Abstract
<span lang="EN-US">By shedding light on the factor intensity, this paper incorporates the Romer (1986)-type knowledge spillover technology into the Uzawa (1961, 1963) two-sector model of consumption and investment goods and studies the effect of the ratio of government expenditure to total output on the economic growth rate under three types of tax financing schemes: lump-sum tax financing, income tax financing, and consumption tax financing. We find that a rise in government expenditure with lump-sum tax financing has an ambiguous effect on the balanced growth rate depending on the factor intensity between the sectors. The balanced growth rate decreases (increases) with a rise in government spending if the consumption (investment) goods sector is capital-intensive. Moreover, the result of consumption tax financing is equivalent to lump-sum tax financing, while an increase in the government expenditure with income tax financing reduces the balanced growth rate. Our two-sector model with lump-sum tax or consumption tax financing seems to be able to provide a channel through which to explain the mixed empirical findings.</span>
Highlights
The relationship between government expenditure and macroeconomic performances has been extensively explored within an intertemporal optimizing framework over the last two decades
To enrich the studies in this field, this paper incorporates knowledge spillover technology of theRomer (1986)-type in the Uzawa (1961, 1963) two-sector model of consumption and investment goods to examine the roles of factor intensity and relative price in evaluating the effects of alternative government expenditure financing scheme.The study of this issue may be justified for three reasons
We have the following proposition: Proposition 2. (The Effect of Income Tax Financing) When there is a two-sector economy composed of consumption goods and investment goods, an increase in the government expenditure ratio based on income tax financing has an ambiguous effect on the steady-state relative price of consumption goods which depends on the relative extent of the difference between s( p) and
Summary
The relationship between government expenditure and macroeconomic performances has been extensively explored within an intertemporal optimizing framework over the last two decades. Turnovsky (2000) introduces an endogenous labor-leisure decision into a simple AK growth model and shows that an increase in either government consumption expenditure or government investment expenditure with lump-sum tax financing improves the steady-state growth rate. To our knowledge, Devereux and Love (1995) make a first attempt to examine the impact of government spending financed by either lump-sum or income tax on economic growth rate under a two-sector endogenous growth model with endogenous labor-leisure decision. Motivated by the empirical evidence, following Uzawa (1961, 1963), the present paper construct a two-sector model of consumption and investment goods in which both sectors use physical capital and labor as inputs in a Romer (1986)-type technology to highlight the important features of factor intensity and relative price between the sectors in evaluating the growth rate effect of government expenditure policy under alternative financing schemes. Section 4presents the main findings of our analysis and concludes
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