Policy Debate: Is more spending on infrastructure
the key to economic growth?
Issues and Background
Economic expansion in a technological age requires continuous investment in public
infrastructure, in generic R&D, and in training and education.... A strong case can be made
that we should now be spending more on public investment, not less, if we do not want to
undermine the prospects for growth.
~ Barry
Bluestone and Bennett Harrison
The relative increase in the stocks of public and human capital along with the
decline in their marginal rates of return below the returns to private and nonhuman capital
suggest the existence of an imbalance in the optimal mix of capital.... [P]olicies that
encourage the relative growth of private and nonhuman capital would do the most to stimulate
economic growth and reduce unemployment.
~ Willis
Peterson
U.S. Presidential elections are often won and lost on the basis of the state of the economy in
the period leading up to the election. When people are asked to list the economic problems about
which they are most concerned, unemployment and inflation generally top the list. Economic growth
is rarely mentioned as one of the most pressing concerns. The importance of economic growth is
often overlooked. While the effects of growth may be small in any one year, the cumulative
effect of compound growth becomes rather dramatic over time.
The "rule of 72" may be used to illustrate the effect of economic growth. This rule
states that:
the period of time required for income to double = 72 / growth rate
Thus, if an economy experiences real per-capita growth at an annual rate of 2%, a typical
person's income will double in 36 years (72/2 = 36). An economy that grows at a rate of 4% per
year will double its income in 18 years (and quadruple its income in 36 years). Consider the
effect of this growth over a period of 72 years (roughly equal to the life expectancy at birth
of U.S. citizens). If real per capita output were to increase by 2% per year over this period,
the income of a typical person would quadruple over the course of an individual's lifetime.
Under a 4% rate of growth, however, the income of a typical person would be 8 times larger at
the end of this same period.
Since economic growth is so important, economists have been quite concerned about the
decrease in the rate of U.S. economic growth during the past few decades. A great deal of
research effort has been (and is being) devoted to understanding the determinants of economic
growth.
The level of output produced in an economy in any given time period is affected by the
quantity and quality of available resources, the level of technology, and the economic incentives
facing individual firms, investors, savers, and workers. Economic growth, therefore, must be
affected by changes in the quantity or quality of resources, technological innovations, and
changes in the incentive structure in society. While everyone agrees on these general principles,
there is a substantial amount of disagreement concerning the relative importance of each of these
factors. The most common recommendations for increasing the rate of economic growth include:
- increasing public investment in the economic infrastructure (the term "infrastructure"
usually refers to public investment in constructing and maintaining roads, bridges, airports,
railroads, communications networks, water supplies, solid waste management, electricity
production and distribution systems, the legal system, police and fire protection services, etc.),
- increasing public investment in education (human capital),
- providing increased incentives for private investment, and
- improving the incentives for research and development that may lead to technological
improvements.
Much of the debate concerning this issue involves a question of the appropriate role of
government in the economy. The first two approaches listed above suggest a larger role for
direct government involvement. Those who believe that markets are more efficient tend to
advocate the latter two approaches.
While economic growth is a feature of all developed economies, many less-developed economies
experience a relatively stationary state in which many individuals receive only a subsistence
level of output and little or no economic growth occurs. Much of the current research on
economic growth involves the question of how to most effectively initiate growth in these
countries so that economic development may begin. Both the World Bank and the International
Monetary Fund provide programs and loans to encourage growth and development. Once again,
though, there is a question of how to best encourage the process of growth and development.
Primary Resources and Data
- Paul Romer, "Economic Growth"
http://www.stanford.edu/~promer/EconomicGrowth.pdf
Paul Romer, provides a very good introduction to the importance of economic growth. In this
online version of his article in The Fortune Encyclopedia of Economics, Romer discusses
the importance of innovations and applied research on economic growth. (To view this document, the Adobe Acrobat
viewer plugin is required. You may download this viewer by clicking
here.)
- Economic Growth Resources
http://www.bris.ac.uk/Depts/Economics/Growth/
This site, maintained by Jonathan Temple, a Research Officer at the Institute of Economics and
Statistics at the University of Oxford, contains an extensive collection of links to economic
growth resources on the Internet.
- Macroeconomics and Growth
http://econ.worldbank.org/programs/macroeconomics/topic/22009/
This page, provided by the World Bank, contains links to a variety of published articles and
data sets that are relevant to the study of economic growth.
- Independent Evaluations Group - World Bank
http://www.worldbank.org/oed/
The Independent Evaluations Group of the World Bank evaluates the success of alternative
programs designed to aid economic growth and development in less-developed economies. This web
site contains links to online reports on these programs.
- International Monetary Fund
http://www.imf.org
While the primary purpose of the International Monetary Fund is to ensure the stability of
international currency markets, it conducts studies of the state of the economies in
participating countries and provides recommendations designed to enhance economic growth and
development. Loans are given to economies experiencing balance of payments difficulties. When the
IMF issues these loans, however, it generally requires economic reforms designed to improve the
condition of the recipient economy. The web site of the IMF contains information on current and
recent IMF programs.
- J. Bradford De Long, "What Do We Really Know About Economic Growth?"
http://econ161.berkeley.edu/Econ_Articles/Hoover/Growth_DeLong_Hoover.html
In this online article, J. Bradford De Long provides a good summary of contemporary economic
models of economic growth. Some of the analysis is a bit technical, but a careful reader should
be able to understand the essentials of the arguments.
Different Perspectives in the Debate
- Willis Peterson, "Overinvestment in Public Sector Capital"
http://www.cato.org/pubs/journal/cj14n1-6.html
Willis Peterson, writing in The Cato Journal, argues that there has been too much
investment in economic infrastructure and education and too little investment in private capital.
- Harry Anthony Patrinos, "Notes on Education and Growth: Theory and Evidence"
http://www.worldbank.org/html/extdr/hnp/hddflash/hcwp/hrwp036.html
Harry Anthony Patrinos provides a discussion of the literature on education and economic growth. He
mentions that numerous studies have found that the educational level of the labor force is an
important determinant of economic growth. Patrinos notes that studies that only include the private
rate of return to education are not capturing the full social return to education. He argues that
externalities associated with education (the "diffusion of knowledge") is an important
determinant of growth and development.
- Human Development Department of The World Bank, "Investing in People: The World Bank in Action"
http://www.worldbank.org/html/extdr/hnp/health/inv_ppl/p2outcom.htm
This document presents the argument that the World Bank initially attempted to stimulate
development by devoting resources to infrastructure improvements during the 1940s and 1950s, but
eventually realized the importance of developing human capital as well. This article provides a
description of current World Bank programs that are designed to improve the quality of the labor
force in less developed economies.
- Barry Bluestone and Bennett Harrison, "Why We Can Grow Faster"
http://www.prospect.org/print/V8/34/bluestone-b.html
In this September/October 1997 article in American Prospect, Barry Bluestone and
Bennett Harrison suggest that economists are too pessimistic about the prospects of growth.
They argue that forecasts of low growth rates have become self-fulfilling prophecies. Bluestone
and Harrison
argue that increased public infrastructure investment will help to encourage
a higher rate of economic growth.
- Jeffrey A. Frankel, "Determinants of Long Term Growth"
http://ksghome.harvard.edu/~.jfrankel.academic.ksg/Apecgrow.PDF
In this background paper, Jeffrey A. Frankel reviews the literature
on the determinants of economic growth and concludes that there is substantial
evidence that investment in both infrastructure and education are beneficial
in stimulating economic growth. (To view this document, the Adobe Acrobat
viewer plugin is required. You may download this viewer by clicking
here.)
- Preston J. Miller and James A. Schmitz Jr., "Breaking Down the Barriers to
Technological Progress"
http://woodrow.mpls.frb.fed.us/pubs/ar/ar1996.cfm
In this article, Preston J. Miller and James A. Schmitz Jr. argue that cross-country studies have
shown that deregulation and open markets encourage economic growth. It is suggested that the U.S.
could gain by continuing to both deregulate industries and reduce trade barriers.
- Vito Tanzi and Hamid Davoodi, "Roads to Nowhere: How Corruption in Public Investment Hurts Growth"
http://www.imf.org/external/pubs/ft/issues12/
Vito Tanzi and Hamid Davoodi examines the effect of corruption on public investment in this
online International Monetary Fund article. They note that the political rewards associated
with public investment projects may result in a bias resulting in overinvestment in some
activities. This inefficient allocation of resources may result in a slower rate of economic
growth. The corruption that is common in many less developed economies result in
further distortions in resource allocation.
- Paul M. Romer, "Beyond Classical and Keynesian Macroeconomic Policy"
http://www.gsb.stanford.edu/research/faculty/news_releases/Romer.Paul/London_Speech.html
In this article, Paul M. Romer argues that government policy should place more emphasis on
stimulating economic growth. He suggests that government should attempt to create an environment
that is conducive to innovation by:
- subsidizing research,
- subsidizing education and training,
- encouraging interaction between researchers in universities and firms, and
- allowing firms and industries to fail.
- Mark Potter and Marc Lee, "The Economic Impacts of the Information Highway: An Overview"
http://www.ifla.org/documents/infopol/canada/cihac010.txt
In this July 1995 discussion paper, Potter and Lee investigate the case for
government subsidies of the development of the Internet backbone. They argue that, in the absence
of government subsidies, the existence of externalities and spillover benefits would result in
the underprovision of this network. Potter and Lee suggest that an investment in this type of
infrastructure would encourage economic growth.
- Edward M. Gramlich, "Infrastructure and Economic Development"
http://www.federalreserve.gov/boarddocs/speeches/2001/20010803/default.htm
Federal Reserve Board Governor Edward M. Gramlich discusses the relationship between infrastructure investment and economic growth in this
August 3, 2001 speech. He argues that public infrastructure investments were very important in explaining
U.S. historical economic growth. Gramlich suggests that public investment in the internet infrastructure has played
a role in encouraging the recent increase in U.S. economic growth. He suggests, though, that the most useful roles for
government include encouraging competition and helping to establish standards that allow network externalities to be
exploited.
- Cesar A. Calderon and Luis Servén, "The Effects of Infrastructure Development on Growth and Income Distribution"
http://www.bcentral.cl/esp/estpub/estudios/dtbc/pdf/dtbc270.pdf
In this September 2004 Central Bank of Chile working paper, Cesar A. Calderon and Luis Servén
investigate the effects of infrastructure development on economic growth and income inequality using
data from over 100 countries during the years 1960 through 2000. They find that, when the
endogeneity of infrastructure investment is taken into account, infrastructure investment
increases economic growth and reduces income inequality. (Some parts of this discussion contain relatively technical analysis.)
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- Johannes W. Fedderke and Zeljko Bogetic, "Infrastructure and Growth in South Africa: Direct and Indirect Productivity Impacts of 19 Infrastructure Measures"
http://www-wds.worldbank.org/servlet/.../Rendered/PDF/wps3989.pdf
In this August 2006 World Bank working paper, Johannes W. Fedderke and Zeljko Bogetic examine the
effect of infrastructure investments in South Africa. They note that previous studies have found that
the effect of public infrastructure investment on economic growth to be ambiguous. They argue that
this result is due to not controlling for the endogeneity of infrastructure investment. When they
control for the endogeneity of infrastructure investment, they find that infrastructure investment
has a positive effect on economic growth. (Some parts of this discussion contain relatively technical analysis.)
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