Public Infrastructure Spending: A Silver Bullet?
Infrastructure is at the top of President Trump’s domestic economic agenda. For more than twenty-five years, a debate has resounded about the amount and quality of US infrastructure. As well as involving a discussion focusing on the quantum of the capital stock, this debate has widened into a consideration of the benefits of, and returns to infrastructure spending, and how it might offer a silver bullet for recent weakness in productivity growth.
The establishment consensus on the benefits of public capital investment
The 2016 Economic Report of the President elegantly summarises the established economic perception of the role of infrastructural capital. It asserts that reliable infrastructure facilitates the efficient exchange of goods, labour, and the diffusion of innovation and ideas: ‘From the Erie Canal in the early 1800s to the Transcontinental Railroad in the 1860s, to the Interstate Highway System in the 1950s and 1960s, previous generations of Americans have made these investments, and they were instrumental in putting the country on a path for sustained economic growth’.
The 1990s: infrastructure investment and New Growth Theory
In the 1990s, discussion about infrastructure formed part of the debate surrounding new approaches to ‘growth theory’: the so-called endogenous theories identifying unusually high returns to certain forms of investment and capital accumulation. This analysis fed into President Clinton’s 1992 election campaign platform; it was a central feature of the New Democrat policy agenda. Several of the principal protagonists in the technical economic debate — such as Brad De Long and Alicia Munnell — came from academia — and, in Dr Munnell’s case, from the Federal Reserve Bank of Boston — to serve in President Clinton’s Treasury department.
The Democrats’ platform in 1992 reflected the experience of a party excluded, for twelve years, from executive office in the federal government in Washington DC. The party’s mayors and state governors — of whom Bill Clinton was one — had developed a political network that emphasised public investment, mirroring their parochial political functions. Infrastructure investment is principally a state and local government responsibility in the US. Arguing the case for infrastructure investment enabled Democrat politicians to appear practical, moderate, and also aligned them with business: business people have a taste for politicians with an appetite for large-scale and complex capital investment. A potent elixir is represented by the combination of construction contracts; complex off-balance-sheet financial vehicles, ultimately guaranteed by the taxpayer; and lobbying, media, and stakeholder management consultancy opportunities. For conference-attending and commentating public-sector and business executives, it is an article of faith that public infrastructure is a good thing. Any challenge about cost or financing is to be brushed aside, apart from the understanding that the ultimate guarantor of such investment has to be the taxpayer.
In November 1992, the long-standing consensus on the merits of infrastructure spending was reflected in the proudest boast of modern, Clinton-supporting Democrat governors. This was the readily repeated assertion that that they had a list of bridges and infrastructure projects that were ‘shovel ready’, and waiting for federal finance. A good example was Bruce Sundlun, the late Governor of Rhode Island. What was interesting was not his list, but his much more guarded explanation of the economic and social returns that would arise from the list’s projects — and particularly, the development of the criterion used to assess them.
This enthusiasm for infrastructure investment has not been confined to the US. In the early 1990s, as the EU completed its preparations of the Single Market, the EU Commission emphasised infrastructure investment. In 1993, the Commission published the so-called ‘Delors’ White Paper on Growth, Competitiveness, and Employment. This argued for ‘trans-European networks’: principally, new high-speed railway lines to raise the rate of growth in the EU. This agenda drew on the perception that railway building was central to the economic history and development of the North-American economy in the 19th century. Similarly, in Japan, infrastructure has been an important part of the fiscal policy response to the years of economic challenge and stagnation, following the banking collapse of the 1990s.
President Trump and the international economic consensus
There are few things that the Trump administration, and the American and international policy-making establishment agree upon. If there is any one thing on which President Trump’s agenda coincides with the establishment economic consensus, it is the benefits of infrastructure investment, and the need to modernise the US economy’s capital stock. This was an important part of the Obama administration’s economic analysis; much of Mrs Clinton’s domestic economic agenda rehearsed the previous investment agenda of her husband’s time in office.
The IMF identifies infrastructure investment as a route to raising rates of economic growth in the context of very low interest rates. Shortly after President Trump was elected in November 2016, the OECD’s Economic Outlook argued that, after a period of fiscal consolidation of debt-to-GDP levels, the time had come to focus on expanding the denominator in that ratio: GDP growth. The OECD argued that very low interest rates had created a fiscal space resulting from lower interest payments on debt arising from rolled-over public debt being refinanced more cheaply. The OECD suggested that higher spending on investment, and on active labour-market polices, would raise future growth rates and labour-participation rates.
Yet a casual glance at the OECD Economic Outlook’s statistical annex is not reassuring regarding the success of such policies in Japan. There, public debt has risen from 128 per cent of GDP in 1990, to 228 per cent in 2016. Much of this debt was accumulated as a result of spending on infrastructure projects that yielded disappointing rates of return, and have been caricatured as ‘the roads and bridges to nowhere’. Despite the country’s infrastructure investment and borrowing, GDP is roughly unchanged from the mid-1990s. Japan’s ‘lost twenty years’ suggest that infrastructure spending and loose fiscal policies do not offer a guaranteed route out of secular stagnation. This approach may have contributed to the stabilisation of output, and helped to avoid a more intense debt-deflation, but it has not been a remedy to secular stagnation.
Just how bad is US infrastructure?
A casual examination of international comparisons of the quality of infrastructure show that the US comes out quite well compared to other G7 economies. The research evidence suggests that the greatest returns on spending come from properly maintaining existing infrastructure. Given that the returns to public capital investment are not taxed, and its financing through the municipal bond market in the US receives a federal government income tax subsidy, there may be a set of incentives working to create the conditions for a potential over-accumulation of public investment assets that have disappointing rates of return.
The dangers of optimism bias and political distortion in selection of public investment projects
Between 1927 and 2013, Harvard’s Cass Sunstein, and his Oxford colleague, Bent, looked at more than 2,000 big infrastructure projects in over 100 countries. They found that costs were underestimated, and potential returns were exaggerated. The cost-benefit ratio was typically overestimated by between 50 and 200 per cent. The Congressional Budget Office has noted that, in a series of reports, the US General Accountability Office commented on the weakness of cost-benefit analysis at in-state and local investment project appraisals. Such analysis was rarely undertaken, and where it was, it was often flawed. And, regardless of its results, decisions were often undertaken for political reasons. It was noted that roads were often built to assist areas with low population densities in order to encourage economic activity, rather than to maximise long-term economic growth in more dynamic communities. In many instances, the results of project analyses undertaken do not appear to have had bearing on the final decisions about public investment.