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Mind your P's and Q's : the cost of public investment is not the value of public capital

  • Pritchett, Lant

The author presents theory and calculations to show that part of the explanation of slow growth in many poor countries is not that governments did not spend on investment, but that these investments did not create productive capital. For a variety of reasons governments take resources from current consumption to"invest"in the economic equivalent of pyramids, items that produce no future output. The most critical assumption necessary for cumulated investment flows to be even more reasonable proxies for capital stocks is that the cost of investments (the p's) is equal to the value of the capital stock evaluated as its increment to future profitability (the q's). This assumption can be justified only if investors act to equalize these. But there is ample reason not to believe that all governments act as profit maximizing investors - and ample reason to believe that some governments invest better than others. The implication is that a dollar's worth of public investment spending often does not create a dollar's worth of public capital. Calculations suggest that in a typical developing country less than 50 cents of capital were created for each public dollar invested. One of the difficulties of development may be that even when public capital is productive it may be difficult to create public sector capital.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1660.

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Date of creation: 31 Oct 1996
Date of revision:
Handle: RePEc:wbk:wbrwps:1660
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  1. Easterly, William & Rebelo, Sérgio, 1994. "Fiscal Policy and Economic Growth: An Empirical Investigation," CEPR Discussion Papers 885, C.E.P.R. Discussion Papers.
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