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Factor substitution is an engine of growth in a model with productive public expenditure

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Abstract

This paper examines the effect of the elasticity of substitution between public and private inputs on the optimal fiscal policy, long-run growth and welfare. To this end, we consider an endogenous growth model with productive public spending. If the baseline government size is suboptimally low (high), the higher the elasticity of substitution the higher (lower) are the optimal government size and, in the presence of congestion, the optimal income tax. In any case, the higher the elasticity of substitution the higher are the optimal long-run growth rate and welfare.

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Notes

  1. Other related research has examined the effect of factor substitution on different issues as, e.g., the convergence speed (Klump and Preissler 2000) and the (in)determinacy of equilibrium (Wong and Yip 2010; Xue and Yip 2015).

  2. A notable exception is Irmen (2011).

  3. For a thorough discussion on the factors that could affect the elasticity of factor substitution see, e.g., Klump and Preissler (2000, Section IV).

  4. In particular, Gómez (2014) finds that this relationship depends on the elasticity of substitution being greater than, equal to or lower than unity—and also on the congestion parameter—in the Barro (1990) model.

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Acknowledgments

Financial support from the Spanish Ministry of Economics and Competitiveness through Grant ECO2014-57711-P is gratefully acknowledged.

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  1. Departamento de Economía Aplicada II, Facultad de Economía y Empresa, Universidade da Coruña, Campus da Coruña, 15071, A Coruña, Spain

    Manuel A. Gómez

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  1. Manuel A. Gómez
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Correspondence to Manuel A. Gómez.

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Gómez, M.A. Factor substitution is an engine of growth in a model with productive public expenditure. J Econ 117, 37–48 (2016). https://doi.org/10.1007/s00712-015-0442-8

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