Friday, February 15, 2013

The Public Financier's Case for More Government Spending

I'm sure that it comes as no surprise to regular readers of this blog that I'm advocating for more government spending--specifically for more infrastructure spending. There's a catch today, though. In the past, when I've called for more government spending, I've argued for it in the context of fiscal stimulus to boost the economy. Fiscal stimulus, the idea that government spending during a recession can boost the economy, is something of a controversial subject among both economists and policy-makers at the moment, so I won't get into that again. But there's another, much less controversial case to be made for more infrastructure spending right now--in terms of pure public finance, it'd be a good long-term investment, so we should spend more regardless of whether or not government spending can boost the economy.

In public finance, much like in private finance, costs and benefits to projects and programs are compared to see if they are, in fact, worthwhile investments. For example, if the costs of borrowing funds for a private firm to build a new factory are 4% per year and the estimated rate of return--basically the amount of money the firm expects to get back--on that investment is 5% per year, then it'd be prudent for the firm to make such an investment. 

Now, public finance works in much the same way, except that calculating the rate of return on most projects is a great deal more complicated. For example, how do you calculate the amount of non-monetary value a whole society derives from a new system of public schools? The monetary returns are easier to calculate, but those can sometimes over- or under-state what's known as the "social internal rate of return," which takes into account those non-monetary benefits to society as a whole. Since that's nearly impossible to calculate accurately, weighing the costs and benefits of a new project can be tricky, to say the least, making it far more difficult to determine whether a project is worthwhile or not.

This may seem like I'm undercutting my own argument for more infrastructure spending, but there's an important point I've been waiting until now to make: leaving aside the benefits of more infrastructure spending for now, the costs of infrastructure at this point in time are negative. That is to say, after adjusting for future inflation, the cost to the government of borrowing money to finance this investment are negative. For you visual learners out there:

So even though we can't truly know with absolute certainty the rate of return on an infrastructure investment, the chance that the rate of return on such an investment would be negative is incredibly small. Especially if you consider the fact that the American Society of Civil Engineers gave us a D on our Infrastructure Report Card. In fact, knowing this makes it more likely that the rate of return on infrastructure investments is actually pretty high. 

Even if you don't buy into the idea that more government spending (fiscal stimulus) can boost the economy, if you view more infrastructure spending through the lens of public finance, it really is a good investment. I'd even go so far as to say that turning down a project with a negative borrowing cost and a (probably large) positive rate of return would be the height of foolishness.