Effects of Government Investment Shocks on Private Investment and Income in India

Abstract

This paper evaluates the effect of shocks in government investment on private investment and national income, focusing on “crowding-in” or “crowding-out” effect in India. Recent studies do not deal with this issue by taking account of the heterogeneous effect of public investment as regards to infrastructure. Hence, I divide government investment into infrastructure vs non-infrastructure. The study uses structural vector auto-regressions (SVAR) and impulse response-functions analysis to evaluate the dynamic change in private investment and income. The study finds evidence of the crowding-out effect of government investment, which is mainly due to the non-infrastructure part of government investment. Private investment has a larger effect on income than both types of public investment. The effect on income due to the infrastructure component of public investment is larger than the non infrastructure component in both the short-term and medium term. However, government investment in non-infrastructure continued to dominate its infrastructure component during the period of this study. Private investment is vital to achieve higher growth in market-led economies and public investment should play a complementary role. Hence, the Indian government should design policies to attract more investment expenditure in infrastructure and other productive activities such as the development of human capital so as to crowd-in private investment.