While recent research has demonstrated that public investment has beneficial effects on future consumption and may even permanently raise growth rates, there have been few attempts to identify its determinants. In Discussion Paper No. 887, Research Fellow Tullio Jappelli and Andrea Ripa di Meana use a simple, overlapping generations model with households, firms and a government sector to investigate how the share of public expenditure allocated to investment is determined. The government raises taxes and issues debt to finance public consumption and investment. The latter raises the stock of public capital and also through externalities in production the marginal productivity of private capital and hence private output. The government faces an intergenerational trade-off, as older households want more spending on public consumption while younger households favour spending less since they expect to reap the future benefits of public investment. The welfare-maximizing share of investment in total public expenditure therefore depends positively on its contribution to current production and negatively on the preference for public relative to private consumption and the weight the government assigns to older households in its social welfare function.

Jappelli and Ripa di Meana then regress the share of investment in public expenditure on its overall share in GDP, per capita income, primary and secondary school enrolment ratios, a proxy for political instability and the proportion of elderly dependents in the total population for a cross-section of 70 countries during 1970-85. Their estimated equation accounts for only 14% of the cross-country variability of the public investment share, and only the old-age dependency ratio proves significant. An increase in this ratio from 5% to 16% i.e. from the African to the OECD average is associated with a reduction in the public investment share by 7.4%, which suggests that population ageing may account for the observed decline in public investment in virtually all OECD countries over the last two decades.

Public Investment and Welfare: Theory and Empirical Implications
Tullio Jappelli and Andrea Ripa di Meana

Discussion Paper No. 887, January 1994 (IM)