Infrastructure is so . . . stimulating, Megan McArdle: Mark Thoma wants us to look at spending for stimulus, instead of tax cuts:
I agree that Fed policy alone may not be enough to get the economy back on track, I've argued that for a long time. But tax cuts are not the only option for stimulating the economy, government spending can also be used, and in theory on short-run stabilization policy, a one dollar increase in government spending has a bigger impact on GDP than a one dollar tax cut. Infrastructure is an obvious target for spending, it's surely needed, but there are other areas that could use help as well.
The idea that we should use emergency infrastructure spending as a stimulus is gaining strength among liberals. ... I can certainly vouch for the fact that many areas of American infrastructure are in dire need of improvement.
However, ... I regret to report that the idea of using infrastructure spending as a stimulus is a complete fantasy. This is not your grandfather's stimulus spending. FDR could spend whacking great sums on dams and roads and rural electrification, and hope to have an immediate effect, because FDR was working on a multi-year depression, and in the pre-1960s regulatory environment.
Between the environmental impact statements, public review periods, and byzantine bidding process, the development cycle for anything more complicated than painting a bus station is now measured in decades, not years. ...
The reason we rely mostly on monetary policy and tax cuts for stimulus is that it is possible to rapidly implement whatever stimulus you decide on. With the exception of a few transfer programs such as food stamps and unemployment insurance, which are hard to funnel very large sums of money through, there is nothing on the spending side that matches tax cuts for speed. You could allocate the money, to be sure, but by the time it actually hit an agency and went through the bureaucratic procedures necessary to actually spend it, the window for effective stimulus would have passed.
We could improve matters by ripping out all of the procedural hurdles and community review procedures we've forced on the government, and in my opinion, that wouldn't be a bad thing. But in my opinion, this is[n't] ... likely to be achieved...
The other thing we might consider is just not having the stimulus. It seems to me that both monetary and fiscal stimulus at this point are trying to attack supply shocks by goosing demand. America is going to have to get used to consuming less oil and less cheap foreign credit some time, and maybe the best way to do that is to let the shocks work their way through the system.
While I was thinking over a response, Free Exchange covered most of the points I wanted to make:
One initial point is that if this slump is anything like the last one (and it probably is), then America can probably look forward to at least another year of the doldrums before regular growth conditions return. That takes a little of the need for immediacy out of the stimulus calculations.
I'd just add that if you go by the last two recessions, the recovery of employment has lagged behind the recovery in output, and may not have fully recovered at all, so from that perspective, the slowdown could be even more extended. This gives more weight to policies that have impacts over a longer time period. Back to Free Exchange:
But Ms McArdle is still right that the appropriate time-frame for an infrastructure project, from idea to ribbon cutting, is at least a decade (in America; China, I believe, is a different story). What's important to note is that there are many infrastructure projects available that are quite close to the construction stage, that have been on the books for some time and only lack final say on funding to begin. In some cases, these projects might have already been underway, had the economic slowdown and credit issues not constrained local and state budgets. It's quite possible, then, that a quick injection of federal funding for ready-to-go projects might provide the economy with a nice shot in the arm. Given the attraction of infrastructure projects as investments generally, this also reduces the economic downside to getting the timing wrong. These are, after all, things that America should be doing anyway.
And I'd emphasize that in this downturn, the fall in property taxes from falling housing values will put local governments under pressure, and decreases in sales and income tax collections due to the slowdown are problematic at the state level as well. Since state and local governments are under budget balancing constraints the federal government does not face, a large fall in tax collections can have a big impact on state and local spending causing cutbacks that can reinforce the downturn in the economy. Thus, filling the state and local revenue shortfalls can have a big impact right away by preventing projects from being cutback or discontinued.
Ms McArdle concludes with a sound point:
It seems to me that both monetary and fiscal stimulus at this point are trying to attack supply shocks by goosing demand. America is going to have to get used to consuming less oil and less cheap foreign credit some time, and maybe the best way to do that is to let the shocks work their way through the system.
At this point, I thought to myself Free Exchange has this covered fairly well, so I'll make the point that infrastructure does address supply-side problems, i.e. it does address supply shocks contrary to the statements above. But that point is covered too:
The economy may recover quickly, but pressures on resource prices and foreign lending will be an issue for years to come. Happily, this is something infrastructure spending can address, by improving productivity and providing a rail and transit means to reduce exposure to petroleum price increases. In all, if there is to be a second stimulus, there is a strong case to be made for designing that stimulus to boost needed infrastructure spending.
I want to come back to the point about how monetary and fiscal policy should respond to a supply-shock in another post because there are some details to consider before asserting that boosting demand is always the wrong policy. It depends, for example, on how flexibly and dynamically firms can respond to a shock (and other things too). If firms can recover fast enough, holding demand in place while they make the necessary adjustments may be appropriate. But if the shock is a permanent drop in long-run supply, or one that cannot be overcome by input substitution or using different technologies, at least not until considerable time has passed, then boosting demand (or holding it in place) may not be correct. But this deserves a fuller treatment.
For now, I want to focus on this:
The reason we rely mostly on monetary policy and tax cuts for stimulus is that it is possible to rapidly implement whatever stimulus you decide on. With the exception of a few transfer programs such as food stamps and unemployment insurance, which are hard to funnel very large sums of money through, there is nothing on the spending side that matches tax cuts for speed. ...
I think Free Exchange has effectively handled the speed issue, i.e. the assertion that infrastructure spending cannot hit the economy as fast as tax cuts, so let me turn to the assertion about monetary policy dominating fiscal policy generally, and dominating spending on infrastructure in particular. Yes, monetary policy can be implemented rapidly, but remember how monetary policy works. It lowers the interest rate or reduces credit market imperfections stimulating investment in new plants and equipment, investment in new homes, that sort of thing. It takes considerable time to plan and build a new factory or to refurbish an old one. People don't build and buy houses over night (usually), that takes time too, since it's only new houses that contribute to GDP. Thus, while monetary policy can be put into place overnight if necessary, it can be quite some time before it impacts the economy.
Stepping away from infrastructure spending for a moment and looking at fiscal policy generally, the usual view on monetary versus fiscal policy lags is that monetary policy can be implemented quickly, but the effects take considerable time to be realized - the peak effect can be as long as a year and a half away and drawn out over a three year period according to many estimates. Fiscal policy takes longer to implement due to factors cited above, but once in place, the effects are realized fairly quickly (though it does take longer for infrastructure that must be planned and built from the ground up).
Interestingly though, lately tax cuts have sailed through congress quickly, i.e. the implementation lag for fiscal policy has been reduced considerably. This is what Megan is relying upon, but this is an ideological outcome, not something baked into the process. Bush wouldn't accept anything but tax cuts, he made that abundantly clear. People needed help, so Democrats did what was pragmatic, imperfect help is better than no help at all, so they went along with tax cuts. It could have ended up in endless wrangling, and I expected it probably would, but it didn't. And with a different congress, and more importantly, a different president saying I won't accept further tax cuts as a stimulus package, I want spending on x, y, and z instead, there's no reason at all why congress can't move quickly and put spending in place right away (and, for infrastructure, bypass all the regulatory hurdles, agency wrangling, and so on, at least for the most part). I'm not saying that Obama, if elected, would insist upon this, or that none of the hurdles matter at all, only that an assertion that tax cuts dominates government spending of all types without considering the underlying ideological driven politics surrounding the choice doesn't capture the whole story.
Going back to the comparison of lags involved in monetary policy and government spending on infrastructure in particular, the comparison doesn't necessarily work against government infrastructure spending. As noted above, lots of projects can be put into place right away (and all of the architectural work, reviews, etc. don't come for free - they involve spending - not much, and perhaps targeted at the wrong people, but it's not zero either, so there's some stimulus before breaking ground). However, firms likely have plans on the shelf with projects ready to go too, so there's not much advantage to either monetary or fiscal policy in that respect.
Beyond the projects that are all set to go, the effects of both monetary policy and infrastructure spending both involve real investments of some sort which take a time to implement. When the Fed lowers the interest rate and a firm decides to build a new factory because of the higher expected profit, it doesn't happen much faster than if the government builds a new building of some sort. Maybe the private sector is a bit more efficient so it does things a bit faster, but if so, I wouldn't expect any great advantage, and the government can, if it wants, bypass rules and regulations that would hinder private sector development.
I wish infrastructure spending had been part of the first stimulus package, many of us called for that so that the stimulus would be distributed over time rather than concentrated over a small time period as with tax rebates (a disadvantage of relying solely upon tax rebates as a stimulus measure). If infrastructure spending had been part of the original package, then the implementation and effectiveness lags wouldn't be so much at issue. However, it wasn't part of the package, though that would have been best, but that shouldn't stop us now. Infrastructure spending can have an impact right away, it addresses the expected long, drawn out recovery process for employment, and it also addresses problems with deteriorating infrastructure.
Even if we are wrong about the need for a second stimulus, so what? As noted above by Megan, "many areas of American infrastructure are in dire need of improvement." What will we have wasted if we are wrong and stimulus is not needed as a stabilization tool? Infrastructure spending still helps us overcome problems in the economy that we have a dire need to address.
Update: Megan McArdle, in comments:
Mark, it just isn't right that Congress can simply rip out the administrative procedures at will. First of all, it would have to amend the 1970 law requiring environmental review, which is not going to happen because it sounds <i>horrible</i> on tv, and second of all, the agencies simply aren't set up to handle those kinds of pass throughs. Bureaucracy is inertial.
Moreover, the first time you did this would be the last, because you'd be tied up in lawsuits and corruption scandals for another decade or so. There's a reason those laws are in place; I think they're excessive, but they reflect a real desire for control on the part of the polity.
This is not a discussion of whether infrastructure spending is good or bad; it's a discussion of whether it works as stimulus. It's pretty arguable whether advancing the transportation pipeline by a year is effective stimulus--it could well be the government equivalent of GM's 0% financing after 9/11. But even with local projects that just need funding, it doesn't move quite that fast--it depends on whether the projects have, for example, been submitted to competitive bid or merely RFP'd. It also depends on who's availabe--even in an area like New York, there aren't more than a handful of construction companies that can handle a major infrastructure project, and they're often very close to fully deployed. Even assuming that you'd put out a bid, closed it, picked the company, and then shelved the project for lack of funding, there's a significant chance that when you pushed the money down to the locals, you'd find the company that had bid it was fully engaged elsewhere. If you put strict time limits on the expenditure of funds, you'd risk getting incompetent work from a company unprepared to handle the job--at the very least, this usually means cost overruns.
Infrastructure isn't a good candidate for stimulus spending for the same reason that health care isn't--it should be done according to need and careful planning, not the exigencies of the business cycle.
Megan - I think I acknowledged that not every regulation can be bypassed, so no problem there. I don't think that if there is one set of regulations that are difficult to overturn, it implies that all are. But again, as I said above, I didn't mean to suggest that all hurdles can be overcome easily.
Where we differ the most is on the speed at which policies can be put into place that are already underway, or ready to go (including aiding state/local government). I believe it can happen faster than you do. But either way, my initial comment did not limit itself to infrastructure spending, it ended with "Infrastructure is an obvious target for spending, it's surely needed, but there are other areas that could use help as well." I should have been more explicit about this, but I had a combination policy in mind, and if the worry is that infrastructure spending can't happen fast enough, those other areas can be used to fill any expected time gaps before the infrastructure spending comes online. So I still see no reason why infrastructure spending cannot be part of an effective stimulus package even if the time gaps are present.
Update: John Irons at the EPI argues that infrastructure repair can be implemented quickly. Also, on state and local spending, here's a ranking of th effectiveness of various countercyclical fiscal policy measures:
More discussion here:
Because states are required to balance their budgets each year, the drop in revenues that results from an economic slowdown can cause serious problems. ... The provision of temporary fiscal relief to state governments can enable states to minimize tax increases and budget cuts, which would be economically damaging during a recession. ...
[T]he bursting of the housing bubble threatens to stress state and local budgets well beyond what is typical in an economic slowdown. States are now forecasting lower state sales tax revenues due to significantly lower tax collections from the sales of furniture, appliances, construction materials, and other housing-related expenditures. Of even greater concern, the decline in housing values is beginning to translate into substantially reduced property tax revenues for many local governments.
For all of these reasons, federal relief to the states would constitute effective stimulus. ... General aid to state governments would ... reduce the likelihood that states would cut back on infrastructure spending included in their operating budgets, such as school repairs.
And, from the same source:
The following measures rank highly according to the criteria for good stimulus:
Strengthened unemployment insurance. ...
State fiscal relief. ...
Uniform tax refunds. ...
Temporary increase in food stamp payments. ...
So, according to this report, state relief, some of which is infrastructure spending, ranks higher than tax cuts as a countercyclical measure.