On National Fiscal Policy and Growth: Searching for Optimality Under Externality

Abstract

In this paper, we examine the view of capital fundamentalism claiming that national fiscal policies, with public investment being subject to adjustment costs, can be considered as the primary determinant of economic growth. According to our analysis, a country that experiences a low rate of 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 public capital. 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 the rather traditional strand of research where the rate of return was invariant with that particular ratio. We also reconsider some properties of optimal fiscal policy and conclude that, in accordance to conventional priors, maximisation of the private-sector utility function corresponds to maximisation of the growth rate of the economy.