Applied Economics

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A normative analysis of public capital

Chunrong Ai & Steven P. Cassou

To cite this article: Chunrong Ai & Steven P. Cassou (1995) A normative analysis of public capital,
Applied Economics, 27:12, 1201-1209, DOI: 10.1080/00036849500000102

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Applied Economics, 1995, 27, 1201-1209

A normative analysis of public capital

C H U N R O N G AT and S T E V E N P. C A S S O U
Department of Economics, S U N Y - Stony Brook, N Y , USA

A normative analysis of short-term public capital investments is carried out using cost
benefit analysis. This cost benefit approach explicitly incorporates the durability of
capital into the computation and thus includes an aspect of public capital omitted
from previous studies which focus on productivity. Estimation methods used else-
where have been improved by properly handling several concerns that have been
raised. In addition, this behavioural model yields many structural equations suitable
for estimation which results in highly efficient parameter estimates. Although a small
elasticity is found for public capital, the benefit is greater than the cost.

1. I N T R O D U C T I O N This paper also makes use of an empirical approach

Considerable interest and controversy has developed re-
cently over the productive usefulness of government-sup-
plied public capital. This interest has been prompted by the
large elasticity of output with respect to public capital found
in the pioneering work of Aschauer (1989, 1990) and
Munnell (1990). These studies suggest that part of the pro-
ductivity slowdown observed over the last 20 years in the
United States may be due to an under-investment in public
capital and that public works programmes of the type
considered in the early months of 1993 by the US Govern-
ment may be useful in stimulating long-term growth.
A number of follow-up studies have been stimulated by
this work, some of which have been supportive (Bajo-Rubio
and Sosvilla-Rivero, 1993; Berndt and Hansson, 1992;
Flores De Frutos and Pereira, 1993; Garcia-Mila and
McGuire, 1992; and Lynde and Richmond, 1993) while
others have not been supportive (Aaron, 1990; Evans and
Karras, 1991; Holtz-Eakin, 1992; Hulten and Schwab, 1991;
and Tatom, 1991). This paper sheds light on the debate by
evaluating public capital using a normative approach. To
this point, all studies have sought to answer the positive
question of how large the contribution of public capital is to
productivity. However, this multiplier approach is difficult
to interpret as a measure for an investment decision since
the benefit from a capital investment depends on how rap-
idly it depreciates.' In this study, we make use of the public
finance technique known as cost benefit analysis to provide
new insight to the public capital debate.
which properly handles complaints voiced about earlier
empirical work. Our empirical approach is a generalized
method of moments (GMM) type procedure which makes
use of instrumental variables and has been described by
Hansen and Singleton (1982). Several aspects of our ap-
proach make it an attractive alternative to regression
methods used in most other studies. One is that simultaneity
of output and inputs is properly handled by using several
different Euler equations and appropriate instruments to
identify the different parameters. Another, is that it is able to
make use of the cross-equation restrictions implied by our
dynamic model to tightly identify the parameters thus im-
proving the precision of the estimates.
In addition, our empirical procedure carefully treats one
of the more objectionable aspects of the regression methods.
As pointed out by Aaron (1990) and Tatom (1991), most of
the data is nonstationary and thus they advise estimating
the model using first differences. Following this advice,
estimates by Aaron (1990), Evans and Karras (1991) and
Tatom (1991) found the elasticity of output with respect to
public capital to be insignificant. However, their estimates
of the other elasticities are sensitive to the differencing
procedure and often are far from what would be considered
theoretically reasonable values. Our procedure also follows
the first differencing suggestion and finds a public capital
elasticity which is less than half that found by Aschauer
(1989, 1990) and smaller than that found by Munnell(1990).
However, because our GMM procedure tightly identifies
the parameters, the standard errors are small and the public

'A moment of thought should convince one that it is possible for an asset with a large multiplier and a large depreciation rate to yield
a lower cumulative benefit than an asset with a low multiplier and a low depreciation rate.
0003-6846 @ 1995 Chupmun & Hall 1201

capital elasticity is highly significant. In addition, because
our GMM procedure tightly identifies the other model
parameters, estimates for these parameters are not sensitive
to the differencing and we obtain estimated values which are
theoretically sound.
We focus our policy analysis on the impact of a short
term (one year) government capital investment impulse.
This focus in part is motivated by the debate in the US
Government surrounding this type of policy during the
early part of 1993 and in part is motivated by our interest in
demonstrating a setting in which the multiplier analysis will
provide incomplete information to base policy decisions
upon.2 The analysis focuses on two cumulative benefit con-
cepts which we call the 'true benefit' and the 'total benefit'.
The true benefit measures the present value of output
changes less costs and is the correct concept to use in order
to make marginal public capital investment decisions. We
find the true benefit from a government capital investment
impulse exceeds the cost even though our estimate of the
elasticity of output with respect to public capital is substan-
tially smaller than has been reported by Aschauer (1989,
1990) and Munnell(1990). This finding is largely due to the
durability of the public capital which our benefit calculation
incorporates. The total benefit measures the present value of
output changes but does not substract costs. This concept is
useful for evaluating the gross changes on output that one
can expect from public capital investment programmes.
The paper has been organized as follows. The dynamic
model used to evaluate this question is laid out in Section 11.
Section I11 describes the GMM empirical approach and the
resulting parameter estimates. In Section IV we describe
how to carry out the quantitative exercises for a short term
stimulus package and present the outcome for several ex-
periments. These experiments illustrate not only the cumu-
lative benefits from a short-term government capital invest-
ment but they also show the advantage of the dynamic
modelling approach used here.
11. T H E M O D E L
Since the empirical methods described by Hansen and
Singleton (1982) make use of instrumental variables consist-
ing of lagged variables, it is important to keep track of the
date at which a variable becomes known. To this end, we
have adopted the notational convention of using subscripts
to denote the date when a variable becomes known. In
addition, the notation E, is used to denote the expectation
conditional on information available at time t.
We explore the issue in the context of a neoclassical
growth model which consists of a representative firm that
chooses its investment sequence {i:},"=o and its labour input
'Studies by Barro (1981,1987)have also sought to distinguish the results of temporary and permanent government spending programmes.
C. Ai and S. P. Cassou
sequence {n,},"=o so as to maximize the present value of its
dividend stream. Formally we assume that a representative
firm maximizes
subject to
+
given kb and the sequence {kB),"=o,where (1/(1 r))' is the
firm's discount factor for dividends d,. In the firm's produc-
tion function there are two types of capital inputs;
,
kf- which is the stock of corporate capital available at time
t and known at time t - 1 and k c which is the stock of
government supplied capital at time t and known at time
t - 1. In addition output is partially determined by the
capital utilization rate u,, a random shock to production O,,
and the level of technological knowledge Apt. In this setup
the stock of government capital is provided by the govern-
ment and taken as exogenous by the firm. Further, the wage
rate w, and the utilization rate u, are also beyond the firms
control. We denote the investment in corporate capital at
time t by if and the corporate capital depreciation rate by 6'.
In addition the government's investment in government
capital at time t is denoted by if and government capital
evolves according to
where hg denotes the rate of depreciation of government
capital.
The Euler equations for this optimization problem can be
written as
where y, = Apt(n,)"' (kf- ,)"'(k,B_l)a3(~l)a4 0,. These equations
are used for two purposes. One is for the policy exercises
which we turn to shortly and the other is in our empirical
procedure which we now turn to.
111. P A R A M E T E R E S T I M A T E S
Data
The data came from a variety of sources and covered the
post-war years of 1947 to 1989. The capital stock series and
investment series were obtained from Fixed Reproducible
A normative analysis of public capital
Tangible Wealth in the United States, 1925-89 (1993). Since The GMM objective function stacks up several different
this report publishes annual time series, the rest of the series moment conditions. One of the beautiful features of the
we collected also had to be annual. This report decomposes G M M methodology is that it is able to make use of many
the government capital and investment series into several different moments with which to identify the parameters.
categories. We used these categories to construct the gov- This greatly improves the efficiency of the parameter esti-
ernment capital and investment series which are appropri- mates. We use three types of moments in our estimation.
ate for our model. This was done by first summing the total The first set of moments are depreciation relationships
capital (investment) series for the federal and state and local which are formulated as
governments. Next we removed from this all types of mili-
tary capital (investment).
The output series, labour supply series and wage series
were obtained directly from the Bureau of Labor Statistics.
The Bureau provided us with series which focus on the
private sector of the economy. Since our objective is to
determine the benefit that government capital has on pri-
vate production, these series are more appropriate than with the assumption that E ( M l , + ,) = 0. These moments
others (e.g. GDP) which included both the private sector identify the parameters 6' and 69. The second set of mo-
and the public sector. The output series is called output ments makes use of the Euler equations and identifies
from the business sector, the labour supply series is called a , and a2. Defining
the total number of hours for all types of workers in the
business sector and the wage series is the real hourly com-
pensation of employees in the business sector. The utiliz-
ation series was obtained from the Federal Reserve Bulletin
(1990).
For the corporate discount rate we used two values and
carried out the analysis using each. The larger value is 8.8 then Equations 2 and 3 imply that E(M2,+,) = 0. To
which is the average annual real return on common stocks identify log(,u), a3 and a,, we use a set of instruments that
over the period 1929-1988 found by Ibbotson and Associ- are correlated with the input variables yet are uncorrelated
ates. The other value is 4.0 which is common value used in with the error term. As noted by Nelson and Plosser (1982),
real business cycle calibration exercise^.^ many macroeconomic aggregates, including the ones used
here, are n~nstationary.~ We follow a standard approach
Empirical methodology which differences the data in order to remove the non-
stationarity. Here we difference the log production function.
To estimate the model we use a G M M approach. One of the Defining
advantages of our approach is that it is able to handle the
endogeneity of y, and n, which is one of the more noted
concerns with the regression methodology used by
Aschauer (1989, 1990). As has become standard for practi-
tioners of these GMM empirical methods, we use a two-step
approach. In the first step we obtain consistent estimates of
the parameters which are then used in the second step to
obtain the optimal weighting matrix and thus obtain the
best G M M parameter estimates. where
For each of the discount rates, we estimate three models.
The models impose increasing restrictions on the para-
meters. This approach allows us to test two general speci-
fications before arriving at the parameter estimates used in
our simulations. Of course we could use the more general
model parameter estimates in our simulations. However,
given the results of the tests, the most efficient estimates are
the ones from the most restrictive model.

3See for example Kydland and Prescott (1982).

4Aaron (1990) and Tatom (1991) correctly point out that if one ignores this feature of the data and uses ordinary least squares then the
parameter estimates will be inconsistent.
 C. Ai und S. P. Cussou
are instruments that are in the information set at time t, then Table 1. Model parameter estimcites
under the assumption that
Discount rate r = 4.0

(la) (24 (34

it follows that E(M3,+ ,) = 0. Note that because our instru- p = 0 and
Unrestricted constant
ments are in the information set we will obtain consistent Parameter model p=O returns
estimates of the parameters even when 0, is serially corre-
lated. Also note that the specification above allows the 1% (14 0.010 0.010 0.0 146
possibility of even higher-order integration, I(2), when (2.25)* (2.46)" (10.45)";:;
p = 1. As part of our empirical exercises we test H o : p = 0 aI 0.652 0.652 0.652
(479.29)'" (496.77)"" (508.54)"';
to determine if further differencing is needed. These
a2 0.168 0.170 0.149
moments are next stacked and imply E {Ml+,) = 0 where (6.09)"" (6.22)"* (6.70)"'
Ml+ = [MI:, I M2;+ M3:+ J'. Our GMM objective a3 0.3 18 0.321 -

function is to choose y = (log(p),or,, or,, or3, or4,bc,bg, p)' SO as (2.99)"* (3.39)""

to minimize a4 0.186 0.193 0.185
(6.34)"' (7.39)"" (7.42)"':'
1 S' 0.1 14 0.1 16 0.097
M'V-IM where M =- M, (4.59)"" (4.69)"" (4.78)':'"
Tr=, Sq 0.0380 0.0380 0.0380
(12.47J4" ( I 2.47)"" ( 1 2.47);:""
and V is a positive definite weighting matrix. The first step -
P 0.109
of the GMM procedure obtains consistent estimates of y by (0.61)
using V equal to the identity matrix. Next, optimal G M M (1.63)
Ho:al+a2+r3=1 (1.16) -
estimates are obtained by using H o : a l + a2 = 1 ( -6.52)"* (-6.51) ( -9.03)":'

Discount rate r = 8.8

(1'4 (2b) (3b)

where M, is M, evaluated at the consistent parameter esti- p = 0 and
mates found in the first step. A consistent estimate of the Unrestricted constant
parameter covariance matrix is given by model p=O returns
log 0.009 0.010 0.01 45
(1.98) (2.16)" (10.26)""
where a1 0.652 0.652 0.652
(479.80)"" (485.14)"" (508.18)""
ff2 0.22 1 0.224 0.199
(7.95)"' (8.13)"" (8.90)""
a3 0.295 0.298
and dfil/dy is dM,/dy evaluated at the second step para- (2.71)" (3.08)""
meter estimates. @a 0.190 0.196 0.185
(6.53)"" (7.45)"" (7.38)""
6' 0.1 15 0.117 0.094
Results (4.62)"" (4.73)"" (4.66)0:3
Sg 0.0380 0.0380 0.0380
Table 1 presents the results of the estimation procedure for (12.47)"" ( 1 2.47)"" (12,47):>::
P 0.1 16 - -
each of the discount rates. We estimated three increasingly
(0.68)
restrictive specifications under each discount rate in order
to carry out two specification tests. The most general speci- Ho:a,+a2+aj=1 (1.39) (1.61) -.

fication, (la) and (lb), imposes no constraints on the optim-
ization exercise described above. This specification is used
to test Ho :p = 0 in order to determine if higher-order differ-
encing is warranted. The table shows that p is quite small
and is never significant, so we impose p = 0 for the next two
specifications. The second specification, (2a) and (2b), is used
to test constant returns to scale, H,: or, + or2 + or3 = 1. The
t-statistic for this test is reported at the bottom of the table.
Again the test is never rejected.
Given these results, imposing both p = O and
+ +
u l or2 or3 = 1 is justified. Further, imposing these
H o : a , + a2 = 1 ( -4.55)"' (-4.51)"" (-6.74)":"
t-statistics are in parenthesis.
'indicates test is significant at 0.05 level in a two-tailed test.
**indicatestest is significant at 0.01 level in a two-tailed test.
restrictions is a sound empirical procedure since this elimin-
ates unnecessary parameters and thus results in more effi-
cient estimates of the remaining parameters. In specification
(3a) and (3b) these restrictions have been imposed. The more
efficient estimates from the specification given in (3a) and
A normative arzalysis of public capital
(3b) results in public capital elasticity estimates of 0.199
when r = 4.0 and 0.149 when r. = 8.8. Both of these are
smaller than the estimates found by Aschauer (1989, 1990)
and Munnell(1990) and are near estimates found by Lynde
and Richmond (1993). However, they are not as small as
estimates found by Aaron (1990), Evans and Karras (1991)
and Tatom (1991) despite using the first-differenced data.
Further, the public capital elasticities are always signifi-
cantly different from zero.'
It is also of interest to compare the other parameter
estimates with those found by earlier studies. The Cobb-
Douglas production function specification implies that
a , should be the share of output paid to labour inputs.
Historically this value is about 0.66 which is what we have
estimated cr, to be. Studies by Aschauer (1989, 1990), Mun-
nell (1990), Tatom (1991), Evans and Karras (1991) and
others have come up with a wide range of a , estimates,
many of which are far from 0.66. Further, a wide range of
estimated values have been reported within a given study
under different model specification^.^ One of the attractions
of our G M M procedure is that the moment condition
2 tightly identifies a , at the theoretical value, thus giving not
only a sound estimate, but also a very small standard error.'
Further, because this moment is used in all of our specifica-
tions, our estimate for cr, does not change much when
additional restrictions are added on other parameters (e.g.
p = 0). Similar remarks apply to our cc2 estimate. Thc gross
capital share of output is historically 0.34. However, one
would expect a, to be less than this once one adjusts for
depreciation. This adjustment is captured by the moment 3.
Table 1 shows that our estimates of 0.149 and 0.199 are
quite close to estimates by Auerbach and Hines (1987) who
found values of 0.166 and 0.181. Our estimate for a4 is close
to values reported by Aschauer (1989,1990), Munnell(1990)
and others.
Perhaps the most important parameters of our model
which have been omitted from the previous public capital
studies are the depreciation rates. Since depreciation rates
differ among different types of capital, aggregate capital
stock depreciation rates will be a weighted average of the
depreciation rates of the aggregate components. Jorgenson
and Sullivan (1981) carried out a detailed study which
estimated the depreciation rate for 34 types of capital stock.
As one would expect, depreciation rates were considerably
higher for equipment than for structures. Auerbach and
Hines (1987) organized corporate capital into two types,
equipment and structures, and estimated the respective de-
preciation rates to be 0.137 and 0.033. Since we aggregate
equipment and structures together our estimates of 0.097
'For specifications (la), (Ib), (2a) and (2b) the t-statistic for the public capital elasticity is reported in parenthesis under the parameter
estimate while for specification (3a) and (3b) the t-statistic is reported in the row marked II, : a , + a2 = 1 .
6Aschauer(1989)found a, estimates ranging from 0.08 to 0.56, Tatom's (1991)estimates range from 0.105 to 0.737 and Evans and Karras'
(1991) estimates range from 0.721 to 1.414.
7The small standard error can be seen by the very high t-statistic for a,.
1205
and 0.094 are in this range. Further, since government
capital includes a larger share of structures than private
capital, we expect the estimated depreciation rate for this to
be lower. Indeed, our government capital depreciation esti-
mate of 0.038 is within the range of 0.0188 and 0.450 which
Jorgenson and Sullivan (1981) estimated for educational
buildings and public utilities respectively.
IV. POLICY IMPLICATIONS
In this section we consider the implications of a one-time
increase in investment of government capital. Our focus on
a one-time impulse is motivated in part by the debate in the
US surrounding this type of policy during the early part of
1993 and in part is motivated by our interest in demonstrat-
ing a setting in which the multiplier analysis will provide
incomplete information to base policy decisions upon. Two
types of cumulative benefit calculations are described below.
We begin with the 'true benefit'. The true benefit measures
the present value of output changes less costs and is the
correct concept to use in order to make marginal public
capital investment decisions. Later, we focus on the 'total
benefit'. The total benefit measures the present value of
output changes but does not subtract costs. This concept is
useful for evaluating the gross changes on output that one
can expect from public capital expenditure programmes.
The true benejt of public capital investment
Because short-term increases in public capital investment
result in long-lasting increases in capital stock, the benefit
will come over many years. The total output gain in present
dollars from a one-unit increase in government capital in-
vestment is given by
We call this the 'total benefit'. Unfortunately, the total
benefit exaggerates the gains of public capital investment
since it does not substract the costs of additional inputs of
labour and capital. Something we call the 'true benefit' does
subtract these costs and is given by
ant+,
di, - rr+sp dig
W t + s y
A simpler expression can be found by writing the produc-
+
tion function at time t s as y,+, = F(n,+,, kF+,- kg+,- ,),,

and noting
and
aF(.) aF(.)
wt+s = - and r,+, =-----
ant+, a&+,- 1 which the economy does not grow technologically and thus
This implies that the true benefit is given by
a F ( . ) ak;l+,-l
{jl(A)zizz T } (6)
In order to compute the true and total benefits using
Equations 6 and 5, some additional information is needed.
Most importantly, we need to find an appropriate rate for
the government to discount at and we need to find expected
values for various future quantities. We use an approach
common to cost benefit studies that is described in Rosen
(1992). In particular, we use a range of values so as to get
a clear picture of what the possibilities are. For the discount
rate we continue to use the two values of 8.8% and 4.0%.
These values are consistent with Feldstein et al. (1983) who
found that the before-tax nominal rate of return in the post
World War I1 period was about 12.0% and the after-tax
nominal rate of return was 5.0%. As described by Rosen
(1992), it is possible to make a case for the government to
use either the nominal rate of 12.0% or 5.0% depending on
how one thinks the government spending impacts the asset
market and thus Rosen recommends using a range of values.
Adjusting these nominal rates for a 3.0% inflation rate gives
a real rate range of 9.0% and 2.0% which is approximately
the range we have used.
To find values for the expectations in Equations 6 and
5 we use an approach common to macroeconomic studies
such as Auerbach and Kotlikoff (1987) which is to assume
perfect foresight. We use two approaches for finding the
perfect foresight values for the expectations. This two ap-
proach method is again motivated by the discussion in
Rosen (1992) which is to find a range for the possibilities.
One approach is an econometric approach which we feel
gives the best estimates for the future values of the variables
in the model. However, we also felt it important to provide
a worst-case scenario. Our worst-case scenario is one in
which the economy does not grow. We call this a 'no
change' approach.
For the econometric approach we explored a number of
forecasting models and decided to use a unit root specifica-
tion. To be specific, we differenced the historical data on
wages and government capital and forecasted the difference
using a second-order autoregressive process. Then we undif-
ferenced the forecasts to obtain a forecast for wages and the
'We choose 200 periods since this is a standard set by the Auerbach and Kotlikoff (1987) work. However, we could have used a shorter
horizon. As we will see from the tables to follow, most of the benefit from government capital is received within 20 years.
C. A i and S. P. Cassou
government capital stock. Each of these forecasts was car-
ried out 200 periods into the future which was far enough so
that the marginal contribution to Equations 5 and 6 was
negligible.' Our 'no change' approach simply assumes that
the wage rate and the government capital stock are fixed at
1989 levels and there is no technological progress for the
rest of time. We consider this to be an extreme outcome in
consider this calculation to provide a lower bound on the
benefits derived from the government capital.
In addition to the discount rates and the forecasts for the
economy, the true and total benefit calculations require
a value for the production function parameter A. This
parameter was determined so that the production function
output level one would get using the 1989 observed input
levels was equal to the observed 1989 output level. Using
this procedure values of A equal to 4.745 and 4.560 are used
when r equals 4.0% and 8.8%, respectively.
Our computation of the true benefit begins by using the
forecasted wage and government capital series to obtain
forecasts for output, labour and corporate capital which are
consistent with the model. Such series will be interpreted as
time paths for the economy prior to the spending impulse.
Following Auerbach and Kotlikoff (1987), we focus on de-
terministic outcomes for the policy exercises by ignoring the
expectations in Equations 2, 3 and 6. Doing this, one can
solve Equation 2 directly for n, and lag 3 to solve for k f - ,,
obtaining
Substituting these into the production function one gets
Using our forecasts for wages and government capital, the
average of the observed utilization rates, 8, = 1 and Equa-
tions 7,8 and 9 we obtain forecasts for output, employment
and corporate capital which are consistent with the model.
Next, we consider a one unit impulse in the investment of
government capital at time t. This implies that the govern-
+
ment capital at time t s is now given by
where @+, is the forecast government capital using our unit
root model described above. We now use this new series for
government capital and the original theoretically forecasted
series for labour and corporate capital in the production
function and obtain a new forecast for output at each future
A normative analysis of public capital
date. Differencing this from the original output series then
gives the marginal output change due to a new unit of
government capital investment which has no external effect
on labour supply or corporate capital investment; that is we
find
This marginal output change can then be used in Equation
6 to obtain the true benefit.
The results of this exercise are presented in Table 2. The
numbers in Table 2 represent the benefits received in vari-
ous time intervals for a $1.00 impulse in spending. Thus, the
cost is $1.00 and the appropriate benefit figure for the cost
benefit analysis is the value reported in the right column
entitled 'Sum'. The table shows that the true benefit of $1.00
spent on government capital is quite substantial, falling in
the range between $3.34 and $9.63 when the 'econometric
forecasts' are used and $2.08 and $4.73 when the 'no change'
forecasts are used. These large true benefits are quite intu-
itive once one recognizes that a government capital invest-
ment depreciates slowly and thus leads to a long-term
increase in the government capital stock and long-term
productivity gains. One of the more important distinguish-
ing features of this work from the work by Aschauer (1989,
1990), Munnell (1990), Tatom (1991) and others is that we
have explicitly quantified the benefit of public capital by
taking into consideration the fact that it is durable and thus
the benefits will be received over many years.
Table 2 also decomposes the timing in which the benefits
are received. The first column represents the benefit which
one expects to receive in the first year and is analogous to
the multiplier described by Aschauer (1989) and the 'impact
multiplier' described by Baxter and King (1993). Further,
because of this analogy the values for the benefit reported
here are similar in magnitude to the multiplier values found
in those studies. The remaining columns represent the pres-
ent values of the benefit which is received in various other
intervals. As can be seen substantial benefits come beyond
the first year in which the public capital is used. For dis-
cussion sake, consider evaluating a government capital in-
Table 2. True benefit over various time intervals
Intervals of time
Discount rate Year 1 Years 2-5 Years 6-10
Econometric forecasts
r = 4.0% 0.365 1.295 1.310
r = 8.8% 0.250 0.811 0.701
No change forecasts
vestment programme when the appropriate discount rate is
4.0% and the unit root forecasts are used. In this case the
impact multiplier is 0.365 indicating that the short-term
benefit to this spending programme is less than its cost. If we
were to use this short-term multiplier then such spending
may be discouraged. However, such a decision would be
shortsighted since it overlooks the long-term benefits which
have a present value of $9.63. By correctly incorporating the
present value of future benefits, we are able to report num-
bers which are appropriate for basing an investment
decision on.
One cautionary note on how to interpret the benefits
reported in Table 2 is very important. Some economists
have interpreted the multipliers presented in other papers as
suggesting that an arbitrage opportunity exists for the gov-
ernment. For instance, they may interpret our benefits as
showing that if the government were to invest any amount,
say x, in public capital, that it should expect to see a benefit
equal to x times $9.63. Such an interpietation would be
seriously incorrect. As one can see from the production
function, in an economy with limited labour resources gov-
ernment capital has diminishing returns. Thus the marginal
return will be lower for each additional unit of government
capital and eventually one would expect that an additional
unit will cost more than its benefit. Thus one should not
expect this to be the benefit one will obtain for any level of
public capital investment. What Table 2 does show is the
benefit for a marginal dollar of investment is currently
greater than the cost and thus the current level of govern-
ment capital is less than optimal.
The total benefit of public capital investment
In the previous analysis we deducted from the total benefit
the costs of endogenous changes in the labour supply and
capital stock in order to obtain the true benefit. This figure
is the correct figure to use to base an investment decision on.
However, the total benefit is interesting because it provides
a figure which captures the total change in output induced
by the public capital investment. We now carry out total
benefit calculations.
Years 11-20 Years 21-50 Years 51- Sum
1.895 2.758 2.01 1 9.634
0.792 0.667 0.124 3.345
1208 C. Ai and S. P. Cussou
Table 3. Total benejt ouer various time interuals
Intervals of time
Discount rate Year 1 Years 2-5 Years 6-10 Years 1 1-20 Years 21-50 Years 51- Sum
Econometric forecasts

No change forecasts
r = 4.0% 1.784 5.896 5.201 5.907 4.521 0.482 23.79 1
r = 8.8% 1.614 4.791 3.462 2.882 1.159 0.030 13.937

ment?' Using Equation 7, we see the impact on employment

is given by

Figure 1 plots the percentage increases in employment over

the next 200 years for a $1 billion spending programme on
government capital. Only one graph is provided because the
employment stimulation is graphically indistinguishable for
the 4.0% parameter values and the 8.8% parameter values.
The figure shows an employment increase of 0.05% in the
first year of such a programme and this employment stimu-
Year
lation slowly diminishes as the public capital depreciates.
Fig. 1. Percentage employment response to $ I billion public capital
investment
V. C O N C L U S I O N S
Begin by noting that Equation 9 implies
This paper has evaluated the benefit of a marginal pub-
lic capital expenditure and found it to exceed the cost.
Several improvements to related studies have been incorp-
orated into the analysis in this paper. These improvements
Next iterate on Equation 1 to get are both theoretical and empirical. The most noteworthy
theoretical feature is that the model is dynamic and explicit-
ly incorporates the durability of a public capital investment
which is very important for evaluating long-lived assets.
Equally important is that our empirical procedure properly
handles several concerns raised about earlier studies.
Further, our empirical approach tightly identifies the
Thus
parameters of the model, thus resulting in highly efficient
parameter estimates.

and the total benefit (Equation 5) can be evaluated using ACKNOWLEDGEMENTS

these formulas. Table 3 contains the results of these calcu-
lations. These results show very substantial total output
gains from a marginal unit of public capital investment.
Another interesting question which can be easily ans-
wered is, 'How much employment stimulation would one
expect from one additional unit of public capital invest-
The authors would like to thank Thomas Muench and
Gerhard Glomm for comments on earlier drafts of the
paper, and Lawrence J. Fulco at the Bureau of Labor
Statistics for providing some of the data used in this study.
Any errors are our responsibility.
A normative analysis of public capital
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