Productive government expenditure and economic growth in a heterogeneous-agents model

Abstract

This paper examines the relationship between productive government expenditure and economic growth. An R&D-based model of endogenous growth is used in which agents have heterogeneous entrepreneurial abilities. We show that if the entrepreneurial ability follows a long- and fat-tailed distribution, then the relationship between government ex-penditure/GDP and economic growth rate is depicted by an inverted U-shaped curve with a fiat top. The fiat top indicates that government size change has a limited impact on growth. We calibrate the model to U.S. data and empirically confirm the above theoretical prediction.