Public investment under fiscal constraints

Alessandro Missale, Emanuele Bacchiocchi and Elisa Borghi

Departmental Working Papers from Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano

Abstract: EU New Member States must comply with the Stability and Growth Pact (SGP) and the investment requirements implied by the Lisbon Agenda. However, the SGP rules may result in underinvestment or distortions in the allocation of public expenditure. This paper provides new evidence on the effects of debt sustainability and SGP fiscal constraints on government expenditure in fixed capital, education and health in OECD countries by estimating government expenditure reaction functions to public debt and cyclical conditions. We find that, at high levels of debt, government capital expenditure and education expenditure are significantly reduced as the debt ratio increases in all OECD countries independently of EMU (or EU) membership. By contrast neither capital expenditure nor education expenditure is affected by the debt ratio in low debt countries. These findings are robust to the inclusion of the government deficit in the estimated reaction functions. Hence, it appears that EU countries have been constrained in their investment decisions more by the need to ensure debt sustainability than by the rules of the SGP. In low debt NMS countries public investment even increases with the debt ratio, a finding that is reassuring for their growth prospects. However, a less optimistic picture emerges when we focus on expenditures in public health and education, as it appears that NMS governments cut such expenditures --even at low levels of debt-- as the deficit increases. Problems in controlling total expenditure together with the preventive arm of the SGP may have penalized investment in human capital in NMSs while leaving fixed capital investment unaffected.

Keywords: Government capital expenditure; government education expenditure; public (search for similar items in EconPapers)
JEL-codes: E62 H52 H54 H63 (search for similar items in EconPapers)
Date: 2009-11-04
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Public Investment under Fiscal Constraints (2011)
Working Paper: Public investment under fiscal constraints (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:mil:wpdepa:2009-45

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