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Public Investment, Economic Performance And Budgetary Consolidation: Var Evidence For The First 12 Euro Countries

  • Alfredo Marvao Pereira

    ()

    (Department of Economics, College of William & Mary)

  • Maria de Fatima Pinho

    ()

    (Instituto Superior de Contabilidade e Administracao, Universidade de Aveiro)

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 first 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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Article provided by Chung-Ang Unviersity, Department of Economics in its journal Journal Of Economic Development.

Volume (Year): 36 (2011)
Issue (Month): 1 (March)
Pages: 1-20

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Handle: RePEc:jed:journl:v:36:y:2011:i:1:p:1-20
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  1. Gonzalo, Jesus & Lee, Tae-Hwy, 1998. "Pitfalls in testing for long run relationships," Journal of Econometrics, Elsevier, vol. 86(1), pages 129-154, June.
  2. Alfredo M. Pereira, 2000. "Is All Public Capital Created Equal?," The Review of Economics and Statistics, MIT Press, vol. 82(3), pages 513-518, August.
  3. Christophe Kamps, 2004. "The Dynamic Effects of Public Capital: VAR Evidence for 22 OECD Countries," Kiel Working Papers 1224, Kiel Institute for the World Economy.
  4. Buti, Marco & Franco, Daniele & Ongena, Hedwig, 1998. "Fiscal Discipline and Flexibility in EMU: The Implementation of the Stability and Growth Pact," Oxford Review of Economic Policy, Oxford University Press, vol. 14(3), pages 81-97, Autumn.
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