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Public investment under fiscal constraints

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  • Alessandro MISSALE

    ()

  • Emanuele BACCHIOCCHI

    ()

  • Elisa BORGHI

    ()

Abstract

EU New Member States must comply with the Stability and Growth Pact (SGP) and the investment requirements implied by the Lisbon Agenda. However, the SGP rules may result in underinvestment or distortions in the allocation of public expenditure. This paper provides new evidence on the effects of debt sustainability and SGP fiscal constraints on government expenditure in fixed capital, education and health in OECD countries by estimating government expenditure reaction functions to public debt and cyclical conditions. We find that, at high levels of debt, government capital expenditure and education expenditure are significantly reduced as the debt ratio increases in all OECD countries independently of EMU (or EU) membership. By contrast neither capital expenditure nor education expenditure is affected by the debt ratio in low debt countries. These findings are robust to the inclusion of the government deficit in the estimated reaction functions. Hence, it appears that EU countries have been constrained in their investment decisions more by the need to ensure debt sustainability than by the rules of the SGP. In low debt NMS countries public investment even increases with the debt ratio, a finding that is reassuring for their growth prospects. However, a less optimistic picture emerges when we focus on expenditures in public health and education, as it appears that NMS governments cut such expenditures --even at low levels of debt-- as the deficit increases. Problems in controlling total expenditure together with the preventive arm of the SGP may have penalized investment in human capital in NMSs while leaving fixed capital investment unaffected.

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Bibliographic Info

Paper provided by Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano in its series Departmental Working Papers with number 2009-45.

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Date of creation: 04 Nov 2009
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Handle: RePEc:mil:wpdepa:2009-45

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Keywords: Government capital expenditure; government education expenditure; public;

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Cited by:
  1. Chiara Del Bo & Massimo Florio & Silvia Vignetti & Emanuela Sirtori, 2011. "Additionality and regional development: are EU Structural Funds complements or substitutes of national Public Finance?," Working Papers 201101, Centre for Industrial Studies (CSIL).
  2. Douglas Sutherland & Peter Hoeller & Rossana Merola, 2012. "Fiscal Consolidation: Part 1. How Much is Needed and How to Reduce Debt to a Prudent Level?," OECD Economics Department Working Papers 932, OECD Publishing.
  3. Bertola, Giuseppe, 2010. "Fiscal Policy and Labor Markets at Times of Public Debt," CEPR Discussion Papers 8037, C.E.P.R. Discussion Papers.
  4. Nicholas Crafts, 2013. "Long-Term Growth in Europe: What Difference does the Crisis Make?," National Institute Economic Review, National Institute of Economic and Social Research, vol. 224(1), pages R14-R28, May.

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