Infrastructure Spending: Good or bad For an Economy?

When China announced its 4 trillion yuan ($586 billion) stimulus package in November, most of which will go to increased spending for railways, highways and other infrastructure projects, the reaction by nearly all observers was positive. Some China watchers cautioned that such large spending over a short period of time might lead to misallocation of resources, but most applauded the government’s efforts.

As President Obama takes office, and talk of a $1 trillion or more stimulus package for the United States economy dominates the talk shows, the reaction to such heavy spending by the government has been considerably more mixed. In fact, one of the conclusions reached by Amity Schlaes in her book, The Forgotten Man: A New History of the Great Depression, is that spending during the administration of Franklin Delano Roosevelt was generally ineffective in pulling the country out of depression. Despite the various public works programs initiated by FDR, unemployment remained stubbornly high at double-digit rates for 10 years after he took office. Her advice: the less the government does the better.

Given these conflicting reactions to using infrastructure spending as a way to lift an economy out of recession, I’ve been puzzled as to why this seems to be a good idea in the case of China, but a bad idea in the case of the United States. I’ve been able to come up with three reasons, which I refer to as crowding out, productivity and bang for the buck.

1.  Crowding Out: In any economy, the sources of total demand are private consumption, government spending and investment. In a developed country like the United States, private consumption and private investment are very robust forces in the economy and rely upon unfettered access to the capital markets to finance their expenditures. To the extent that the government steps in and becomes a larger source of demand and investment, it begins to consume more capital through higher taxes and increased borrowings. As it does, the government, in effect, “crowds out” private companies and investors, making it more expensive, and perhaps impossible, for them to finance their investments. It’s a zero-sum game. The more the government does, the less resources there are available for the private sector. The question then becomes, “Would you prefer to have the government or private businessmen and investors make the investment decisions for the economy?”

I submit that listening to a single session of congressional hearings on any economic matter will cure most reasonable people of any desire they might have to have the government perform this function.

In the case of China, however, private spending and investment is a growing, but much, much smaller part of overall demand. Many of the largest companies in China are state-owned enterprises, so their investment programs are merely extensions of government policy. While China needs to encourage the development of its private sector, this will take a long time and require much different and more diverse capital markets to get more capital to the private sector. In the meantime, increased government spending for infrastructure does not have the same crowding out effect that it has in the United States

2.  Productivity: Although I am certain that not every project undertaken by the Chinese government would meet the return expectations of a cold-eyed private investor, the country is in an embryonic stage of development, so new infrastructure projects can have a significant impact on overall productivity. Building a new bridge or highway where none existed before that provides improved access for hundreds of thousands, and perhaps millions, of people will enable them to be much more productive. As much as it might be needed, repairing an existing road or bridge is unlikely to generate a similar level of incremental productivity gains.

A cursory review of the Mainstreet Economic Recovery Report, issued recently by The United States Council of Mayors on “Ready to Go” infrastructure projects reveals why many are skeptical about increased government spending. Water parks, community and recreation centers, skateboard parks and “weed and seed” programs may be worthwhile social projects in an economy with unlimited resources, but not in times like these when the government is already running a huge deficit and productivity and global competitiveness are key issues for the American economy.

3.  Bang For the Buck: When I drive past a major infrastructure project in the United States—-a widening of the Pennsylvania Turnpike, the building of a new bridge, or a modernization of the Trenton Train Station—I can’t help but think how horribly expensive it is compared to China. Construction equipment is at least four times more expensive in the United States than it is here, and those equipment operators at $50 per hour are vastly more costly than their Chinese counterparts. This is no one’s fault—it’s just a fact of life. In a highly-developed economy like the United States, doing anything is more costly and requires substantially more investment.

In this regard, I was particularly struck by an article that appeared in the November edition of “that’s Beijing.” In reviewing the Olympic venues, the article said that the National Stadium (the Bird’s Nest) cost $423 million to build. If built in the West, the cost would have been $4 billion, more than 10 times what China spent.

Anytime I am asked to compare China’s development with that of India, I first refer to the different states of their infrastructure development. Anyone who has traveled to both countries will immediately make the same observation. By placing so much emphasis on developing its highway, railway, power, airport and telecommunications infrastructure, China has provided a very conducive physical environment for business development, particularly in manufacturing. India has not done the same, and therein lies a big part of the differences in their development speed.

Because China can still build modern infrastructure that improves the country’s productivity relatively cheaply, and does not need to be overly concerned about crowding out private investors, increased spending is likely to work much better in the short term than in more developed countries like the United States. This will not always be the case, however. Over the longer term, private investment and consumption, not government, must play a larger role in demand generation.

2 Responses to “Infrastructure Spending: Good or bad For an Economy?”

  1. Excellent column. Problem in the US is the government is the only entity with funds. Banks are closed until further notice and private companies are worried about funding operations. Only options seem to be government stimulus or no stimulus. Most aren’t willing to run the risk of no stimulus.

    Rgs, Charlie

  2. Charlie,

    It’s ironic that the US has come full circle and is now where China is as far as the private side of the economy. As you say, private companies in the US are worried about funding operations because the banks are closed. Private companies in China have the same problem. Both the US and China face the same issue—how to bolster the confidence of private investors, companies and consumers.