Government investments in buildings and capital in general are often used to boost demand in a weak economy due to its high labor content. Government investments in buildings are increased permanently by 5 per cent of the baseline corresponding to 1000 million kroner in 2005 prices in the first year (See experiment). Section 4 holds a similar scenario of more government investments in machinery.
Table 3. The effect of a permanent increase in public investment in buildings
| 1. yr | 2. yr | 3. yr | 4. yr | 5. yr | 10. yr | 15. yr | 20. yr | 25. yr | 30. yr | ||
| Million 2005-kr. | |||||||||||
| Priv. consumption | fCp | 36 | 200 | 262 | 268 | 276 | 474 | 705 | 843 | 879 | 857 |
| Pub. consumption | fCo | -7 | 52 | 111 | 168 | 222 | 458 | 646 | 798 | 920 | 1017 |
| Investment | fI | 1281 | 1435 | 1337 | 1246 | 1202 | 1168 | 1214 | 1217 | 1194 | 1165 |
| Export | fE | -54 | -112 | -184 | -260 | -344 | -801 | -1209 | -1503 | -1664 | -1713 |
| Import | fM | 404 | 528 | 480 | 419 | 385 | 348 | 334 | 289 | 233 | 197 |
| GDP | fY | 812 | 1007 | 1014 | 978 | 952 | 950 | 1034 | 1089 | 1124 | 1162 |
| 1000 Persons | |||||||||||
| Employment | Q | 0.83 | 1.14 | 1.22 | 1.17 | 1.07 | 0.52 | 0.17 | -0.05 | -0.21 | -0.25 |
| Unemployment | Ul | -0.44 | -0.58 | -0.60 | -0.57 | -0.52 | -0.25 | -0.08 | 0.03 | 0.10 | 0.12 |
| Percent of GDP | |||||||||||
| Pub. budget balance | Tfn_o/Y | -0.04 | -0.03 | -0.03 | -0.03 | -0.04 | -0.06 | -0.07 | -0.08 | -0.09 | -0.10 |
| Priv. saving surplus | Tfn_hc/Y | 0.01 | -0.01 | -0.01 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| Balance of payments | Enl/Y | -0.03 | -0.04 | -0.04 | -0.04 | -0.04 | -0.05 | -0.07 | -0.09 | -0.10 | -0.10 |
| Foreign receivables | Wnnb_e/Y | -0.06 | -0.13 | -0.18 | -0.22 | -0.26 | -0.47 | -0.72 | -0.99 | -1.26 | -1.53 |
| Bond debt | Wbd_os_z/Y | 0.01 | 0.03 | 0.05 | 0.08 | 0.11 | 0.31 | 0.54 | 0.78 | 1.04 | 1.28 |
| Percent | |||||||||||
| Capital intensity | fKn/fX | -0.03 | -0.01 | 0.01 | 0.03 | 0.05 | 0.13 | 0.18 | 0.21 | 0.23 | 0.23 |
| Labour intensity | hq/fX | -0.02 | -0.02 | -0.01 | -0.01 | -0.01 | -0.01 | -0.02 | -0.02 | -0.03 | -0.03 |
| User cost | uim | 0.01 | 0.01 | 0.02 | 0.03 | 0.04 | 0.06 | 0.08 | 0.08 | 0.08 | 0.07 |
| Wage | lna | 0.01 | 0.03 | 0.05 | 0.07 | 0.09 | 0.16 | 0.19 | 0.20 | 0.19 | 0.16 |
| Consumption price | pcp | 0.00 | 0.01 | 0.02 | 0.03 | 0.04 | 0.07 | 0.09 | 0.10 | 0.10 | 0.10 |
| Terms of trade | bpe | 0.00 | 0.01 | 0.02 | 0.02 | 0.03 | 0.04 | 0.05 | 0.06 | 0.05 | 0.05 |
| Percentage-point | |||||||||||
| Consumption ratio | bcp | -0.02 | -0.01 | 0.00 | 0.00 | 0.00 | 0.00 | 0.01 | 0.02 | 0.02 | 0.02 |
| Wage share | byw | -0.01 | 0.00 | 0.00 | 0.01 | 0.01 | 0.01 | 0.01 | 0.00 | -0.01 | -0.01 |
The higher public investment raises private sector production and employment in the short run. Compared to the government purchase of goods and services experiment, the effect on the domestic economy is larger because the import content of building investments is low. The income multiplier increases the initial effect proportionally.
In the medium term, the expansion of the domestic economy entails a higher wage and price level and a fall in competitiveness. A lower competitiveness reduces exports and raises imports. Consequently, domestic production and employment fall. Over time the effect on unemployment disappears.
The expansionary nature of public investment raises production in the short run. The higher production requires an equivalent increase in capital. And a given change in capital requires a more than proportional change in investment. This is because capital stock is far larger than annual investment. As a result, the impact on investment peaks strongly in the short run. This reflects the accelerator mechanism. The accelerator impact on building investments is larger than the impact on machinery. This is because buildings are used for longer periods and the ratio between capital stock and investment is higher.
As in the previous two experiments, real wages increase permanently leading to a permanent positive effect on private consumption. There is also a small positive effect on production in the long run. This is because the relative price of capital falls due to the import content in investment. This induces an increase in the capital intensity of the production and hence an increase in labor productivity. Consequently, the same workforce can produce a higher output. In general, there are some long run effects on production due to factor substitution in most of the demand shocks, usually the substitution effects are smaller. See more about factor substitution and factor relative prices in the long run in the experiments concerning supply side shocks from section 12 and onwards.
A permanent increase in public investments can deteriorate the government budget permanently, which may require other fiscal measures, e.g. a tax increase. Higher public investment in one period may be financed by lower public investments during economic boom.
Figure 3. The effect of a permanent increase in public investment in buildings
