The decline in public investment: “social dominance” or too-rigid fiscal rules?

Public investment in advanced economies is at historical lows, and shows a declining trend since at least the 1980s. Two main hypotheses have been posed to rationalize this fact. On the one hand, the “social dominance hypothesis” claims that this is related to structural factors, given the upward social expenditure trends related to ageing populations and social preferences, and the operation of the government budget constraint (limits to further increase significantly tax revenues and public debt, in a context of secular stagnation). On the other hand, another branch of the literature indicates that too-rigid fiscal rule frameworks cause fiscal retrenchment episodes to hinge heavily on public capital expenditure, which does not recover enough in the subsequent expansion, creating a sort of downward hysteresis behaviour in this budgetary item. In this paper we look jointly at both sets of duelling explanatory factors, and show that both are key to understanding public investment dynamics in advanced economies over the past decades.