Endogenous Fiscal Growth and Public Macroeconomics

Abstract

In this research paper, we critically examine the view of capital fundamentalism, claiming that national fiscal policies can be considered as the primary determinant of dynamic and equilibrium economic growth, and then carefully assess the effectiveness of optimal fiscal policy for the economics of welfare, reflecting on familiar externalities associated with public expenditures and taxes. In accomplishing such a hybrid task, we managed to derive rather than postulate the simplest possible formulation of neoclassical origins, aimed at constituting a benchmark for endogenous fiscalist rules, underpinning the role of productive public expenditures and the ensuing complementarity properties for the governmental size and the rate of economic growth. By encompassing traditional and modern literature strands on endogenous growth, the structural analysis is initially developed and subsequently presented in two main thematic units. The first part puts forward an intertemporal model of a small open economy that is suitable to capture the dynamic interdependence of output growth and the real interest rate, in the presence of adjustment costs on private investment, the effective utilisation of which might help determine the rate of public capital accumulation too. According to our analysis, a country that initially experiences a low rate of output growth, with a relatively low public to private capital ratio, can generate and attain a higher long-run rate of economic growth, equivalent to the growth rate of installed capital. A non-trivial role is also attributed to capital efficiency characterising both the analysis of transitional dynamics and the steady-state effects. Intuitively, dependence of government expenditure on the costs of adjustment drives the notional wedge not only between private and public sectors, but also between output growth and intertemporal welfare as it significantly influences the distributive channel of resources allocation. The second part puts emphasis on welfare economics and particularly on the policy dimensions characterising the size of governments and the rate of growth. By introducing a closed-type economy with policy variations, both the roles of productive spending and government financing are greatly enhanced while the analogous effects on production and/or utility are discussed. In this vein, the privately determined choices for saving and growth - after accounting for a partial impact on consumption - may easily end up suboptimal, owing to governmental externalities. As a principal result, it is revealed that the after-tax marginal product of capital, hence the rate of return, depends positively on the ratio of private to public capital, something that sharply contradicts the results obtained in earlier strands of research where the rate of return was invariant with that particular ratio. A rather subsidiary outcome, from reconsidering certain properties of optimal fiscal policy in accordance to conventional priors, is that maximisation of private welfare corresponds to maximisation of the growth rate of the economy, thereby satisfying the natural condition for productive efficiency.