Efficient Public Investment in a Model with Transition Dynamics

A long history of debate exists among macroeconomists regarding the degree to which public capital contributes to overall economic activity. Estimates of the output elasticity with respect to public capital range anywhere from 0.06 in early work by Ratner (1983) to as high as 0.39 in a widely cited study by Aschauer (1989). This elasticity refers to the percentage change in GDP induced by a given percentage change in government capital.1 Glomm and Ravikumar (1997, 197) remark that economists have generally been skeptical of Aschauer’s estimate, mainly because “the productivity of public capital is simply not believed to be larger than the productivity of the private capital stock (which is roughly 0.36).” That being said, few would argue that public infrastructure plays no productive role, and estimates of the public capital elasticity of output lying between 0.05 and 0.15 are often put forward.2 In an economy where government investment in equipment and structures complements private investment, it is only natural to ask what factors determine the optimal share of public investment in output. The trade-off involves public capital that is productive but that must also be financed through distortional taxation.