Is infrastructure spending the “way out”?

In “How to shock the U.S. economy back to life” Mark Thoma prescribes the “infrastructure pill”:

During the Great Recession, U.S. gross domestic production — the nation’s total output of goods and services — dropped below the trend rate of growth that prevailed before the collapse. More than five years into the recovery, the economy shows no signs of returning to that prior rate of growth.

Instead, as the following graph shows, although the economy is growing at roughly the same rate as before the crisis, the growth is from a much lower level of output:

Thoma Shock_1

Is this the “new normal” we hear so much about? Do Americans have no choice but to accept the lower level of output, and the lower level of employment and living standards that comes with it, or is there something we can do to push the economy back to the pre-Great Recession trend?

One solution is to increase government spending on America’s roads, bridges and other infrastructure. But does infrastructure spending raise the level of GDP and employment while at the same time enhancing the prospects for future growth? Or does it simply crowd out other types of private sector spending so that, all told, there is little or no net stimulus?

Recent research from economists at the Federal Reserve Bank of San Francisco suggests that infrastructure spending on highways enacted with the stimulus package just after President Obama took office in 2009 might be just what the doctors ordered.

Is that true? Is government spending on infrastructure “what the doctor ordered?”

First, let´s check the behavior of real output relative to trend over the last 60 years. The trend here is estimated for the period 1954-07.

First, from 1954 to 1999. That includes the Great Inflation period (1966-1980). During that sub period, growth was a bit “too high” and inflation on an upward trend, determined by the upward trend of nominal spending growth.

As the chart shows, with the end of the Vietnam War government purchases (consumption and investment) drops. A further fall in the early 90s is due to the piece dividend from the end of the Cold War. Note that despite the drop in government purchases, real output hugs the trend, with inflation low and stable.

Thoma Shock_2

With President Bush, government purchases climb fast but that doesn’t stop real output from falling. In fact, real output only makes a recovery when the Fed adopts forward guidance, despite the fall in government purchases.

Nevertheless, given that real output does not regain the long standing trend level it is likely that negative supply-side factors came into play. When Bernanke took over the Fed government purchases begins to rise but real output, which although a bit below the trend level was growing at the trend rate, begins to grow more slowly distancing itself from the trend level.

Thoma Shock_3

During the last year of the Bush presidency real output tanks notwithstanding the sharp rise in government purchases. Also, note that the steep decline in government purchases from mid-2009 did not stop real output from trending up, after the Fed introduced QE1.

Thoma Shock_4

It is very unlikely that adoption of a wide ranging “infrastructure program” would make a difference.

Better to adopt a “money pill”, at least one more “potent” than what we´ve had so far. Unfortunately, that´s also unlikely.

3 thoughts on “Is infrastructure spending the “way out”?

  1. Fascinating post. I confess, I have entertained thoughts the USA should engage in more-robust infrastructure spending (even with the inevitable clumsiness and corruption).

    Why? There appears to be global gluts of capital. I have written about Bain & Co. before, but now PWC chimes in and says much the same thing. See here:

    http://www.pwc.com/us/en/press-releases/2014/pwc-global-assets-under-management.jhtml

    I do not think Bain and PWC have any ideological axes to grind, at least in this case. I think they are simply making pragmatic observations of global capital markets. Capital markets are glutted.

    Marcus Nunes has done a masterful job in this post of showing how the US economy expanded or contracted with little heed of federal purchases, but much heed of monetary policy.

    Still, I wonder if robust infrastructure spending coupled with QE and Market Monetarism could be effective. Of course, some infrastructure spending is needed anyway.

    • Ben, I don´t want to leave the impression that I am against infrastructure spending. God knows I live in a country where infrastructure is way, way out of date. Just that the reason for it shouldn´t be stabilization!

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