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Do States Optimize?: Public Capital and Economic Growth

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  • David Alan Aschauer

Abstract

First, there is the question of whether a permanent increase in public investment induces a permanent, or merely a temporary, increase in economic growth. The traditional neoclassical growth model of Solow (1956) predicts that any positive effect of an increase in the national savings and investment rate on economic growth will be transitory; the steady-state growth rate is fully determined by population growth and exogenous technological progress. In the neoclassical setting, an increase in spending on productive public capital will induce a period of temporarily high investment, but the pace of capital accumulation, and of economic growth, will slow over time as the accumulation of capital diminishes the return to capital and the incentive for further investment. In the long run, the level of output will be higher but the growth rate of output will return to the same level as before the public spending initiative. Second, the effect of an increase in public investment on economic growth is likely to depend on the relative marginal productivity of private versus public capital. In the neoclassical setting, an increase in public investment (at the expense of private investment) will raise or lower the economic growth rate depending on whether the marginal product of private capital. This consideration validates the concerns of Aaron and others that the range of empirical estimates of the output elasticity of public capital is too large to be informative to the public policy process; we need to know, rather precisely, not only that public capital is productive but that it is sufficiently productive to be confident of a beneficial effect of increased public investment on economic growth. Third, the effect of public investment on growth is likely to depend on how the increased spending is financed. Empirical studies such as Engen and Skinner (1996) find evidence that increases in tax rates reduce the rate of economic growth. Thus, it is to be expected that an increase

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Paper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_189.

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Date of creation: Apr 1997
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Handle: RePEc:lev:wrkpap:wp_189

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  1. Alicia H. Munnell, 1990. "How does public infrastructure affect regional economic performance?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, Federal Reserve Bank of Boston, vol. 34, pages 69-112.
  2. Alicia H. Munnell, 1990. "Why has productivity growth declined? Productivity and public investment," New England Economic Review, Federal Reserve Bank of Boston, Federal Reserve Bank of Boston, issue Jan, pages 3-22.
  3. Evans, Paul & Karras, Georgios, 1994. "Are Government Activities Productive? Evidence from a Panel of U.S. States," The Review of Economics and Statistics, MIT Press, vol. 76(1), pages 1-11, February.
  4. Randall W. Eberts, 1986. "Estimating the contribution of urban public infrastructure to regional growth," Working Paper 8610, Federal Reserve Bank of Cleveland.
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