INCREASING GOVERNMENT SPENDING ON INFRASTRUCTURE WILL NOT FIX THE ECONOMY
Randy M. Mott
To allay concerns that they are “tax and spend” liberals, for several years the American Left has referred to government spending on infrastructure or education as an “investment.” In a philosophical sense this is accurate, but it does not change the character or effects of such spending. The Obama Administration coming into office promising to create a massive number of new jobs by government spending programs. Historical data overwhelmingly supports the opposite conclusion, the net effect of government spending is neutral at best and more frequently negatively correlated to employment. While we can “hope” that this broad body of empirical research is wrong, that is unlikely to “change” the results for future spending plans. Another corollary to the liberal creed is that anything stimulating business investment is a “trickle-down” theory that does not work for the poor and middle class: a notion equally at odds with all empirical data. These twin myths remain part of the American liberal’s articles of faith and are evident in the incoming Administration’s pronouncements to date.(1)
The assumption of the Left that government spending can provide an alternative to private sector growth is largely a delusion. Government expenditures are all at the bottom of the list in terms of economic stimulation. Even labor intensive highway building has a dubious net effect on jobs. The money to do the government stuff has to come from the economy- parts of it actually profitable in fact. The overall benefit is negligible and often negative in terms of general economic effects. Even deficit spending must be funded by government bonds, which compete with private capital formation and divert money from the private sector.
“The insidious notion persists that government job creation actually generates an increase in employment. According to this view, if construction companies increase employment by 100,000 jobs due to a $3 billion government spending program to finance highway construction, then employment is 100,000 jobs ahead of what it might be in the absence of the program.” Why Government Can’t Create Jobs October 1993 by Mark Ahlseen, Associate Professor of Economics at King College. He points out that this view ignores the impact of taking the money from somewhere else to fund the highway building. [“Interestingly, from 1960 to 1988 there has been a positive, and statistically significant, correlation between public aid (as a percentage of GNP) and the unemployment rate. Conventional wisdom would have the public believe that as government “invests” in people the unemployment rate decreases.”]
Empirical studies generally find negligible or negative correlations between public works spending and employment. The Congressional Budget Office in 1998 reviewed multiple studies and found no significant job creation effects from Federal Government infrastructure spending in the numerous studies:
“This paper finds that increased federal spending on investment in infrastructure, education and training, and R&D is unlikely to have a perceptible positive effect on economic growth. That conclusion rests in part on the observation that many federal investments have little net economic benefit—either because they are selected for political or other noneconomic reasons or because they displace private-sector or state and local investments. Federal spending can also reduce growth under the following circumstances: when it displaces investment that is more productive; when it leads others to defer investments in the hope of getting federal funds; or when its full costs (including opportunity costs) exceed its benefits. Even federal investments that appear to be economically justified generally have moderate returns, and the supply of those productive investments is limited.” (2)
A 2003 economic study found no substantial positive impact on employment by increased public spending:
“...we studied the impact of public capital on employment in a variety of sectors including agriculture, manufacturing, mining, construction, transportation, wholesale trade, retail trade, finance, and services. In general, we found that public capital either has a negative effect on employment, or no effect at all under the preferred method of estimation that accounted for stationarity problems and simultaneity bias.... Our results indicate that there is no overwhelming evidence that supports the contention that public capital projects reduce the unemployment rate or increase employment for most of the sectors we studied...” (3)
The GAO study released in 1986 on an earlier highway spending “stimulus package” showed very limited net employment gains.(4) Most reports claiming “new jobs” created do not include an assessment of the net effect of the program:
“[T]here is substantial crowding out of private spending by government spending.…[P]ermanent changes in government spending lead to a negative wealth effect.” Shaghil Ahmed, “Temporary and Permanent Government Spending in an Open Economy,” Journal of Monetary Economics, Vol. 17, No. 2 (March 1986), pp. 197–224.
Public expenditures become increasingly ineffective macroeconomic tools after a percent of GDP is already reached: “This analysis validates the classical supply-side paradigm and shows that maximum productivity growth occurs when government expenditures represent about 20% of GDP.” E. A. Peden , “Productivity in the United States and Its Relationship to Government Activity: An Analysis of 57 Years, 1929–1986,” Public Choice, Vol. 69 (1991), pp. 153–173.
International studies in dozens of countries have shown a negative correlation between government expenditures and GDP growth.(5) Marcelo Soto, “Capital Flows and Growth in Developing Countries: Recent Empirical Evidence,” OECD Technical Paper 160, Paris July 2000. An empirical study of data from 44 developing nations for the period 1986-1997 showed higher government consumption has reduced GNP growth. Some government spending in emerging economies may enhance growth to a point, but the level is only what is needed for basic services, roads, schools, etc. Many studies showed that a curve exists where a point is reached that government spending increases actually cause major negative economic impacts. The Japanese experiment in massive infrastructure government spending in the 1990s helped to cause a slippage in GDP, as should have been expected from the previous economic studies at the time. Similarly, the American economy remained depressed for years under FDR despite massive new public works spending.(6) We certainly cannot claim ignorance of the data at this point.
When the United States and other industrial nations advise emerging economies with bloated public sectors and high tax rates, they always advise to reduce government spending and lower taxes to create sustainable growth. We are advising others, we understand implicitly the value of capital formation and business investment.(7) Many of us just seem to lose objectivity when it is our own businesses that we are talking about. If public works spending created wealth and prosperity, then Belarus, North Korea and Cuba would be the leading world economies.
The old Keynesian idea that "demand" simulation via public transfer payments was an effective tool for long-term economic growth has been soundly refuted. Even Keynes at the time argued it was only a temporary solution for periods of economic downturns. But now we know that the basic math is wrong. (8)
While the United States continues to have the second highest effective tax rates on business in the industrialized world, the Liberal reaction to the crisis is to increase business taxes to pay for more handouts and bail-outs of unprofitable businesses. Thankfully, Obama may have “rendered inoperative” his campaign pledges to increase business taxes, but the idea of reducing those taxes to create investment and new jobs is still not on the plate. There are a legion of studies from all over the world that point to lowering business taxes as a successful and effective route to job creation and sustained growth. This is heresy to the Left and, despite all of the post-partisan charades, there do not appear to be any visible advocates of true growth and recovery policies in the incoming Administration.
So we will get massive pork-barrel spending that will cost the taxpayers hundreds of billions over the future years as we pay off the debt for this knee-jerk, ideological impulse. A year ago, politicians were making points in public by blasting at the same type of pork barrel projects. As the 2003 study concluded: “... we found that public capital projects either raise the unemployment rate in most cases [or have no net effect] ....” (9) The only thing that has changed is the public perception.... a year ago everyone wanted to cut pork barrel spending, now it is applauded as necessary by the Democrats. A more effective policy would be to assess where the economy can prudently get the most sustainable short-term stimulus at the lowest long-term costs, and that answer is not to increase public works spending.
1 On December 6th, the President-elect announced his plans for "the single largest new investment in our national infrastructure since the creation of the federal highway system in the 1950s" as well as "the most sweeping effort to modernize and upgrade school buildings that this country has ever seen." Michael Lind writing in Salon capsulizes this liberal mantra: “public investment aimed at accelerating U.S. economic growth should be domestic reform priority No. 1.” This view is virtually unanimous among the liberals. Louis Uchitelle, “A Trap in Obama’s Spending Plan,” NYT, December 21, 2008: “Mr. Obama’s expenditures will no doubt generate jobs and wages in the construction phase.”
2 Congressional Budget Office, The Economic Effects of Federal Spending on Infrastructure and Other Investments, June 1998, at www.cbo.gov/ftpdocs/6xx/doc601/fedspend.pdf (March 26, 2008).
3 Raymond G. Batina (Professor, Washington State University), Dr. James Feehan (Professor, Memorial University), Dr. Christopher N. Annala (Assistant Professor, State University of New York - Geneseo). "The Impact of Public Inputs on the Private Economy" 2003.
4 U.S. General Accounting Office, Emergency Jobs Act of 1983: Funds Spent Slowly, Few Jobs Created, GAO/HRD–87–1, December 1986, at http://archive.gao.gov/f0102/132063.pdf (March 26, 2008)[GAO emphasizes the delay in the spending, but the net effect was in the end small].
5 “Beginning in 1991-1992, Japan adopted the spending approach now advocated by many in the U.S. Congress when it embarked on a massive nationwide program of infrastructure investment. Between 1992 and 2000, Japan implemented 10 separate spending stimulus packages in which public infrastructure investment was a major component.” Ronald D. Utt, Ph.D. Heritage Foundation, “Learning from Japan: Infrastructure Spending Won't Boost the Economy,” December 16, 2008. The effects in Japan were the opposite of their intentions: “the relative prosperity of the Japanese has been on the decline as government spending has advanced. After peaking at 86 percent of U.S. income in 1991 and 1992, Japanese income continually fell behind the U.S.” Id. Keiichiro Kobayashi, with the Japanese Research Institute for Economy, Trade & Industry, noted: “Fiscal policies [in Japan] are based on Keynesian economics. When goods do not sell because of recession, the harmful influence of the recession can be eased if the government buys goods by increasing public works. In addition, if the government's purchases are very large, they can "prime the pump" and invigorate the private-sector economy. Such was the way of thinking that formed the foundation of Japan's measures for dealing with recession. Based on this "pump-priming" theory, fiscal expenditures should have brought about sufficient results after just one or two stimulus packages. In fact, policymakers who were in charge of economic stimulus steps immediately after the collapse of the bubble also said they thought, "Only one or two injections of fiscal outlays would be needed. However, in reality, we saw time and again that once the effects of the fiscal stimulus had worn off, the economy swiftly decelerated. In the end, the government had no choice but to continue providing fiscal stimulus practically every year. Such a situation clearly runs counter to the assumptions of Keynesian economics. Under the textbook assumptions, the economy should recover on its own once the pump is primed.” This did not happened, he notes. www.rieti.go.jp/en/papers/contribution/kobayashi/08.html
6 “Nearly a decade of then-unprecedented increases in federal spending on public relief and public works projects never managed during the Depression to lower the unemployment rate into single digits or restore our gross domestic product to the level it had achieved in 1929.” William F. Shughart II, prof. of economics, University of Mississippi, “'New New Deal' likely ineffective, wasteful,” Honolulu Advertiser, January 4, 2009.
7 As the Tax Foundation web site argues: “Recent research has focused on the lower corporate tax rates enacted by OECD nations over the past two decades to explore the link between corporate taxes and wages. This research has found that wage rates have gone up the most in countries with the largest reduction in corporate taxes. This finding is important because is tells a story whereby the corporate tax is borne by workers, through lower real wages, rather than by owners of capital. The intuition is simple: a tax will generally be borne by the input that is the least mobile. In today's world economy, capital flows freely across borders, while labor does. Thus, the corporate tax lowers workers' real wages relative to where they would be set otherwise.”
8 Increases in federal spending were the initial reaction of the Hoover Administration to the Great Depression and they did not work: “After the stock market collapse in 1929, the Hoover Administration increased federal spending by 47 percent over the following three years. As a result, federal spending increased from 3.4 percent of GDP in 1930 to 6.9 percent in 1932 and reached 9.8 percent by 1940.” Ronald D. Utt, Ph.D. Heritage Foundation, “Learning from Japan: Infrastructure Spending Won't Boost the Economy,” December 16, 2008.
9 Batina et al., supra, "The Impact of Public Inputs on the Private Economy" 2003.