Public Investment, Growth, and Debt Sustainability: Putting Together the Pieces

55 Pages Posted: 9 Aug 2012

See all articles by Edward F. Buffie

Edward F. Buffie

affiliation not provided to SSRN

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division

Catherine A. Pattillo

International Monetary Fund (IMF) - Research Division

Rafael Portillo

International Monetary Fund (IMF)

Luis-Felipe Zanna

International Monetary Fund (IMF)

Date Written: June 2012

Abstract

We develop a model to study the macroeconomic effects of public investment surges in low-income countries, making explicit: (i) the investment-growth linkages; (ii) public external and domestic debt accumulation; (iii) the fiscal policy reactions necessary to ensure debt-sustainability; and (iv) the macroeconomic adjustment required to ensure internal and external balance. Well-executed high-yielding public investment programs can substantially raise output and consumption and be self-financing in the long run. However, even if the long run looks good, transition problems can be formidable when concessional financing does not cover the full cost of the investment program. Covering the resulting gap with tax increases or spending cuts requires sharp macroeconomic adjustments, crowding out private investment and consumption and delaying the growth benefits of public investment. Covering the gap with domestic borrowing market is not helpful either: higher domestic rates increase the financing challenge and private investment and consumption are still crowded out. Supplementing with external commercial borrowing, on the other hand, can smooth these difficult adjustments, reconciling the scaling up with feasibility constraints on increases in tax rates. But the strategy may be also risky. With poor execution, sluggish fiscal policy reactions, or persistent negative exogenous shocks, this strategy can easily lead to unsustainable public debt dynamics. Front-loaded investment programs and weak structural conditions (such as low returns to public capital and poor execution of investments) make the fiscal adjustment more challenging and the risks greater.

Keywords: Public Investment, Growth, Debt Sustainability, Infrastructure, Aid, Economic Growth, Economic Models, Low-income Developing Countries

JEL Classification: E62, F34, H63, O42, H54

Suggested Citation

Buffie, Edward F. and Berg, Andrew and Pattillo, Catherine and Portillo, Rafael and Zanna, Luis-Felipe, Public Investment, Growth, and Debt Sustainability: Putting Together the Pieces (June 2012). IMF Working Paper No. 12/144. Available at SSRN: https://ssrn.com/abstract=2127037

Edward F. Buffie (Contact Author)

affiliation not provided to SSRN

No Address Available

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-8843 (Phone)
202-589-8843 (Fax)

Catherine Pattillo

International Monetary Fund (IMF) - Research Division ( email )

700 19th Street NW
Washington, DC 20431
United States

Rafael Portillo

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Luis-Felipe Zanna

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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