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Public Infrastructure and Private Productivity
Public Infrastructure and Private Productivity
University of Georgia
Athens, Georgia
1. Introduction
Since the classic analysis of public infrastructure by Arrow and Kurz
(1970), a number of empirical studies have examined the role of public
capital as an input in the production process. 1 Many of these studies have
reported estimates of the marginal product of infrastructure that are positive
and statistically significant, but often implausibly large. In particular, As-
chaner (1989b) and Munnel] (1990) generated a lively debate on the ira-
*We thank two anonymous referees, the editor, participants of the Georgia Productivity
Workshop II, Kevin Fox, Cliff Huang, and David Robinson for helpful comments on an earlier
version of this paper. We also thank Dale Jorgenson and John Tatom for making their data
available to us.
1For examples, see Ratner (1983), Aschauer (1989a, 1989b), Munnell (1990, 1991), Tatom
(1991), Holtz-Eakin (1994), Nadiri and Manuneas (1994), Andrews and Swanson (1995),
Garcia-Mil~, McGuire, and Porter (1996), Mullen, Wilfiams, and Moomaw (1996), and Otto
and Voss (1996).
Journal of Macroeconomics, Summer 1999, Vol. 21, No. 3, pp. 56:3-576 563
Copyright © 1999 by Louisiana State University Press
0164-0704/99/$1.50
C. D. DeLorme, Jr., H. G. Thompson, Jr. and R. S. Warren, Jr.
~Recent exceptions to this generalization are provided by Nadiri and Manuneas (1994) and
by Morrison and Schwartz (1996). Both of these studies examine the effects of public capital
on manufacturing-sector productivity in the context of a system of cost and input-demand
functions. As a consequence, both the technical (neutral) and allocative (biased) efficiency ef-
fects on private output of public infrastructure could be estimated.
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Public Infrastructure and Private Productivity
results suggest that public capital increases both output and productive ef-
ficiency in manufacturing. However, the estimated, direct output elasticity
of public capital is quite small.
In this paper, we also specify and implement a test of the role of public
infrastructure in reducing technical inefficiency in the production of private-
sector output. Our study differs from Mullen, Williams, and Moomaw
(1996), however, by using aggregate time-series data. Consequently, our em-
pirical results pertain to the entire U.S. private economy, rather than just to
the manufacturing sector.
The paper is organized in the following way. First, we replicate the
findings of previous empirical studies by estimating an average production
function that is augmented with public capital as an input. We then estimate
a stochastic production frontier without public capital. These latter estimates
are used to establish the presence of aggregate technical inefficiency. Sub-
sequently, we show that the estimated level of technical inefficiency is nega-
tively related to the stock of public infrastructure. Finally, we estimate a
production frontier which includes public capital, and report that its esti-
mated coefficient is not significantly different from zero. Therefore, we find
that public capital affects U.S. private productivity only indirectly, by re-
ducing aggregate technical inefficiency, rather than by directly increasing
private-sector output. Our results, then, provide only mixed support for the
empirical findings reported by Mullen, Williams, and Moomaw (1996). How-
ever, we affirm the conclusions of Tatom (1991), Evans and Karras (1994),
and Holtz-Eakin (1994) that public capital does not directly increase private
productivity.
2. Analysis
The starting point for our analysis is the commonplace empirical fnd-
ing that public capital affects aggregate, real private output in the U.S. econ-
omy_ Following Ratner (1983), Aschaner (1989b), Munnell (1990), Tatom
(1991), Gramlich (1994), Andrews and Swanson (1995), and Otto and Voss
(1996), we represent aggregate technology by a constant-returns-to-scale
Cobb-Douglas production function augmented by Hicks-neutral technical
change. Because the dependent variable in this model (output per worker)
varies procyclically over time, a control for the phase of the business cycle
is included, a This also facilitates a comparison with studies such as Aschauer
(1989b), which attach importance to declining capacity utilization in explain-
aFor an illustrationof the use of a control variablefor the phase of the business cyclein a
time-seriesmodelof production,see Lovell,Sickles,and Warren (1988).Aschauer(1989b) and
Tatom (1980) also employthe capacityutilizationrate to controlfor business-cycleeffects.
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C. D. DeLorme, Jr., H. G. Thompson, Jr. and R. S. Warren, Jr.
ing the productivity decline of the 1970s and 1980s. Annual data from the
period 1948-1987 are used in the empirical analysis, and are described in
Table 1.
The model can be written
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Public Infrastructure and Private Productivity
5Detailed results of the D-F unit-root tests and the Johansen cointegration tests are available
from the authors. A discussion of the Johansen test procedure can be found in Dickey, Jansen,
and Thornton (1991, 73-75).
4This assumption explains why, in Table 1, the mean of G (the stock ofpubfic capital) exceeds
the mean of K (our measure of the flow of public-capital services). Because the estimating
Equations (2) and (3) are specified in logarithmic first differences, this method for measuring
public capital does not affect the estimated coefficients, which are interpreted as elasticities.
567
C. D. DeLorme, Jr., H. G. Thompson, Jr. and R. S. Warren, Jr.
6The first difference (v') of a normally distributed random variable (v) is also normally
distributed.
7The estimate of 3'1 in Table 2 is somewhat higher than typicallyreported° but nonetheless
falls within the range of estimates recently provided by Evans and Karras (1994)_There are two
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Public Infrastructure and Private Productivity
where v' is a normally distributed error term, and I-t > 0 is a one-sided error
which represents technical inefficiency in production, s The argument dis-
cussed above, that public capital reduces technical inefficiency, implies that
there is an auxiliary relation
in which ~1 < 0 is predicted, and where w -> - [~0 + ~IA ln(G/L)] since
the distribution of the dependent variable, g, is truncated at zero.
569
C. D. DeLorme, Jr., H. G. Thompson, Jr. and R_ S. Warren, Jr.
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Public Infrastructure and Private Productivity
~11 = m3/m3/2 ,
where m2 and ma are, respectively, the second and third moments of the
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C. D. DeLorme, Jr., H. G. Thompson, Jr. and R. S. Warren, Jr.
OLS residuals. The distribution of ~/~ is widely tabulated, and Bowman and
Shenton (1975) provide the 10%, 5%, and 1% critical values for various
(small) sample sizes. For the problem at hand ~ = 0.623, which exceeds
the 5% critical value for the present sample size. As a consequence, we reject
the null hypothesis of symmetry of the OLS disturbances and from this result
infer the presence of technical inefficiency in the U.S, economy.
The results of estimating (4) by the truncated-normal regression pro-
cedure, in which the one-sided residuals from the estimated production fron-
tier were regressed against the "omitted variable," the ratio of public capital
to labor, are presented in Table 4. As before, estimates were obtained using
both contemporaneous G and G lagged one period. The estimated coeffi-
cient on public capital is negative in each case and significantly different
from zero at the 5% level. These results show that the one-sided residuals
(the estimates of private-sector technical inefficiency) are negatively related
to public capital, regardless of whether public capital is defined contempo-
raneously or with a one-year lag. This finding is consistent with the hypoth-
esis that public capital facilitates the production of private-sector output by
lowering technical inefficiency.
These results provide an explanation for the statistical significance of
public infrastructure in estimated average production functions, which as-
sume no technical inefficiency. If private-sector technical inefficiency is as-
sumed to be zero when in fact it exists, then the stochastic structure of the
production function is misspecified. In the case, then, in which technical
inefficiency is omitted from the model but is negatively correlated with pub-
lic capital, the latter will be positively related to output if it is included as an
explanatory variable in an estimated average production function.
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Public Infrastructure and Private Productivity
3. Conclusion
The stochastic-frontier approach to modeling aggregate production
was employed in this paper to test the hypothesis that public infrastructure
reduces technical inefficiency in the private economy. Most previous em-
pirical studies of the effect of public capital on aggregate real private output
have reported estimates of average production functions. A number of those
studies concluded that public capital increases real private output but in the
context of a model in which public capital is included as a conventional input
in the production function, along with private capital and labor. With the
exception of Mullen, Williams, and Moomaw (1996), however, none of these
studies considered the potential role for public capital in reducing the tech-
nical inefficiency of private-sector production. Consequently, the stochastic
structure of these earlier models may well have been misspecified, thereby
calling into question the conclusions based on their estimates.
To determine whether public capital reduces aggregate technical in-
efficiency in the private sector, we employed a specification test originally
proposed by Schmidt (1986). A stochastic production frontier was estimated
in first-differenced form, and the one-sided residuals were regressed against
the change in the ratio of public capital to labor. The empirical results are
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C. D. DeLorme, Jr., H. G. Thompson, Jr. and R. S. Warren, Jr.
consistent with the view that public capital reduces private-sector technical
inefficiency, but does not directly affect private output. A policy implication
of these results is that additions to the public-capital stock cannot be used
countercyclically to replace periodic shortfalls in private-capital accumula-
tion or reductions in employment. Instead, infrastructure investment can
contribute to a steady-state policy of reducing the technical inefficiency of
private-sector production.
The results reported in this paper are, of course, conditional on the
particular specifications of technology and technical inefficiency that were
employed. A constant-returns-to-scale, Cobb-Douglas production function
was specified in order to provide comparability with the preponderance of
past empirical studies of public capital as a productive input. A more flexible
representation of technology (the translog) has been used by Mullen, Wil-
liams, and Moomaw (1996) in previous research on this topic. However,
Moroney (1992) showed that, with aggregate U.S. time-series data (of the
sort used in this paper), the translog function generates severe multicol-
linearity and is conclusively rejected in favor of a constant-returns-to-scale,
Cobb-Douglas representation of technology. Finally, technical inefficiency
was modeled by a random disturbance that has a half-normal distribution.
Other stochastic specifications of inefficiency (like the exponential distribu-
tion) are feasible, and it may be worthwhile to examine the sensitivity of
these results to alternative parameterizations.
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