16 April 2021





THE INFRASTRUCTURE BILL IS VITAL BUT IT MUST FOCUS ON PRODUCTIVITY




By Raul Elizalde

This article also appeared on forbes.com


From the point of view of creating long-term growth, the huge $2 trillion infrastructure proposal from the Biden Administration is a mixed bag. Revamping the long-neglected infrastructure is urgent if the U.S. cares about maintaining and improving global competitiveness. But the package is a mish-mash of initiatives that need to be sorted in order of importance. Giving preference to projects with high payouts over others that are unlikely to produce much economic growth seems like a reasonable way to go.


The key concept is whether a particular proposal can enhance productivity, or economic efficiency measured by output per hour of work. High-productivity nations crank out a lot of GDP per person, while low-productivity nations do not. This gap tends to widen over time because tomorrow’s output depends on today’s investments. Investing early gives nations a big advantage, while investing late makes it difficult to catch up. Both high and low productivity create feedback loops. This is an urgent problem for the U.S. because productivity is stuck well below the average of the last 70+ years.

source: Bureau of Labor Statistics
Research shows that technological advances are essential for raising productivity. Often, this means engaging in basic research or developing infrastructure at a national level, but this requires lots of money for projects with unclear payoffs. The private sector can rarely take such risks, so the government steps in with public funds as a matter of national policy.


While this contributes to fiscal deficits, the U.S. has been remarkably consistent in doing so because both sides of the political spectrum recognize that deficits can be viewed as investments in the future to enhance productivity. But they don’t agree on what is the “right” kind of deficit.


One side argues that cutting taxes increases deficits in the short run but it leads to businesses creation, new jobs and more private sector output. This expands tax collection even when (and, indeed, because) tax rates are reduced. As a result, federal revenues go up, the deficit comes down, and everyone ends up with more money in their pockets with a more productive economy to boot.


There’s been a lot of debate about whether this “trickle-down” effect in fact works. One report from the non-partisan Congressional Research Service (an agency of the Library of Congress) argues that the relationship between taxes and growth actually works the other way around – i.e. higher growth is associated with periods of higher taxes. The study includes the following table showing that this is in fact the case:

source: Congressional Research Service
The report hastes to state that the relationship is “not causal” – i.e. they do not believe that raising tax rates cause higher growth, but they find little evidence that cutting tax rates spur growth either.


The other side argues that increasing government spending increases the deficit today but leads to higher productivity and a more vibrant private sector, because it makes the kind of investments that the latter won’t. To that point, they note that many businesses would not exist without public investments that required tons of taxpayer money – and indeed it seems inconceivable to think of Apple, SpaceX or even Fedex to be what they are today without DARPA’s applied research (internet, GPS, autonomous vehicles), NASA or the Interstate Highway System.


The infrastructure package from the Biden administration, unsurprisingly, embraces the public spending approach. Some parts of the package seem well-aligned with fostering key technological advances, such as investments in semiconductor fabrication equipment (to repatriate high-paying jobs and reduce dependence on foreign supply), development of 5G and broadband infrastructure (to improve business efficiencies), and a large expansion of EV recharging stations (that can help develop automated truck transportation).


Academics rightly noted that “the provision of adequate infrastructure is a necessary condition for private firms to be productive.” But the devil is in the details: Not all infrastructure spending leads to the same productivity gains, and it may be impossible to quantify whether expanding broadband has a higher or lower multiplier than onshoring semiconductor production, for example.


The problem is that the $2 trillion package includes projects that can hardly claim to raise productivity, such as caring for the elderly and disabled, investing in VA hospitals or a establishing a “new program to reconnect neighborhoods cut off by historic investments.” This is not to condemn those initiatives, as they are evidently desirable in and of themselves. But given the enormous price tag, a yardstick such as productivity seems needed to prioritize goals when we talk about infrastructure.


The experience of other nations is illustrative, and one cautionary tale comes from Japan. During the 1990s it tried to create growth through massive spending. Yet, the economy remained stagnant while the public deficit skyrocketed. Research papers place the blame on public investment that was “used as a policy tool for adjusting income inequality”rather than raising the efficiency of economic output.


Some of the more recent arguments against the infrastructure bill point out that the recently-released job numbers are very strong and therefore the bill is unnecessary. Those arguments are flawed, because the largest components of job growth, by far, are leisure and hospitality, and government. Those have very low productivity and will not lead to higher output in the future.


An infrastructure package is essential if the U.S. wants to keep up with global competition, because productivity rates in the U.S. are way below their historical average. Fears that higher tax rates will hurt the economy are not supported by history, and if they lead to higher productivity, they will repay much of today’s expenditure. The important thing is to choose wisely among the many competing demands of where money should be spent. Productivity is the appropriate yardstick.


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