Written By: Xue Han
Luxembourg Garden Fellow, Global Infrastructure Asset Management LLC
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Written: March 14, 20122
A Quick Note
The discussion about infrastructure spending in policy conversations centers on its impact on employment. Missing from the debate is a compelling argument for how spending on infrastructure improves productivity and increases wealth in the U.S. economy. This is due in part to the fact that voters frown on government spending and in part on the difficulty in proving how adding to the existing legacy system of public infrastructure will improve the productivity of private enterprise. Following Xue Han's previous paper "Deficit Reduction and Multiplier Effects" in which she estimated the fiscal multiplier that she expects to work in reverse with the impending automatic federal budget cuts, we asked the question "what multiplier is at work with spending on infrastructure?" and, ultimately, "how should makers of policy consider the benefits of spending on infrastructure when allocating contracting financial resources?" Xue Han's next paper addresses these questions.
This research paper examines the necessities and benefits of investments in infrastructure under the current condition of deficient infrastructure and contractive economic climate in the United States.
The first section of this paper reviews the insufficient infrastructure investment during recent years, and carefully examines the poor conditions of major infrastructure. Due to a falling investment rate from 1980 to the present, a 2.7% annual average growth rate compares unfavorably to the 4.0% growth rate during the period 1950-79. As a consequence, the country's infrastructure has deteriorated badly over the past generation and has received an average grade of D in the 2009 Report Card for America's Infrastructure by the American Society of Civil Engineers (ASCE). Such deficit in infrastructure is costing the U.S. economy $129 million a year. This paper further assesses the additional investments needed for maintenance or improvement of the core economic infrastructure, which include transportation, public school building, water and energy infrastructure, and reaches the conclusion that additional spending of between $73 billion and $132 billion is needed per year to maintain and improve these infrastructure assets.
The second section explores the anticipated benefits of these investments including (a) substantial increases in the productivity of the economy, (b) a highly beneficial fiscal multiplier effect to increase wealth, and (c) improved employment effects.
With the economy still in the prolonged slump after the financial crisis in 2008, the stimulating effects of infrastructure investments on economic growth becomes even more important for speeding up the recovery.
Productivity Effect. Both fundamental theories and statistical evidences indicate that investments in public infrastructure improve private-sector productivity, leading to a "crowding-in" instead of "crowding-out" of private investments. More specifically, as suggested by Heintz, Pollin and Peltier, a sustained one-percentage point increase in the growth rate of core public economic infrastructure leads to an increase in the growth rate of private sector GDP of 0.6 percentage points.
Multiplier Effect. Due to its relatively larger multiplier effects compared to other types of spending, infrastructure investment provides a strong stimulus to economic growth even without consideration of its productivity impact. Using the reliable estimates on employment generated from an Input-Output model in How Infrastructure Investments Support the U.S. Economy (Heintz, Pollin and Peltier, 2009) and a solid assumption on the relationship between GDP increase and employment effects made by Romer and Bernstein, we estimate the multiplier effect featured by investment specifically in infrastructure at 2.8, meaningfully larger than the general multiplier of all forms of fiscal stimulus of 1.88, as estimated in my previous research Deficit Reduction and Multiplier Effects.
Employment Effect. The employment effects of infrastructure investment come in three ways: direct effects, indirect effects and induced effects. As estimated in How Infrastructure Investments Support the U.S. Economy (Heintz, Pollin and Peltier, 2009), each $1 billion in infrastructure investment will generate between 9,819 and 17,784 jobs if we consider only direct and indirect effects and between 14,515 and 23,784 jobs if we account for induced effects, which is far beyond the number of jobs created with the same amount of investment in tax cuts.
Therefore, more infrastructure investments, or at least smaller budget cuts on infrastructure projects are called for, due to its urgent necessities and profound benefits to the current economy.