1 Public Investment: Growth and Quality Measurement By Vinicius Pinto de Menezes Advisor: Prof. William Handorf Washington, DC – December 20072 INTRODUCTION.......................................................................................................................3 1 - PUBLIC SPENDING..............................................................................................................5 1.1 - Scarcity of resources..................................................................................................5 1.2 - Externality....................................................................................................................7 1.3 - Information..................................................................................................................7 1.4 - Paternalism..................................................................................................................8 1.5 - Market power.............................................................................................................8 1.6 - Infrastructure...............................................................................................................9 2. PUBLIC INVESTMENT AND GROWTH................................................................................11 2.1 – Rate of growth.........................................................................................................11 2.2 - Productivity................................................................................................................12 3 – FISCAL POLICY.................................................................................................................14 3.1 – Endogenous growth models..................................................................................14 3.2 – Growth effects of taxes and expenditures in a “Barro model”........................15 3.3 - Budget deficits and growth....................................................................................16 4 - PUBLIC EXPENDITURE MEASURING.................................................................................17 4.1 – Investment evaluation............................................................................................17 4.2 – Methods....................................................................................................................22 CONCLUSION........................................................................................................................24 REFERENCE.............................................................................................................................273 INTRODUCTION In the Century 20th, public investment sector was one of the most important factors in the economic growth all in many countries all over the globe. At that time, the governments’ role was fundamental once it was the only one capable of raise a considerable amount of funds to spend in productive area. In the other hand, economic growth means demand for social services and expenditures. Decades later, increasing needs in investment, infrastructure a public services, allied to constrains budgets, led countries an upward fiscal deficits causing poor results in social development and economic growth. So, the size and the role of state were put in discussion. The conclusion was that, to be more effective, public sector should be smaller – The Minimal State -, providing only the essentials services and leaving economy take care of itself. The State should change directions from “enterpriser” to “regulator” in order to recovery capacity in make investments in infrastructure an provide services with quality. In this context, reforms have been made inspired by the belief of the efficacy of market solutions, looking forward not only withdraw the public sector from areas where private sector could operate better, but also searching ways in which market could improve performance in areas that would remain in the public sector. Nevertheless, these reforms have shown various results in different countries and, mainly in low-income and developing countries,4 many times the expected growth didn’t happen or happened in lower level than expected and necessary to be sustainable. The villain became current expenditures or, in another words, the resources that governments spends to maintain itself and other inefficient social policies. So, the reforms have stocked in a certain point that, in order to cut expenses to allow government to recover investment capacity got to, it is necessaries put in place unpopular changes in laws that can take decades to happen, since sometimes involves cultures and believes as well. But, as said in Brazil, “the optimal is good’s enemy”. So, in present paper it will be shown a model that defines the conditions to reach economic growth from a certain ratio of capital to current expenditure. Besides this, since the scarcity of resources is something really hard to solve, maybe is time to discuss evaluation of public investment. By Investing with quality government can maximize the allocation of public funds and bring effectiveness to public service.5 1 - PUBLIC SPENDING 1.1 - Scarcity of resources The increase of the demand for public services and the increasing necessity of investments in infrastructure necessary for the economic growth put pressure under government to enlarge its structure and to increase public expenses in a bigger ratio than the growth of revenue from taxes. In low-income and developing countries, the problem was getting worse by the degradation of public accounts caused by currency emission, that generate inflation, and by securities issuance, that compromise future revenue. Fiscal disequilibrium led to the degeneration of services provided to population and to a harder administration of public debt that suffer with the increasing interest rates and diminishing terms. One of the consequences was the retreating of the capacity of investment in both public and private sector (crowding-out). Public debt grew skyrocket and capacity of government’s spending became critical.6 The solution was cutting both current and capital investments, which includes the downsizing of state institutions, privatization of public enterprises, economic liberalization and moreover, some services were transferred to private sector (under