Productivity-Enhancing Effect of Government Expenditure in a Two-Sector Intertemporal Optimizing Model

This paper analyzes the productivity-enhancing effects associated with the government expenditure y directly applying it to the production function as one of the factors of production. Since the model incorporates a foreign-capital-dependent developing economy in an intertemporal optimizing setup, it shows an explicit dynamic relationship between external debt and capital stock accumulation. Unlike the demand-side analysis of the government expenditure, it is found that the increase in government expenditure accelerates the rate of investment, which results in more current account deficits. This implies the government expenditure affects the dynamic variables, whereas the demand-side analysis of government expenditure does not. In addition, the rise in the government expenditure may increase consumption under a certain restraint through the change in the outputs, not through the change in the aggregate demand. This is because the supply-side ejj‘ect of the government expenditure dominates the demand-side eï¬ ect. In general, consumption falls in a demand-side analysis of the government expenditure.