Tag Archives: Infrastructure

Glossy projects vs Maintenance – Governments need to get the basics right.

Since the GFC economics has been dominated by fiscal and monetary policies to stimulate aggregate demand. Monetary policy has in particular been reinventing itself with low interest rates not being enough to stimulate demand and the introduction of numerous rounds of QE.

Other policy areas might lack the excitement of delving into the unknown but are just as important to an economy. Maintenance of a country’s infrastructure, assets and government accounts are essential to the long-term development but government’s tend to avoid them as they are not creating anything new and therefore not recognisable by voters. A new hospital, school or major road grab the headlines and inform the electorate that they have been busy putting tax payer money to good use. Maintenance lacks the glamour of innovation.

The US after the GFC did spend a lot of money on new vanity infrastructure projects but these were in sparsely populated areas. However, it was busy cities that really needed their transport infrastructure upgraded and you would think this would be a priority for governments. In the US the fraction of existing road surfaces that are too bumpy has risen from 10% in 1997 to 21% in 2018. Invariably if infrastructure is not maintained it causes significant costs for an economy and in some cases fatalities – the recent bridge collapse in Genoa, Italy. One of the issues for economists is that the typically used measure of an economy, GDP, doesn’t take into consideration the cost of wear and tear. In order to do this they must work out the lifespan of each asset and decide on its depreciation. Some are similar to light bulbs which means they work until they blow – economists refer to this as the “one hoss shay” case. This is based on a poem where it imagines a horse-drawn cart built so well that it never broke down until it eventually fell apart. victim of a “general flavour of mild decay”. Other assets are more linear in how they depreciate in that they lose the same amount each year. Japan assumes that houses lose 4% in value each year and that is why Japan’s consumption of fixed capital is high – 22% of GDP – see graph from The Economist.

Too often governments, and organisations for that matter, preserves day-to-day spending by cutting maintenance and investment. Finance ministers might invest more in maintenance if the resulting boost to public wealth became more transparent. Furthermore if all government departments had to account for all the capital tied up in their operations, they might feel obliged to be more productive with it. New Zealand seems to be the only country to update its public-sector balance-sheet every month, allowing for timely assessment of public-sector worth. So instead of impressing voters with ideas and glossy projects, being boring might actually do some good. Economists tend to be good at this.

Source: The Economist – October 20th 2018

How do we stimulate the global economy in tackling the next downturn?

There is growing anxiety that policymakers in the develoPublic Debtped world will need to consider some radical approaches to tackling the next downturn. Quantitative easing (the buying of government bonds using the money of the central bank) is limited and with interest rates already a record lows a further drop is unlikely to stimulate much more aggregate demand. Fiscal policy could be employed – tax cuts and increases in government spending. However the issue here is how much fiscal stimulus can government’s afford with the debt they already have? See table

Government policy in recent years has done little to improve the economic climate. Although there has been many rounds of quantitative easing the productivity of those in work has been poor leading to lethargic growth levels. This ultimately limits real wage growth and tax revenue to reduce government debt levels.  Economies are now doomed to many years of weaker growth with lackluster demand which will mean more radical policies outside the square. Some policy options could be:

Fusing Monetary and Fiscal Policy

An option discussed in The Economist was to finance public spending and the tax cuts by printing more money. This could be more effective than Quantitive Easing (QE) as the money now bypasses the banking system and goes straight into the pockets of the consumers. This would hopefully encourage consumers to spend money straight away instead of going through the process of borrowing money from the bank as is the case with QE.

Incomes Policy – wage-price spiral

The aim of an incomes policy in the 1960’s and 70’s was to link the growth of incomes to the productivity so as to prevent the excessive rises in factor incomes which raise costs and hence prices. However the idea here is to generate higher incomes at all levels by using tax incentives and to encourage a wage-price spiral. This seems bizarre in the context of the 1970’s as this is what governments were trying to solve.

Infrastructure development

InfrastructureCapital spending on infrastructure is seen as a much more effective tool to stimulate growth than tax cuts. Unlike tax cuts, capital spending goes directly into the circular flow and it attracts complementary spending elsewhere in the economy more than any other intervention. It is estimated that a third of roads in the USA are in a poor state and over 10% of its bridges are not structurally sound. However although it might sound a good idea, infrastructure spending can be wasteful as even many years of capital spending in Japan hasn’t had the desired effect of boosting the economy.

Where to from here?

The problem, then, is not that the world has run out of policy options. Politicians have known all along that they can make a difference, but they are weak and too quarrelsome to act. America’s political establishment is riven; Japan’s politicians are too timid to confront lobbies; and the euro area seems institutionally incapable of uniting around new policies.

Source: The Economist – 20th February 2016

 

Lost opportunity to upgrade infrastructure in developed economies

InfrastructureThe Economist had an article on the lost opportunity of a lot of developed economies upgrading their infrastructure EG

  • 33% of railway bridges in Germany is over 100 years old
  • 50% of London’s water mains are also over 100 years old
  • In the US the average bridge is 42 years old and the average dam 52.

The American Society of Civil Engineers rates around 14,000 of the country’s dams as “high hazard” and 151,238 of its bridges as “deficient”. As well as being dangerous it is also expensive as traffic jams on urban highways cost America over $100 billion in wasted time and fuel each year; congestion at airports costs $22 billion and another $150 billion is lost to power outages.

The G20 economies will need to spend between $15 trillion-20 trillion by 2030 to upgrade infrastructure. McKinsey, a consultancy, reckons that in 2007-12 investment in infrastructure in rich countries was about 2.5% of GDP a year when it should have been 3.5%. This was a missed opportunity to upgrade infrastructure for the following reasons:

  • Interest rates have been a extremely low levels
  • There has been a lot of spare capacity in the construction industry which in turn means that the costs of contracting companies to do the work is low.

Investment in infrastructure can provide a tremendous boost to an economy:

  • Paving roads has helped double school attendance by girls in Morocco;
  • Improved sanitation has helped reduce child mortality in India by over 50%.
  • Increased government spending on infrastructure by 1% of GDP would increase GDP, after 3 years, in the USA by 1.7%, 2.5% in the UK and 1.4% in the Euro Zone.

Politics vs Practicality

Politicians still seem to favour investment projects that attract attention. Rather than upgrading bridges, roads, subways etc the priority is more eye-catching ventures. The USA post stimulus spending on infrastructure dedicated $8bn to a high speed rail service but only $1.5bn to small more practical projects.

The Perils of Deflation

DeflationFor so long central banks and policy makers have been obsessed with inflation but with inflation falling the dangers of deflation are now on the horizon. In the USA, Britain and the euro zone inflation is dropping below the 2% target and Japan is struggling to maintain higher prices. Why is deflation bad:

1. Money made today will be worth less tomorrow so investment is discouraged
2. Goods cheaper tomorrow reduces consumption and therefore aggregate demand
3. Central banks struggle to set real interest rates which are stimulatory
4. People who borrow money find that what they owe is worth more in real terms
5. Demand runs below the economy’s capacity to supply goods and services leaving an output gap. This can lead to unemployment and wage cuts which worsens the situation

One of the main problems at present is the fact that Central Banks are running out of ammunition – interest rate cuts – as rates are close to 0%. Therefore in order to stimulate demand they now have to use fiscal policy and more government spending would assist especially in areas that are in need – e.g. roads, bridges etc.

Would US public infrastructure spending drive up prices?

Some alarming figures have been banded about with regard to America’s infrastructure. It is estimated that over 700,000 bridges are rated as structurally deficient. In 2009 Americans lost approximately $78 billion to traffic delays – inefficient use of time and petrol costs. Also crashes which to a large extent have been caused by road conditions, cost a further $230 billion.

According to the American Society of Civil Engineers the US needs to spend $2.2 trillion bring their infrastructure up to standard. The Congressional Budget Office estimated in 2011 that for every dollar the federal government spent on infrastructure the multiplier effect was up to 2.5. Other indicators state that every $1 billion spent on infrastructure creates 18,000 jobs, almost 30% more than if the same amount were used to cut personal income taxes. – The Economist

Positive Externalities from infrastructure.

Investment in infrastructure has a lot of positive externalities – faster traveling time for consumers and companies, spending less time on maintenance. Research has shown that the completion of a road led to an increase in economic activity between 3 and 8 times bigger than it initial outlay with eight years after its completion. But what must be considered is that now is the best time to invest in infrastructure as it is very cheap – much cheaper than it will be when the economy is going through a boom period.

Bridging the gap – BRICS Development Bank

Qingzang_Tibet_Train_01A new BRICS development bank has been established with its headquarters in Shanghai. The focus of the bank will be on infrastructure in developing countries. China has used infrastructure spending as a extensive part of its own development strategy – China’s national trunk highway system of 35,000km of highways was built between 1992 and 2007 at a cost of $120bn. It has spent 8.5% of its GDP investing in infrastructure from 1992-2011 and according to McKinsey the developing country norm is 2-4% of GDP.

Although it is difficult to measure the precise effect of infrastructure spending, it is the long run impact on an economy that is the most important. The Economist identified two benefits from infrastructure spending:

1. It can generate a rise in incomes if reduced transaction costs promote trade.
2. It can raise growth rates if it leads to greater information sharing and thus improved productivity.

Recent research into the high-altitude railway connecting the Chinese province of Qinghai to Tibet provides a natural experiment. The region was one of the poorest in China meaning that prior growth did not prompt investment. The results showed a 33% increase in GDP/person in counties that got the railway = 12 billion Renminbi extra GDP a year, exceeding its 33 billion Renminbi cost in just 3 years. The main positive out of this railway network was the ability of local manufacturers being able to sell to the national market. However there is a downside as local industry find it hard to compete with goods from more advanced areas and this can lead to a contraction of its economy and ultimately a loss of jobs.

qinghai-Tibet Network

US infrastructure could create those jobs

US InfrastructureSome alarming figures have been banded about with regard to America’s infrastructure. It is estimated that over 700,000 bridges are rated as structurally deficient. In 2009 Americans lost approximately $78 billion to traffic delays – inefficient use of time and petrol costs. Also crashes which to a large extent have been caused by road conditions, cost a further $230 billion.

According to the American Society of Civil Engineers the US needs to spend $2.2 trillion bring their infrastructure up to standard. The Congressional Budget Office estimated in 2011 that for every dollar the federal government spent on infrastructure the multiplier effect was up to 2.5. Other indicators state that every $1 billion spent on infrastructure creates 18,000 jobs, almost 30% more than if the same amount were used to cut personal income taxes. – The Economist

Positive Externalities from infrastructure.

Investment in infrastructure has a lot of positive externalities – faster traveling time for consumers and companies, spending less time on maintenance. Research has shown that the completion of a road led to an increase in economic activity between 3 and 8 times bigger than it initial outlay with eight years after its completion. But what must be considered is that now is the best time to invest in infrastructure as it is very cheap – much cheaper than it will be when the economy is going through a boom period.

The long road to Beijing

You might have read about the huge traffic jam along a highway leading into Beijing – at one point over 100km long and lasting for 11 days. With the growth of the middle class and the subsequent increase in demand for energy and other goods there is huge pressure on the country’s infrastructure – in 2010 China has budgeted $11.8bn for transport infrastructure. However as the Chinese economy grows and the new motoring class emerges is this a sign of the future – more massive traffic jams. The major concern here is that in recent years rising vehicle ownership has outpaced the growth of China’s express highway – see graphic below from The Economist