Welcome to Finance and Fury. Can public infrastructure spending help to boost a depressed economy?

In this episode we look at the theory of infrastructure spending on public goods, such as roads and bridges, versus the practical reality of this type of fiscal policy.

At the moment – there are lots of Proposals for Infrastructure to boost economy – USA, Aus, EU – beyond other stimulus measures – this is one that billions of dollars can be pledged to

First- what infrastructure governments spend funds on –

  1. Public infrastructure – for instance – spending on roads, bridges, train lines, sewerage systems – other such projects which are considered a public good – i.e. usable for all –
  2. This type of spending is one of the most advertised tools of anti-recessionary fiscal policy
    1. Why? When the economy struggles, politicians and public economists call for greater infrastructure spending as a form of stimulus
    2. This can be politically expedient as well – especially when the spending takes place in the politician’s state.
  3. However – how well does it provide stimulus to the economy?

The theory of infrastructure stimulus –

  1. Government stimulus spending – infrastructure or other Gov consumption on goods and services – part of the Keynesian assumption where an underproductive economy can be spurred back to full output by using new public expenditures – we have gone through this theory in previous FF episodes – but the aim is to boost aggregate demand – GDP
  2. In relation to infrastructure – the theory is that involuntarily unemployed persons can be given public infrastructure jobs and receive an income
    1. This then feeds back into the economy with consumption spending – meant to promote more GDP growth
    2. John Maynard Keynes theorised that public infrastructure deficit spending could produce a multiplier effect on economic growth
      1. Especially when real interest rates are low – can borrow – create jobs while the project is under way and those incomes produce more GDP in economic spending
    3. Australian GDP composition –
      1. household consumption: 56.9%, investment: 24.1%, net exports 0.5%, government consumption: 18.5%
      2. Of gov consumption – around 4.4% is infrastructure spending – pretty high compared to a lot of other nations –
      3. China 8.3%, India 5.6%, Saudi Arabia – 5.1%, South Africa – 4.7%, 5th on the list – Australia – 4.4%
    4. Basic assumptions on this theory – Keynesian stimulus spending assumes essentially zero opportunity costs if the deficit spending occurs during a period of higher-than-normal unemployment –
      1. Those who are unemployed could not be employed anywhere else – for higher incomes –

What this looks like in practice –

  1. Some assumptions I have seen – Economic policy institute – The “bang for the buck” is estimated by the one-year dollar change in gross domestic product (GDP) for a given dollar increase in spending. Multiplier indicates how much total output (GDP) changes in response to a $1 increase in deficit resulting from the fiscal policy change
  2. Outcome from increased infrastructure spending – $1.57 – could find a fair amount of papers theorising the benefits-
  3. One problem with theory of infrastructure spending – it ignores so-called “Cantillon effects”
    1. the relative change in different prices as the result of new money entering the economy
      1. new spending increases prices and demand in some areas faster and more deeply than in other areas – it has the side effect of misdirecting production away from areas where private citizens might voluntarily choose to dedicate their money – creating a misallocation of pricing
      2. Example – Massive inflows of funds into infrastructure spending pushes up the cost of infrastructure up – anyone who has had a damaged driveway gutter and requires the local council to replace this knows what I am talking about – minimum costs of $1,500 in most cases, just for a wheelbarrow of concrete
    2. Essentially, the economy trades off a short-term reduction in unemployment for a long-term misallocation resources and employment potentials that produces higher unemployment long term – as once the project is over those jobs are gone
      1. Also – employment only benefits one sector of the economy – those in public works/construction – at this stage of where the economy is at – this is not where the unemployment issues have materialised
    3. Another problem – it ignores opportunity costs – these may be very large opportunity costs and implementation costs associated with the high levels that are required for infrastructure spending
      1. I talked about the issue with not having any feedback loops in deacision making – governments do not produce anything with a calculable market value – or do they receive any feedback – it is not like their revenues, or the taxes we pay can be withheld by us if we don’t think they are doing a good job or agree with what they are spending it on –
        1. Their spending decisions are independent of consumer valuations and therefore blind to any real economic feedback
        2. There – no feedback on if infrastructure spending is the best use of resources, let alone any specific project for a road, bridge or highway – in addition, no recourse for wasted spending – i.e. the $1bn wasted on the east west link tunnel that never got built in Melbourne
      2. Good infrastructure can enhance the productive potential of the economy, but the political decision-making process often leads to bad decisions on spending, whether that is for electoral reasons or inefficiencies driven by a lack of market discipline – or having any recourse or feedback loops in helping make decisions
        1. Dig a hole and fill a hole policies can be implemented – to help boost employment and spend a budget – but it won’t provide any infrastructure benefit to our lives
      3. Based around the cantillion effect and having no opportunity costs in decision making – governments can impedes the private-sector from delivering infrastructure.
        1. If infrastructure projects are financed through taxes – the private economy shrinks by at least a corresponding amount long term
        2. If they are financed through deficit spending and the issuance of government bonds, then current capital markets experience crowding-out effects and other financial assets become more or less expensive than they otherwise should be – long term – when those government bonds are paid back through higher taxes or higher inflation (to eat away the real value of the debt) – the private economy loses again
  • The estimate of the 1.57 multiplier doesn’t take into account these opportunity costs

 

Practical Reality

  1. Economists do have a hard time to produce empirical results of the benefits – they can in theory and produce models about assumptions – but even models that predict things like inflation show that they are off –
  2. difficult to find solid, demonstrable evidence about how effective changes in infrastructure spending have been
    1. The IMF produced a working paper in 2014 – found little evidence that global infrastructure projects produced economic gains – when projects received debt funding for growth – no change to trends for growths
  3. Practical Challenges – paper by the National Bureau of Economic Research (NBER) in 2013 called – “Roads to Prosperity or Bridges to Nowhere? Theory and Evidence on the Impact of Public Infrastructure Investment.”
    1. Good title – but within it the economists identified at a few major challenges to the standard theory of increasing infrastructure spending for GDP growth
      1. the endogeneity of public infrastructure spending to economic conditions – endogeneity broadly refers to situations in which an explanatory variable is correlated with the error term or your probability assumption – simple English – there are too many variable to accurately predict what is having an effect on GDP – was is Gov spending or is it just good economic conditions?
      2. the decentralized nature of implementation – there are too many departments and no communication between them – delays and costing become an issue –
  • lags between approved spending decisions and actual project completion – money may not be there by the time the works are ready to be completed – delivery of infrastructure generally tends to be slower and more costly due to extensive government regulations, such as land use planning laws, environmental commitments, direct government monopoly decisions and restrictions on transport infrastructure funded through charging the user – such as tolls
  1. as I quickly went through earlier – government generally is not excellent at managing money or roads – Federal spending for highways is as much a political tool as an economic one –
    1. In addition – projects also tend to lose their “shovel-ready” status because of lengthy and expensive environmental and permitting reviews
    2. Approvals for public infrastructure projects can take between five and 10 years to be implemented, all the while costing taxpayers as tedious approval processes play out – then they have to buy up land and properties that lie on them – then regulations change and new approvals need to be applied for –
    3. Example – Moved to Brisbane in 2000 with my parents – were looking around and Kenmore bypass was planned – since the 1960s – have the land and in 2009 bought up the final blocks – but still have no money
    4. What good infrastructure like loads can help with – reduced connection and travel times – does this happen?
      1. A few anecdotal examples from my own life –
      2. One – spent $34m adding in a round about that added 20mins to travel
  • Another was $60m spent adding an additional inlet to the ICB – actually made traffic congestion worse – an extra 15 mins as down the line the bottle neck still exists

 

Despite constant policy proposals – there is little practical evidence that public infrastructure projects are a net positive to the economy, or that they even boost net employment figures – There appears to be a disconnect between the theory – the political rhetoric and economic reality – how big? Who knows

  1. The macroeconomic models are all assumption based – and only deal with a handful of variables compared to what can actually affect the economy – plus it assumes individuals behaviours are fixed – that we aren’t adaptive
  2. So whilst in theory it does sound good – the actual output is unknow and the funds may be better spent elsewhere

 

 

Next week – look at Past examples of infrastructure and leading to crisis.

 

Thanks for listening.

 

Resources:

 

https://resources.saylor.org/wwwresources/archived/site/wp-content/uploads/2011/08/HIST312-10.1.2-Panic-of-1893.pdf

https://www.federalreservehistory.org/essays/banking_panics_of_the_gilded_age

https://www.statista.com/statistics/566787/average-yearly-expenditure-on-economic-infrastructure-as-percent-of-gdp-worldwide-by-country/

https://www.epi.org/publication/the-potential-macroeconomic-benefits-from-increasing-infrastructure-investment/

https://www.nber.org/papers/w18042.pdf

The Financial Curse – When a Financial System does more harm than good

Welcome to Finance and Fury the Furious Friday Edition On the last episode we talked about the City of London Corporation, a mini plutocracy Today we are exploring at what point does a financial sector state to crowd out real economic growth? Referred to as the...

The skinny on spare change investment apps and building wealth when you’re earning $25,000 or less a year.

Say What Wednesday The skinny on spare change investment apps and building wealth when you’re earning $25,000 or less a year. Welcome to Say What Wednesdays – Where we answer your personal finance questions each week. Two questions this week from Chris: No 1 what are...

Furious Fridays: Is minimum wage such a good thing after all?

Furious Friday Is minimum wage such a good thing after all? Welcome to Finance and Fury! The main aim of our Furious Friday editions is to clear up misconceptions. We’ve been seeing a lot of news stories lately about companies underpaying staff – 7-Eleven, hospitality...

Fractal property investments: dipping your toe into the property market

Episode 19 Fractal property investments: dipping your toe into the property market It’s no secret that property is expensive in Australia – it can be pretty disheartening for those trying to get into the property market especially if you’re trying to buy your first...

Say What Wednesdays: The slippery sponsorship slope and why I’ll never sell out

Happy New Year! Welcome to Finance & Fury’s Say What Wednesday. It’s been pretty quiet on the question front, I’m guessing with everyone away over the holidays… so today will be a quick episode covering the number 1 question I got all of 2018 but never answered –...

Buying Property inside an SMSF: Tips and traps, what works and what doesn’t

Say What Wednesday Buying Property inside an SMSF: Tips and traps, what works and what doesn't Welcome to Finance and Fury, 'Say What Wednesdays' where each week we answer your questions. This week's question is from Sandeep: “Hi, Can you please talk about how to...

Furious Fridays: The price of free is freedom – Taking a look at Lenin’s reign of terror

Furious Fridays The price of free is freedom: Taking a look at Lenin's reign of terror Today we’re going to run through the very first implementation of Communism on a mass scale. Our last few Furious Friday episodes are a lead up to this. If you didn’t catch those...

Younger than 35 are experiencing low to negative income growth – but there are real ways of actually getting around it

Episode 27 Younger than 35 are experiencing low to negative income growth - but there are real ways of actually getting around it Today we’re talking about a news article that came out highlighting that young Australians’ are experiencing either zero, or negative...

Never let a crisis go to waste – Why to watch out for proposed economic solutions after a financial collapse.

Welcome to Finance and Fury, The Furious Friday Edition Today – want to explain why to watch out for proposed solutions to economic or societal issues Last ep – talked about the battleground between the Bankers and Governments back in the early 30s – Was a wild...

What has created a system where the share market can go down so quickly?

Welcome to Finance and Fury, The Furious Friday edition What has created a system where the share market can go down so quickly? The perfect storm – Panic, OPEC agreement breaking down – computer algorithms kicking in, mass sell-offs of index funds The recent collapse...

Pin It on Pinterest

Share This