public infrastructure, and education and health facilities are significant. Based on the model and the calibration exercise, a practical rule of thumb seems to be that about two-thirds of public investment should be directed towards public infrastructure that facilitates market production. The remaining third should be split more or less evenly between public investments in facilities that support the provision of health and education. Such a division of resources would maximize (per capita) income and welfare. This is due to the fact that the facilitation of market good production directly increases the availability of public resources, while the other two expenditure categories first have to permeate the economic system before affecting the availability of public resources and thus growth and utility. This result has relevance for policy debate on the composition of expenditure necessary to achieve the Millenium Development Goals (MDGs), which include an income target (halve the number of people below the poverty line) as well as specific targets related to the achievement of health status and access to educational services. The stylized model in this paper suggests that greater emphasis on the health and educational targets relative to investments that may contribute to expansion of market production may result in slower progress on reducing poverty.

During this numerical exercise, attention was also paid to the evolution of public debt. Quite surprisingly, the debt-to-income ratio was almost invariant to all possible investment expenditure compositions. In the considered case the ratio stabilized below 70%. Here the rule of thumb seems to emerge that in the long run debt sustainability does not pose a problem as long as resources for public investments are used in a growth-maximizing way.

We conclude with some observations regarding possible extensions of the model described in this paper. One possibility (described in the appendix) is to estimate the model using time series methods. However, this will only be possible for countries where high-quality time series data are available. An important extension of the model would be to develop the revenue side of fiscal policy in order to study the effects of various forms of taxation on per capita income. Another extension would be to consider the growth implications of variations in the balance between recurrent and capital expenditure by allowing government employment of teachers and doctors. Finally, the debt sustainability tests proposed in this paper could be applied to country-specific studies.

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