The Spurious Effect of Public Capital Formation on Private Sector Productivity
Tatom, John A., Policy Studies Journal
The analysis of public capital formation had been one of the most routine tasks in the economists' catalogue until the late 1980s. While professional controversy continued as economists perfected methods of assessing project benefits and the appropriate cost of capital, the cost-benefit approach to public capital expenditures was well known, widely used, and accepted. Recent efforts to assess the effects of public capital formation in a macroeconomic or aggregate context, especially using an aggregate, business-sector production function, have destroyed this status quo, and have created both a groundswell of concern and activity among special interest groups and a new growth industry among economic analysts.
Beginning with studies published by Aschauer and continuing with work by Munnell and others, the hypothesis that public capital formation boosted private sector productivity gained growing support and popularity. Some of these studies are cited below, but interested readers should see the recent survey prepared by the Federal Highway Administration 1992) for a more inclusive list. When Ratner (1983) originally pioneered tests of the influence of t he public capital stock on business-sector output, this influence was only one external effect of public expenditure policy. The more recent work has claimed such large external effects, however, that analysts and policymakers have lost sight of the principal factors influencing public spending decisions: the direct benefits of public capital, which largely accrue as final goods to consumer-taxpayers, instead of as intermediate goods used as resources by businesses. In Aschauer's view (1990), public capital boosts private output directly, given the employment of private capital and labor resources, and indirectly, by boosting the rate of return to private capital, together thereby leading to larger private capital stock and an even larger output gain. The fundamental problem with this view is that it is strongly at odds with what is known about public capital and public-sector activities.
What Is Public Capital?
Public capital includes many types of goods which are used to produce final goods and services for consumers. The largest components of public capital are highways, streets, roads, and public educational buildings. Others include building and equipment used in public hospitals; police and fire protection; prisons; courts; public electric or gas utilities; communications activities; water, sewer, and garbage facilities for distribution, collection, or processing; parks; airports; locks and dams; ports; or mass transit and irrigation systems. Contrary to the new infrastructure hypothesis, many of these capital goods are substitutes for other public capital, not to mention private capital. For example, locks and dams, airports, highways, and public railways or other mass transit facilities are all substitutes which provide transportation. An increase in the quantity and services of one of these capital goods reduces the benefits and rate of return to others. More important, while the return to related private-sector investments could be boosted, the returns to the private-related activities of competing transportation modes are reduced. Thus, better and more extensive roadways might benefit truckers, but they reduce the return and desired quantity of capital in private airlines, rail, and water transport.
There is also some confusion over the issue of whether public capital affects private-sector output or productivity. For example, the Federal Highway Administration's study (1992) of the private productivity effects of infrastructure concludes:
Indeed, the traditional method of assessing an infrastructure project, cost-benefit analysis, indicates a positive relationship between public capital and productivity, because it finds in selected instances the rate of return for public capital investment projects …
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Publication information: Article title: The Spurious Effect of Public Capital Formation on Private Sector Productivity. Contributors: Tatom, John A. - Author. Journal title: Policy Studies Journal. Volume: 21. Issue: 2 Publication date: Summer 1993. Page number: 391+. © 1999 Policy Studies Organization. COPYRIGHT 1993 Gale Group.