Steve H. Hanke: Public Infrastructure Full of Hot Air

2017-03-30 IMI

This article appeared on OMFIF Bulletin (January 2017). Steve H. Hanke, Member of IMI Advisory Board, Professor of Johns Hopkins University Economic policy is subject to fads and fashions, and the latest trend is public infrastructure. Its advocates include progressives on the left of the political spectrum, like Barack Obama, Hillary Clinton and Bernie Sanders, and populists on the right, including President-elect Donald Trump. They tell us to remove the chains of fiscal austerity and spend on public works, and that this elixir will cure all economic ills. Globally, economic growth remains muted, and the US provides an important example. It has been over eight years since the 2009 recession, and the US has failed to bounce back. The economy may be growing, but the pace of expansion is below its trend rate. US aggregate demand, which is best represented by final domestic sales, is growing at a nominal rate of 2.8%, well below the trend rate of 4.7%. The secular stagnation argument Many argue that fiscal austerity has been responsible for keeping growth down. They advocate fiscal stimulus instead, through spending on public works. Another line of argument used to support increased spending on public works is based on ‘secular stagnation’. Its leading advocate is Larry Summers, Harvard economist and former US Treasury secretary. He argues that private enterprise is failing to invest and that the government must step in and spend on public works. Summers points to anaemic private domestic capital expenditure as evidence for his thesis. The Chart shows that net private domestic business investment is relatively weak and has been on a downward course for decades.

Investment fuels productivity. So, with little fuel, one should expect weak US productivity numbers. Productivity growth is indeed weak and has been trending downward. The US is in the grips of the longest slide in productivity growth since the late 1970s. Advocates of the secular stagnation theory assert that the deficiency in net private investment and the resulting productivity slump can be made up by public works spending. Escaping fiscal austerity This argument has been put forward many times in the past, but seems to be gaining ground as a means of escaping fiscal austerity. If proposed public works proceed as projected, the government financing magnitudes would be stunning. The McKinsey Global Institute estimated that annual spending of $3.7tn per year between 2013-30 was ‘required’ worldwide. Trump has jumped on this infrastructure bandwagon by proposing a $1tn public works programme. But the alleged benefits of infrastructure spending are often wildly inflated, with cost estimates downplayed or distorted. Analysis of the economic multiplier of infrastructure spending – around 1.6 by some estimates – is often flawed due to incorrect assumptions, and can be subject to misuse in the artificial inflation of benefits. Once public works are installed, the hot air comes out of their alleged benefits. These projects are poorly maintained, and users are often not charged for what they use, or they are charged prices set well below the relevant costs incurred. Water is a classic case – on average 34% of the water delivered to water systems is either stolen or leaks out of distribution systems. It is hard to take seriously claims that billions of dollars are required to develop more water resource capacity when much of the water produced in existing systems leaks away. Adjusting for leaks and thefts, the alleged benefits for many new projects, which have been inflated by ‘multipliers’, wither away to almost nothing. The reality of infrastructure funding Infrastructure projects are always subject to cost overruns. While the projects might look good on paper, the reality is very different. Detailed studies show that the average ratios of actual costs to estimated costs for public works projects in the US typically range from 1.25 to over 2. In addition to cost overruns, the financing of infrastructure requires the imposition of taxes, and taxes impose costs beyond the amount of revenue raised. The excess burdens of taxation include ‘deadweight’ distortions, enforcement and compliance costs. In short, it costs more than a dollar to finance a dollar in government spending. The best estimates indicate that, on average, it costs between $1.50 to $1.60 to raise a dollar in tax revenue. Taking proper account of cost overruns and the costs of collecting taxes, one wonders if there are any public works projects that could justify federal financing, let alone financing to the tune of $1tn. This is the wonderful world of infrastructure waste, fraud, and abuse.

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Steve H. Hanke: Public Infrastructure Full of Hot Air

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