Complementarity in Models of Public Finance and Endogenous Growth

Abstract

This paper considers the effects of complementarity in private production between private and public inputs on optimal fiscal policy under the objective of growth maximization. Using an endogenous growth model with public finance and CES technology, it derives two central results. First, it shows that with complementarity, growth-maximizing fiscal policy is also affected by preference parameters, the degree of complementarity and the stock-flow properties of public inputs to private production. Second, it shows that optimal public spending composition and taxation are interrelated and also depend on the efficiency of public spending under growth maximization. Both results contrast with standard findings in the literature that are typically based on the assumption of Cobb-Douglas technology, and have important lessons for policy settings.