Output and Employment Effects of Public Policy

Over the past decade, a considerable amount of research has been conducted on the relationship between "public capital" or "infrastructure capital" and economic performance. Since the initial work of Aschauer (1989), researchers have used a variety of data sets of investigate an even wider variety of hypotheses regarding the linkages between public capital and the economy. In particular, many authors have made use of state level data to look at the importance of infrastructure to productivity (e.g., Munnell (1990)), to costs of production in manufacturing sectors (e.g., Holtz-Eakin and Schwartz (1995)). This paper, along with Aschauer (1997b), also makes use of state level data to consider the static and dynamic effects of the provision of public capital on economic growth. The basic notion is that a nonlinear relationship can be expected to arise between the level of the public capital stock--relative to the private capital stock--and output and employment growth at the state level. This nonlinearity might be due to a variety of reasons. One such reason, given by Barro (1990) and, by extension, Aschauer (1997a), is that the benefits of public capital rise at a diminishing rate but the costs of providing public capital (e.g., through distorting taxation) rise at a constant rate. Another (related) reason, explored in Arrow and Kurz (1970), is that at any particular point in time the aggregate capital stock is misallocated unless the marginal product of public capital equals the marginal product of private capital. Both of these arguments imply that there should exist an output (and, by extension, an employment) growth maximizing level of the public capital stock relative to the private capital stock. For relatively low levels of public capital, increased public investment raises the economic growth rate; but for relatively high levels of public capital, increased in public investment decreases growth.