The Infrastructure Death Rattle

November 6, 2011

by Mario Rizzo

The incessant discussion and demand for job-creating infrastructure spending on the part of the news media, Democratic politicians, and some unreconstructed Keynesian economists is both frustrating and pathetic. It is frustrating because how many times can people repeat the same thing without listening to the objections? It is pathetic because the level of understanding is akin to pre-Newtonian physics.

The case for infrastructure spending must be made on the value of what is to be built or repaired and the efficiency with which that is done, not on the number of jobs that may be created. Frederic Bastiat made this point in the middle of the nineteenth century.

The Obama administration is making wild estimates of how many jobs a $60 billion expenditure on infrastructure spending (that is, construction-union largesse) will create.  “The median estimate [of economists surveyed by Bloomberg] was 275,000 jobs in 2012 and 13,000 jobs in 2013 for a total of 288,000 jobs — far fewer than the 2 million claimed by the president.” This is about $208,000 per job. 

But all of these guesstimates are beside the point.  In order to have a recovery we must have sustainable lines of spending, not one-shot spending. Furthermore, the problem with infra-structure spending is that there are few “shovel-ready” projects. Local governments must get their acts together and then proposals must generally clear lengthy environmental impact assessments. Local interest groups will launch objections (especially in places like New York City). Minority groups will want their “fair-share” of the spending projects.

Then, of course, thanks to the Davis-Bacon Act, union labor which keeps out the poor, but able, must be used – or, at least, union-prevailing and above-market wages must be paid. (Herbert Hoover thought during the Great Depression that it was good to pay high wages to keep total demand from falling. His disciple FDR agreed.)

So what we are going to get, under the guise of making jobs, is a total disregard for the efficiency with which infrastructure is created or repaired. Bridges to nowhere with political support will be built with the cost over-runs.  Even the normal pressures to introduce some sanity into the spending projects will be absent because of the political exigencies to get the projects up and running to save the Obama presidency.

On the other hand, if you were a private entrepreneur thinking about investment projects, how confident would you be in the present tax and regulatory climate? I venture the guess – and truly it is only a guess – that the more this administration gets done the less confident entrepreneurs will become. The confidence multiplier may be negative.

The infrastructure-jobs mantra by the Obama administration may simply be its death rattle.

21 Responses to “The Infrastructure Death Rattle”

  1. KT Borland Says:

    Exactly!


  2. All resource allocation by government is subject to the argument of the socialist calculation debate. There is no mechanism to allocate resources rationally.

    Why are roads, bridges, schools, etc. in bad repair? Poor stewardship. If property is publicly owned, it is no one’s responsibility. There is no residual cliamant who bears the cost of poor stewardship, or reaps the benfits of good stewardship.

  3. Mario Rizzo Says:

    Jerry,

    You make an important point. The present political class seems totally uninterested in the micro-economic changes and reforms that are needed. Under the rubric of stimulus and job creation all of that is ignored during recessions. But during prosperity no basic reforms seem that urgent.

  4. Allan Says:

    Prof. Rizzo,

    Could you explain in more detail about why you think that “the more this administration gets done the less confident entrepreneurs will become”? Thanks.

  5. Greg Hill Says:

    Mario writes, “The case for infrastructure spending must be made on the value of what is to be built or repaired and the efficiency with which that is done, not on the number of jobs that may be created.”

    Let’s explore this proposition using a simple example. Suppose a local, municipally-owned electric utility is contemplating investment in high-tech LED streetlights that have higher up-front capital costs than conventional streetlights, but use a less energy and last longer.

    So, we do a cost-benefit analysis. First question: should we value the energy savings from the LED streetlights at the projected price of energy tout court, or should we add to this price a rough estimate of the environmental costs associated with marginal energy production? Theoretical sidebar: if rational resource allocation is impossible in a socialist economy without prices, doesn’t this imply that a decision which ignores unpriced environmental costs is also bound to be irrational? (For global warming skeptics, imagine there’s a 5% chance of catastrophe.)

    Next, we have to decide what discount rate to use in evaluating the costs and benefits of this project. Should we use a relatively low discount rate because the utility’s borrowing isn’t likely to displace another investment project, or should we try to figure out what the “natural” rate of interest is and use this as our discount rate? Theoretical sidebar: saying that new public investments should be judged on efficiency grounds begs the question – in the present circumstances, do these investments displace other investments or not?

    If our little utility hires unemployed workers to install these LED streetlights, and these newly employed workers buy goods whose prices exceed their marginal cost of production, should we count these “extra” benefits in our cost-benefit analysis? Theoretical sidebar: this is not to say that projects should be judged by the number of jobs they create, but that pecuniary externalities shouldn’t be ignored.

    To conclude, it’s not very helpful to say, “only invest in projects that pass the test of efficiency.” It turns out that “what’s efficient” depends on much deeper questions about the nature of our current economic circumstances.

  6. Allan Walstad Says:

    Greg Hill: I think the consensus in these parts, which I share, is generally against government allocation of resources. For the most part your comment reinforces that view by illustrating how much information the politicians and bureaucrats must possess and analyze effectively (under political rather than market incentives). Nevertheless, there may be some relatively narrow range of activities, necessary for the preservation of liberty, of free trade, and of the common environment, for which fully functioning markets are not possible, and which therefore must be entrusted to government. Citizens do well to insist that government limit itself to that narrow range. The proper aim of government spending is not to hire more people, but to fulfill a narrow role with as little labor as possible — thereby saving labor for productive use in the market economy.

    Municipally owned electric utility? Please. And why would the electricity supplier be buying the streetlights, anyway? As for the chances of catastrophe, what are the chances of catastrophe arising from unbridled government intervention in productive activities? How good was the environmental stewardship of the collectivist economies of the old Soviet Union and Eastern bloc countries? What happens if our productivity and technical prowess are stunted to the point where we are less able to meet whatever environmental challenges we do face?


  7. I’m going to make 3 points on Greg Hill’s comment.

    (1) There are always opportunity costs to any action

    (2) Labor is not homogeneous. Even in construction, there are few skills of unemployed workers in homebuilding that carry over to road construction.

    (3) The problem with the precautionary principle is that there are many, many possible catastrophic events. Even assigning a low probability to each would mean all resources would be exhausted in taking precautions to avoid them. Society would paralyze itself.

  8. Greg Hill Says:

    Allan,

    “Municipally owned electric utility? Please.” I was thinking of Seattle City Light (SCL), which was created in 1905 because the private electric monopoly at the time was charging $0.20/kWh. City Light began by charging $0.08/kWh, and the monopoly quickly reduced its price to $0.085/kWh. You say, sarcastically, “Please,” but I suspect Seattle ratepayers said, “Thank you.”

    Hayek made a very important point in stressing the dispersion of knowledge within an economy. But knowledge alone is not sufficient to produce efficient resource allocation. Private power producers have no economic incentive to take account of unpriced environmental costs in their decision making. You seem to acknowledge this point when you allow a possible role for government in the “preservation of the common environment.”

    You write, “The proper aim of government spending is not to hire more people, but to fulfill a narrow role with as little labor as possible — thereby saving labor for productive use in the market economy.” Do you really believe that modest public investment in energy efficiency improvements when the rate of unemployment is very high will deprive private firms of the labor they require? If there are 8 unemployed workers for every job opening, does it make sense to save labor for “productive use in the market economy”?

    Finally, why focus on the bad “environmental stewardship of the collectivist economies of the old Soviet Union and Eastern bloc countries” when you’ve there are plenty of examples of good environmental stewardship undertaken by democratic governments, e.g., Costa Rica?

  9. Greg Hill Says:

    Jerry,

    I agree that “there are always opportunity costs to any action,” but I think the issue is how big they are when so many people are unemployed and interest rates are so low.

    I agree that “labor is not homogeneous,” but I suspect there are lots of unemployed people who work in road construction, and a lot of other people who could hold the stop signs to manage traffic if nothing else.

    I agree that “society would paralyze itself” if we took steps to protect ourselves from every conceivable catastrophe, but climate change seems pretty risky, on the one hand, and, according some studies, not that costly to avoid.


  10. Greg,

    Your broad thesis is market failure. You then infer that government is the solution without addressing Mario’s points about government failure. You present no evidence that governments do better on such things as environmental externalities. There is mcuh evidence they do not.

  11. Allan Walstad Says:

    Greg, 1905 is a long time ago, relatively early in electrification. If electricity could be profitably sold for less, it was likely that a competing firm would enter the market before long, unless there were some political barrier to entry. The most striking thing about monopolies in free markets, historically, has been their rarity. Most monopolies have been government run or government enforced. How much choice do electricity customers have in Seattle now? How much money and how many minds have been wasted by our nationwide system of K-12 prisons? Or the space shuttle and its porkbarrel successor the space station?

    I do make allowance for possible government action in protection of the common environment, but given the crudeness of politics as an instrument we should keep a very tight leash on that. If more government intervention is needed now for the environment, I suggest setting priorities: for every additional increment in government regulation and/or spending here, eliminate a roughly equivalent amount there. Otherwise, we just keep getting ratcheted. The high and lingering unemployment is itself the result of multifarious government intervention in the economy. Also what Jerry said about labor inhomogeneity.

    I don’t know much about Costa Rica beyond its small size; it’s hard to imagine that any beneficial effects of government intervention there could possibly compare to the magnitude of environmental depredation that apparently occurred across Europe and Asia under economic collectivism. That’s what happens when you let coercive government run amuck.

  12. Greg Hill Says:

    Jerry,

    I did offer two little pieces of evidence: 1) as soon as Seattle City Light started up, electricity prices in Seattle fell from $0.20/kWh to $0.08/kWh; and 2) Costa Rica’s world renowned stewardship program.

    The difficulty in arguing with Austrians sometimes is that you want to compare, say, the national health insurance systems of the Scandinavian countries, not with the less government-controlled U.S. system, but with some imaginary free market health care system.

    I could say that Seattle City Light has been a pretty successful venture with marginal-cost pricing, an effective energy conservation program, and even the foresight not to purchase shares of WPPSS nuclear plants 4 and 5, which our local investor-owned utility couldn’t resist. But then you might say that the IOU is a regulated utility, which doesn’t operate in an unfettered market.

    The biggest problem City Light ever faced was the “energy crisis” of 2001 when the utility had to buy energy in the wholesale market for $200/MWH or more. But this crisis was largely the result of Enron’s manipulation of the market according to the courts. In fact, the deregulation of electricity was all the rage in 2000, until we got a taste of what deregulated prices look like when firms have market power.


  13. Greg,

    You give one example. Critics offer systematic evidence.

    If Seattle’s system is so cheap, where is the charge for environmental impact? Energy can’t be cheap and be priced according to the pecautionary principle. You can’t have it both ways. You want rates low and you want them high.

  14. Greg Hill Says:

    Jerry, you write, “Energy can’t be cheap and be priced according to the pecautionary principle. You can’t have it both ways. You want rates low and you want them high.”

    In fact, we do have it both ways with non-linear pricing. We charge a very low rate for the first 400 kWh/month, the demand for which is inelastic, and a higher, marginal cost-based rate for demand in excess of 400 kWh/month. Thus, our average rate is very low, but 90% of our customers face a price equal to marginal cost.

    QED


  15. I don’t know about Greg Hill’s numbers for Seattle, but he has bought a load of hogwash about Costa Rica. Once known as the Switzerland of Central America (a title it never desrved), it would be better known today as the Greece of Central America. Or Costa Risa as some in the country are now calling it. http://online.wsj.com/article/SB10001424052970204358004577032030879059346.html?mod=WSJ_Opinion_BelowLEFTSecond

  16. Mario Rizzo Says:

    All this is has gotten far from the original post. And that is fine. There are many problems, conceptual and empirical, with the government provision of infrastucture. The public-choice effects compound these problems.

    My central point is that Obama and his labor union friends have put forth a bill that will — especially because of its “rushed” nature as a “jobs” bill will be especially vulnerable to all of the worst of the standard problems.

  17. Mario Rizzo Says:

    Allan,

    I am thinking of the article by Robert Higgs on “Regime Uncertainty.” The more Roosevelt did or tried to do the more uncertainty was created and the climate for private investment grew worse. Obama is learning the wrong lessons from Hoover and Roosevelt.

  18. Greg Hill Says:

    Jerry,

    So, you’re citing a WSJ opinion piece as your evidence of Costa Rica being a mess!

    Here are a few facts about the Costa Rican economy from the CIA:

    GDP – real growth rate: 4.2% (2010 est.)
    -1.3% (2009 est.)
    2.7% (2008 est.)

    GDP – per capita (PPP): $11,300 (2010 est.)
    $11,000 (2009 est.)
    $11,300 (2008 est.)
    note: data are in 2010 US dollars

    Unemployment rate: 7.3% (2010 est.)
    8.4% (2009 est.)

    Investment (gross fixed): 19.7% of GDP (2010 est.)

    Public debt: 42.7% of GDP (2010 est.)
    42.1% of GDP (2009 est.)

    Does this look like a mess to you? Of course, my original point was that democratic Costa Rica has a widely praised environmental stewardship program.


  19. You have selected stats to suit your case and ignored the numbers in her column. Costa Rica’s budget deficit is the highest in LA and forecast to rise next year.

    Mary O’Grady is one of the most knowledgeable writers on LA. She and I worked together on the Index of Economic freedom for 4 years. She knows what she is talking about.

    Just to clarify, I’m not going to respond further to you either here or elsewhere.

  20. Greg Hill Says:

    I don’t quite understand, what is it you’re clarifying?

  21. Xerographica Says:

    Here’s the mystery…Bastiat was referenced in the original post…and the “opportunity cost” and “partial knowledge” concepts were referenced in the comments…yet nobody considered the potential value of allowing taxpayers to directly allocate their taxes.

    The question is…what is the public goods allocation disparity between A) 538 congresspeople spending other people’s money and B) millions and millions of taxpayers spending their own hard earned money?

    The trick is…the “Fatal Conceit” concept does not just apply to liberals…it applies to libertarians as well. We’re all just blind men arguing over the scope of government. The true scope of government can only be determined by allowing each and every taxpayer to use their taxes to highlight private sector supply failures.

    Here’s the problem…your confirmation bias towards either Team Hayek or Team Keynes will probably prevent you from genuinely and objectively considering the value of this compromise. Because, if you were capable of setting aside your confirmation bias in the first place then chances are good that you would have already come to the same conclusion.

    Maybe I’m wrong…but if any of you are willing to entertain the tiniest sliver of the doubt that you might be wrong as well…then please feel free to check out my post on the opportunity costs of public transportation.


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