Public investment crowds in private investment – with ifs and buts

Abstract

This study explores the relationship between public and private investment using a sample of 33 industrialized economies of the OECD. The methodology relies on the fact that the relation between stocks of public and private capital can affect private investment also in the short term. We demonstrate that the immediate effect of public investment on private investment is either small or statistically insignificant, whereas in the medium to long term, extra public investment crowds in private investment as the latter adjusts in order to bring the stock of private capital closer to its long-term cointegrating relationship with public capital. The estimated median public investment multiplier over a horizon of seven years is around 2, which means that each additional dollar of public investment attracts approximately two dollars of private investment. Additionally, we examine whether the crowding-in effect depends on a country’s institutional quality and the area of public spending. We show that it gets stronger with improvements in the quality of institutions related to the rule of law, government effectiveness and control of corruption. Public investment in economic affairs, education and health infrastructure is the most effective in attracting private investment.

Keywords: public investment, private investment, crowding in, crowding out, public investment multiplier, local projections, forecast errors, governance quality indicators.
JEL codes: C23, E22, E62, H54