Do States Optimize?

Studies that have examined the effect of public spending on economic growth have reported esmates for the marginal product of public capital that are well in excess of, equal to, and less than the marginal product of private capital. Not only does this wide range of estimates call for further examination, but several questions about such spending have been neglected. Does a permanent increase in public spending induce a permanent or temporary increase in economic growth? Is public capital sufficiently productive to increase the rate of economic growth? Does the method by which new (public) spending is financed have a larger negative effect on growth than any positive effect induced by the increase in spending itself? Visiting Scholar David Alan Aschauer, of Bates College, explores these issues, making use of state-level data to examine the static and dynamic effects of public capital spending on output and employment growth.

Aschauer formulates a growth model that contains a utility function and a Cobb-Douglas production function.
The utility function has constant intertemporal elasticities of substitution and is maximized by producers and
consumers; in the production function capital is divided into two components: public infrastructure capital and
a broad measure of private capital containing both tangible and human capital. The production function exhibits
constant returns to scale across private and public capital inputs, but increasing returns to scale across raw
labor and capital. The government sector purchases and maintains a stock of public capital that is proportional
to the stock of private capital. Public capital also is assumed to have some positive productivity effect on private
capital. The initial public capital stock is funded by the issuance of perpetuities (debt) and is thereafter
maintained by a tax levied on private production. (See also, Working Papers No. 190 and No. 191.)

Working Paper No. 189(2.88 MB)