In Discussion Paper No. 1179, Research Fellow Willem Buiter and Kenneth Kletzer extend the analysis of the effects of fiscal policies in endogenous growth models under the assumption of perfect international financial capital mobility by considering the role of domestic capital market imperfections. Capital markets are incomplete because young households cannot borrow against the future returns to human capital to finance the educational expenditures necessary for augmenting their endowments of human capital.

The authors begin by extending their own previous analysis of cross-country growth rate differentials when the technology for producing final goods displays constant returns to scale and to augmentable factors. They also investigate, in a closed economy setting, the financial crowding-out or crowding-in of private sector physical and human capital accumulation by lump-sum fiscal intergenerational redistribution and public spending on education. Their results show that intergenerational redistribution policies that discourage physical capital formation may encourage human capital formation. Despite common technologies and perfect international mobility of financial capital, the non-tradedness of human capital and the illiquidity of human wealth make for persistent differences in productivity growth rates (in the endogenous growth version of the model) or in their levels (in the exogenous growth version).

Capital Mobility , Fiscal Policy and Growth Under Self-financing of Human Capital Formation
Willem H Buiter and Kenneth M Kletzer

Discussion Paper No. 1179, May 1995(IM)