Abstract
The paper analyzes welfare effects, in a second-best world, of public spending of three different types: transfer payments, public consumption and public investment. It is shown how these effects depend not only on the type of spending but also on the initial level of spending, as well as on anticipated consequences for future taxes and transfer payments. The analysis is performed in an overlapping generations model with (i) individuals who in each period endogenously allocate their time between (taxed) market work and (tax free) home production, (ii) a publicly provided good (‘public consumption’) that enters as a second factor in home production, and (iii) productivity-enhacing public investment in the private (market) production sector. The consequences for the current account of the balance of payments of the different spending alternatives are also studied.
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