Volatility and level of public investment and growth

Public capital and public investments are essential to promote growth in an economy. They constitute the base on which private capital can build. Public investments in infrastructure, education and health are important for healthy private capital accumulation process and growth. Bayraktar and Fofack (2011) show that one of the essential determinants of private capital and economic growth is public capital, independent of whether the country belongs to low-, middle-, or high-income groups in Sub-Saharan Africa.

We try to understand the significance of the level and volatility of public investment and public capital accumulation in determining its direct and indirect effects on growth. The importance of the level of public capital and investment is investigated under the name of threshold effects. It is expected that returns of public investment on economic growth would be exponentially higher in economies where the level of public investment is high enough beyond a threshold level. The volatility of public investment can also determine the growth path of countries. It is expected that the higher volatility in investments, the higher the fluctuations in the growth process.

Countries with low and volatile public investments are expected to grow at a much slower pace. Higher public investment can provide the required push to the engine of growth because in countries where public investment is high enough and less volatile, private investment is expected to flourish more easily and promote growth more effectively.

A simple growth model is introduced to explain the importance of threshold and volatility effects of investment. Regression equations are used for growth and are estimated using the dynamic general method of moments (GMM) introduced by Holtz-Eakin, Newey, and Rosen (1988), Arellano and Bond (1991). The instruments consist of lagged values of independent variables. To determine the threshold effect of public investment, I use methodology introduced in Hansen (1999) Herzog (2010). The data set covers selected sub-Saharan African countries for the period of 1980-2015. To determine the threshold effect of public investment and capital, I use methodology introduced by Herzog (2010). Following Museru, Toerien, and Gossel (2014), we examine volatility by calculating rolling standard deviations of public investment over 2-year overlapping sub-periods.

The initial empirical results show when the level of public capital per capita is higher than a specific threshold, public capital gets more effective in promoting growth. Similarly, the volatility measure of public investment has a clear negative and statistically significant impact on growth.