For this blog post, I hoped to explore a modern-day application of Keynesian economic policy: infrastructure spending during a recession. During the recent recession, policymakers took several monetary and fiscal policy actions to stimulate the economy. These included the American Recovery and Reinvestment Act (ARRA), which increased federal spending and enacted temporary tax reductions to stimulate demand. A persistently anemic recovery, however, has led to a widespread desire to do more to spur job creation. One approach that has enjoyed renewed attention, and was also included in the ARRA, is infrastructure spending: using accelerated investments in highways, transit, airports, water supply, and other facilities to create jobs while promoting long-term economic growth.
In response to these economic concerns, President Obama proposed the American Jobs Act (S.1549) on Sept. 8, 2011. The plan includes $80 billion in spending on transportation infrastructure and school repair and modernization, and establishment of a national infrastructure bank to finance large infrastructure projects.
To what extent can infrastructure investment spur economic growth and job creation? The question is a difficult one to answer empirically, and requires a discussion of several issues. Most economists agree that infrastructure investment is a necessary condition for long-term economic growth. Just imagine the American economy without adequate roads, bridges, telephone lines etc. -- it doesn't work. The short-term picture, however, is much more complicated.
Productivity and Output
The argument for infrastructure is simple: infrastructure is a public good that produces positive externalities for production. It plays a central role in the economy's ability to produce goods and services. Few would dispute that. But the precise way in which infrastructure is significant, and to what degree, are matters of much debate. Public roads by themselves don't produce anything; they are linked only in complex ways to growth.
The modern-day Keynesian argument, advanced by economists like Paul Krugman, is that when neither consumers nor businesses are spending a massive infusion of infrastructure spending can stimulate labor demand in an underutilized labor market. At the same time, it can enhance productivity by improving long-neglected investments in roads, bridges, ports, etc. and improve America's "D" grade on infrastructure given by the American Society of Civil Engineers.
The concept of a Keynesian multiplier effect plays an important role in this argument. Infrastructure spending directly increases employment by hiring workers to build. But it also generates demand for goods and services through purchases of materials and supplies, and through additional spending by the workers hired. This indirect increase in demand leads to further hiring.
The I-O model for job creation
To quantify the impact of infrastructure investment on employment, economists often use an "input-output (I-O) model" of the economy. An I-O model captures the interrelationships between industries in the production process by showing how the dollar value of a sale of inputs (e.g. concrete, steel, etc.) translates into final outputs (e.g. buildings, roads, and dams). The output requirements from each intermediate and final good are then converted into employment requirements. The final measure is expressed as the number of jobs per billion dollars of expenditure valued in a given year's dollars.
The Federal Highway Administration (FHWA) I-O model, for example, suggests that a $1 billion expenditure on highway construction in 2007 supported 30,000 jobs. Another example of an infrastructure job creation estimate is provided by the BEA's Regional Input-Output Modeling System (RIMS II). The BEA report reported that job creation varied widely by state, but $1 billion of state expenditure directly or indirectly supported between 9,000-14,000 jobs per state.
Short-term vs. Long-Term
Recent evidence (including the data above) suggests that investing in infrastructure yields significant long-term gains in employment and output. But what about infrastructure spending as short-term stimulus? Here the issue of timing makes it very difficult, some would argue impossible, to use infrastructure spending as a short-term economic jolt.
The timing of fiscal stimulus is crucial: if the economy is not in a phase of very slow growth or recession, infrastructure projects will provide little help when the economy needs it most. Poorly timed policies may actually do harm by aggravating inflationary pressures and adding to the federal debt.
Perhaps most importantly, large scale construction projects generally require years of planning, preparation, and implementation. Based on CBO data, the National Governor's Association reported spend out rates for several infrastructure categories. Only 19% of airport construction spending, for example, is spent out during the first year. About 24% of drinking water spending goes out in the first to years, and still only about 54% over the first three.
As President Obama joked the ARRA's impact last year during a meeting of his Jobs Council: "shovel-ready was not as shovel-ready as we expected." Similarly, the CBO has written that "as a practical matter, the experience with ARRA suggests that fewer projects are "shovel ready" than one might expect."On the other hand, prioritizing ready-to-go projects may result in approval of substandard (i.e. meritless) construction efforts -- instead of addressing real economic needs.
Conclusion
Ultimately, the best short-term policy may lie in pursuing infrastructure projects based on economic need -- not "shovel-readiness" -- with a heavy emphasis on projects that can be done quickly. Meanwhile, longer-term projects can continue to lay the foundation for productivity that most economists seem to believe is necessary. Such an approach would balance both short-term and long-term goals, and ensure that our essential infrastructure is sustained and enhanced.
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