Effects of public investment on sectoral private investment: A factor augmented VAR approach

Public investment decreases aggregate private investment in both neoclassical and Keynesian models. There are no findings, however, on how public investment affects private investment on a disaggregated basis, such as sectoral private investment. More specifically, previous research has neglected the distinctions of sectoral investment behavior in response to public investment and the possibility of crowd-in effects in some industries, such as industries blessed with public demand. Meanwhile, public investment decreases sectoral private investment not only by keeping rental cost high, but also by differences in the resource misallocation effect of public investment itself; one sector receives a positive wealth effect while another suffers the opposite. In this paper we use a factor-augmented VAR (FAVAR), a model capable of analyzing large-scale VAR models, to investigate the extent to which public investment is crowded out or crowded in in different categories of industrial investment. Our results demonstrate that public investment confers different effects, both quantitative and qualitative, in individual sectors. This implies that public investment reaps different benefits in different sectors and that it can bring the worse effect of resource misallocation on some sectors.