Mind Your P's and Q'S: The Cost of Public Investment is Not the Value of Public Capital
56 Pages Posted: 20 Apr 2016
Date Written: October 1996
A dollar's worth of public investment spending often does not create a dollar's worth of capital, especially in developing countries. One deep difficulty of development may be that even when public capital is productive it may be difficult to create this capital in the public sector.
Pritchett presents theory and calculations to show that part of the explanation of slow growth in many poor countries is not that governments did not spend on investments, but that these investments did not create productive capital. For a variety of reasons, governments take resources from current consumption to invest in the economic equivalent of pyramids, items that produce no future output.
The most critical assumption (of the many) necessary for cumulated investment flows to be even reasonable proxies for capital stocks is that the cost of investment (the p's) is equal to the value of the capital stock evaluated as its increment to future profitability (the q's). This assumption can be justified only if investors act to equalize these - and under many conditions, profit-maximizing investors will do so. But there is ample reason not to believe that all governments act as profit-maximizing investors - and ample reason to believe that some governments invest better than others.
The implication, especially in developing countries, is that a dollar's worth of public investment spending often does not create a dollar's worth of public capital. A variety of calculations suggest that in a typical developing country less than 50 cents of capital were created for each public dollar invested. One of the deep difficulties of development may well be that even when public capital is productive it may be difficult to create this capital in the public sector.
This paper - a product of the Poverty and Human Resources Division, Policy Research Department - is part of a larger effort in the department to investigate the impact of policies on long run economic growth.
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