Public Investment and Economic Growth

Article excerpt

In the years following World War II, the papers of any major city . . . told daily of the shortages and shortcomings in the elementary municipal and metropolitan services. The schools were old and overcrowded. The police force was under strength and underpaid. The parks and playgrounds were insufficient. Streets and empty lots were filthy, and the sanitation staff was underequipped and in need of men. . . . Internal transportation was overcrowded, unhealthful, and dirty. . . . The discussion of this public poverty competed, on the whole successfully, with stories of ever-increasing opulence in privately produced goods.

J. K. Galbraith (1958), p. 253

After a lively debate in the late 1950s and early 1960s about the merits of John Kenneth Galbraith's theory of social balance (The Affluent Society), the economics profession dismissed (or forgot) Galbraith's admonitions about the perils of neglecting the public infrastructure. David Aschauer, however, rekindled a great deal of interest in the efficiency of public capital spending by showing that additional spending by governments for nondefense capital goods apparently had a very large positive effect on private productivity and, hence, output.

Although economists were not surprised that public infrastructure spending could promote private output growth, the magnitude of the effect found by Aschauer was startling to most. Aschauer estimated that additional public capital spending would increase the output of private firms by more than 1-1/2 times as much as would an equivalent dollar increase in the firms' own capital stock.

A Congressional Budget Office (CBO) study of the effects of public infrastructure spending concluded that Aschauer's results merited some skepticism because "the statistical results are not robust [and] there is a lack of corroborating evidence" (CBO 1991, p. 25). The CBO observed that other empirical research, including cost-benefit studies, found private output to be more responsive to investments in private capital than to investments in public capital. There were a number of other studies in response to Aschauer.(1) Some of the studies found the effects of public investment on economic growth to be smaller than Aschauer found them to be.

Alicia Munnell, formerly of the Federal Reserve Bank of Boston, tried a different statistical approach to measuring the productivity of government spending. Although Munnell (1990), like Aschauer, used a production function approach to evaluate the effects of government infrastructure spending, she approached the problem by estimating her production functions from cross-sectional state-by-state data.

Munnell (1990) used estimates of gross state product and of private inputs of capital to develop estimates of public capital stocks for 48 states over the 1970-86 time period. She then used the state-by-state data to estimate the production functions, concluding that "the evidence seems overwhelming that public capital has a positive impact on private output, investment, and employment" (p. 94).

Munnell's (1990) estimates of the relative effects of public investment were smaller than those made by Aschauer. Hulten (1990), commenting on Munnell, observed that her findings of smaller relative effects were consistent with other studies that analyzed state data but that her findings differed sharply from the results of studies that were based upon time series.

The CBO (1991), in summarizing the results of cost-benefit studies, noted that there has been little support for the view that across-the-board increases in public capital programs have remarkable effects on economic output. Rather, they concluded that "cost-benefit analysis paints a fairly consistent picture of high returns to maintaining the existing stock of physical infrastructure and to expanding capacity in congested urban highways and runway traffic and air traffic control at major airports" (p. …