A Model of State Infrastructure with Decentralized Public Agents : Theory and Evidence

The imperative of the state, irrespective of its organization, is to provide law and order, contract enforcement, and property rights. The government provides the foundation for markets to function and for society to prosper. A common thread in any government is that, for a given society, the state holds a monopoly over most of its services. Although the state may choose not to exploit this market power, the public agents that represent the state within the aggregate production process, necessarily will. The following paper presents a macroeconomic framework that explicitly considers the local monopoly power of public agents. In the context of a representative agent model, I consider a private sector production function versus a public sector production function in which both sectors compete over labor and capital. Estimates are made of the productivity of private versus public capital, of private versus public labor, and of public infrastructure within the private sector production function. The theoretical implications of decentralized public agents are then analyzed within an endogenous growth framework. The results suggest that the elasticity of public infrastructure is significantly lower than previous estimates. They also confirm that the elasticity of private infrastructure is country specific. The theoretical results suggest that decentralization of public agents which, intuitively is greater in less developed countries than industrialized ones, is associated with steeper growth paths that lead to lower steady state capital labor ratios and per capita consumption levels. This implies that shocks to less developed countries have more dramatic effects but shorter life spans than shocks to industrialized countries, or more simply, business cycles in developing countries are shorter but more volatile