ABSTRACT
This paper investigates how the long-run rate of economic growth can be affected by government spending and public debt policies in a small open economy. Models of endogenous growth provide a natural starting point for studying the growth incidence of government intervention in the economy. In this framework budgetary policies may affect the long-run rate of growth in two possible ways. On the one hand, through a ‘supply-side channel’, government spending in the form of the provision of public goods generates production externalities that directly affect the return to capital. This mechanism was first investigated by Barro (1990), who established a ‘Laffer-type’ relationship between the long-run rate of growth and the share of government spending to output. On the other hand, budgetary policy may influence the long-run rate of capital accumulation through a ‘demand channel’, by altering the aggregate propensity to save. Of course, this mechanism cannot be operative in an infinite-horizon, representativehousehold economy. As is well known (Barro, 1974), in such an economy Ricardian equivalence of public debt and taxes always holds. Moreover, changes in government spending are just compensated by changes in the private savings rate, therefore leaving capital accumulation unaffected. In order to get non-neutrality of budgetary policy with respect to growth, one has to consider some degree of selfishness in the economy-by dropping the assumption of a fully operative chain of intergenerational transfers-as, for instance, in Diamond (1965).2
