Is Public Expenditure Productive? Evidence from the Manufacturing Sector in U.S. Cities, 1880-1920

By Yeoh, Melissa; Stansel, Dean | The Cato Journal, Winter 2013 | Go to article overview

Is Public Expenditure Productive? Evidence from the Manufacturing Sector in U.S. Cities, 1880-1920


Yeoh, Melissa, Stansel, Dean, The Cato Journal


This article provides the first examination of the relationship between public expenditures mad labor productivity that focuses on municipalities, rather than states or nations. We use data for 1880-1920, a period of rapid industrialization in which there were both high levels of public infrastructure spending and rapid growth of productivity. We use a simple Cobb-Douglas production function to model labor productivity in the manufacturing sector, letting total factor productivity depend on "productive" public expenditure by city govermnents--that is, on public spending that may raise the productivity of labor and encourage human capital accmmulation.

Using a data set of 45 of the largest cities in the United States, we find no statistically significant relationship between productive public expenditure and labor productivity in the manufacturing sector during this period. These findings are robust to three different econometric approaches. We do, however, find a strongly positive mad statistically significant relationship between private capital and labor productivity. Our results are consistent with those of much of the literature examining this same relationship in states and nations and they have important implications for contemporary public policy issues.

An Overview

The decline in labor productivity in the United States during the 1970s created a challenging puzzle for economists to solve. Aschauer (1989) found that public capital had a strongly positive relationship with productivity in the United States, and argued that the productivity decline had been caused by a decline in public expenditure on infrastructure. Munnell (1990) and others found similar results. These initial Findings were used by politicians and policymakers as evidence of the need for large increases in government spending on infrastructure. Some critics identified flaws in the econometric approach of this early work and, after correcting those flaws, found either a negative relationship or no statistically significant relationship between public capital and productivity. Peterson (1994) found that the marginal rate of return on public capital had declined substantially since 1950 and was substantially lower than that on private capital. He suggested that policies to increase private capital would contribute more to the growth of output than would the increases in public infrastructure recommended by Aschauer and others. The early literature on both sides of the debate is summarized in Munnell (1992) and Gramlich (1994). Few have been able to replicate the large effects found by Aschauer. Work in this area has slowed, but there remains no consensus (see, e.g., Kalyvitis and Vella 2011, and Lithgart and Suarez 2011). Moreover, virtually all of the existing literature has focused on national, regional, or state data and has analyzed contemporary time periods. While there is a substantial empirical literature investigating the relationship between local government spending and economic growth, (1) there appear to be none that examine the relationship with local labor productivity. (2)

One of Asehauer's (1989: 177) key findings was that "'a 'core' infrastructure of streets, highways, airports, mass transit, sewers, water systems, etc. has [the] most explanatory power for productivity." Since the bulk of that infrastnleture spending is done by local govermnents, we take a different approach than previous researchers and focus on local-level data and do so for a period of rapid industrialization, 1880-1920. During that time, there was a great deal of public expenditure on the construction of infrastructure and a rapid increase in the productivity of labor. (3) If public expenditure is positively associated with productivity, as some have claimed, then that relationship should be readily apparent in the data we have chosen.

The period between 1880 and 1920 saw tremendous growth in cities and wide variations in the labor productivity and public expenditure in areas across the United States. …

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