Editing Public capital (section)

==Economic growth==

One of the most classic [[macroeconomic]] inquiries is the effect of public capital investment on [[economic growth]]. While many analysts debate the magnitude, evidence has shown a statistically significant positive relationship between infrastructure investment and economic performance.<ref name="Why is Infrastructure important?"/> U.S. [[Federal Reserve]] economist David Alan Aschauer asserted an increase of the public capital stock by 1% would result in an increase of the [[total factor productivity]] by 0.4%.<ref name="Public Capital and Economic Growth">Haan, J., Romp, W., and Sturum, J.E. (2007). Public Capital and Economic Growth. World Bank, Preliminary Paper.</ref>  Aschauer argues that the [[Post–World War II economic expansion|golden age of the 1950s and 1960s]] were partly due to the post-[[World War II]] substantial investment in [[critical infrastructure|core infrastructure]] (highways, mass transit, airports, water systems, electric/gas facilities). Conversely, the drop of U.S. productivity growth in [[1973–75 recession|the 1970s]] and [[Early 1980s recession in the United States|1980s]] was in response to the decrease of continual public capital investment and not the decline of technological innovation.<ref name="Why is Infrastructure important?"/> Likewise, the [[European Union]] nations have declined public capital investment through the same years, also witnessing declining [[productivity growth]] rates.<ref name="Public Capital and Economic Growth"/> A similar situation emerges in [[developing nations]]. Analyzing [[OECD]] and non-OECD countries’ real-GDP growth rates from 1960 to 2000 with public capital as an explanatory variable (not using public investment rates), Arslanalp, Borhorst, Gupta, and Sze (2010) show that increases in the public capital stock does correlate with increases in growth. However, this relationship depends on initial levels of public capital and income levels for the country. Thus, OECD countries witness a stronger positive link in the short term while non-OECD countries experience a stronger positive link in the long term. Hence, developing countries can benefit from non-concessional foreign borrowing to finance high-prospect public capital investments.<ref name="Public Capital and Growth, International Monetary Fund">{{Cite web |last=Arslanalp |first=Serkan |last2=Bornhorst |first2=Fabian |last3=Gupta |first3=Sanjeev |last4=Sze |first4=Elsa |date=1 July 2010 |title=Public Capital and Growth |url=http://www.imf.org/external/pubs/ft/wp/2010/wp10175.pdf |access-date=14 March 2023 |website=[[International Monetary Fund]]}}</ref>

Given this relationship of public capital and productivity, public capital becomes a third [[factor of production|input]] in the standard, [[Neoclassical economics|neoclassical]] [[production function]]:

:<math>\qquad\qquad Y_t = A_t * (N_t, K_t, G_t) </math>

where: 
:''Y''<sub>''t''</sub> represents real aggregate output of goods and services of the private sector
:''A''<sub>''t''</sub> represents productivity factor or Hicks-Neutral technical change
:''N''<sub>''t''</sub> represents aggregate employment of labor services
:''K''<sub>''t''</sub> represents aggregate stock of nonresidential capital
:''G''<sub>''t''</sub> represents flow of public capital stock (assuming services of public capital are proportional to public capital)<ref>Aschauer, D. A. (1989). Is Public Expenditure Productive? Journal of Monetary Economics, Vol. 23. Pp. 177-200.</ref>

In this form, public capital has a direct influence on productivity as a third variable. Additionally, public capital has an indirect influence on [[multifactor productivity]] as it affects the other two inputs of labor and [[private capital]].<ref>Eberts, R. (1990). Public infrastructure and regional economic development. Economic Review (00130281), 26(1), 15.</ref> Despite this unique nature, public capital investment, used in the production process of nearly every sector, is not sufficient on its own to generate sustained economic growth.<ref name="Public Capital and Economic Growth"/> Thus, rather than the ends, public capital is the means. That is, instead of being seen as [[intermediate good]]s used as resources by businesses, public capital should be seen as goods which are used to make the [[final goods]] and services to consumers-taxpayers.<ref name="Public Capital Formation"/> Note that public capital levels should not be too high that it leads to financing costs and high tax rates issues which will negate the positive benefits of such investments.<ref name="Public Capital and Growth, International Monetary Fund"/> Moreover, infrastructure services carry the market-distorting features of pure, non-rival [[public goods]]; [[Network effect|network externalities]]; [[natural monopolies]]; and the [[Common-pool resource|common resource]] problem such as congestion and overuse.<ref name="Public Capital and Economic Growth"/>

Empirical models that attempt to estimate the public investment and economic growth link involve a wide variety including: the [[Cobb-Douglas]] production function; a behavioral approach [[Cost curve|cost]]/[[Profit (economics)|profit]] function which includes public capital stock; [[Vector autoregression|Vector Auto Regression]] (VAR) models; and government investment growth [[regression analysis|regression]]s. These models nonetheless contend with [[reverse causation|reverse causality]], [[Homogeneity and heterogeneity|heterogeneity]], [[Endogeneity (econometrics)|endogeneity]], and [[Nonlinear system|nonlinearities]] in trying to capture the public capital and economic growth link.<ref name="Public Capital and Economic Growth"/> [[New Keynesian]] models, though, analyze the effect of government spending through the supply side rather than traditional [[Keynesian]] models that analyzes it through the demand side. Therefore, a temporary surge of infrastructure investment yields an expansion of output, and vice versa that dwindling infrastructure, like in the 1970s, hamper longer-term movement in productivity.<ref>Crain, W.M. and Oakley, L.K. (1995) The Politics of Infrastructure. Journal of Law and Economics Vol. 38, no. 1</ref> Furthermore, new research on regional growth (as opposed to national growth with GDP) shows a strong positive relationship between public capital and productivity. Both [[fixed costs]] and [[transport]] costs lower with expanded infrastructure in localities and the resulting cluster of industries. As a result, economic activity grows along its pattern of trade.<ref name="Public Capital and Economic Growth"/> Therefore, the importance of [[business cluster|regional clusters]] and [[metropolitan economy|metropolitan economies]] comes into effect.