Economic growth with an optimal public spending composition

Abstract

This paper uses a one-sector, endogenous growth model to study optimal composition between public investment and consumption in government expenditure and its relationships with economic growth. Assuming a benevolent government which maximizes a representative household's lifetime utilities, the paper determines the unique, interior public investment share in government's budgets, which is determined by policy and structural parameters, and finds that the conventional determinants of economic growth now generate stronger growth effects, via their indirect impacts upon optimal public spending composition. The effects emerge from raising the marginal utility of private consumption, relative to the marginal utility of public consumption, thereby inducing public investment and increasing economic growth. Our quantitative results suggest that the growth effect is sizable. The large growth effect via optimal public investment in our model has implications for East Asian economic growth miracles where public investment share and economic growth are both higher than other area's countries.

Government spending and growth in a neoclassical model

“…Employing the traditional distinction between productive and non-productive spending [23,27], they are able to determine the optimal composition of different kinds of expenditures, based on their relative elasticities. Following a similar line, Chen [15] investigates the optimal composition of public spending and its relationship to economic growth. He derives the optimal productive public service share of the total government budget and the optimal public consumption share, which is determined by policy and structural parameters.…”

“…Aschauer [6] demonstrates that a large part of the differential performance among countries can be explained by the use of infrastructure resources. To be more precise, countries with a greater proportion of productive public expenditures have higher growth than countries with a smaller proportion of productive public expenditures [15].…”

“…These in turn tend to affect economic growth through the composition of public spending [15]. Given the different impact these two types of government expenditure have on preferences and technology, changing their composition may affect the rate of capital accumulation and work effort [44].…”

An Empirical Research on the Structure of Public Expenditure and Economic Growth—Evidence from China

“…Since then, many scholars (Chen, 2006;MacDonald, 2008;Woodford, 2011) have studied the relationship between public expenditure and economic growth. Barro(1990), as the typical representative, has built and improved the theoretical model of the relationship between productive expenditure and the economy, based on endogenous growth model.…”

General Fund Financing, Earmarking, Economic Stabilization, and Welfare

“…The intersectoral externality 4 Recent studies concerning public goods such as Barro (1990), Glomm and Ravikumar (1994) and Chen (2003) have adopted the production specification, while other studies like Cazzavillan (1996), Bianconi and Turnovsky (1997) and Devereux and Wen (1998) have used the utility strategy. Chen (2006) used both types of specification.…”