14 and education spending; 3) both papers show that an increase in unproductive expenditures is associated with lower GDP growth rates, while productive expenditures are marginally significant with a positive growth effect; 4) the impact of taxes is unambiguously negative and significant<sup>12</sup> , with the magnitude of the coefficient similar to the elasticity of output with respect to productive expenditure.

For policy purposes the main lesson is to consider jointly the effects of both spending and taxation on economic growth. The signs and magnitudes of the tax and expenditure variables in both studies cited above, indicate that both effects offset each other when dealing with productive expenditures, but in the case of unproductive expenditures the effect will be unambiguously negative. These results explain why many countries that instituted generous pension benefits in the past, and have had to reduce productive spending or raise current taxes to pay those liabilities, experience slower growth, such as Brazil, Uruguay, and Colombia.

# **2. The difference between investment (flow) and public capital (stock)**

Besides considering the effect of the additional resources required to fund spending, policymakers must bear in mind that growth and welfare depend on the flow of services provided by capital, rather than on spending itself. The services, in turn, are better approximated by the capital stock, while investment spending is associated with changes in it. Hence, the amount of investment that actually is transformed into public capital, or the efficacy of investment, is an essential element to incorporate in the measurement of the impact of public spending on growth or estimations of the rate of return of public spending. Initially, in the area of infrastructure, researchers were limited by data availability on capital stocks and public investment. Hence, researchers inferred the efficacy of public investment from aggregate macro data and results indicated that between 40 and 50 percent of investment was incorporated into physical capital, with great variability across countries (Pritchett, 1996 and 2000).<sup>13</sup> These findings have clear analytical and policy implications. From the analytical viewpoint, the ineffectiveness would explain why some studies don’t find a relationship between public investment and growth. When simulating the growth impact of changes in public capital spending it would be advisable to include some measure of the effectiveness of investment (Agenor, et. al. 2007). From the policy standpoint, changes in public capital spending are not linked one-to-one with changes in output. In terms of

> 12 In the Adam-Bevan paper, while in the WB paper the tax coefficient is negative and significant in three out of 4 cases

> 13 Pritchett estimated the efficacy of investment based on a growth accounting exercise. He estimated the rate of capital accumulation that would be consistent with a “true” Total Factor Productivity (TFP) growth of between 0 and 1 % per year.  This “implicit” rate of factor accumulation would be compared with the observed rate of capital accumulation.  Generally the implicit rate would be much smaller than the observed rate, leading Pritchett to conjecture that recorded (actual ) figures overestimated the real capital accumulation due to the low efficacy of investment. Efficacy fluctuated between 8% and 95%, depending on the TFP benchmark (0 or 1%) and the region, with Sub-Saharan Africa and South Asia exhibiting the lowest efficacy and the high performing Asian economies reaching (95%).  The OECD average fluctuated between 74% and 98%.