Fiscal Spending for Economic Growth in the Presence of Imperfect Markets

51 Pages Posted: 22 Dec 2011

See all articles by Asif Islam

Asif Islam

World Bank - Development Economics Group (DEC)

Ramón López

University of Maryland - Department of Agricultural & Resource Economics

Date Written: December 2011

Abstract

Political economy factors tend to induce many governments to spend on private goods (non-social subsidies) to the detriment of spending on social and public goods. We show that this bias in spending patterns is particularly costly for economic growth when capital markets are imperfect. We thus provide a simple taxonomy of government spending: spending in goods that mitigate market failures versus spending in non-social subsidies which frequently have the sole purpose of benefiting special interest groups. We develop a theoretical model and link it quite closely to an empirical model. The empirical results fully corroborate the hypothesis that spending biases in favor of non-social subsidies reduce the rate of economic growth over the long run. The empirical findings are exceptionally robust.

Keywords: economic growth investment, government spending, market imperfections, non-social subsidies

JEL Classification: H42, H44, H5

Suggested Citation

Islam, Asif Mohammed and López, Ramón, Fiscal Spending for Economic Growth in the Presence of Imperfect Markets (December 2011). CEPR Discussion Paper No. DP8709. Available at SSRN: https://ssrn.com/abstract=1976051

Asif Mohammed Islam (Contact Author)

World Bank - Development Economics Group (DEC) ( email )

1818 H Street N.W.
Washington, DC 20433
United States

Ramón López

University of Maryland - Department of Agricultural & Resource Economics ( email )

Symmons Hall, Rm 2200
University of Maryland
College Park, MD 20742-5535
United States
301-405-1281 (Phone)
301-405-9091 (Fax)

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