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Martin Beznoska / Björn Kauder / Thomas Obst IW-Policy Paper No. 2 3. February 2021 Investment, Human Capital and Growth Effects of Public Spending

Unlike public sector consumption, public investment is often regarded as contributing to growth. Yet while spending on "intangible" goods such as education does not count as investment, even though it is potentially growth-enhancing, expenditure with little to no effect on growth often does.

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Investment, Human Capital and Growth Effects of Public Spending
Martin Beznoska / Björn Kauder / Thomas Obst IW-Policy Paper No. 2 3. February 2021

Investment, Human Capital and Growth Effects of Public Spending

IW-Policy Paper

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German Economic Institute (IW) German Economic Institute (IW)

Unlike public sector consumption, public investment is often regarded as contributing to growth. Yet while spending on "intangible" goods such as education does not count as investment, even though it is potentially growth-enhancing, expenditure with little to no effect on growth often does.

This raises the question as to whether the concept of investment should not be expanded to include government spending that has an impact on the future but is currently classed as consumption.

The traditional distinction between government consumption and public investment is not always clear. Expenditure is often defined as investment if it results in an asset which can be used repeatedly in the production process and potentially generates income in later periods, and which is at the free disposition of its owner or funding body. Educational expenditure is thus mostly defined as consumption because while it serves to generate future income, the productivity it builds up is person-related and thus not unrestrictedly available to those funding it.

In contrast to consumption expenditure, investment projects have a longer-term and sustained effect on an economy and a positive impact on its growth potential. Studies of the effect of fiscal policy measures on GDP find fiscal multipliers between 0.3 and 1.7, suggesting that government spending increases GDP but not necessarily private activity. Both macroeconomic models and the majority of empirical studies confirm the importance of human capital investment for economic growth. However, empirical identification is not without its problems and the results are much more heterogeneous than the literature often suggests.

In view of the relatively low rate of public investment activity in recent years, economists are calling for the creation of an investment fund of around 450 billion euros over the next ten years. The selection criterion for projects to be financed by such a fund should not be whether they meet the classical definition of investment, since, especially in the case of infrastructure projects, particularly on the municipal level, personnel costs will often be an essential component. Rather, goal-related cost-benefit analyses should be conducted to ascertain the long-term impact of each individual investment project. The projects should also meet the criterion of additionality. For projects that include ongoing expenditure, continued financing beyond the timespan of the fund needs to be secured.

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Investment, Human Capital and Growth Effects of Public Spending
Martin Beznoska / Björn Kauder / Thomas Obst IW-Policy Paper No. 2 3. February 2021

Martin Beznoska / Björn Kauder / Thomas Obst: Investitionen, Humankapital und Wachstumswirkungen öffentlicher Ausgaben

IW-Policy Paper

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German Economic Institute (IW) German Economic Institute (IW)

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Melinda Fremerey / Andreas Lichter / Max Löffler in CESifo Working Papers External Publication 20. June 2022

Fiscal and Economic Effects of Local Austerity

We study the consequences of a large-scale austerity program targeting financially-constrained municipalities in Germany. For identification, we exploit the quasi-random assignment of treatment among equally-distressed municipalities using a ...

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Michael Grömling IW-Trends No. 2 9. May 2022

The Productivity Effects of Capital Formation in Germany

Despite broad-based digitalisation, productivity advances in Germany in recent years have been considerably lower than in previous decades. This paper conducts a growth accounting which points to steeply declining stimuli from technical progress and especially ...

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