Optimal Government Spending Ratio on the Research Sector

This paper investigates the optimal government spending ratio on the research sector by introducing government effects into Romer’s endogenous model. The government spending has positive effects on both the final-output sector and the research sector. Under this circumstance, we first show that there exists a minimum government spending proportion to maintain endogenous growth and there are two optimal spending ratios on the research sector given a constant government proportion. Then we analyze how the government chooses between these two ratios. When the government is interested in the balanced growth rate, it will always choose the high spending ratio on the research sector. But since there is a dynamic transition process in our model, short-run welfare must be taken into the government’s account. If the stock of endowed knowledge is much more than that of endowed physical capital, then the government will choose the low spending ratio on the research sector.