Elasticity of substitution in public capital formation and economic growth

Incorporating monopolistic competition in an endogenous growth model with a driving force of public capital, we have shown that when the elasticity of substitution among goods in public investment is sufficiently small relative to those in the private sector, an increase in the government purchase of goods decreases the effective price elasticity of total demand and thereby the demand of each firm for capital, and that, because of this negative demand-side effect, an increase in the income-tax-financed public investment ratio to GDP may result in a lower balanced-growth rate even below the government size of the natural efficiency condition. (C) 2004 Elsevier Inc. All rights reserved.