Dynamics of Investment in Human Capital and Infrastructure in the Process of Urbanization and Economic Growth

Standard two-sector endogenous growth model with human and physical capitals as inputs does not involve allocation of public expenditure between human capital accumulation and investment in infrastructure. However, public expenditure takes a predominant role in human capital accumulation and investment in infrastructure. By introducing public expenditure into a model of urbanization and endogenous growth, the allocation of public expenditure between human capital accumulation and investment in infrastructure is endogenized. The condition of inter-temporal inter-sector transfer of human capital lends itself to the analysis of the transitional dynamics of the model. Results from numerical simulation indicate that there are complicated transitional dynamics in the model of urbanization and endogenous growth with public input. When there are diminishing returns to physical capital, the size and allocation of public expenditure are endogenously determined and stabilized. If there is somewhat degree of increasing returns to physical capital, the inter-sector allocation of public expenditure is endogenously unstable. In the latter case, government policy in public expenditure plays an important role in stabilizing the economy. In addition, an analysis of the comparative statics of the model suggests that there exists an optimal tax rate and consequently an optimal size of public expenditure, implying that public expenditure supported by an income tax is pro-growth in a certain range, beyond which an increase in public spending will exert negative effect on growth. This is in line with the findings in Barro (1990).