Endogenous growth and fiscal policy with productive government expenditure

Fiscal policy can be considered as a key driver of economic growth. The government can either provide for the public good used in firm's production process, or invest in public education that improves the abilities and skills of workers. In term of the public good and public education, the growth rate of economy is undoubtedly enhanced. However, the magnitude of growth also depends on how the government levies the distortionary tax to finance its spending. Since different kinds of taxes contribute to the different states of economy, as well as the long-run growth, the main purpose of this thesis is to examine the effect of the fiscal policy on economic growth in various theoretical frameworks, particularly the representative-agent approach and the three-period overlapping generations model.

The theoretical analysis reveals a number of interesting findings. Firstly, the productive externalities from public investment and procyclical endogenous consumption tax creates the multiplicity of balanced growth paths (BGPs) in the representative agent framework. Two BGPs arise due to the existence of the Laffer curve. In addition, local indeterminacy may occur around the lowest balanced growth path if consumption tax is mildly procyclical. As a result, there is no trade-off between growth and volatility. Secondly, the growth-maximising tax rate is investigated in the three-period overlapping generations economy in which altruistic parents provide private tuition for their children and the government subsidises public education. When the government misconceives of the existence of private tuition, public education is over-provisioned. This leads the economy to the growth-reducing area of the Armey curve. Finally, in the presence of stochastic productive government expenditure, the economy experiences a higher growth rate than it does in the perfect foresight economy when households are risk-averse agent. The inverted-U shape relationship between economic growth and permanent income tax disappears in the stochastic growth context; nevertheless, the condition of growth-enhancing tax rate remains valid. Furthermore, the first-best fiscal instruments are explored based on the difference between centralised and decentralised economies in the case of proportional congestion. To prevent the welfare loss, the initial capital should be sacrificed in the interest of the higher level of consumption. For this reason, the trade-off between growth and welfare is unavoidable in a decentralised economy.