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How can public finance reforms boost economic growth and enhance income equality?

by Boris Cournede, Head of Public Finance Workstream, OECD Economics Department

Most OECD countries have very large government sectors: public expenditure amounts to 43% of economic activity, measured by GDP, on average across OECD countries. This proportion exceeds 50% in four OECD countries. The programmes on which governments spend have thus deep implications for people’swell-being and a country’s economic fortunes. Similarly, the choice and design of taxes that fund expenditure will also shape economic decisions and influence people’s  choices to work, invest and consume.

New OECD empirical work has identified lessons provided by the experience of OECD countries over the past three decades. These empirical investigations shed light on the effects of public finance on economic activity as well as on the distribution of income across households.

First, large governments can be compatible with high levels of economic activity: the condition is that governments provide their services very efficiently. The Nordic countries display the levels of government effectiveness at which governments can be large without weighing on growth. Where governments are less effective, reducing their size can be expected to lead to higher growth; however, reducing the size of government typically entails arise in income inequality, because public expenditure, and especially transfers, are a powerful equaliser of incomes.

Second, leaving aside questions about government size, many public finance reforms that change the composition of spending or the mix of taxes offer the potential to boost economic activity and household incomes:

  • Some reforms can boost overall economic activity while reducing income gaps:
    • One important reform of this nature is to reduce the effective tax that low-income workers face (taking into account the withdrawal of benefits) and funding this change through proportional increases in other taxes.
    • Another reform that belongs in this win-win category for higher activity and less inequality is to increase inheritance taxes and use the proceeds to reduce other taxes proportionally.
  • A number of public finance reforms can increase activity without altering income differentials, thereby “lifting all boats”roughly equally. They include:
    • Higher public investment, while reducing other spending programmes by the same amount;
    • Higher recurrent property taxes, while lowering other taxes by as much;
    • Lower effective rates of corporate income tax,while increasing other taxes.
  • One public finance change that benefits the poor with no substantial effect on overall activity is to expand spending on family policy while reducing other spending programmes by the same amount.
  • Finally, a number of changes to the structure of public finance can be expected to boost economic activity but widen relative income gaps yet leave no income group worse of in absolute terms. Such reforms include:
    • Lowering public subsidies, while increasing other expenditure categories by as much, giving priority to the most favourable for growth such as investment and education;
    • Lowering net wealth taxes while raising other taxes by the same amount;
    • Easing the tax burden on workers earning above-average wages while increasing other taxes to make up for the revenue shortfall.

The empirical work shows that reforms of sizes that correspond to changes that have been observed in OECD countries in the past three decades can have substantial effects on economic activity (Figure). This work can help select reform priorities in the light of their expected overall economic benefits and their distributional consequences, which will determine how inclusive, and therefore acceptable in political terms, they are likely to be. Importantly, the exact choice and design of the reforms will also have to reflect country specificities in terms of institutions and preferences.

Read more:

  • Cournède, B., J.-M. Fournier and P. Hoeller (2018), “Public Finance Structure and Inclusive Growth, “  OECD Economic Policy Paper, No. 25.    https://www.oecd-ilibrary.org/economics/public-finance-structure-and-inclusive-growth_e99683b5-en
  • Akgun, O., D. Bartolini and B. Cournède (2017),“The Capacity of Governments to Raise Taxes”, OECD Economics Department Working Papers, No. 1407, OECD Publishing, Paris, http://dx.doi.org/10.1787/6bee2df9-en.
  • Akgun, O., B. Cournède and J. Fournier (2017),“Effects of the Tax Mix on Inequality and Growth”, OECD Economics Department Working Papers, No. 1447, OECD Publishing, Paris, http://dx.doi.org/10.1787/c57eaa14-en.
  • Fournier, J. (2016), “The Positive Effect of Public Investment on Potential Growth”, OECD Economics Department Working Papers,No. 1347, OECD Publishing, Paris, http://dx.doi.org/10.1787/15e400d4-en.
  • Fournier, J. and Å. Johansson (2016), “The Effect of the Size and the Mix of Public Spending on Growth and Inequality”,OECD Economics Department Working Papers, No. 1344, OECD Publishing, Paris, http://dx.doi.org/10.1787/f99f6b36-en.
  • Hagemann, R. (2018), “Tax Policies for Inclusive Growth: Prescription versus Practice,OECD Economic Policy Paper, No.24.  https://www.oecd-ilibrary.org/economics/tax-policies-for-inclusive-growth_09ba747a-en



Does public spending foster inclusive growth in your country?

by Debbie Bloch, Public Economics Division, Economics Department

Governments today need to balance the policy goals of boosting economic growth and improving equity when making budget decisions.  How can public spending choices promote inclusive growth?  What can be learned from previous spending decisions in times of crisis?

As it becomes increasingly important for policymakers to look at public finances in terms of both growth and income equality, a new set of indicators has been developed to help governments assess how public spending can be geared toward achieving these twin goals.

A first set of indicators combines information on the mix of public spending. Each spending item share is multiplied with an estimated coefficient from growth and inequality equations to build both a growth and an income distribution component, which is then summed up to an aggregate inclusive growth indicator.  The outcomes show that public investment and family and child benefits help butress inclusive growth, while old age pensions and government subsidies hurt the most. The indicator below shows that the public spending mix is least conducive to inclusive growth in Greece and most conducive in Australia.

publicspending-components-blog debbie

Taking the analysis further, a second set of indicators adds information on the size and effectiveness of governments to the public spending mix analysis, providing an overall indicator on the effects of public spending on inclusive growth.  This indicator shows that countries with large but efficient governments, such as Nordic countries, along with those favouring inclusive-growth friendly spending items do well in the indicator ranking, while those with less-effective governments, and with high old-age pension spending tend to do worse.

 

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Policymakers need to be aware of these effects when facing hard choices, particularly during times of economic crisis.  Analysis based on these new indicators have shown there is a striking link between the growth component of the public spending mix indicator and the output gap: the capacity of the public finances to support inclusive growth deteriorated markedly in the countries hardest hit during the recent crisis, as governments slashed budgets with little regard to which items would underpin inclusive growth.

What can we take away from this?  Countries facing pressure to reduce spending during an economic downturn need to consider which spending items would be most – and least – condusive to inclusive growth, to ultimately help them come out stronger after a crisis.  Increasing public investment and family benefits, for example, while targetting reductions in less productive spending items should help assure healthier, fairer economies.

Reference:

Bloch, D. and J. Fournier (2018), “The Deterioration of the Public Spending Mix during the Global Financial Crisis: Insights from New Indicators”, OECD Economics Department Working Papers, No. 1465, OECD Publishing, Paris, https://doi.org/10.1787/2f6d2e8f-en.

Further reading:

Fournier, J. and Å. Johansson (2016), “The Effect of the Size and the Mix of Public Spending on Growth and Inequality”, OECD Economics Department Working Papers, No. 1344, OECD Publishing, Paris, https://doi.org/10.1787/f99f6b36-en.

Johansson, Å. (2016), “Public Finance, Economic Growth and Inequality: A Survey of the Evidence”,OECD Economics Department Working Papers, No. 1346, OECD Publishing, Paris,https://doi.org/10.1787/094bdaa5-en.

Bloch, D. et al. (2016), “Trends in Public Finance: Insights from a New Detailed Dataset”, OECD Economics Department Working Papers, No. 1345, OECD Publishing, Paris,https://doi.org/10.1787/4d3d8b25-en.




An empirical investigation on the drivers of income redistribution across OECD countries

By Orsetta Causa, OECD Economics department

Income inequality has increased in most OECD countries over the past two decades. This has come about both because incomes before taxes and transfers have become more unequally distributed, and because the extent of redistribution through taxes and transfers has fallen (“Income redistribution through taxes and transfers across OECD countries”). A new OECD paper by Orsetta Causa, Anna Vindicis and Oguzhan Akgun provides an empirical investigation on the drivers of the widespread decline in income redistribution across OECD countries over the last two decades.

The results suggest that the size of the redistribution system plays a major role for income redistribution, in particular on the spending side, confirming previous OECD findings. Hence, the relatively widespread decline on cash transfers to the working-age population is found to have contributed to the decline in income redistribution to the working-age population.

On the revenue side, the empirical analysis uncovers an interaction between increased economic integration and the capacity of personal income taxes to reduce income inequality. Indeed, the results suggest that stronger trade ties across countries have made a given level of tax receipt through personal income taxes less effective at reducing income inequality. The estimated marginal effect of the personal income tax to GDP (PIT-to-GDP) ratio on redistribution thus depends on the degree of countries’ openness (Figure 1): for around half of OECD countries, the effect of the PIT-to-GDP ratio on redistribution is significantly positive but this effect declines with openness levels. For a country at the OECD average level of trade openness, a one percentage point increase in the PIT-to-GDP ratio is associated with a 2% increase in redistribution. For the countries for which such effect is statistically significant, it ranges from 3.7% (USA) to around 1.5% (Korea).

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For a given overall size of the tax and transfer system, the estimation results suggest that changes in specific tax and transfer instruments have contributed to the decline in redistribution. Most important among these are:

  • Reductions in the progressivity of personal income taxes, driven by a flattening of the tax schedule in the upper-part of the wage distribution as well as by a decline in top personal income tax rates and in the taxation of dividend income at the personal level.
  • Reductions in the generosity and duration of unemployment-related transfers, including cuts to social assistance for the long-term unemployed, which have often taken place in combination with increases in spending on active labour market policies. This finding is thus likely to reflect the effect of policy reforms to boost work incentives among target groups and to shift from passive to active support for the unemployed.

At the same time, not all policy changes went in the direction of reducing redistribution: the decline in redistribution has been partly mitigated by progressive family-friendly policies, such as widespread increases in spending on early education and childcare, as well as by tax cuts to low wage earners.

These estimates are used to simulate the income redistribution effect of selected tax and transfer reform scenarios, taking into account the countries’ relative starting point in each policy area. Transfer reform scenarios deliver larger effects than tax reform scenarios. The scenarios consistently point to major redistribution gains in countries where social spending on working-age population is relatively low and/ or weakly targeted to low-income households (Figure 2). Increases in long-term unemployed- related transfers to married couples deliver major redistribution gains where these transfers are low or non-existent  (e.g. Chile, Greece, Italy, Turkey and the United States)  The magnitude of these effects reflects the large implied size of the simulated reforms for these countries and should therefore be interpreted in light of alternative policy objectives, in particular efficiency objectives in terms of job search incentives, alongside budgetary constraints.  Still, those same countries that exhibit comparatively low passive support for the long-term unemployed tend to also exhibit comparatively low active support. As a result, policy packages that would combine more generous cash transfers with more effective activation and training for jobseekers would likely meet equity and efficiency objectives. The United States and Turkey would also boost redistribution by increasing spending on early education and childcare; and so would Mexico and Japan. This would not only increase redistribution but also help narrowing gender gaps and curbing child poverty. Reforms to enhance access to quality childcare for disadvantaged families are likely to maximise policy synergies between efficiency and equity.

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References: 

Causa, O., A. Vindics and O. Akgun (2018), “An empirical investigation on the drivers of income redistribution across OECD countries“, OECD Economics Department Working Papers, No. 1488, OECD Publishing, Paris, https://doi.org/10.1787/5cb47f33-en.

 

 




Income redistribution through taxes and transfers across OECD countries

By Orsetta Causa and Mikkel Hermansen, OECD Economics department

Many OECD countries have been facing a prolonged period of low growth and stagnating income of the poorest. This challenges governments’ fiscal redistribution, all the more so in a context where new forms of work are calling into question the effectiveness of traditional social safety nets and population ageing is putting pressure on public finances. Yet, the system of taxes and transfers  that underpins social protection  is a fundamental pillar of an inclusive growth policy agenda that aims at sharing the benefits of growth more equally. A new OECD report by Causa and Hermansen (2017) (“Income redistribution through taxes and transfers across OECD countries”) takes stock of the extent to which tax and transfer systems mitigate market income inequality today, and how this has changed over a period of rising globalisation and rapid technological change.

Redistribution through taxes and transfers has tended to decline across OECD countries since the mid-1990s

Since the mid-1990s, the redistributive effect of taxes and transfers has declined in the majority of OECD countries for which data are available (Figure 1, Panel A). The trend towards less redistribution was most pronounced over the pre-crisis period, and was temporarily reversed during the first phase of the crisis, reflecting the cushioning impact of automatic stabilisers and fiscal discretionary measures. The decline in redistribution was particularly pronounced in some Nordic countries, which are among the most egalitarian OECD countries. Admittedly, the extent of the decline observed in these countries was amplified by high levels of redistribution prevailing in the mid-1990s due to high unemployment. The steadily improving labour market outlook during the subsequent decade reduced the need for redistribution. The inequality-reducing effect of redistribution also declined among the least egalitarian of OECD countries, especially Israel, but also Australia and Canada. Trends in redistribution were more heterogeneous over the most recent decade, with increases in around half of OECD countries, in particular those hardest hit by the crisis (Figure 1, Panel B).

Orsetta1

The decline in redistribution was largely driven by insurance transfers to working-age households

By and large, the decline in redistribution across OECD countries has been primarily driven by a decline in redistribution by cash transfers, which is not surprising insofar as cash transfers account for the bulk of redistribution. Personal income taxes also contributed but played a less important and more heterogeneous role across countries (Figure 2, Panel A). In turn, the decline in transfer redistribution was largely driven by insurance transfers (e.g. unemployment insurance, work-related sickness and disability benefits). This was partly mitigated by more redistributive assistance transfers (e.g. minimum income transfers, means- or income-tested social safety net) in some countries such as Germany and the United Kingdom (Figure 2, Panel B). Assistance transfers are in many OECD countries less redistributive than insurance transfers, for instance due to low take-up but also due to relatively low benefit amounts, so that their size is generally smaller than insurance transfers.

Orsetta2

Policy implications

One finding highlighted  in Causa and Hermansen (2017) is a fairly widespread shift in transfer policy from out-of-work to in-work support, at least partly driven by reforms to make work pay, especially for workers with weak labour market attachment. While this is likely to have mitigated market income inequalities by spurring employment growth, it could have contributed to the decline in redistribution. This should not lead to the conclusion that countries have no choice but to trade more efficiency for less equity. The reason is that redistribution policies should be considered as part of broader policy packages to make growth more inclusive. For example, well-designed inclusive growth packages should combine tax and transfer policies to make work pay and boost jobs with policies to improve employability, skill adaptability and wage prospects. To the extent that such packages have not been broadly deployed by OECD countries, potentially reflecting budgetary constraints, reductions in market income inequality induced by such reforms have not been sufficient to prevent disposable income inequality from rising.

References

Causa, O. and M. Hermansen (2017), “Income redistribution through taxes and transfers across OECD countries”, OECD Economics Department Working Papers, No. 1453, OECD Publishing, Paris, http://dx.doi.org/10.1787/bc7569c6-en.




Economic research on international capital flows: where do we stand 10 years after the Global Financial Crisis started?

Stéphanie Guichard, our guest author, is a former Economic Counsellor to Catherine L. Mann, OECD Chief Economist.

Financial globalisation has given international capital flows a central role in the functioning of the global economy, leading to considerable economic research over the past 30 years. Making the most of these capital flows has always been a challenge, as they can bring both good and bad. On the one hand, they can support long-term growth through a better international allocation of saving and investment, through technology and management improvements associated with FDI inflows or through enhanced transparency and corporate governance due to the exposure of flow recipients to international investors. On the other hand, they complicate macroeconomic management of recipient countries, increase financial vulnerabilities and amplify domestic distortions, and can lead to financial crises and sudden stops with negative implications for economic growth.

This challenge has become even more acute after the Global Financial Crisis financial revealed the complexity of global financial relations and their role in shock transmission. The crisis also questioned the ability of fundamentals to protect countries from financial instability and the global financial cycle. Overall it showed that global financial integration has not only led to an increase in the size of capital flows (annual gross cross-border capital flows increased from about 5% of world GDP in the mid-1990s to around 20% in 2007) but has also affected the drivers of these flows as well as the transmission and contagion mechanisms.  For instance, there has been a growing decoupling between gross and net flows since the late 90s which means that surplus countries do not necessarily “finance” deficit countries, and economies with a balanced current account may still get important financing from abroad and be vulnerable to sudden stops. These changes have implications for a wide range of policies from surveillance, to how to best deal with inflows and outflows in order to reap their benefits while reducing associated risks. Moreover, over the past few years, while financial globalisation has marked a pause, the nature of capital flows has continued to evolve and new concerns have emerged.

The new OECD working paper Findings of the Recent Literature on International Capital Flows: Implications and Suggestions for Further Research takes stock of recent empirical and theoretical research. It assesses how this literature helps assess the current situation, associated risks and policy needs.  The main findings are as follows.

  • Foreign debt accumulation by EMEs non-financial corporation has become a potential source of instability. Foreign debt accumulated by EMEs non-financial corporation (NFC) has increased substantially since 2010. There is also evidence suggesting a significant part of this debt has been financing financial assets acquisitions or deposited in local banks rather than investment in fixed assets, supported by the favourable carry trade opportunities resulting from the low dollar interest rates. A USD appreciation and an increase in dollar interest rates could hence lead to a fast unwinding on some of these positions.
  • The protecting role of good fundamentals is being questioned. The capital inflow surge to EMEs that followed the implementation of QE in advanced economies, the “taper tantrum” episode, the vulnerabilities associated with EME corporate borrowing have all revived the debate on EMEs vulnerabilities to global financial shocks, especially the monetary policy stance in advanced economies. The analysis of push (global) and pull (local) factors has focused on the mechanisms by which push factors affect EMEs and whether some fundamentals affect the sensitivity of countries to these factors. and mitigate the impact of the global financial cycle. However, findings have been mixed, potentially questioning the traditional view that good fundamentals necessarily protect countries from financial turbulences.
  • The ability of exchange flexibility in mitigating the risks associated with capital inflows is also questioned. The existence of a global financial cycle that affects countries independently of their exchange rate regime has questioned the ability of the move towards more exchange rate flexibility by many EMEs over the past two decades to shield them better from financial turbulences than the less flexible regimes of the 90s. This is especially the case as exchange rate fluctuations may amplify the impact of financial shocks via balance sheets effects. While this point is largely shared by recent analyses, the further implications for policy making including monetary policy and capital controls is under debate. While some argue that under full capital mobility, countries outside the US lose monetary autonomy, even with flexible exchange rate, and call for a greater use of prudential and capital flow management tools, (e.g. Rey 2016), others reject this view and rather stress that central bankers have to deal with worse trade-offs related to financial stability issues (e.g. Banerjee et al. (2015) and Obstfeld (2015)).
  • While capital controls have been increasingly considered as a complementary policy tool to deal with international capital flows, evidence on their impact remains inconclusive. The reliance on capital controls or more generally capital flow management measures remains an important, and yet unsettled, policy debate regarding international capital flows. As the risks associated with international capital flows have become more obvious, there has been a slow shift in the post-Bretton woods consensus view that capital should be allowed to move freely across countries and that the use of capital control, even in face of large inflows or sudden stops, was unwarranted. However, most of the issues regarding the use, effectiveness and spillover effects of capital control remain largely open, as empirical results point to different directions, partly because of the diversity of the measures of capital controls that have been used, the different time horizon and countries under review.
  • International policy coordination is essential. Deeper global financial integration means that monetary and financial shocks are transmitted through the financial system across countries and that imbalances or credit booms abroad can affect the domestic economy and its stability, as seen during the financial crisis. Domestic policies, especially monetary and financial policies, may spill over to other countries and even have spillback effects on the domestic economy. Hence international cooperation and coordination of policies have been put forward to deal with international capital flows in three main areas: monetary policy; capital control management and more broadly financial policies; the global safety nets.

The paper points to many areas where further investigation is needed to guide policy making. They include the role of fundamentals in protecting countries against the risks associated with capital account openness, the impact of exchange rate fluctuations taking into account the balance sheet transmissions channels, the costs and benefits of capital controls, financial policy spillovers, the costs and benefits of the global financial safety net, the drivers of capital outflows — especially as China is further liberalising its capital account–, how the characteristics of the sectors receiving/exporting inflows affect the drivers of the flows and their impact on the economy.

References:

Banerjee, R., M. Devereux and G. Lombardo (2016), “Self-oriented monetary policy, global financial markets and excess volatility of international capital flows“, BIS Working Papers, No 540 Jan.

Guichard, S. (2017), “Findings of the recent literature on international capital flows: Implications and suggestions for further research“, OECD Economics Department Working Papers, No. 1410, OECD Publishing, Paris.

Obstfeld, M. (2015), “Trilemmas and Tradeoffs: living with financial globalization” in Global Liquidity, Spillovers to Emerging Markets and Policy Responses, edited by C. Raddatz, D. Saravia, and J. Ventura, Santiago, Central Bank of Chile.

Rey, H. (2016), “International Channels of Transmission of Monetary Policy and the Mundellian Trilemma”, IMF Economic Review, Vol. 64, Issue 1.

 




Time to deploy the fiscal levers actively and wisely

by Catherine L. Mann, OECD Chief Economist, OECD Economics Department

The role of fiscal policy has been at the heart of the policy debate since the financial crisis. With the global economy stuck in a low-growth trap and monetary policy overburdened, it is time to re-assess the use of fiscal policy levers.

Government interest payments have fallen sharply as interest rates have declined to very low levels, freeing up cash. In addition, new OECD estimates show that “fiscal space” – the gap between current government debt and levels at which market access would be compromised – have widened since 2014, as lower interest rates have more than offset headwinds from lower potential growth. This creates a window of opportunity.

fiscal-levers-two

Most OECD governments have space to pursue a ½ percent of GDP deficit-financed “fiscal initiative” to support productivity-enhancing measures for 3-4 years without increasing public debt in the medium term. The withdrawal of deficit financing after the initial fiscal initiative and the outcome of higher growth from the initiative are enough to ensure that debt sustainability does not deteriorate, while the low interest rate environment means that stimulus is not crowded out.  The benefits are greater if boosting short-term activity helps to avoid high and persistent unemployment, if countries reduce regulatory burdens, and if countries undertake these efforts collectively.

fiscal-matrix

While it may be easy to relax the fiscal stance, the success of the fiscal initiative to promote growth, enhance long-run potential output, and improve debt sustainability depends on an effective strategy of additional spending or tax reductions to achieve more inclusive and higher growth.

Several major economies are now using the fiscal levers more actively, following the consolidation of the years following the crisis. But, some countries – notably in Europe – have yet to seize the opportunity.

However, are countries using the fiscal levers more wisely? The evidence of recent years is that many countries have cut the share of spending on investment and education, while increasing the share of taxes that are most harmful to growth and equality. A shift toward a more effective mix is needed.

The OECD is today releasing new research on the mix, size and quality of public investment, including a new dataset on the composition of public spending. Soft investment, such as skills and R&D, together with well-governed public investment in infrastructure, can yield large growth gains. Good institutions enhance the effectiveness of government spending and tax policy.

The policy debate will continue, but now is the time to deploy the fiscal levers actively and wisely !

References:

OECD (2016), “Using the fiscal levers to escape the low growth trap“, in OECD Economic Outlook, Volume 2016 Issue 2, OECD Publishing, Paris.

Mourougane, A., J. Botev, J-M. Fournier, N. Pain and E. Rusticelli (2016), “Can an increase in public investment sustainably lift economic growth?” OECD Economics Department Working Papers, No. 1351, OECD Publishing, Paris.

Botev, J., J-M. Fournier and A. Mourougane (2016), “A reassessment of fiscal space in OECD countries“, OECD Economics Department Working Papers, No. 1352, OECD Publishing, Paris.




Most countries have room to increase public investment

by Jean Marc Fournier, Economist, Public Economics Division, OECD Economics Department

Public investment benefits current as well as future generations. My research shows that public investment is a game changer, when it comes to boosting long-term growth. Increasing the share of public investment in primary government spending by one percentage point (offset by a reduction in other spending) would increase the long-term GDP level by about 5%. For countries that are catching-up to the productivity frontier, there is also evidence that public investment can substantially speed up the pace of convergence.

Public investment is good for economic activity because it stimulates private investment. Indeed, a recipe that mixes public and private investment produces a bigger economic pie. For instance, roads and railways connect firms. This suggests that the most relevant investment projects are those with the largest spill-overs. For instance, investment in health (hospitals and their equipment) is found to have a large effect as healthier workers are more productive. Investment in research and development also can have a particularly large effect as public research can spur private innovation.

The long-term effect of public investment depends on the initial level of the public capital stock, which includes, for instance, roads, schools or patents. In countries where this initial level is relatively low compared with the size of the economy, there is more scope for high-yielding investment projects. The analysis shows that virtually all countries have room to expand the public capital stock, with the exception of Japan, where it is already very large (Figure).

estimates-of-decreasing-returns-to-public-investment

The evidence that the public capital stock is below its optimal level means that public investment should rise above the pre-crisis level. However, the opposite has happened. In most countries, public investment has declined substantially during the recent fiscal consolidation period. In 2015, net investment was even negative in Germany, Italy, Portugal and Spain. This means that public investment does not suffice to compensate for the natural depreciation of the existing public capital stock in these countries. In the United States, net investment has reached an almost record low level of 0.5 per cent of GDP in 2015, so that the public capital stock grows much less than GDP.

Major challenges are to identify the right investment projects, and to implement them in an efficient way. For this, governments need sound public investment policies (provide the right incentives, carry out cost/benefit analysis underpinned by good data). Moreover, the focus should be on projects with high spill-overs.

References:

Source: Fournier, J.M. (2016), “The Positive Effect of Public Investment on Potential Growth”, OECD Economics Department Working Paper, No. 1347, OECD Publishing, Paris.

Related material see:

The effect of the size and mix of public spending on growth and inequality

Using the fiscal levers to escape the low-growth trap