Mises Wire

Home | Wire | Infrastructure and Public Works: Crowding Out and Economic Instability

Infrastructure and Public Works: Crowding Out and Economic Instability

  • Highway_401_by_401-DVP.jpg
0 Views

Tags Booms and BustsOther Schools of Thought

02/04/2015

“Infrastructure investments” or public works have long been the refuge of Keynesians and other progressives of like stripes as a cure for recession or stagnation. How can there be any significant costs to such projects when resources are idle and interest rates are low? The charge has been renewed with the announcement earlier this week of the Obama ‘budget’ where per a Denver post headline (February 2, 2015, p. 1A), “Obama poses public works.” In today’s Wall Street Journal, Holman W. Jenkins, Jr. (“The Infrastructure Medicine Show: Today’s low interest rates are hardly a testament to investor confidence in government spending decisions”) argues, “Infrastructure is the latest salvation of the economy proposed by those who believe government must stimulate employment and demand. Infrastructure is a recent favorite of President Obama ’s.” Jenkins then proceeds to debunk the effectiveness of such policies based on recent world wide experience. Some highlights:

The International Monetary Fund, recently a hotbed of infrastructure enthusiasm, likes to burble that projects can’t help but be winners when interest rates are so low. Ask Japan, whose stagnant economy has to support towering debts partly incurred to fund dubious public investments. In the U.S., why does top-down infrastructure enthusiasm always seem to turn to California-style bullet trains—i.e., projects certain to lose money but beloved by politicians and pork-barreling interest groups?

And

Herein resides the real danger—as in Japan, the proposed infrastructure binge might just leave taxpayers and voters more despairing than ever about the political class’s ability to cure the industrial world’s self-inflicted stagnation.

Hayek in the 1970s (Unemployment and Monetary Policy: Government as Generator of the “Business Cycle” – pdf on request) made two adjustments to his approach to business cycles that provide a theoretical foundation for Jenkins assessment of infrastructure ‘investment’. He moved from structure of production emphasis to emphasizing the Cantillon effect that stimulus creates a  misdirection of production. By doing so he his broadens concern to fiscal spending as well as monetary stimulus. In addition he clearly addresses the issue of effect of stimulus with idle resources and comes to the conclusion that production is still misdirected. While the policy may appear to work ─ the effect is temporary. One can achieve a short term lower unemployment rate but only at the cost of higher unemployment long term and increased instability.

Adrian Ravier (Universidad Francisco Marroquín) and Nicolas Cachanosky (Metropolitan State University of Denver) have a new paper, “Fiscal Policy and Crowding Out Effects in Capital Based Macroeconomics with Idle Resources”, which provides a more rigorous foundation for Hayek’s insights. The conclusion:

While Garrison’s model has been mostly used to analyze, theoretically and empirically, business cycles, other potential venues have not been explored. The effects of fiscal policy is [sic] one of these applications. In this paper we show how Garrison’s model can be used to analyze the effects of fiscal policy in the presence of idle resources. This yields two important results. First, the crowding out effects can be shown even if total investment (or consumption) increases. Second, the model shows that even if potential output is reached, the result is imbalances in how resources are allocated in the structure of production of the economy.

John P. Cochran (1949-2015) was emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He was also a senior fellow of the Mises Institute and served on the editorial board of the Quarterly Journal of Austrian Economics.

Add Comment

Shield icon wire