Infrastructure spending, if properly executed, could provide a boost to the economy

The presidential election is entering its final push and the candidates are working hard to convince voters of the merits of their platforms. As is typical with elections there are few areas in which the candidates share common ground. However, both Donald Trump and Hillary Clinton agree on the need for a significant increase in infrastructure spending. Upgrades are badly needed as evidenced by the poor conditions of our roads and bridges as well as the Skagit River Bridge collapse on I-5 in 2013. However, there is another benefit. Improvements in our power transmission, transportation networks and educational facilities represent investments that should create jobs and boost economic growth.

Investments in infrastructure, if done properly, have a positive economic impact in both the near-term and over time. Most infrastructure projects are large in scale and capital intensive with high upfront costs, but provide benefits for many years in the future. Once construction begins, the economy is positively impacted as workers are hired and construction firms purchase the necessary equipment and materials. This results in an immediate increase in demand that helps to boost economic growth. However, there are also long-term benefits. Over time, we should be positively impacted by the increase in output that occurs in the years after construction is completed.    

The International Monetary Fund conducted a study, “Is It Time For An Infrastructure Push? The Macroeconomic Effects of Public Investment,” (World Economic Outlook, October 2014) in which they found that the benefits of infrastructure investment are greatest when the economy is performing far below its potential level of output, the level of monetary accommodation is high and when there is a high level of efficiency in the execution of the infrastructure development program. The method of financing the construction is also a significant factor.  

Given this framework, the current economic environment appears well suited to benefit from an increase in infrastructure spending. Our economy is running at a pace that is below its potential. In fact, for 2015 the International Monetary Fund estimates the output gap, which compares our actual economic growth relative to what the economy is capable of producing, to be 1.6 % (IMF, World Economic Outlook Database, April 2016). In other words, the economy is capable of growing much faster than it did last year. In addition, the level of monetary accommodation is exceptionally high resulting in interest rates that are near record lows. As a result, we can borrow at attractive rates, if necessary, to finance these projects. 

In spite of the low level of interest rates, we must remain cognizant of the method of financing these projects. Given our high debt level and persistent budget deficits we are constrained in our ability to fund these initiatives. As we’ve discussed in the past, high levels of debt are associated with low rates of economic growth. This is due to the fact that once there is a large amount of debt outstanding; repayment takes a significant amount of capital away from other productive uses. Alternatively, we could pay for these projects with an increase in taxes, but that presents a significant risk of slowing the rate of economic growth and offsetting the positive impact of the infrastructure investment.  

The key to success with infrastructure development is the efficiency of the execution. In other words, we must select the projects that have the greatest benefit such that the positive impacts far outweigh the financing and construction costs. Notably, the American Society of Civil Engineers provides their assessment of the state of our infrastructure every four years. In their last report, they gave the U.S. infrastructure a grade of D+, on their grading system of A through F, which suggests there is plenty of low hanging fruit (infrastructurereportcard.org).   

Time will tell who will win the presidential election, but regardless of the victor, it appears that an increase in our nation’s infrastructure will be part of the new political agenda. This is a significant change as it represents a focus on investments that can have positive implications for economic growth in both the near-term and over the long run, while also providing much needed improvements to transportation networks and facilities that we use on a daily basis. However, in order to successfully stimulate economic growth, we must be efficient in our execution and pursue those projects that provide benefits that extend well beyond the costs.