Modelling government investment and economic growth at the macro level: A review

This paper reviews empirical research on the impact of government capital spending on economic growth. The pros and cons of five different ways to model the relationship between public investment and economic growth are reviewed, while some estimation results are presented for illustrative purposes. We start with the production function approach in which the public capital stock is added as an additional input factor in a production function, which is then estimated at a national or regional level. Alternatively, a cost or profit function in which the public capital stock is included could be estimated by what we call the behavioural approach. A third way to examine the relationship between government investment and economic growth is the so-called VAR approach. By imposing as few economic restrictions as possible this approach tries to solve some of the problems raised by the production and behavioural approach. The first three approaches are all based on time-series (or panel data). A fourth way to model the growth effects of public capital spending is to include government investment spending in cross- section growth regressions. Finally some attempts to estimate the growth effects of public investment spending using structural econometric models are discussed.