Friday, November 28, 2014

Wanna boost the economy? Go for infrastructure spend

The IMF is now telling us that public spending on infrastructure can provide a great stimulus to the economy- and in the developed world as much as the developing world.

 Larry Summers comments on the IMF findings:
Consider a hypothetical investment in a new highway financed entirely with debt. Assume – counterfactually and conservatively – that the process of building the highway provides no stimulative benefit. Further assume that the investment earns only a 6 per cent real return, also a very conservative assumption given widely accepted estimates of the benefits of public investment. Then, annual tax collections adjusted for inflation would increase by 1.5 per cent of the amount invested, since the government claims about 25 cents out of every additional dollar of income. Real interest costs, that is interest costs less inflation, are below 1 per cent in the US and much of the industrialised world over horizons of up to 30 years. So infrastructure investment actually makes it possible to reduce burdens on future generations.

In fact, this calculation understates the positive budgetary impact of well-designed infrastructure investment, as the IMF recognised. It neglects the tax revenue that comes from the stimulative benefit of putting people to work constructing infrastructure, as well as the possible long-run benefits that come from combating recession. It neglects the reality that deferring infrastructure renewal places a burden on future generations just as surely as does government borrowing.

It ignores the fact that by increasing the economy’s capacity, infrastructure investment increases the ability to handle any given level of debt. Critically, it takes no account of the fact that in many cases government can catalyse a dollar of infrastructure investment at a cost of much less than a dollar by providing a tranche of equity financing, a tax subsidy or a loan guarantee.
Spending on infrastructure thus involves an increase in government spending and an increase in the ratio of public debt to gdp at the beginning of the period but translates into a reduced debt to gdp ratio at the end of the period.

When this is so obvious, it has never been clear to me why in India the government has been leery of a sharp increase in infrastructure spending- and I am not referring to the recent period where concerns about inflation have come to dominate the debate.

1 comment:

Anonymous said...

So you too believe that in an inflation driven economy ,high public expenditure funded by borrowing helps to reduce cost of borrowing &induce output. The theory is that inflation ,erodes cost of capital &maximise value. I too have your doubt since in India why this theory fails despite we have made considerable investments that too funded by borrowings&inflation has been persisting for a long period. I assume that this economic models are incapable for depicting real life condition since not only economic but there are other factors which has bearing on a nation's productivity like socio-politico-geo factors.Isolating one of this factors in laboratory situation gives confusing results that doesn't support empirical evidence