Factor-biased public capital and private capital crowding out

The Asymmetric Link between Public Debt and Private Investment in Malaysia

“…Shetta and Kamaly's (2014) vector autoregression analysis on Egypt also suggests government borrowing crowds out private investment. The crowding-out effect can take place through four channels: (i) "liquidity constraints' hypothesis suggests that public borrowing induces higher interest rate for private investment by reducing available credits (Codogno et al, 2003;Hauner, 2009;Huang et al, 2016;Ismihan, & Ozkan, 2012;Njuru, Ombuki, Wawire, & Okeri, 2014;Shetta & Kamaly, 2014); (ii) public investment competition takes away physical and financial resources that would otherwise be used for private investment (Ang, 2009a); (iii) debt-financed public investment can depress private investment through higher future tax rates, which will reduce returns to private investment (Bom, 2017); and (iv) heavy use of public debt may alter a country's debt portfolio and change the demand for financial assets in the country (da Silva et al, 2014).…”

“…Public debt can bring in more private investment if public debt is used to finance productive areas such as economic development (Lora, 2007) and public services and infrastructure support (Ang, 2009a). By contrast, many literatures also highlight that rising public debt may erode the net benefits of private investment in several ways: (i) it raises the cost of borrowing (i.e., interest rate) of the scarce domestic credit (Codogno, Favero, Missale, Portes, & Thum, 2003;Huang, Pagano, & Panizza, 2016), (ii) it increases the use of physical and financial resources that otherwise can be reserved for private investment (Ang, 2009a), (iii) it induces the expectation of higher future taxes (Bom, 2017), and (iv) it alters a country's debt portfolio and changes the demand for financial assets (da Silva, de Castro Pires, & Bittes Terra, 2014).…”

Public Capital and the Labor Income Share

“…This relationship was studied by Fisher and Turnovsky [52] using a closed-economy model, who found that congestion effects may cause public investment to crowd-out private investment. Bom [53] studied this relationship in an overlapping generations model of a small open economy, where the private investment response critically depends on the degree of substitution between private capital and labor. Overall, the empirical evidence on the relation between public and private capital is quite mixed.…”

“…Firms choose the required amounts of private capital and labor to achieve the desired production level, taking as given the existing level of public capital provided by the government. The production technology available to firms features a constant elasticity of substitution (CES) [53], which is written as…”

“…To determine the macroeconomic equilibrium of the model, one must first aggregate the many existing overlapping generations, indexed by the birth date v. Since the death probability is β and the total population is normalized to one, the size of each generation is given by βe β (v−t) . Aggregating the individual variables in the household sector thus amounts to integrating them across the birth dates of all living cohorts, from −∞ to t. It turns out that the aggregate versions of the static Equations (9), (13) and (14) are obtained by simply dropping the cohort index v. However, the dynamic Equations (11) and (12) assume a slightly different form at the aggregate level [53]:…”