Productive government spending and its consequences for the growth–inequality tradeoff

Abstract

This paper investigates the effects of productive government spending on the relationship between growth and inequality in an economy subject to idiosyncratic production shocks and heterogeneous endowments. Assuming lognormal distributions, we derive tractable closed form solutions describing the equilibrium dynamics. We show how the effect of government investment on the equilibrium dynamics of both inequality and growth depends crucially upon the elasticity of substitution between public and private capital in production. This has important consequences for the growth-and welfaremaximizing rates of government investment. Finally, we supplement our theoretical analysis with numerical simulations, calibrated to approximate the productive characteristics of a real world economy. With the empirical evidence strongly supporting the complementarity between public and private capital, our simulations suggest that conclusions based on the commonly employed Cobb-Douglas production function may be seriously misleading.Key words: Government investment; Idiosyncratic shocks; Growth; Inequality JEL Classification: D31, O41 Revised versionJune 2015*The paper has benefited from comments received on earlier versions from seminar participants at the University of Durham and the University of Pretoria. We also thank Santanu Chatterjee for useful suggestions. Research for this paper was carried out while Getachew was visiting the University of Washington in the Fall of 2013. Turnovsky"s research was supported in part by the Van Voorhis endowment at the University of Washington.**Corresponding author: sturn@u.washington.edu 1 IntroductionThe role of public investment in infrastructure as a source of economic growth continues to be widely debated in both developing and advanced economies, with different economies adopting different policy options. Several emerging-market countries including India, China, and Brazil have undertaken extensive public investment, to which their high growth rates of recent years may at least in part be attributed. In contrast, several European countries have reduced public spending, as they have pursued austerity measures intended to deal with concerns related to their rising debt levels.Contemporaneously with these diverse policies toward public investment, we have witnessed increasing income inequality, both in emerging markets and in most OECD countries. This raises the important question that we address in this paper, namely the relationship between public investment directed toward growth enhancement and its consequences for income inequality.Interest in the relationship between public investment, output, and growth has a long history, dating back to Arrow and Kurz (1970), who examined it in the context of a neoclassical economy.Beginning with Barro (1990), an extensive literature has evolved addressing the issue in an endogenous growth framework, with a general consensus that government spending on infrastructure can yield significant productivity gains and thus enhance growth. See e.g. F...

Macroeconomic (in)stability and endogenous market structure with productive government expenditure

“…According to Inkaar's (2007) estimation, we set γ = 1.03, the average value of 0.74 and 1.32. As documented by Getachew and Turnovsky (2015), the output elasticity of public goods lies within the range from 0.2 to 0.4, which covers most of the plausible values parameterized by Eden and Kraay (2014). Thus, in line with Eden and Kraay (2014) and Getachew and Turnovsky (2015), the production externality arising from public goods is set to χ = 0.3, which is the average value of 0.2 and 0.4.…”

Credit constraints, growth and inequality dynamics

“…The value for the elasticity of public capital widely varies among empirical estimates. We follow Getachew and Turnovsky (2015) and set = 0:1 and 0:2, which encompass a large set of the estimates; 22 we also set 2 at 0:16 following this literature, which implies a 0.4 standard deviation for the logarithm of total factor productivity (TFP) shocks. There are no estimates regarding the value of .…”

“…24 Compared to the preexisting condition, a negative distributional e¤ect of public capital of the magnitude of = 2 almost doubles the steady-state inequality and more than doubles the intergenerational elasticity when = 0:2. 23 This is in contrast to Getachew and Turnovsky (2015), in which the public-private capital ratio and the tax rate play a central role in determining the distributional dynamics and equilibrium. Despite its advantage of full tractability, the Cobb-Douglas assumption in the current model is quite restrictive due to its unitary elasticity of substitution assumption when it comes to distributional analysis.…”

“…The paper relates to the literature of imperfect credit markets, inequality and growth, particularly with respect to linking inequality dynamics to the dynamics of aggregate capital and output, although this literature does not focus on transitional dynamics in Ak models. 5 The paper is also related to the recent literature on inequality, growth and public investment (e.g., García-Peñalosa and Turnovsky, 2007, Chatterjee and Turnovsky, 2012, Getachew, 2010, and Getachew and Turnovsky, 2015.…”

“…6 Getachew and Turnovsky (2015) study the distributional and growth e¤ects of public investment in a growth model with missing capital markets and a CES production function, where both growth and inequality are endogenously determined. In the paper, the e¤ects of public investment policy on inequality and growth depend on the elasticity of substitution between between public and private capital.…”