Public Capital Spending Shocks and the Price of Investment: Evidence from a Panel of Countries

A multi-sector growth model is developed where public spending affects output in one of two ways. First, the government taxes income to fund capital expenditures. Second, public capital is used in the production of both final goods and intermediate private capital goods. Inclusion of an intermediate private capital sector allows the potential of public capital investment to affect output in an indirect way that has previously not been studied in that past public investments make the accumulation process for private capital more efficient. In this case, it is shown that public investment policy is directly related to the relative price of intermediate investment goods and final goods. Using a panel of OECD countries, we find that public capital spending shocks account for a statistically important percentage of the movements in the relative price of private investment. As a result, deviations in public investment policy can account for a nontrivial portion of the cyclical variations in output even though the direct effect of public investment policy on final good production is found to be small (public capital's share in the output of final goods is only 2%).