Wednesday, February 24, 2010

Ask Commentarama

Today on Ask Commentarama, we respond to a question from Scott about infrastructure.

Q. Is government spending on infrastructure a good idea?
Yes. . . if it’s done right.

Let’s begin by defining infrastructure. Infrastructure projects involve the creation of fixed assets of the type that are needed to operate or organize society or to make an economy function. These are projects like roads, harbors, hospitals, airports, power grids, etc.

Free market economic theory tells us that government spending is always more wasteful than private sector spending (which is true). Thus, many argue that infrastructure spending is inherently wasteful and should be left to the private sector. These people argue that if people truly value a road, they would be willing to pay tolls to allow a private company to build the road.

But there are two flaws with this theory that I accept. First, this theory assumes that the private sector has perfect knowledge and the perfect ability to act. But that’s not always true. In other words, the fact that people want a road does not mean that a private company will be ready, willing or able to build the road.

This is particularly true where you have a chicken and egg problem. For example, I am an advocate of converting from gasoline powered cars to natural gas powered cars (for a variety of reasons that would need a separate post). But, gas stations won’t put in natural gas pumps until there are more natural gas vehicles on the road. . . but car companies won’t make more natural gas vehicles until people are willing to buy them. . . but people won't buy them until they can fill them anywhere in the nation ("and we can't make our video until we get Eddie Van Halen"). This is one of those instances where the government should step in because market mechanisms won’t work. Thus, “infrastructure spending” that encourages the creation of natural gas pumps and natural gas vehicles makes sense.

The other problem arises in the allocation of the costs and benefits. A road may have many more benefits to society than a private company could capture. Indeed, highways made most of our modern economy and cities a reality, but there was no way for a highway maker to fully collect that benefit. Therefore, from a cost-benefit analysis, the private company would not undertake the project because it did not appear to be a worthwhile project even though the benefits to society far outweighed the costs. Thus, again, the only way to get it done would be with government involvement.

Consequently, in my opinion, government infrastructure spending makes sense when a project will produce a social good that justifies its price, but no private sector company can/will undertake the project.

Infrastructure projects also make sense where requiring user fees would be inefficient. For example, suppose that every road in America were suddenly a toll road -- right down to the road in front of your house. The loss in time and gas to our economy as drivers constantly need to stop to pay tolls would be too great to the rest of our economy (not to mention the cost of building hundreds of millions of toll booths and enforcing tolls). A similar problem arises if you eliminated police forces and left it up to private citizens to find ways to protect themselves -- the duplication of effort would be far too wasteful to society. Likewise, society benefits from a well-educated workforce. But private schools can't tap into that benefit. Instead, they can only assess fees against students. Thus, if only private schools existed, society would free-ride on the tuition paid by those students. This would result in fewer kids going to school and a less-educated work force and all of the associated problems with that (increased poverty, crime, etc.),

Thus, infrastructure spending also is good when it prevents wasteful duplication of "public services" or when it eliminates significant barriers to the use of publicly beneficial services.

So does infrastructure spending create jobs? That depends. One of the problems with the jobs claim is that "job-creation proponents" are relying on simple Keynesian theory, which says that every dollar you spend creates five jobs because the bridge workers you hire will need hotdogs, and the new hotdog vendors that appear will need equipment and the equipment makers need houses. . . etc. But this theory ignores the fact that the money comes from somewhere, and the taxes needed to build the bridge will have a nearly equal negative effect elsewhere in the economy. Thus, while the bridge workers need hotdogs, the car salesman across town who pays the taxes so the bridge can be built can no longer afford hotdogs. Thus, his vendor goes out of business.

The real question is whether or not the project has an overall net economic benefit to society. If the economic benefits of the project outweigh the costs, then yes, it will generate jobs. But if the economic benefits don't outweigh the costs, then it will lose more jobs than it creates.

Finally, is there anything that can be done to decrease the chance of waste? Absolutely. The construction and operation of all such projects should be contracted out to private sector companies after competitive bidding (rather than hiring government workers, as was done in the FDR era). Moreover, we need to eliminate laws like the Davis Bacon Act, which requires government contractors to pay “the prevailing wage” (i.e. union rates) for labor. And, lastly, we need to privatize these industries whenever possible without running afoul of the problems identified above. For example, once a harbor is built, there is no reason it couldn't be sold to private interests.


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That's it for this week. Remember to post your questions for next time or to e-mail them to me at Commentarama@yahoo.com.

16 comments:

LawHawkSF said...

Andrew: Damn, I wish I had written that. That's the best summary of infrastructure I've seen in as long as I can remember, and the only one-paragraph destruction of Keynesian economics that I've ever seen, period.

I work very hard at trying to disagree with you, but absolutely nothing comes to mind right now. Give me some time. LOL

ScottDS said...

I know I asked the question but I don't have a lot to contribute! It was on the brain since this month's Popular Science features a cover story on Rebuilding America. And anytime the History Channel or National Geographic Channel airs a documentary about the NY subway system or monorails ("No, good sir; I'm on the level!"), I tune in.

Of course, anytime PopSci or Popular Mechanics does a story on all the cool infrastructure developments being pioneered at corporations and universities (like phosphorescent poison detectors for water pipes or power lines that heal themselves via nanoparticles), I always think, "Yeah right, like we'll see that anytime soon."

Loved the Bill & Ted reference!

AndrewPrice said...

Thanks Lawhawk, High praise indeed! I'm glad you like it.

AndrewPrice said...

Scott, I hope it at least answered your question?

I watch a lot of those shows too. It's amazing what the human race can do when they put their minds to it, isn't it?

ScottDS said...

Of course it did. :-) But like so many other issues, I'm forced to ask, "Okay, then what?" Unfortunately, while we have other fish to fry, no one seems to think about this stuff until a bridge collapses.

Writer X said...

When I got to the section that discussed tolls, my skin started to itch. Of course, I'm reminded of the Chicago toll roads that have been in existence ever since I can remember. And the roads are still terrible. And the toll price always go up.

Interesting post, Andrew! I like this new feature.

AndrewPrice said...

Writer X, Thanks! I'm glad you liked it, and I'm glad you like the new feature. Feel free to ask a question for the upcoming week(s)!

As for toll roads, they are evil. . . pure evil. I am not a fan of toll roads in any way.

AndrewPrice said...

Scott, What do you mean what next? Next would be that we try to convince Congress to change the way they spend money -- to stop playing the jobs game and the pork barrell spending game, and instead focus on spending money on necessary and worthwhile projects. . . and to repeal Davis Bacon, and to privatize as much as possible. That's what I would say is "what's next."

Individualist said...

Andrew

Here, Here! This insight can help us to answer a common meme thrown at conservatives every time we talk about reducing government spending. The mot egregious example being the comparison of a single payer public health insurance with the Fire Fighters.

I really like the fact that you stressed the idea that when the government does spend on infrastructure it hires private contractors to do this. There is one other benefit to this that I'd like to add. When the private company is responsible for building it there is no pressure on the bureaucrat to hide any wrongdoing by the company. When it is a government agency that is negligent the issue becomes a political football in a blame game and the problem is not identified let alone corrected.

AndrewPrice said...

Individualist, Thanks. I'm glad you find this useful. As I note, I think that infrastructure spending can be a necessary thing, but it needs to be done sensibly, as compared to how it's done now -- which seemed to have more to do with political connections.

As for privatization, in a prior life, I was involved privatization issues and I can tell you that it is an excellent system for deliverying government goods for a variety of reasons. First, it's cheaper. Secondly, the workforce is much more responsive. Third, private companies tend to have much more access to modern methods, equipment and know-how. Finally, as you very correctly point out, government employees who watch over contractors have an incentive to make sure the contractor does a good job -- they don't have the same incentive when they do it themselves.

There are some things that just can't be privatized, but much can. And I'm a big advocate of it for those reasons.

StanH said...

“For every action, there is a equal opposite reaction!” The fatal flaw in Keynesian economics. Government takes money from the taxpayer, and uses it for public jobs programs, that’s one less dollar in the productive private sector.

I’ve got a question tax policy, most specifically the “Fair Tax.” I know the challenges repealing the 16th amendment the biggest. It was developed by MIT and Harvard economics professors years ago not scientologist. This would pull the IRS up by it’s roots, and stir business in this country on super drive. Financial gurus estimate there is 12 trillion dollars banked sitting overseas, these dollars would pour back into the states, without the punitive taxes. The rate would be fixed at 18 to 23%, revenue neutral It would exclude people that make less than $30,000.00 by using a voucher program, where you’d get a monthly rebate check for taxes paid. This eliminate meddlesome politicians playing with the tax code...I think it’s brilliant. A good book “Fair Tax,” by John Linder & Neal Boortz, back it up with stats. Just a thought.

ScottDS said...

Andrew - I guess that's what I meant. :-)

AndrewPrice said...

Scott, Glad to hear it! :-)

AndrewPrice said...

Stan, I'll see what I can do about talking about the Fair Tax.

You're right about Keynesian economics -- its problem is that it doesn't account for the negative effect, it just assumes that good things will happen.

Pittsburgh Enigma said...

Good article! I think of infrastructure as one of those "reasons government exists", like national defense or police protection. If I don't have the basics of a good road system to get me around town efficiently or a sewage system to connect my house or business to, I won't be able to live or run a business very effectively.

And you make a good point about sensible or frivolous infrastructure. Pittsburgh's got a perfect example of frivolous--the so-called "chunnel" that is being built under one of our rivers to connect our light rail system to the stadium on the other side. Never mind that we've already got several bridges to get people over there. It's already over budget, but who cares about that when all of YOU are paying for this federally-funded boondoggle. And don't even get me started on light rail--another money-losing favorite of planners and bureaucrats.

AndrewPrice said...

Thanks Pitts! That's one of the problems with the way we do infrastructure spending -- it becomes a game of getting as much out of Congress for your district as you can, rather than doing things that make sense.

Sadly, our country is dotted with highways and bridges to nowhere, rail systems no one uses or wants, and other pork projects. That's why I'd like to see Congress change the way they handle infrastructure spending -- maybe eliminate earmarks and require every construction project to be evaluated by the CBO. That might be a good start.

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