2 complementary to private investment. The international experience, as surveyed in a multi-country study by Easterly, Rodriguez and Schmidt-Hebbel (1994), suggests that it is far more common for public investment to crowd out than to crowd in private investment.<sup>2</sup> Another way that public investment affects output growth is by influencing the rate of productivity growth, independent of its effect on factor accumulation. If public infrastructure capital is complementary to private capital, an increase in public investment would not only attract more private capital, thereby boosting factor accumulation, but it would also render private capital more productive. This effect is absent when public investment substitutes for private investment. In fact, it will even reduce overall productivity if public expenditures are made with less regard for appropriate procurement procedures than private investment. That is, a Peso of public investment will have bought fewer goods or machines than the same Peso invested by the private sector, so that the level of actual capital accumulation would be lower than the measured capital accumulation<sup>3</sup> -- which in a growth accounting framework becomes reflected in lower productivity.

The same is true if public investment expenditures are made with less concern for efficiency and profitability than private investments. When measured by the amount spent, the public capital stock would overstate its true value, which is measured more appropriately by the discounted stream of returns. If, for example, public investments are directed to sectors or regions based mainly on an expected political payoff, their financial returns will obviously be lower than those of private investments primarily undertaken in response to profit incentives. Furthermore, to the extent that this public capital is not properly operated and maintained, the rates of return diminish even further.

Finally, the impact of public investment on growth may also depend on how that investment is financed. To the extent that an increment in public investment is financed through higher taxes or through increased public debt -- which spreads out the tax burden over time -- the net return of that investment is reduced by the distortionary impact that those taxes may have on the economy. That distortionary impact on growth also manifests itself through the two channels discussed previously: (i) on reduced factor accumulation, which occurs when higher taxes lead to a net reduction in total investment, and, (ii) on lower productivity, which occurs when investors shift to less socially

- 2 Among their main findings and conclusions, the authors state, "The conventional wisdom that public investnent is good for private investrnent is contradicted by the evidence in half of the case studies, where public investment has a negative and statistically significant effect on private investment. The negative association in some cases is explained by the likelihood that public investment is replacing rather than complementing private investment. Concentration of public investment on infrastructure and on privatization of other state enterprises would ensure a complementary relationship between the public and private sectors." (pg. 1).

- 3 Pritchett (1996), for example, provides calculations to show that in a typical developing country, less than 50 cents of capital is created for each public dollar invested.