Public infrastructure capital and private investment

In contrast to the traditional macroeconomic models of fiscal policy which focus on the effects of government financing decisions on key private macroeconomic variables, more recent models downplay the relevance of fiscal financing decisions and focus instead upon the ability of variations in real fiscal variables such as tax rates and the current/capital spending mix to alter private incentives to invest, produce and consume. Although the recent work recognises the necessity for budgetary control as an important ingredient of responsible macroeconomic policymaking, cuts in the ratio of capital to current expenditure programs are recognised to have potentially adverse effects on the economy’s infrastructure which may impede future performance. During the latter part of the 1980s in Australia, fiscal tightening resulted in the reigning in of capital rather than current spending programs. Concern with this development has hitherto primarily focused upon the implications for output, productivity and trade performance. The purpose of this paper is to extend this focus by examining the implications for private investment behaviour. More specifically, this paper formulates and solves a dynamic rational expectations model which is designed to analyse the extent to which public capital spending impacts upon private investment behaviour. The analysis builds upon the work of Aschauer (1989) in allowing for the effects of both public investment and the public capital stock on private rates of return and on the decision to invest. The model’s steady state properties are first described and it is then simulated to illustrate the short, and long, run effects of variations in the level of public infrastructure provision, on the rate of private corporate investment and other macroeconomic variables. Amongst the main findings are that public infrastructure expenditure can 'crowd in' private investment.