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(Corrects cost of Alaskan bridge project in 14th paragraph.)
It's hard to imagine at the moment, with America's fractious and politically vicious midterm elections drawing near, but the outline of Round Three in the federal government's efforts to stimulate the economy is becoming clearer.
Round One came in late 2008 with the Bush Administration's bank bailout and the Federal Reserve's easing of monetary policy. The defining initiative of Round Two was the Obama Administration's nearly $800 billion fiscal stimulus package signed into law on Feb. 17, 2009 (along with more Fed easing).
Round Three is largely based on—who else—the Fed taking steps to bring down long-term interest rates even more by buying up U.S. Treasury securities, the so-called quantitative easing. The fiscal lever this time around? A boost in infrastructure spending.
The latter initiative is vulnerable, of course. The Obama Administration on Oct. 11 proposed a $50 billion up-front investment in highways, roads, and the air transport system. That's on top of the $68 billion infrastructure spending that was part of the 2009 fiscal stimulus bill, money earmarked for highways, rail, transit, broadband, school modernization, water treatment, and airport improvement. The Administration has also proposed an "infrastructure bank" to cut down on duplicate projects and to attract private capital as co-investors in various initiatives.
Large capital projects on infrastructure traditionally appeal across party lines since so many constituents benefit from the investment. But that traditional political calculation may not hold in an era when the Tea Party movement is repelled by the federal government's red ink and even a silent majority of more mainstream political participants seems to share a common worry about the soundness of fiscal policy.The backlash against government spending carries over to the state level.For instance, New Jersey Governor Chris Christie cited the cash-strapped state's finances when, on Oct.7, he cancelled its participation in an $8.7 billion-plus train tunnel project under the Hudson River.
But the embrace of fiscal conservatism, while understandable, risks ignoring what should be a top priority for the nation's long-term economic health. For one thing, the Aug. 1, 2007, tragic collapse of the I-35 bridge in Minneapolis vividly signaled the nation's deteriorating infrastructure. The investment need is there. For another, it's the kind of government spending that not only yields public quality-of-life benefits; it also raises private rates of return.
And with the government's cost of investment capital extremely low—taken a look at Treasury yields recently?—and heading even lower, the hurdle rate for a positive rate of return on government expenditures won't be hard to reach.
"Spending now on infrastructure stimulates the economy in a way that will help provide for long-term higher economic growth that will increase future tax revenue and bring down the debt-to-GDP ratio," says David Aschauer, economist at Bates College. He's the author of an influential set of research papers from the late 1980s and early 1990s on the effect of infrastructure spending on national productivity. "It's real supply-side economics." (One of Ashauer's better-known articles, "Why Is Infrastructure Important?" is available on the Boston Fed's website.The late Edward Gramlich, economist and former Federal Reserve Board governor, wrote a critical review of the infrastructure/productivity literature of the time in "Infrastructure Investment: A Review Essay," which can be found on the World Bank's site.)
The most striking example in U.S. history of the economic payoff from infrastructure expenditures has been largely obscured with time: the building of the Erie Canal. It was a 363-mile-long canal dug through the middle of New York State. A bold adventure, it cost about $7 million, an astounding sum equal to more than a third of all the banking and insurance capital in New York State (and more than three-quarters of the federal budget in 1810). The Canal was started in 1817 and finished 8 years later, after much political wrangling.
Perhaps even more striking (considering the current economic climate), after the panic of 1818 the price of money and labor fell sharply when the economy sank into recession. "By 1820, the canal commissioners were drawing contracts at prices 30 percent to 40 percent below what they had paid during the first three years of construction," notes the late Peter Bernstein in Wedding of the Waters: The Erie Canal and the Making of a Great Nation.
When it was done, the cost of commercial transport plunged. For instance, it had taken three weeks and $120 to send a ton of flour from Buffalo to New York City before the canal opened. Afterwards, it took 8 days and $6. "The Erie Canal would prove to be the most consequential public works project in American history and make New York, both state and city, the linchpins of the American economy for more than a century," writes historian John Steele Gordon in An Empire of Wealth.
O.K., so that may be reaching too far back in history. How about some more recent figures? U.S. companies and individuals enjoyed a net direct economic benefit from the nation's highways, rails, and waterways of $603 billion a year, according to Robert Shapiro, former undersecretary of commerce for economic affairs during the Bush Administration, and Kevin Hassert, director of economic policy studies at the American Enterprise Institute. In their 2005 paper, "Healthy Returns," they calculated that Americans gained more than $788 billion a year from transportation infrastructure and paid taxes and fees of $185 billion to support that infrastructure.
The authors note that their net figure was conservative, a narrow take that didn't include, among other things, the value people get from easier access to schools, medical facilities, and other destinations. "These findings establish clearly that strong commitments to surface transportation and the spending required to support it well serve America's economic interest," they concluded.
Of course, infrastructure spending is controversial. It often goes by another name, such as "pork barrel spending" or "corporate welfare." The most recent infamous example is the so-called Bridge to Nowhere. The Alaskan Congressional delegation, especially Representative Don Young and the late Senator Ted Stevens, pushed for a nearly $400 million bridge to connect Alaska's Gravina Island (pop. less than 50) to the town of Ketchikan (pop around 8,000).
Japan also offers a cautionary tale. It has poured concrete into bridges, roads, dams, airports, and other projects—many of them unwanted and unneeded—for some 20 years in an effort to emerge from its deflationary stupor, to little avail.
Before cutting the first check, officials should ask, "Is it a good project?"" says Jeffrey Miron, economist at Harvard University.
Nevertheless, the cost of congestion on the roads, airports, and other core infrastructure is significant, measured in time wasted in traffic (both commuters and trucks) and lost productivity. The bigger issue is that the Administration missed an opportunity to expand the definition of infrastructure to include high-return investments in human capital—the infrastructure of the modern American economy.
Specifically, the federal government should seize the opportunity to invest billions in high-quality, early childhood education in low-income communities. James Heckman, Nobel laureate and economist at the University of Chicago, estimates that the inflation-adjusted rate of return on such investments is in the 6 percent to 10 percent annual range. That's better than the postwar return to stocks of 5.8 percent.
"I would argue that the infrastructure with the highest rate return is in high-quality, early childhood education for at-risk kids," says Art Rolnick, senior fellow at the Humphrey Institute for Public Affairs. "Human capital is by far the most important infrastructure we have, and early childhood education offers the biggest bang for the buck."
Here's the thing: The economy is in danger of sinking into an ominous quietude, marked by slow growth and high unemployment. The consensus forecast among economists appears to be that an unemployment rate below 6 percent isn't in the cards for the next several years, even as the recovery grows long in the tooth. This is an unhealthy state of affairs. It threatens to turn today's cyclical unemployment (reflecting the downturn) into structural unemployment (in which too many workers lack the skills employers want).
So let Uncle Sam put stimulus money where it could do some real good: not just in highways and runways, but in classrooms, libraries, and laboratories. Investing in a more broadly defined infrastructure not only offers the prospect of more jobs and income in the short run, but it would also put the U.S. economy on a healthier long-term growth path. The economics are compelling. Are politicians listening?