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RAPPORT

Public capital in the 21st century

As productive as ever?

The global financial crisis and the euro area sovereign debt crisis that followed induced a rapid deterioration in the fiscal positions of many advanced economies. Governments reacted to this by increasing tax revenues and implementing expenditure cuts. In the process of expenditure adjustment, public investment bore a large share of the burden, in particular in countries under market pressure. General government gross fixed capital formation as percent of GDP in the EU28 was in 2015 more than 20% below its peak level in 2009, with the decline in, for example, Spain amounting to more than 50%.

The cuts in public investments in the aftermath of the crisis may be caused by eco- nomic or political factors. In an environment of low growth, the number of viable projects could well be low, whereas in some countries there might have been overinvestment in the years before the crisis. Moreover, financial market pressure and European fiscal rules urged countries to deliver budget balance improvements in the short run. In doing so, planned investment projects may - practically or politically - be more easily terminated or postponed than most types of current spending.

Cuts in public investments might come at a significant cost. Public investments, or public capital, have been shown to contribute to economic growth both in the short and the long run (see e.g. Núñez-Serrano and Velázquez, 2016; IMF, 2014; Pereira and Andraz, 2013; Romp and De Haan, 2007), although the effect varies greatly across regions, industries and types of investment (Bom and Ligthart, 2014b). Furthermore, due to international spillovers, investment cuts may harm the growth prospects in neighbouring countries (Bom and Ligthart, 2014b).

Despite the presumably positive effect of public capital on actual and potential out- put, the growth of public capital stocks in many countries already started slowing down during the eighties. As a percentage of GDP, public capital stocks are generally either flat or falling. This means governments spent too little on investments to sustain the existing capital stock. The question now is: is this something to worry about, do govern- ments miss out on the opportunity to benefit from potentially high marginal returns to investments? And has the recent strong decline in public investments aggravated the sit- uation? This need not be the case. Jong-A-Pin and De Haan (2008) show that the effect of a public capital shock on output has decreased over time, suggesting that marginal benefits of public capital have not increased. However, their sample ends in 2001 and hence sheds no light on developments in the early years of the 21st century.

We contribute to the literature in a number of ways. First of all, we expand existing series on public capital stocks for 20 OECD economies, as constructed by Kamps (2006), applying a common methodology. This provides us with capital stock series for the years 1960-2014. Secondly, we estimate recursive VAR-models - starting from the period 1960- 2000, then expanding the sample period by one year at the time - to obtain some idea of the potentially changing relationship between public capital and other model variables, most notably economic growth. Lastly, by comparing the impulse responses from a VAR model for the euro area as a whole to the weighted impulse responses of VARs for individual euro area countries, we scrutinize the importance of spillovers between European countries. Our results show that the effect of a public capital shock on GDP growth differs widely between countries. The effect of public capital shocks on economic growth has not increased in general, leaving little ground to conclude that the current low level of public investments forms an immediate threat to potential output. Of course, if low investment levels are sustained for a long time, this could change. Furthermore, we provide some tentative evidence of the existence of positive spillovers of public capital between European countries.

In the empirical sections of this paper, when we use the term ‘public investment’, this refers to general government gross fixed capital formation as used in the National Accounts (NA). This has some implications for the economic meaning of the term ‘public capital’. First of all, the economic and accounting concepts of what constitutes public capital are not always aligned. Private investors or state-enterprises not classified within the perimeter of the general government can and do invest in public good types of as- sets, such as roads. Secondly, expenditures on regular maintenance are counted in the NA as current expenditures rather than investments. However, maintenance spending obviously is important in sustaining the public capital stock (see e.g. Kalaitzidakis and Kalyvitis, 2005). Thirdly, other types of current spending which have characteristics of an investment, such as spending on education (other than educational structures) are not considered as government investment in the NA.

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