Growth through taxes or borrowing? A model of development traps with public capital

Abstract

We consider a simple model of growth in an economy with public capital. The government finances public capital with tax revenue or debt. This results in areas of increasing returns to scale and different (sets of) feasible steady states that are determined by initial conditions. With a balanced budget, it may not be feasible to move from low to high income levels. In this case, external debt may be the only way out of such a development trap, provided the world interest rate is low enough.