Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Is All Government Capital Productive?

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Is All Government Capital Productive?

Article excerpt

The early 1970s witnessed dramatic change in per-capita output and labor-productivity growth rates in the United States. These growth rates averaged 2.2 percent and 2.0 percent, respectively, for the 1950-1969 period compared to 1.3 percent and 0.8 percent for the 1970-1989 period. Aschauer (1989) advances the idea that an important explanatory factor in this productivity slowdown is the government's stock of capital. Estimating a production function that relates private sector output to private sector labor and capital and to total government capital for the aggregate U.S. economy (1949--1985), Aschauer finds the output elasticity of government capital to be 0.39.(1) That is, for every 1 percent change in government capital, output responds by 0.39 percent. This productivity coefficient, coupled with the sharp fall in the average growth rate of government capital from 4.1 percent for 1950-1970 to 1.6 percent for 1971-1985, constitutes the evidence underlying Aschauer's view.(2)

The Aschauer (1989) study is innovative and important. His evidence suggests that government capital plays a significant role in economic growth. His findings are, however, surprising and somewhat unconvincing. The evidence is surprising because the output elasticity of government capital is relatively high and because government capital contains many different types of stocks (e.g., museums, hospitals, airports, prisons, seawalls, and wildlife preservation facilities), some of which are highly unlikely to make a direct productive contribution to output.(3) Aschauer's evidence is unconvincing not only because it fails to distinguish the growth rate of the productive component of government capital from the growth rate of total government capital, but also because the output elasticity of government capital may be inflated from reverse-causation bias.(4) That is, the productivity-coefficient estimate may be capturing the effect of output on government investment spending and hence on government capital instead of the effect of government capital on output. Output could affect government investment spending because government investment decisions possibly depend on output performances--higher output can lead to more tax revenue to finance such investment.

Aschauer's (1989) work raises many questions. What is unique to government capital that could be so productive? Which components of government capital play a role in production? What is the nature of the production channel through which they exercise this role? Do these channels differ across components? What are the magnitudes of the associated productivity coefficients, controlling for possible reverse causation? How do these magnitudes explain output and labor-productivity growth rates in the post-World War II United States? Finally, are the real returns to investing in productive government capital components high?

This article addresses these questions. The answers provide guidance for government investment policies by elucidating how components of government capital influence output production and by quantifying their effects on economic growth. Lucas (1987) underscores the importance of these questions by showing that changes in economic growth as small as 1 percentage point can have huge social welfare effects.

The article proceeds as follows. Section 1 describes the components of total government capital and considers their possible production roles. The resulting analysis suggests that only government-owned, privately operated capital (GOPO), government enterprise capital (ENTP), and government highway capital (HGWY) directly contribute to private production. GOPO's and ENTP's contribution to private production stems from the measurement of private sector output. One possible way that GOPO and ENTP enter the production function is through the same channel as most private sector capital; i.e. GOPO and ENTP perfectly substitute for private sector capital. …

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