy reactions necessary to ensure debt-sustainability; and (iv) the macroeconomic adjustment required to ensure internal and external balance. Well-executed high-yielding public investment programs can substantially raise output and consumption and be self-financing in the long run. However, even if the long run looks good, transition problems can be formidable when concessional financing does not cover the full cost of the investment program. Covering the resulting gap with tax increases or spending cuts requires sharp macroeconomic adjustments, crowding out private investment and consumption and delaying the growth benefits of public investment. Covering the gap with domestic borrowing market is not helpful either: higher domestic rates increase the financing challenge and private investment and consumption are still crowded out. Supplementing with external commercial borrowing, on the other hand, can smooth these difficult adjustments, reconciling the scaling up with feasibility constraints on increases in tax rates. But the strategy may be also risky. With poor execution, sluggish fiscal policy reactions, or persistent negative exogenous shocks, this strategy can easily lead to unsustainable public debt dynamics. Front-loaded investment programs and weak structural conditions (such as low returns to public capital and poor execution of investments) make the fiscal adjustment more challenging and the risks greater.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/144.

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Length: 54
Date of creation: 01 Jun 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/144

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Keywords: Public investment; Debt sustainability; Infrastructure; Economic growth; Economic models; Low-income developing countries; public debt; private capital; commercial borrowing; risk premium; commercial debt; domestic debt; domestic borrowing; private investment; external debt; external borrowing; concessional debt; debt accumulation; foreign debt; investment spending; debt sustainability analysis; investment program; government debt; debt dynamics; debt crisis; investment projects; external shocks; foreign aid; rates of return; external public debt; investment plans; real interest rates; debt relief; private debt; debt ratios; interest payments; productive capital; investment management; debt market; excessive borrowing; public sector debt; external financing; debt relief initiatives; external debt accumulation; debt service; private external debt; multilateral debt relief; debt terms; net foreign assets; debt contracts; sovereign bonds; foreign investment; public finance; tax revenue; investment growth; debt stocks; fiscal gap; domestic debt market; investment bankers; external resources; official creditors; sovereign debt; public external debt; stock of debt; multilateral debt;

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References

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Cited by:
  1. Yibin Mu, 2012. "Striking an Appropriate Balance Among Public Investment, Growth, and Debt Sustainability in Cape Verde," IMF Working Papers 12/280, International Monetary Fund.

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