An IMF working paper was released today entitled “The Macroeconomic Effects of Public Investment:Evidence from Advanced Economies”. Six years after the global financial crisis, the recovery in many advanced economies remains tepid. This is highly relevant to the current Australian economic and budget debate.
There are now worries that demand will remain persistently weak — a possibility that has been described as “secular stagnation”. One response that is being considered (see for example the European Commission 2014) is an increase in public infrastructure investment, which could provide a much-needed fillip to demand and is one of the few remaining policy levers available to support growth. But there are open questions about the size of the public investment multipliers and the long-term returns on public capital, both of which play a role in determining how public-debt-to-GDP ratios will evolve in response to higher public investment. To assess appropriately the benefits and costs of increasing public investment in infrastructure, it is critical to determine what macroeconomic impact public investment will have. The paper attempts to shed more light on this subject.
What are the macroeconomic effects of public investment? To what extent does it raise output, both in the short and the long term? Does it increase the public-debt-to-GDP ratio? How do these effects vary with key characteristics of the economy, such as the degree of economic slack, the efficiency of public investment, and the way the investment is financed? To address these questions, the paper examined the historical evidence on the macroeconomic effects of public investment in 17 OECD economies over the 1985–2013 period.
They found that such investment raises output in both the short and long term, crowds in private investment, and reduces unemployment, with limited effect on the public debt ratio. They also found that these effects vary with a number of mediating factors. The effects of public investment are particularly strong when there is slack in the economy and monetary accommodation. In such cases, the boost to output from higher government investment may exceed the debt issued to finance the investment. Government projects are more effective in boosting output in countries with higher efficiency of public investment. Finally, the mode of financing investment matters. They find suggestive evidence that debt-financed projects have larger expansionary effects than budget-neutral investments financed by raising taxes or cutting other government spending.
The findings suggest that for economies with clearly identified infrastructure needs and efficient public investment processes and where there is economic slack and monetary accommodation, there is a strong case for increasing public infrastructure investment. Moreover, evidence suggests that increasing public infrastructure investment will be particularly effective in providing a fillip to aggregate demand and expanding productive capacity in the long run, without raising the debt-to-GDP ratio, if it is debt financed. Finally, the results show how critical increasing investment efficiency is to mitigating the possible trade-off between higher output and higher public-debt-to-GDP ratios. Thus a key priority in many economies, particularly in those with relatively low efficiency of public investment, should be to raise the quality of infrastructure investment by improving the public investment process.
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