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Is there an economic case for more infrastructure spending?

Kevin Milligan on what economists are thinking about when politicians promise investment in infrastructure


 
Liberal leader Justin Trudeau greets apprentices while touring a crane operator training facility Thursday, August 27, 2015 in Oakville, Ont. (Paul Chiasson/CP)

Liberal Leader Justin Trudeau greets apprentices while touring a crane-operator training facility on Aug. 27, 2015, in Oakville, Ont. (Paul Chiasson/CP)

Looking at the 2015 election platforms, political aspirants seem to be falling over each other to spend more on infrastructure. The Conservatives started things off in May’s budget, with a pledge to increase infrastructure spending by $750 million a year, starting in 2017-18. The Liberals have now announced a major expansion on top of the May budget plan. The NDP has promised a $1.5-billion increase by the end of a mandate, funded by a gas tax transfer. Not to be outdone, the Green party promises a “massive” increase in funding for transit and infrastructure. This political consensus is echoed by a number of think tanks and organizations across the spectrum, from the Canada West Foundation and the Chamber of Commerce to Canada 2020 and the Canadian Centre for Policy Alternatives.

But what do economists really think about infrastructure investment in today’s context? Last year, here on Econowatch, Stephen Gordon expressed some skepticism, while I explored David Dodge’s pro-infrastructure position. Below, I’ve put together a deeper dive into the motivations and criticisms of the infrastructure proposals, with six questions an economist would consider when thinking about infrastructure.

1) Can infrastructure spending fight off a recession?

The economy is not doing well right now—if not in full recession, we are certainly in a slowdown. Some economists argue this is a great time to push against these downward trends with some countercyclical fiscal policy. See, for example, Kevin Lynch writing recently in the Globe and Mail that infrastructure spending should play this fiscal policy role.

However, other economists argue that this particular commodity-driven economic situation demands a different approach. Stephen Gordon in the National Post explains that expansionary government spending is the wrong  choice for a recession driven by commodity price changes. He posits that lower commodity prices effectively lower productivity, meaning we have a supply-side shock rather than an aggregate-demand deficiency. Moreover, given we have an open trading economy and a flexible exchange rate, the effectiveness of fiscal policy is muted.

To this, I would add that a general infrastructure program is unlikely to hit the weak parts of the economy, either in time (it will take years to get new projects going), or in space (help is needed in oil-producing provinces). Taken together, I find the cyclical case for infrastructure spending to be much less than convincing, given today’s circumstances.

2) Can the federal budget afford more infrastructure spending?

As always, the question of affordability comes down to priorities. Almost anything can be afforded if taxes are sufficient and other spending is kept in check so a particular budget balance can be obtained. But what if the budget balance goes negative?

The Liberals revealed that their plans may push the federal deficit toward $10 billion for two years. In the context of our $2-trillion economy, this amounts to 0.5 per cent of GDP. To gauge the sustainability of deficits, economists typically turn to the debt-to-GDP ratio, which relates the size of the debt to our ability to pay. As long as the annual deficit stays belong the long-run growth trend, the debt-to-GDP ratio shrinks. In those terms, a 0.5 per cent of GDP deficit is small potatoes and has virtually no impact on the long-run sustainability of our public finances.

For the other parties, they’ve committed to making their infrastructure investments while maintaining a balanced budget.

3) Do public infrastructure projects pay sufficient returns?

Public infrastructure investments pay off in many ways. A volume of academic research finds public infrastructure makes workers and firms more productive. In addition, philosopher Joseph Heath argues that the impact of improved public infrastructure on quality of life is large and underappreciated.

Whatever the potential return on public investments, it only makes sense to go ahead with the investment if the return exceeds the cost of financing the investment. Which brings us to the important questions of interest rates.

4) Do interest rates affect the affordability of projects?

In basic finance classes, students learn that the decision to go ahead with a project depends on a comparison of a project’s internal rate of return with the cost of funds (sometimes called the “hurdle rate). As the government’s borrowing costs are currently at historic lows, more projects should now exceed the hurdle rate and get a financial thumbs up.

This argument for expanding public infrastructure spending—even if it means taking on some debt—has come from some surprising places. Last year, 1990s deficit-slayer David Dodge laid out the economic case for borrowing for infrastructure in today’s low-rate environment. Going further, Larry Summers was one of the architects of the U.S. budget balance in the 1990s, yet he argues that public infrastructure investment is a “free lunch” because it expands our economic capacity at a low price.

Some commentators continue to recite the 1990s arguments about debt and deficit. In my view, we need to choose a policy that is right for our current situation, and not get stuck in justifications from the very different 1990s era of high interest rates and large structural fiscal deficits.

5) Are we already investing enough in infrastructure?

It’s useful to look at the time series of public infrastructure spending to get a sense of where we are. The chart shows that, between 1981 and the onset of the financial crisis in 2008, government infrastructure investment bounced around three per cent per year. In response to the need for fiscal stimulus, Canada ramped up infrastructure spending until 2010. After that point, we fell back in the same range for investment we saw in previous decades.

govt-infrastructure

If we take the Dodge-Summers argument seriously, we should be investing much more today than we were in the 1980s and 1990s.

6) Should the federal government be doing this?

Economists like Jack Mintz have argued that the federal government ought to leave it to the provinces to choose and finance infrastructure projects, in order to ensure fiscal transparency about who is paying for what. Fiscal transparency is good, and I’ve always believed that Canada’s decentralized fiscal federation is an institutional strength, rather than something to be cast aside when inconvenient. However, a couple of offsetting arguments should also be considered.

First, local infrastructure can have national consequences. One of my favourite driving shortcuts takes me along Low Level Road in North Vancouver, alongside massive elevators filled with resources bound for foreign shores. Ports like Vancouver’s serve as national infrastructure, shipping out goods such as Saskatchewan potash and prairie-grown wheat, durum, and canola. A federal government can properly account for the national spillovers and externalities of these facilities better than lower orders of government can.

Second, the Parliamentary Budget Officer’s annual Fiscal Sustainability Report shows an increasing long-run fiscal imbalance between the federal and provincial governments. With the federal government taking on some more of the financial load for infrastructure, the fiscal burden of the provinces is somewhat lightened.

Taking this all together, what should the next government do? That depends on how the six factors above are weighted, of course. But, it seems clear that a fairly strong economic case can be made for increasing the federal government’s role in infrastructure projects.

Kevin Milligan has contributed to policy discussions with officials from all three major parties, most recently as an outside economic adviser to Liberal Leader Justin Trudeau. A full disclosure statement is here.


 

Is there an economic case for more infrastructure spending?

  1. Ports like Vancouver are also under terrific stress from several directions. Maybe railroad level crossings need to keep up with a city choked with traffic; maybe the tracks and trackbeds are hurting from increased loads; maybe the buildings, track and giant cranes need a second look for increased seismic risk; maybe in 20 years the wharf will have to be a foot higher each decade. That’s without looking at expansion and dredging to keep up with bigger and faster vessels, and the competition from land developers, the cruise ship terminal and, oh yes, Seattle and other west coast ports trying to keep or get an edge. Infrastructure matters.

  2. If there’s someone out there who doesn’t know we need infrastructure……they shouldn’t be allowed to vote.

  3. Gotta love Macleans. On the day that the Libs announce they want to spend all of our money so we can have nice roads to where our jobs used to be, the magazine gets an unbiased opinion from a guy who worked “most recently as an outside economic adviser to Liberal Leader Justin Trudeau.” Hmmm. Funny how he agrees with his own strategy.

    • Flame you are on the mark. Socialist Emily, left leaning MacLeans and the author of this tripe all believe we can spend our way to happiness. The same philosophy is how the Ontario Liberals have created a province that looks a lot like Greece.

      • Sorry, Emily is not, and never has been,, a socialist

        Go wash your mouth out with soap.

        • You sure act like one. Can you describe what you think you are?

        • She’s not socialist, she’s socially underdeveloped.

          • If you gys think I’m a socialist it just means you don’t know what a socialist is.

            PS Emily is laughing at loser Cons who are frantic over the mess they are in

  4. I’m in favour of a massive infrastructure program, the likes of which we’ve never seen before. I’m talking a twinned raised freeway coast to coast, and that’s just for starters. (Don’t laugh, Chretien wanted to do it before the Martinites who by then controlled the Liberal party made it impossible. They wanted to preserve the entire surplus for their boy to spend.)

    How to pay? No need to borrow or raise taxes. Just end all corporate subsidies and tax credits, which amount to billions upon billions per year. Spending directly on infrastructure upgrades would have a much more immediate impact on economic growth, and a bigger payoff in the long term. But no, we’ll never do that. Whichever party gets in will simply keep playing the subsidy shell game like we have since the post-War era.

    • Emily still hasn’t come out of the closet and you Goat don’t understand competitive business. If the entire world would all agree at the same time to end subsidies the competitors in global markets would all have a level playing field. Most Canadian subsidies were put in place so that those running businesses in Canada were not disadvantaged to subsidized similar businesses in the U.S. and elsewhere. To end them unilaterally would cause businesses to pull up stakes and go south. Now if we could end these for businesses, we should end it elsewhere as well like for university tuitions. If students had to pay the real cost there would be far less of them taking degrees that provide little opportunity for employment like BAs.

      • Emily has never been in a closet. You’ve confused me with Harper.

  5. As usual the economists miss the real issue. To whom is the debt owed and to whom is the interest paid. Setting aside the corporate welfare costs to the government which is considerable, if the Bank of Canada loans the money to the government the interest the government then pays on that borrowing is returned to the government. The present budget is transferring $25.7 billion to the well-off money-lenders as interest on the debt. If the Bank of Canada acquired half of that debt there would be more than a $12 billion dollar budget surplus. Any additional borrowing from the Bank of Canada would also result in the interest being returned to the government. Think — of it this way. If you owned a gas station would you buy gas for your car at your own station or would you buy it from the station down the street? Lib and Con governments have been going down the street. Then that interest gets piled on to the debt which is the Liberal plan of running deficits and what the Cons have been doing for the past 11 years. The question is what would the NDP do in this regard? Would they be able to generate enough funds through cutting back on the corporate welfare to fund infrastructure and other promises they are making? Or would they plan to borrow from the Bank of Canada and recoup virtually 100% of the interest they paid whereas under the Lib and Con approach the interest payments would be hidden from the tax man through loopholes and parking it off-shore in a tax haven.

  6. Yes and no. No if the only reason is that there is an election coming. Yes if the reason is a) the infrastructure is degraded. b) it is the provinces responsibility so the Feds should do the 50% dollar bit perhaps but only while the interest rate is in bargain basement levels, and c) if the prime responsibility is the province – witness Quebec’s corruption-ridden infrastructure projects – I don’t want to pay for their crappy lack of integrity. A friend of mine in Montreal said you need a hard hat to go under an overpass and a life jacket if you are going on a bridge over a river!
    Otherwise a moratorium about talking about a Keynsian approach to economic problems during an election campaign.

    As for Emily, we just have to suffer, I guess.

    • The only thing you ‘suffer’ is that there is someone with a different opinion than yours.

      You grow up an only child, or what?

  7. Yes, infrastructure is good provided you get the money from efficiency, waste, cuts elsewhere. Trudeau is immature, 9 years of tax greed, debt to unborn, devaling us for government debt addiction is the very source of economic downturn of Canada.

    Shows Trudeau’s economic stupidity as oil is no longer carrying the rest of dysfuntional Canada any more. 35% devaled money in 2.5 years means people have less to spend as devaluation taxes are high. And devalued money is a tax.

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