GOVERNMENT POLICY ANO PRIVATE ~ INVESTMENT IN BRAZIL
(1955/82)
19 8 70 1 881
THESIS SUB~ITEO TO THE ASSEMBLY THE GRAOUATE SCHOOL OF ECONOMICS (EPGE) OF THE BRAZILI~~ INSTITUTE OF
ECONOMICS TO OBTAIN
THE OOCTOR'S OEGREE IN ECONOMICS
BY
. MARCIO VAL~RIO RONCI
Rio de Janeiro, RJ June , 1987
TESE DE DOUTORADO
APRESENTADA
À
EPGE
-C I R -C U L A R NQ 36
Assunto: Apresentação e defesa
pública de Tese de Doutorado
em Economia
Comuniaamos formalmente ã congregação da Escola que está marcada para o dia 16 de julho de 1987 (5a. feira), as 15 : 30h., no Auditório Eugenio Gudin (lOQ andar) , a apresentaç ão e defesa pública da Tese de Doutorado, intitulada: "POLtTICA ECO
NOmCA E INVESTIMENTO PRIVADO NO BRASIL (1955/82)", do candida
-to ao título de Dou-tor em Economia , Mareio Valeria Ronci.
Anexamos uma súmula dessa Tese Doutoral para seu prévio estudo .
A Banca Examinadora "ad hoc" designada pela Es-cola será compos ta pelos doutores: Fernando de Holanda Barbosa, lIelson Cava lcanti Braga, John James Thomas(*) e Mario Henrique Sirnon se n(Presidente) .
Com esta convocaçao oficial da Congregação de
Professores da Escola , estão ainda convidados a participarerndes se ato acadêmico os alunos da EPGE , interessados da FGV e de outras ins ti tui ções .
Rio de Janeiro, 29 de junho de 1987
Ma~~Sirn
Diretor da EPGEo nsen
Obs: (*) Professor do Dept.of Economics , da "The Lendon School of Economics"
,,-t "ormllO l .. t~rna d O Il. 1
ESCOLA D E PÓS_GRADU AÇÃO E M EC ONOMIA DA FUNDA ÇA o GETUI..IO V AR G A S PRAIA DE eOTAFOGO. Iga/1 0," ANDAR RIO DE JANEIRO . aRAS l1.. _ C!:P 22.2~O
LAUDO SOBRE TESE DOUTORAL
Como i ntegrante da Banca Examinadora , designada pela EP,GE para julgar a tese doutoral , intitulada " POLtTICA GO-VERNAMENTAL E INVESTIMENTO PRIVADO NO BRASIL, 1955/82 ", do candid!'.
t o ao titulo , Sr. MÁRCIO VALt:RIO RONCI , apresento as seguintes
IX>!:!.
derações que justificam meu parecer e . voto:1) O candidato produziu um traba l ho de excelente qualidade técni-ca e que constitui urna signifitécni-cativa . contr,ibuição para omelhor conhecimento da economia brasileira;
2) Demonstrou perfeito dominio da teoria econômica e do instrumen ta l econométrico , e
3) Ao longo do processo de e l aboração da tese revelou a capacidad e de iniciativa e o rigor analítico que caracterizam o bom pes-q u isador em economia .
. Assim , e nessas condições , sou de parecer que a referida tese seja aprovada e outorgado o título pretendido p e lo candidato e autor deste trabalho .
Rio de Janeiro , 16 de julho de 1987,
~ELSON
CAVALCANTEoBRAGA, - - -ExarnTno:dor-eonv-id-ado-, _---ESCOI.A DE PÓS-GRADUAÇÃO EM ECONOMIA
DA FUNDAÇÃO GETUI.IO VARGAS PRAIA DE eOTAFoGO, 190/10.0 ANDAR RIO DE .JANEIRO - BRASIL - CEP 22.250
f
LAUDO SOBRE TESE DOUTORAL
Como integrante da Banca Examinadora, designado pela EPGE para julgar a tese de Doutorado intitulada "PO-Ll:TICA ECONÔMICA E INVESTIMENTO PRIVADO NO BRASIL (1955/82) ", do candidato ao titulo, Sr. MARCIO VALERIO RONCI,apresento as seguintes ponderações que justificam meu parecer evoto:
1) O autor contribuiu com a sua pesquisa'para um melhor conhecimento dos fatores que determinamo comportamento do investimento do setor privado na economia brasileira no periodo recente;
2) O autor contribuiu na sua pesquisa, sobre utilizar com proficiência a teoria econômica e os métodos econométri-cos na investigação de um tema bastante importante da economia brasileira.
Assim, e nessas condições, sou de parecer que a referida tese seja aprovada e outorgado o titulo pretendi-do pelo candidato e autor deste trabalho.
Rio de Janeiro, 16 de julho de 1987
ESCOLA OE PÓS-GRAOUAÇÃ.O EM ECONOMIA OA FUNOAÇÃO GETULIO VARGAS PRAIA DE BOTAFOGO. 190/10.0 ANDAR RIO DE .JANEIRO· BRASIL - CEP 22.2:50
DOCTORAL THESIS VERDICT
As a member of the examination board, appointed by EPGE in order to
evaluate the {lo~toral thesis "POLITICA ECONOl1ICA E INVESTTI1ENTO PEDI !J)()
NO BRAZIL: 1955/82" (GOVERNHENT POLICY AND PRrrATEINVESTHENT IN :BRAZIL: 1955/82)
of Mr MARCIO VALERIO RONCI, I present the following remarks that justify my
opinion:
1) The candidate has provided a ~ell-researched and penetrating summarJ of the previous work that has beendone on the subject of invest;nent and, in particular, the problem of 'crowding out'.
2) He has proceeded to develop a model that is sensible anà seems suitable for application to a country such as Brazil. This has involved the use of judgcment and good econo~c theory.
3) He has handled the collcction of data well and made sensible decisions about what to do when faced with problems of missing data &~d data adjustment. 4) While at the London School of Economics, he worked h2~d in Econometric Theory and, as a result, the econometric &~alysis in his thesis is excellent. He has set UI' his hypothesis in a proper manner, in order to obtain explicit results and has applied appropriate diagnostic tests ·to ensure mis-specification is detected. Having found evidence of a structural break in
1973,
he has handled the problem well with the aid of dummy variables. .5) Having derived interesting results, he has proceeded to complete the
analysis with a thoughtful discussion of the policy implications of his empirical findings.
6) Overall, this is an excellent piece of applied econometric research.
Therefore, in my opinion the cited thesis should be approved and the
Doctor' s Degree in Econoi!lics should be granted to the author 01' this work.
A-4 Formeto Internacional ZJOx2S7mm
London, 16 July 1987
John James Thomas,
Lecturer in Economics at
LAUDO SOBRE TESE DOUTORAL
Como integrante da BAnC? Examinadora, designado pela EPGE para julgar a tese de Doutorado i~titu1ada "PO-L1TICA ECONÔMICA E INVESTIMENTO PRIVADO NO BRASIL (1955/82)
li,
do candidato ao título, Sr. MARCIO VALERIO RONCI,apresento as seguintes ponderações que justificam meu parecer e voto: 1) Trata-se de um trabalho que contribui para a explicaçãodos fatores qte dete~minam o investimento privado no Brasil assunto pouco explorado na literatura econô-mica.
2) O trabalho ~ desenvolvido e~ excelente nível te6rico. 3) Os métodos eeonometricos sao usados cem profissionalismo
e competência.
Assim, e nessas condições, sou de parecer que a referida tese seja aprovada e outor~ado o título pretendido pelo candidato e autor deste trabalho.
A-4- Formato Internacbnal
UOx291ilüll""'-Rio de
JaneW=:987.
~~~enr
j...q.i..l.e--S±mónsen I~or/EPGE e
The questlon of the crowding-out of private !nvestment
by public expenditure, public investment in particular , ln the
Brazilian economy has been discussed more in ideological terrns
than on empirical grounds. The present paper tries to avoid the limitation of previous studies by estlmatlng an equation for
private investment whlch makes it possible to eval uate the effect
of economic policies on prlvate investment.
The private lnvestment equation was deduced modifylng the optimal flexible accelerator medel (OFAM) incorporating some channels through which public expendlture influences private
investment. The OFAM consists in adding adjustment costs to the
neoclassical theory of investrnent. The investment fuction deduced is quite general and has the following explanatory variables: relative prices (user cost of capitaljimput prices ratios), real
interest rates, real product, public expenditures and lagged
private stock of capital.
The model was estimated for private manufacturing industry data. The procedure adopted in estimating the model was to begin with a model as general as possible and apply restrictions to the model ' s parameters and test their statistical significance. A complete diagnostic testing was also made in order to test the
stability of estirnated equations. This procedure avoids ' the shortcomings of estimating a model with a apriori restrictions on its parameters , which may lead to model misspecification.
The main findings of the present study were: the
increase in public expenditure, at least in the long run, has in general a positive expectation effect on private investment greater than its crowding-out effect on priva te investment owing to the simultaneous rise in interst rates; a change in economlc policy, such as that one of Geisel administration, may have an important effect on private lnvestment ; and reI ative prices are relevant in determining the leveI of desired stock of capital and private investrnent.
I would like to acknowledge the awards frem the
Brltish Councl1 and the National Program for Econornlc Research
(PNPE), which made this research possible . I also thank J . J.
Thomas and Helson C. Braga for their elese tutorlng and José
Luis Carvalho, Pedro Luiz Valls Pereira, Mario Henrique Simonsen
and Fernando de Holanda Barbosa for helpful comments, Margareth Hanson Costa and Alice Gusmão Veloso for the data used in this research, Maria Luiza Altieri and Geoffrey Gilbert for reviewing the manuscripts and Fabio Ronei for drawing the graphs. I am
specially grateful to Proi. Paulo Rabello de Castro who
graciously gave me logistic support and incentive to undertake
this research. Finally I could not forget Ofélia Barbosa de Barros who patiently and efficiently typed this paper.
Chapter one
Chapter two
PRIVATE INVESTMENT VERSUS PUBLIC EXPENDrruRES. .• 1
Notes.. . . . . . . . .. 5
PUBLIC SECTOR AND PRIVATE INIIES'IMENT IN BRAZIL. . . 6
2.1 - The Fir s t Round of Inport SUbstitution:1947/61 7 2 . 2- public Sector Between: 1947/61 . . . • . . 8
2.3 - The G100my Years: 1962/67 •. . . .• ••.•••••• 10
2 . 4- The Brazilian "Go l den Years " : 1969 / 73 . . . 12
2.5 - The Impact of ExternaI Shock s : 1974/83 .. 13
2.6- The 1 949/83 Period in Review • • . • . . . 16
Notes . . ... .. .. ... .. . ... .. . .. . . .. . . 19
Chapter three THE SPECIFICATION OF THE INVES'IMENJ' FUNCTICN • .. . 30
3 . 1- The J\ggregate Investrrent for Deve10ping Countries 31 3.2 - The Optimal Flexible Accelerator Model .. 35
Notes .. . . .. . . ... . . .. . . .. 42
Appendix to chapter three . . . .. ... 44
Chapter four EMPIRICAL RESULTS .• • .•••.• . • . . . . • .•• • .. .. ..••• 47
4 . 1- Tailoring the Model . . . 47
4.2- Data . . . .. . . • . • . . .. .• . . .. . .. . . 48
4.3- Fitting the Mod,ü . . . . • . . . . .• . . . •.. . . 5 0 Notes . . .. . . . .... .. ... . . .. . . ... . . 57
Chapter fi ve CONCLUDING ' REMARKS ... . .. . . ~ • •••• ~ •• • ••• • ••• 60
Notes . . . . .. . . • . . . .. . . 66
APPENDIX : Data Sources . .. . . .. . . .. . . 68
REFERENCES . . . .. . . .. . . • . . . 76
Tab. 11.1 'Relative Size of Brazilian Public Sector • .•. . . 21 Tab. 11.2 Real Growth of GNP I Private an:l Publlc Investments ••••• 22
Tab. 11 .3 Chronology of Important Events . • • • . . . • . • . • . . . • • .. 23 Tab. IV.l Estima t es of Private ManUfactur.1.n:] rnd.ustry Invesbrent •• 55 Tab. V .I 'Average Long Run Elasticlties of Private
Manufacturing Industry (se l ected periods) •. •• •.•.•. 67
LIST DF FIGURES
Fig. 11.1 Shares of Total Priva te and To tal Public
InvestInents lil GNP . ••• • •••••• • ••••••• •.•••••• •• ••• 24
Fig. 11 . 2 Shares of Total Priva te Company, Public Company
and Federal Governrnent Investme nts in GNP •.•...•• 25
Fig. 11.3 Shares of Private Manufactu ring I ndustry and
Total public Inves tments in GNP .•..•. •••••••.. . •• . 26
Fig. 11.4 Real Growth of Total Private and Total
Public Investments . . • .•. • •••••••••.••.... •. . .•.. . .• 27
Fig. II . S Real Growth of Tota l Private Company, Publlc
Company and Fede ral Governrnent Investments •.... .. •• 28
Fig . 11.6 Real Growth of Priva te Manufacturing Industry and Total Public Investments •. ..• .•.•• •....•.. •..• . .... 29
Fig. IV.l Actual and Fitted Private Manufacturing
Industry Investment (equation 3
1 •.••••• • •. •..•.• .
56CHAPTER ONE
PRIVATE INVESTMENT VERSUS PUBLIC EXPENDITURE
It 15 widely accepted that public expenditures and ln particu l ar public inve s trnen~provldes a s i gnificant stimulus
to private investment and a powerful lnstrument of stabilization
and growth. In the developed countries the debate on public
policies has centered on the effectiveness of countercyclical
fiscal policy . The crowding- out phenomenon 1s well known in the
economic literature. Crowding- out occurs whe n expansionary
fiscal policy causes interest rates to rise , thereby reducing
private spending, particularly investment. As governrnent
spending increases aggregate demand output tends to rise. But
the highe r output leveI raises the demand for money and; hence ,
the interest rate in the asset markets . The higher interest rates redu ce the leveI of investment spending , or crowd out private investment . The extent of the crowding - out will depend on the inte r est rate sensitivity of dernand for rnoney and of
private expenditure
l~
In general, Where the deficits are moredebt - financed the crowding-out will be greater
l /.
Regarding private investrnent much of the ~ecentempirica l evidence appears to be consistent with the crowding-out phenomenon. In the case of the USA and CanadaCebula ( 198 5, 1980 and 1975) and Ostrosky (1979) showed that partia1
crowding-out of private investment by public expenditures (governrnent
consumptlon and investrnent) does occur and has moreover a 10n9 term inflationary impacto For Britain Arestis (1979) presented similar results. The critique to these studies 1s that they foeus only on the increase of aggregate deman~ by public
expenditure ignoring entirely the public investment. in
infrastructure and its 10n9 term effects o n the growth rate of the economy .
The relationship between public and pr ivate investments in deve10ping countries has been 1itt1e studied in general or properly tested against empirical evidence. Pionering works on this subject are those of Blejer and Khan (1984) and Sundararajan and Thakur (1980). The authors deve10ped models of investment dernand adapted to the particular institutiona1 characteristics of deve10ping countries, which is the close interaction between government policies and the private sector . In both works they were ab l e to find evidence that government investment crowds out private investment in the short run but is has positive long term effec~on private investment.
models and did not study in detail tbe relationshl0 between public and
prlvate 1nvestments . The most recent studies on prlvate
lnvestment demand focusing on the competition for physical ar
financiaI rescurces, which might be taking place between the
public and private sectors in Braz!l, have been discussed more
in ideologlcal terms than on empirical grounds. An account of the present state of this debate can be feund in Martone (1983
and 1981) and Coutinho and Reichstul (1983 and 1977) I which show
tWQ extremes of the idelogical spectrum . Martone argues that
4 /
the rise in public enterprise - investIrent has been the main
faetor in reducing private lnvestment in recent years and that
the government was negle cting its important function, which is
to provide public services such as education and health ,
investing mainly in productive activities. On the other hand
Coutinho and Reichstul say that public enterprise investment is
rnainly countercyclical with a positive lagged effect on private
investment. Th e y also affirm that the government with pressing
economic problerns, such as inflation and balance of payrnents,
has cut public enterprise investment generating instability in
the economy and reducing private investment . The flaw in these
studies is the lack of empirical evidence based on some
theorétical background . Both authors observing only the strong
nega tive autocorrelation pattern between private and public
company inves.tments ended up with very different conclusions.
It will be useful at this point to summarize the
channels through which public investment affects p rivate
a) public lnvestment competes with the prlvate sector for scarce
physical and financiaI resources and, therefore, exerts a
negative influence, at least in the short run;
b) to the extent that public lnvestment replaces private lnvestment by creating infrastructure and raising the
productivlty of the private capital stock, private lnvestment
requirements per unit of output are reduced;
c) increased public lnvestment raises the demand for private
sector production and thereby influences output expectatlons
and investment requirements of the priva te sector;
d) pub lic investment raises aggregate output and savings
supplementing the economy 's physical and financiaI reSQurces,
and this offsets at least part of any initial crowding-out effect on private investment.
Therefore the cri ti cal issue is . whether the positive effects of public investment are strong enough to offset the negative effects , and how long they will last. This is very important in assessing the growth effects of stabilization programs involvin g control of public expenditure.
The objective of the present paper is to estimate a private investment demand function and study the interaction between government po licies, in particular its investment
with a summary of the main empirical results
irnplication for economic policies.
Notes
and their
1. We rule out the extreme cases of the Liquidity trap (LM
hori-zontal) and the Classlcal case (LM vertical) .
2. A permanent real deficit financed by debt 1s stable only if
the nominal lnterest rate on public debt 1s srnaller than
the growth rate of the economy.
3. It 1s worth noting that even a balanced fiscal policy will
have an expansionary effectan inane(The Balanced Budget
Multiplier Theorem), lead to an increase in the demand f o r
rnoney, a r i se in interest rates and, hence, rnay reduce
private investments.
4. Throughout this work the term public enterprise ar public company 1s used to denote a company which 1s partly ar
CHAPTER TWO
PUBLIC SECTOR AND PRIVATE INVESTMENT IN BRAZIL
The' public sector began to have more influence on the Brazilian economy after 1930. It was mainly the result of the Great Depression, which forced the governrnent to intervene i n the economy to avoid a sharp reduction of aggregate dernand, and a strengthenlng of the State due to a corpo rate ideology borrowed fram fascismo The immediate i.npact of tre Great Depression was a big drop in Brazilian export revenues fram 445.9 milIion dollars in 1929 to 180.6 milIion dollars in 1932. In an eo:::nany largely dependent on farm exports this could give rise to a severe decline in GNP, employment and the balance of payments surplus. However the measures adopted by the governrnent
11
succeeded in counteracting the effects of the World crisis As for the balance
oI
payments, a combination of quantitative controls and exchange rate devaluations reduced imports from 416.6 mil1ion dollars in 1929 to 108.1 mi1lion dollars in 1932. Income from the export sector was to a great extent protected by governrnent support to coffee prices and the famous burning of coffee surp1uses, which in 1929 rep~ted70 % of export revenues. These policies sustained aggregate demand preventing the crisis from deepening
~(
chemicals and cement. The Second Wor ld Nar gave a further inpetus
to lndustrlalizatlon. The lnternational shortage of various
goods and difficulties in maritlme transport lead to a drop in
imports of 10% between 1939 and 1942. Although exports decreased they becarne more dlverslfied and gained with the improvement in
the terms of trade. The country was able to increase its
forelgn currency reserves, and dornestic industry without foreign
competition grew fast
l(
The 1930/47 period also witnessed a growth in public
companies. Natlonalization of the railways and marltime
transport, the settlng up of the Vale do Rio Doce Mining Company
(CVRD) in 1942, the National Alkali Company and National Motor
Plant (FNM) both in 1943 and the National Steel Company (CSN)
in 1945 are some examples of the expansion in the productive
activities of the public sector
il
2.1- _ First I<:>und Of II\port'Sú>stitution: 1947/ 61
Soon after the Second World War the governrnent lifted
quantitative contrels on imports and as a consequence of the
intensity of repressed import demand foreign currency reserves
were quickly depleted. Exchange contrels carne into force again
in 1947 and were kept until 1953. "In view of the shortage of
hard currency a policy designed to provide substantial protection
to .domestic industry frem forelgn competition was put into
effect. Firstly, protection was achieved through a system of
import licenses, which were denied for products produced
adopted where imports were classifled lnto five groups, each
one cor r esponding to a specific exchange rate that was fixed
through an auctlon of vouchers issued for each class of goods.
At a later date heavy tariffs were levied on imports . The
adoption of policies to deal with balance of payment problems
resulted in incentives to lndustrialization, as Baer puts it:
'''lhe industrial1zation illpulse after the seo:nd . Wor1d War was initial1y a roilsequance of
neasuze5 acbpted to ccpe wi til balance of paynent prcblems. cn1y litUe by litUe
(that 15 to say in the fiftie5) did these
neasuze5 beoare de1iberate tools to pronote
the fonration of an industrial carplex'·.
(Baer, 1983 , p. 42)
Between 1947 and 1956, as a consequence of such a
developrnent policy concentrating on import substitution , the GNP
grew 6 . 4% per year on average . The expansion of agriculture
was less impressive (3.9% per year) but industrial output
reached an average annua l figure of 8.8 %. Industrialization
was mainly directed towards the production of raw mate rials and
capital goods, which had been almost totally imported
~ / .
In the mid 50's the foreign exchange po licy was not
only an instrument to deal with balance of payment problems
but also a policy to promote industrialization
~ / .
2.2 - Pub11c Sector Between 1947 / 61
In this period government investment and planning
played a very important part providing infrastructure to the
World War the first plannlng attempt was the SALTE plano Thls
was a 5 year program of public spending in faur sectors: health, food, transport a,nd energy. The pIan was to have been carried
out in the 1950/ 54 period with a total estimated spending of
19.9 billion cruzeiros. However it soon ran lnto difficulties
and lasted for no more than a year rnalnly. due to financiaI
problerns.
The next most ambi tious and cx::mprerensive planning effort
was the work of the Brazil-USA Commission for Economlc
Development, which made a complete survey of the Brazilian
economy and formulated a series of infrastructure projects with
their respective executive programs for the 1951/ 53 period. The planned spending on railways, roads, harbour facilities and
electricity was equivalent to 387.3 million dollars in fore1gn
loans and 14 billion cruzeiros in domestic resources.
The p lan of the Brazil-USA Cornrnission was never formally
approved but r es ulted in a series of benefits. It led to the
creation of the National Bank for Economic Development (BNDE),
which a imed at analysing and financing development projects.
Many studies of the commission were later used as the basis
for projects financed by the BNDE and international institutions.
Analysts of the BNDE and Latin American Economic
Commission (CEPAL) carried out a systematic planning effort
between 1953 and 1955. Based on the 1939/ 53 period, this work
main1y consisted in examining the behaviour os some economic
7/
aggregates and in making forecasts for a seven-year period -.
This concern with development and p1anning was 1ater
Kubtschek (JK) administration (1956/61). This program was not
a global plano It did not comprise alI bas1e industrles and
neither sought to adjust aggregate demand to available reSQurces.
The five braad areas included in the prograrn were: energy,
transport, food, basie lndustries and education. Investments
in infrastructure were directed to eliminate bottlenecks and in
many cases projects prepared by the former Brazil-USA OamUssion
were used. In terms of basie industries the objective was to
give incentives to sectors such as aluminum, metallurgy, cement,
cellulose , chemicals , heavy mechanics, shipbuilding and motor
cars . The JK admi ni stration created special programs for each
industry administered by BNDE and Executive Commissions to
8/
propose particular measures and follow up such programs - .
2 . 3- The G100my Years: 1962 / 67
In the 1956/61 period the Brazi lian economy achieved
high growth rates. GNP expanded 7% a year on average, the
agricultural production 5 . 8 % and industrial output 11.1 % a
year. This was the consequence of a policy o f industrialization
at any cost, protected by heavy customs duties and currency
exchange incentive s, and lar ge public investments undertaken
by the JK administration.
However the strategy adopted in the 50 ' s left behind
i t a series of problems such as backward agriculture, income
d~fferences between regions, inflation and balance of payment
problems. The short-lived Janio Quadros administration tried
president b09ged down any serious effort to solve them. The
Goulart government was a period of political turma!1 and there
was no consistent economic policy. prlvate and foreign
investments declined due to the political uncertainties and
the growth rate of the econorny fell steadily ln relation to
the 1961 peak.
After Goulart ' s departure, in april 1964, the Castelo
Branco administration forrnulated a short-run policy prograrn
(Government Economic Operation program - PAEG) , whose main 90a1s
were control of inflation and correction of distortions owing
to the rapid import substitution process of the fiftles.
Severe measures were adopted such as cuts in ~t
outlays, the elirnination of subsidies , a squeeze on private c~t
and wage controls. The new administration also made a suxessftll
tax reform, which gratly increased tax revenues. Parallel to
this stabilization program a great number of structura1 reforms
were made. Among the most important ones were the mxEnUzatian
of the financia1 and stock markets. Special tax exemption
incentives were granted for investments in sectors that the
government wanted to develop
~ (
After 1964 the government did not reduce its _ inve~t
expenditure. The investments in infrastructure of projects
underway continued and at the same time sectorial studies were
made in order to expand the electricity supply , the transport
system , urban facilities and heavy industry. However there was
a considerable lag between the studies and the time the actua1
inve stme nt were made, as a result of comp1ex negotiations for
blg projects was only felt in the late slxties 10/
2.4- The Brazilian "Golden Years": 1968/ 1973
The 1968/ 1973 period contrasts with the years of
economic slow-down, 1962) 1967 . The GNP grew at an average rate
of 10 % a year. Is seems that these hi gh ~ rates cauld not have been achieved if the stabilization policy, institutional
reforms and planning had no t been adopted in the 1964 /6 7 per1od.
The main slngle source of gr ow th in 1968/ 1973 was the
economic actlvity of the public sector . The real growth of
total public investment (including public enterprises) was 8.9%
a year between 1968 /73 compared to 7.8% a year durin g the 196 21
1967 period . The proportion of governrnent expenditure in the
GNP rese frem 17.1 % in 1947 to around 30% in the early
seventies 11/ The share of total public investments in the GNP
wa s an average 7.0% in 1968 /73 compared to 6.6% in the
1962-67 period.
The productive activities of the public sector a lso
expanded in that period. During the sixties the · big pub li c
companies became predominant in electricity generation.
Their share in total production increased from 36% in 1962 to
80 % in 1971 . The public companies were responsible for 56% of
t o tal sales and 72 % of total assets in the steel industry. A
single public company , eia . Vale do Rio Doce, was responsible
f o r arround 80% of total exports of iron ore. Petrobras , the
largest Brazilian company, accounted for 41 % of total sales and
had 81% of total assets of the Oil and Petrochernical industry
telecom systems and CCIltrolled 70% of rnaritime transporte
!l(
During the mid-sixties the governrnent made studies to
expand the public power companles and the transport network and
started huge investment programs at the end of the decade.
Modernization in sectors dorninated by ~ublic companies such as petrochemicals and mining was also carried out. The
expansion of the steel industriy 90t underway in the early
seventies when loans trem international institutions became
available. Finally the Housing FinanciaI System (SFH) oantrilxUred
a great deal~wards boosting the bui l ding industry. Ther,e was a lar ge increase in loans trem SFH, which rase trem 89 milIian
c ruzeiros to approximately 14 billion cruzeiros in 1972 13(
An examination of these facts suggests that public
investment in infrastructure and the expansion of publi'c
companies may have played an impo rtant r ole in the fast growth
of the Brazilian economy in 1 968/ 73.
2 . ;; - Impact ,of Externai ShocJ,s, .1974/83
In the late seventies and early eighties the Brazi1ian
economy wa s again in a state of disarra y , which left nostalgic
memories of the "Go1den Years". Inf1ation r ose from 1ess than
40 % in the mid- seventies to an average of 100 % in 1980i 82 period
and readled 211% per year in 1983 . The r ea l GNP growth rate ,
which was on average 7% a year in 1974/ 79 fell to 0 . 8% in the
1980/ 83 period . The total investrnent as a percentage of GNP
decreased from 26 % in 1974 - 79 to 20.6% in
1980/
83!!~
The 1974( 83Figueiredo admlnistratlons. In both subperiods the government
used the public oompanies to carry aut economic policies.
After the Oil Crisis in 1973, the Geisel administration
.
(1974 / 79) sought a policy of accommodation in arder to preserve
real GNP growth at the expense of a rise in lnflation. The
government undertook an ambitlous investment program 1n lts
public companies after 1975, which reached its peak in 1979.
This program was rnainly directed t owards the p r oduction df
energy (the building of power plants , oil mining and production
of alcohol as an alternative fuel) and a second round of import
substitution (heavy engineering, fertilizers and metallurgy of
non-ferrous meta I s) .
In order to finance this program i t was necessary to
borrow heavi1y from abroad and in the darestic market . 'lhe GoveI1'Ul'eIlt ' s
deficit as a percentage of GNP grew from 1.4% in 1974 to 13.1 %
in 1979 as a consequence of the c onsiderab1e increase ~_ in
pub1ic investment 15/ .
In 1979 the Figueiredo administration (1979/85) was
faced wi th a huge externaI debt , the servicing of which a:msurred 67%
of e xport revenues, internationa1 demands t o e1iminate tax and
credit subsidies to Brazi1ian exports, a falI in agricu1tura1
production due to bad weather, the SeccI1d Oi1 Crisis as a\consequence
o f the Iranian situation and the dramatic impact of rising
l~ternat ional intere st rates.
In December 1979 the government adopted the fo11owing
measures to cope with the increasing disorder in the economy: a
30% deva1uation; e1iminated the one-year deposit on the
increased the tariffs on public se rvices; revoked the
Similar Law, which protected domestic goods tram foreign
competition; eliminated the deposit on the entry of capital;
reducted of the tax on lnterest sent abroad fran 12.SS\ to 1.5% to incentivate borrow:i:.ng trem abroad; and .introduced a wage Bill , whid"l reduced the period of adjusting wages to rising livin g costs
trem one year to 6 months 16( Early in 1980 the governrnent
announced that exchange rate devaluation would be limited to
40% and indexation of contracts to 45% a year. It also strengthened price contraIs on industrial goods to avoid
readjustments in prlces owing to devaluation, higher tariffs on
public services and prices of agricultura! goods. The government
also planned to limit credit expansion to 45% for the year
' 17/
and cut public enterprise investments by 8% - - o
However actual credit expansion was a great deal above
the target set (79.3 %), the wage Bill contributed a great deal
to the increase in industrial costs and price controls were not
effecti ve. As a consequence of this bcx::>st of aggregate demand real
GNP~ew 7.9 % and inflation rose to 110% in 1980. Improvement in export competitiveness due to the devaluation of December 1979
was partially lost because devaluations fell short of inflation
during 1980. By the end of 1980 the target for the exchange
rate was disregarded. As for the balance of payments , the huge
externaI debt was respons1ble for the large deficit in the
current account 18( In the 1981/83 period, as a consequence of
high inflation and serious balance of payment problems which
were worsened by the rise in international interest rates
and the internationaldebt crisis , the country went into its
A rnain ieature oi the 1979/ 83 period was that pub1ic
companies were instruments in economic policies with serious
consequences for their financing and investment capaclty . These
companles were used b y the gove rnrnent t o borrow rnoney irem abroad ln arder to finance the balance of payrnent. They became
very vulnerable to devaluations and increases in international
interest r ates because their liabilities in foreign currency
grew rapidly ln this per1od. The financiaI situatión oi
public companies was also worsened by governrnent regulation of
their tariffs in order to control inflation and cuts in Treasury
financing . AlI these factors greatly reduced the lnvestment
capaclty of public companies in this period 20 (
2.6- The 1 949t1983 Period in Review
Figure 11.1 and Table 11,1 show that after the Second
World War until 1956 ~ figures for total government investment as a percentage of GNP and total investmen t were very low, 3 . 2% and
20.2 % respectively. Total government investment in r eal terms was fairly constant in the same period (Fig. 11.4). Although there were three plannlng attempts between 1947 and 1956 none
was successfu1 and the government c1ear1y p1ayed no active part
in the economy. The re al growth rate of private investment was
very 10w and unstab1 e . 'I1E figures for total ?ri vate invest:ne'lt and for
manufacturing industry investment . were - 0.2% and 11.4 % respectlve1y (Table 11.2) , showing no evidence of
countercyc1ica1 policy in the period.
unti1 1973 (Fig. 11.1 and Tab1e 11.1). Governrnent investment
in the period was on average twice the arnrnount invested by the
public companies (Fig. 11.2) . The total ~rivate investment
share in the GNP increased Qver the whole period with small
reversals in 1964 and 1 967. The share of private manufacturing industJ:y
investrnent in the GNP was fair l y stable during the saroe
p~riod (betw~en 6 and 8 % of GNP). In terms of real growth,
both private and public inves t ments increased during the period ,
even in t he 196 1 /67 subperiod of l ow GNP growth. The variance
of total private investment waS lower than the forme r period
as Table I1.2 indicates. These facts show that the governrnent was successful1 in stabilizing private investment
expenditure.
Another major feature of the 1957/73 period was that
publ ic investment was eaneentrated in infrastruetu re (here
re? rese nted by Federal government investment) as is shown in
Figure 11.2. This faet may suggest that during this period
publie investment was eamp l ementary to private investment.
The relative smoath 1 957/73 period was fallowed by
one of great instability. The 1974{83 periad ean be divided
inta twa subperiods. The first ane, the Geisel administratian
(1974 / 79) ,witnessed a huge investrrentpragram, mainly in public
enterprises . As we can see in figure 11.2 Federal g:>verment investrcents
declined steadi l y in the period as opposed to . !?ublle
campany investments , whlch greatly increased their share in the
GNP rising from 2.1% in 1 957 / 73 to 6.3% in the 1974 / 79
1
7.
In the second period after 1979 Federal investment
through posltive and negative phases owing to the stabilization
programs of the Figueiredo _admlnistration 22/.
pri vate investment suffered the consequences of these policies. During the 1975/ 79 period the boost in public
enterprise lnvestrnent seems t o be highly negatively oorrelated with
the private l.nvestment as i t 1s shown in figures 11.2 and 11.5 23/.
After 1979 the combination of low GNP growth, decreased
investrnent in infrastructure and highly variable public company
lnvestrnents was extremely prejudicial to the private sector.
Table 11.2 ShOW5 the unsteady pattern of grc7W'th in total private and
manufacturing industry investment in the period, -1. 7% and -2.8 % respectively. In both cases the growth rates were
low ar negative and their variances rese a great dea1.
However, an ana1ysis of the 1974/82 period does not
allow us to determine /wbe.ther government investment acted
countercyc1icaIIy or whether i t crowded out private investment.
The negative ,corre l ation between pubIic and private
investments during this period could be interpreted as evidence
o f crowding-out as well as a lagged response of tle goverrurent to
Notes
1. For a summary of 1930/ 47 period see Sirnonsen (1974) p . 34-35.
2 . Sirnonsen (1974) p . 34 .
3. 51monsen (1974) p. 35. For another account of the governrnent
policies during the Great Depression see also Furtado (1976)
p. 186-94.
4. Baer (1983) p. 264 - 65.
5. Sirnonsen (1974) p.
6 . Baer (1983) p . 42. For a detailed description of the import
substitution process in the 1948 /6 1 period see Tava res(1979)
p. 63 - 99.
7 . Baer (1983) p. 57 - 58.
8. For an exarnination of JK ' s Target PIan see Lessa (19B3)
p. 27 - 91. For a description of the role of the BNDE and
Executive Commissions in the excution of this p lan see
Benevides (1979) p . 224-33.
9. A swnmary of the Castelo Branco fad!!ú.ni.stration I 5 po licies can
be faund in Simonsen ( 19'74) !' . 39-4 O. For a detailed account
of that period see Viana Filho (1975),
10. Baer (1983) p. 229.
11. Baer (1983) p. 241.
12. Baer (1983) p . 242.
14. Inflation figures are percentual varlation rates Dec-Dec of
IGP price lndex from Conjuntura Econômi'cêt:, (April 1984). GNP
figures from Nationa l Accounts published in Conjuntura
Eco-nômica (March 1985 ). 15 . Marques (1985) p. 36l.
16. Baer (1983) p. 414-15 .
17. Baer (1983 ) p . 416. 18. Baer (1983) p. 417. 19. Baer (1983) p. 420.
20. For an evaluation of how governrnent policies affected public
companies in the 1980/83 period see Werneck ( 1 985) p. 23-24.
2 1 . Marques op. cito
22. Werneck op . cito
23. The correlation coefficient between private and public
company investments was 0.94 in 1947 / 73 and -0 .85 in the
1974 /8 4 period. The correlation coeff i cient between private
and Federal governrnent investments was 0.94 in 1947/73 and
TABLE 11.1
.Relative Size of Braz11ian Pub11c Sector
\ (as a percentage , per10d average)
.Federal Publ1c Enterprise Total Publ1c
Years
Investment Investment
Total "Manufacturing
industry
..$hare in t he GNP
1947/56 3.6 0.5 0 .4 ( *) 4 .1
1957 /73 4.6 2.1 1.0 6.7
1968 /73 4.5 2.5 1.0 7 . 0
1974 /82 3.1 6.7 2 . 2 9.8
1 974/79 3.5 6 . 3 2.1 9 . 8
1980/82 2.3 7.6 2 . 3 10.0
Share in To tal Fixed Investment
1947 /56 21.2 2 . 9 2.5(*) 24.1
1957 /73 22.5 10.3 5.0 32.8
1968/ 73 18.1 10.2 4.1 28.3
1974 /82 12.5 28 . 5 9 .1 41.0
1974 / 79 1 3.3 25.0 8 .2 38.3
1 980/82 10 . 9 35 .7 10. 9 46.6
Note: (*) 1953/ 56 pe riod
YEAR 1947/ 56-1957/73 1968/ 73 1974/ 82 1974/79 1980/ 82 N.otes
TABliE II.2
Real Growth of GNP , Private and pub l ic Investrnents .
(percentual var i ation, period average)
Private Investment Fed.Gov. public Enterprise
•
.
InvestmentGNP Invest .
Total : Manufac .. Ind.
Total Manufac.
.
6.4 - 0.2 -1.4 (*) 7.3 13 . 9 (2.4) (21. 7) (10.0) (16 . 8) (56 . 0)
8.8 12.7 18. 8 12.1 26 . 2 28.8
(5. O) (13.1) (31.1) (18 . 2) (43.4) (66 . 0) 11 . 1 18.7 . 35.9 8 . 6 16 . 5 27.8
(1.6) (9.2) (22 . 6) (14 . 7) (46 . 5) (88.4)
5.4 0.6 -3.4 0 . 02 26.3 26.4
(3 . 7) (18.5) (54 . 5) (11.2) (40.8) (37 . 9) 7.0 - 1. 7 -2 . 8 - 1.2 38.0 40 . 9 (2.2) (11.4) (50 . 9) (12 . 7) (38.2) (33.6)
2.2 5.1 - 4.8 2 . 4 2.9 -2.7
(4 . 5) (31. 7) (73.5) (9.0) (41.9) (32 . 1)
The numbers in brackets are standard deviations
(*) 1953/56 period
Ind.
Sources : see appendix
Total Public
Invest .
7.1 (17 . 4)
14 . 2 (19.6)
8.9 (13.3)
13 . 5 (23.6)
18.9 (18.6)
Chro nology of important events
30
Grea t Depression
•
~
Beginnlng of Stateintervention in
the economy
~
,
.
40•
~
Foundation of bigSecond World War public companies
,
,
474
~
Post - war planning
First round of attempts
import substitution
,
,
56I
JK ' s Target Pr ogram61
64
•
Bu l hões - Camposstabilization program
~
,
adjustments) (reforms and67
First Oil Shock 74
4
~ Second round ofi1lport substitution
~
,
79Second Oil Shock
Increase of International Interest rates
International Debt Crisis
,
83 Getúlio Vargas adm . 45 Jusoelioo Kubtschek administration Janio/Jango -Castelo Branco administrationCOsta e Si!
vai
~ci adm.
Geisel adm.
Figueirecb adrn.
24
20
15
1-2
8
4
o
~
'.,
.
.'
..
.
',~
,
,
,
,
,
,
- '1955 1957
total private
investment
~
total publh:
__
investment
,, -.... , /.-' '. .
,
,
,
__ '-, I _. __ ' ','
- ""
...
,---
-
..
~/ '..
:
'-.'
• •
1961 1965 1969
1973
I .. ' \
,
-'
1977
1981/ /
,
24
20
IB
12
B
4
o
-total pr,ivate,
Investment
'\
federal goverment
publlc compony
"
Investment
Inves/menl,' \
I
~.-j
,
...
,
"
,,'
,
...
--.
__
...
.-"'-,, ,-
..
~ ,.'....
~'.-.-/ . .
"'.-'0;"-. •
I , " ... _ .
--...
...
_~
,
.
...
,
." .
.
"
"
,
"
...
-
...
'
...
,_
...
-
....
-.-.
,.-
... ....
,."
"
_ . ... . _ . ... <1"*
1955 1957 1961 1965 1969 1973 1977
/9BI
"
12
10
8
6
4
2
O
I
" I
~,
.
, ' , I I
•
'.'
rotal public
Investment
,
"
,
,
1\ ... , . \
I\. I ' ,
,
,,,
'
,
'
, , I , , \
, # , , '
I ' I
I ' I
"
,
" . , . I "
"
,
,'-',
~,
'
,o"~
' , / '
,r-'"
II ... " ",
I'· '
~
_ .
•
II • - " • ,
:
~
private
Industl'
rnanufacturing
investment
1955 1957 1961 1965 1969 1973 1977 1981
'"
70
60
50
40
30
20
10
O
.--10101 privale Inveslment
..
'1 ' ... · - - '
_.----
...
~ -..
_.'
,,-
.-
-
"
,I
,"\
,
,
,
,
.
, ' I
,
,
,
"
,
...
,
~I 0.
I
,
I
,
,
.
" lotai pubhc
, in veslmenl
I 4
• I
I' ... ",
. _ . ____ . _.1'
.--1955 1957 1961 1965 1969 1973 1977 1981
,
,
,
70
80
50
40
30
20
10
O
total private
.
.
.
publ
i
C compony ;jnvestment
,\
j
~
.
,.
,
;
\
.
, .1
• '\o
I
,
•
I
~-i
te
dera I gov.
;
inyestm
ent
/,/
._0 ._, .
J . ' •
'r -
...
....
.
.
...
-... . . - J(" , ...
• -.. . '" I
. ,. ... __ .- ,t '"
.-
... .
'",.-
...
....
."....
.
"
,_._ ....
_
... .
,
... ___ .
..
'_.'0_'--'-'---1955 /957 1961 1965 1969 1973 1977 1981
'"
.'"
80
50
40
30
20
10
O
--
,.--'"'--- , , '
1953
1957
,'I
,
,
,
r,
I \
I ,
I ,
I
I
i
total public
Iinvestmel'lt
~,'
, I
I I
1/
_ _ - I
_...
.. _,
''' -
..
'"--, o'
/ ,
-,
1961
196~1969
,
I
, .
'\,.,.,
,
'
I
"
..
/I •
I I I
,
,
1973
y I I,
,,
privote mOl'lufoc.
industry mas'lil6lf
\
1977
1981
I ",
'"
CHAPTER THREE
THE SPECIFICATION OF THE AGGREGATE INVESTMENT FUNCTION
As was discussed in chapter one goverrunent p:>licies,
in particular public investments, may have positive and negative effects on pr ivat e investment and, hence, the criticaI issue 1s
whether the positive effects of public lnvestment are strong
enough to balance its negative effects, and how 10ng they will
last.
Modeling alI the effects of public investment on
private lnvestment (listed in chapter one) may prove very
difficult and only possible within a complete growth madel where
besides the aggregate investment function we alsa have the production and savingsrelationships of the economy. The approach adopted by the present work 1s a single equation madel which takes account only of: (a) direct ~ crowding-out arising from the competition between public and private investments for scarce .physical and financiaI resources; b) substitution effect between public and private investments, resulting from public investment raising the productivity of the private stock: of capital and, hence, reducing private investment requirements ger unit of outputi c} expectaticn effect 0f oublic investment on output and private investments. A important positive effect will be left out:
public investment raises aggregate output and savings
This chapter 15 divided lnto tWQ parts. The first
one examines an adaptation of the models for determlnin9
private investment demand rnade by Blejer and Khan (1984) for
developing countries. The second part proposes an extension
of that medel using the optimal flexible accelerator modelo
3.1- Tn~ Aggregate Inyestment for " D~veloptng Countries
Recently there have been attempts to develop models
of investment, which take account of particular lnstitutional
characteristics feund in developing countries. The main feature
of these countries 1s the elose interaction between governrnent
policy and the private sector. one examp l e of this kind of mede1 was deve10ped by B1ejer and Khan (1984)!( They used a
variant of the flexible accelerator mode~, adapted to inoorporate
some institutional and structural characteristics of developing
countries.
They specified an adjustment function for gross
investrnent, as follows
~ /
(111 .1 )
where IP is gross private investment , IP* is the desired level
of investment, which is a function of the lags in the leveI of
output, and b is the coefficient of adjustment between desired
and actual investment, which is related to the stage of the
cycle, the availability of financing and the leveI of public
by affectlng the speed of adjustrnent rat he r than by directly
changing the desired leve I of real private l nvestment. The
authors adopted the following linear representation for the
coefflcient of adjustment
1
= b
o + --~~ (IP~ - --- IP (bl
t _1)
(III.2)
where GAP expresses cycllcal factors , given by the difference
between the actual output and the output trend ; OCR 1s the
change in real bank credit to the private sector; and GIR 1s
the rea l pub l ic sector investment. Suhstituting (111.2) lnto
(111.1) and the desired leveI of lnvestrnent hy the 1ag5 in
the leveI of output we can derive the following estirnable
function for actual investment:
where a(L) 1s a distributed 1a9 polynomial and Y 1s the output
leveI. According to the authors the effect of cyclical factors
on private investrnent is ambiguous . During the expansionary
phase of the cycle the private sector can be expected to
respond more rapid l y to changes in desired investment .
Alternatively , investment could respond mor e rapidly in
situations of excess capacity . It 1s not ent1rely clear what
effect , on average , cyclical factors may have on private
1nve s trnen t , so b
The effect of availability of financing 15 clearer.
In contrast to developed countries, one of the principal
constraints on lnvestments in developing countries 15 the
quantity rather than the cost of financiaI reSQurces. The
rudirnentary nature af capital rnarkets in developlng countries
limits financing of private lnvestment to the use of retalned
profits and bank credito Of these , according to the authors,
the flow of bank credit to the priva te sector wauld perhaps be
quantitatlvely the most important. An increase in real credit
to the private sector will in general encourage private
investment, 50 b
2 > O.
Finally, public sector investment can cause
crowding-out lf i t utilizes scarce physical and financiaI resources that would otherwise be avaiIabIe to the private sector. Furthermore, the financing of the pubIic sector - thtough inflation , taxes or public debt ...,. tedu::es the resources avaiIable to the private sector and depresses private investment. On the other hand , public investment that is related to
infrastructure and the provision of public goods can also cIearly be complementary to private investment. This type of public investment can improve the possibilities for private investment and raise theproductivity of capital, increase the demand for inputs and increase total resource availability by expanding aggregate output and savings. 50 the overall effect of public investment on private investment is arnbiguous, b3~O.
firms. Secondly the authors confuse stock and flux varlables.
Th ey say public goods and private lnvestmen~are complernentary
(flux variables) when in fact it would be oorrect to say publlc and
private stock of capitaIs are complementary. The whole public
stock of capital lncreases the efficiency of the private stock
of capital and does not compete for scarce resources, except
may be for a few pub lic companies running deficits. The
crowding-out effect arises only tram current public investments,
which compete for scarce physical and financiaI resources.
Thirdly, the authors used in their study figures of public and private lnvestments tram the National Accounts of a group of Latin American countrles. However, pUblic
company investrnents in some countries, in particular Brazil, are included in the total private investment. As public
companies react less to market forces and their investments are exogenously determined by the government
l(
i t would have been more oorrect to subtract the public company investments from the total private investment!/
Finally, the authors for lack. of data, reliable interest rates and nominal wages figures, were not able to test their model against a more general Jorgenson-type
investment model, which includes relative prices~ Testing a model with a priori restrictions on its parameters, as in
3.2- orhe Optimal Flexibl~ .1\ccelerator M,odel
To get arround the objections of ~ Blejer and Khan medel a private investment function has been derived by
rnodifying the optlmal flexible acdelerator medel in arder to
incorporate some of the channels through which public
investment influences pr17ate lnvestment . The optimal flexible
accelerator medel (OFAM) was developed in various versions
by Mortensen (1973) , Grossman (1970) and Lucas (1967) and
consists in adding adjustrnent costs to the neoclassical theory.
The investment demand function 1s similar to (II!.I) but that
the coefficient of adjustment b nQw results form the optimal
firm's behaviour and 1s a function of real interest rates and
adjustment costs. The empirical evidence for this kirul of
model can be found in Epstein and Denny (1983), Morrison and
Berndt (1981) and Schram (1970).
It is assumed that the private sector determines its
desired leveI of capital by minimizing total cost, TC, defined
as the discounted present value of future costs including the
costs of production,a~sitian capi~al and adjustrnent costs .
The cost C of producing the p l anned private sector output Y
is a function not only of the planned out put l eveI but also
oftne private stockof capital KP and the available infta~ucture
represented by 1;he governarrent stock of capital KG. The
acquisition cost of capi tal is the va lue of net and replacement
investments at current prices. The adjustment oosts of the private
sector, according to Lucas (1967), rise because 1nstalation
because the firm 15 rnonopsonlst in the faetor market. Is 1s
also assumed that when tre share of total public expenditure. in tre
GOPAIGT) , rlses i t increases the adjustment costs of private
sector because public investment competes with the private sector
for scarce physical and financiaI resources
Qut effect). Therefore, the private sector
Te =
E
vtt=O
(direct crowding-minimizes
~
(III.4)
where v 1s the discount faeter defined as (l+r) - l; r is the
real short term interest rate 1/; q denotes the price of
capital goodsi Ó denotes the rate of depreclation of private capital; and the quadratic term (KP
t - KPt _1)2 representes the adjustment costs, which are also scaled up by an increasing
8 / .
function of the share of total public expenditure in the GDP - .The Euler conditions for minlmizing (11I.4) are given 'py
~/
and
lim
+ q (r + ó ) = O
(1 + r)
n
v
(III.5)
The l ong run equilibrium ls obtained by setting
•
KP
=
KPt+1
=
KPt=
KPt_1ae
- - =
-q (r+
õ)(1 + r)
= - U
t (IU.7)
where U denotes the user cost of capital. We assume that
the production function i5 Cobb-Oouglas:
where L denotes labour input and A denotes the effec ts of
shifts in the production functi on owing to technica1 change, then the variable cast functi on can be expressed as
ao aI
a a
(KG
t ) 2 (KP t) 2 (IU.S)
where W denotes the nominal wage. Differentiating this
cost function with respect to KP and substituting into the
equation (111 .7), we get
_ 01 + U2 "" a (KP
