Public Investment Rules and Endogenous Growth with Empirical Evidence from Canada

This paper examines theoretically and empirically the effects of public investment rules on output growth in an economy with private and public capital. It is shown that the decisions on public capital formation are closely associated with the growth rate of output and generate endogenous growth. A permanent change in the policy rule implies a new long‐run growth rate of output, but the economy will only gradually approach the new steady-state due to adjustment costs in private capital accumulation. The model predictions are tested using data from Canada for the period 1955--1999. The data support the endogenous growth hypothesis and the two central assumptions of the model: (i) the growth rate of output follows closely the rate of infrastructure formation and (ii) private capital formation also follows the rate of infrastructure formation but adjusts with a delay. Copyright Scottish Economic Society 2003