Public Investment, Productivity, and Economic Growth in Developing Countries

By Khan, Mohsin S.; Kumar, Manmohan S. | Journal of Public Budgeting, Accounting & Financial Management, Fall 1997 | Go to article overview

Public Investment, Productivity, and Economic Growth in Developing Countries


Khan, Mohsin S., Kumar, Manmohan S., Journal of Public Budgeting, Accounting & Financial Management


Mohsin S. Khan and Manmohan S. Kumar*

ABSTRACT. This paper estimates a neoclassical model of growth in which investment is separated into its public and private components. Estimates are also obtained for the effects of public and private investment on total factor productivity. The paper then examines whether the speed of convergence in real per capita incomes across developing countries is influenced by the shares of the two types of investment. The results show that both public and private investment have different effects on economic growth and productivity -- a relatively high share of public investment is associated with a decrease in the speed of convergence.

INTRODUCTION

The role of public sector investment in determining private sector productivity and long-run economic growth has been the subject of a number of recent studies (Aschauer, 1989a, 1989b; Ford and Poret, 1991; Munnell, 1990; Rubin, 1991). This interest has been marked in industrial countries, particularly in the United States, where the productivity slowdown after the first oil-price shock in 1973-74 has been regarded as due, in part, to inadequate public investment in infrastructure (Munnell, 1990). In the case of developing countries, the respective roles of public and private investment in the growth process have come under increasing scrutiny. The conventional wisdom is that in these countries public investment in infrastructure and in human capital formation is likely to increase the productivity of private capital and have a beneficial effect on growth. But, equally, public investment expenditures can crowd out private investment by using scarce resources and thus have an adverse effect on growth.

At the empirical level, a number of studies on developing countries have concluded that public investment has a smaller impact on growth than does private investment (Coutinho and Gallo, 1991; Khan and Kumar, 1993; Serven and Solimano, 1990). Others maintain that this effect may even be negative (Khan and Reinhart, 1990). However, these studies have not looked specifically at the effects of the components of investment on total factor productivity. Also, to examine the relative effects of public and private investment, a number of other important issues related to differences in the two components of investment across developing country regions or across countries in different income groups need to be considered.

From a policy perspective, if public investment does have a weaker impact on growth than private investment, it would highlight the need to rationalize public investment and the privatization of state-owned activities. From a theoretical perspective, if public and private investment have differential impacts on growth, there would be important implications for the determination of the steady-state growth path as well as for the convergence of real per capita incomes.(2)

The empirical analysis in this paper covers a sample of 95 developing countries for the period 1970-90. The large sample allows for tests of the hypothesis that there are marked differences in the effects of the two components of investment on growth and productivity for four developing country regions--Africa, Asia, Europe and the Middle East, and Latin America. Such an examination is of considerable interest in view of the marked differences in the performance of developing countries during the last two decades. Asian countries, for instance, have in general had a significantly superior performance compared to African or Latin American countries (see Kumar, 1992; Ossa, 1990). To the extent that the steady-state conditions underlying the differential growth performance-reflecting, for example, the rate of technological change and population growth--are likely to be more similar across developing countries, looking specifically at these countries can yield additional insights into the process of convergence.(2)

This article will first note the extent to which public and private investment may be complements or substitutes in developing countries, and describe the estimation equations used in the empirical analysis. …

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