Human capital formation and public debt: growth and welfare effects of three different deficit policies

Abstract

We analyze an endogenous growth model public educational spending. We show that the balanced budget policy and the policy with a slight deficit yield higher growth than a debt policy where public debt grows at the same rate as GDP, unless the government is a creditor. As concerns welfare, it can be demonstrated that a strong deficit policy yields lower welfare than a balanced budget and a slight deficit policy, unless initial debt ratios are low and the intertemporal elasticity of substitution is high. Finally, there may exist an inverted U-shaped relation between welfare and deficit-financed educational spending.

Keywords:

• public debt
• human capital formation
• economic growth
• welfare

AMS Subject Classifications:

• E62
• H52
• H63

Acknowledgements

I thank three referees for comments on an earlier version that helped to improve the paper.

Notes

No potential conflict of interest was reported by the authors.

1 Further models as well as empirical evidence can be found in Greiner and Fincke (2015).

2 We omit the time argument t if no ambiguity arises.

3 For more details which debt policies guarantee sustainability, see Greiner and Fincke (2015).

4 The denotes BGP values and we exclude the economically meaningless BGP and is not feasible because h is raised to a negative power in Equation (13(13) ).

5 For more details as concerns the strong deficit policy, we refer to Greiner (2008).

6 Technically, this implies that public debt and the debt to physical capital ratio are negative.

7 This implies that the primary surplus is defined exclusive of the tax revenue from interest income. But, using the gross interest rate to discount public debt and including the tax revenue from the interest income in the primary surplus does not change the outcome.

8 A debt to capital ratio of 10, 30, 50, and 70% implies an initial debt to GDP ratio of 33.2, 99.6, 166, and 232% for , respectively.

9 Note that a decline in represents a deficit-financed increase in educational spending.