Public Investment and Corruption in an Endogenous Growth Model

Abstract: High capital spending is favored by economists and politicians for its beneficial effects on economic growth. However, there is empirical research associating high levels of public investment and low economic growth due to corruption. I provide an endogenous growth model with Ramsey taxation that is consistent with this empirical finding. In the model, government maximizes the weighted average of consumers’ utility and its own utility coming from expropriation of tax revenues. The weight determines the benevolence of the government. I show that a self-interested government sets a higher public-to-private-capital ratio than a benevolent one in order to increase the before-tax returns to private investment and hence increase tax revenues that can be expropriated. However, after-tax returns to private investment are lower and hence the growth rate is lower. Another result is that self-interested governments choose a high level of non-productive public investment, which provides a channel for the government to expropriate tax revenues for its private gain, thereby inflating total public investment.