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Policy Debate: Is more spending on infrastructure the key to economic growth?

Issues and Background

Economic expansion in a technological age requires continuous investment in public infrastructure, in generic R&D, and in training and education.... A strong case can be made that we should now be spending more on public investment, not less, if we do not want to undermine the prospects for growth.
~ Barry Bluestone and Bennett Harrison
The relative increase in the stocks of public and human capital along with the decline in their marginal rates of return below the returns to private and nonhuman capital suggest the existence of an imbalance in the optimal mix of capital.... [P]olicies that encourage the relative growth of private and nonhuman capital would do the most to stimulate economic growth and reduce unemployment.
~ Willis Peterson

U.S. Presidential elections are often won and lost on the basis of the state of the economy in the period leading up to the election. When people are asked to list the economic problems about which they are most concerned, unemployment and inflation generally top the list. Economic growth is rarely mentioned as one of the most pressing concerns. The importance of economic growth is often overlooked. While the effects of growth may be small in any one year, the cumulative effect of compound growth becomes rather dramatic over time.

The "rule of 72" may be used to illustrate the effect of economic growth. This rule states that:

the period of time required for income to double = 72 / growth rate

Thus, if an economy experiences real per-capita growth at an annual rate of 2%, a typical person's income will double in 36 years (72/2 = 36). An economy that grows at a rate of 4% per year will double its income in 18 years (and quadruple its income in 36 years). Consider the effect of this growth over a period of 72 years (roughly equal to the life expectancy at birth of U.S. citizens). If real per capita output were to increase by 2% per year over this period, the income of a typical person would quadruple over the course of an individual's lifetime. Under a 4% rate of growth, however, the income of a typical person would be 8 times larger at the end of this same period.

Since economic growth is so important, economists have been quite concerned about the decrease in the rate of U.S. economic growth during the past few decades. A great deal of research effort has been (and is being) devoted to understanding the determinants of economic growth.

The level of output produced in an economy in any given time period is affected by the quantity and quality of available resources, the level of technology, and the economic incentives facing individual firms, investors, savers, and workers. Economic growth, therefore, must be affected by changes in the quantity or quality of resources, technological innovations, and changes in the incentive structure in society. While everyone agrees on these general principles, there is a substantial amount of disagreement concerning the relative importance of each of these factors. The most common recommendations for increasing the rate of economic growth include:

  • increasing public investment in the economic infrastructure (the term "infrastructure" usually refers to public investment in constructing and maintaining roads, bridges, airports, railroads, communications networks, water supplies, solid waste management, electricity production and distribution systems, the legal system, police and fire protection services, etc.),
  • increasing public investment in education (human capital),
  • providing increased incentives for private investment, and
  • improving the incentives for research and development that may lead to technological improvements.
Much of the debate concerning this issue involves a question of the appropriate role of government in the economy. The first two approaches listed above suggest a larger role for direct government involvement. Those who believe that markets are more efficient tend to advocate the latter two approaches.

While economic growth is a feature of all developed economies, many less-developed economies experience a relatively stationary state in which many individuals receive only a subsistence level of output and little or no economic growth occurs. Much of the current research on economic growth involves the question of how to most effectively initiate growth in these countries so that economic development may begin. Both the World Bank and the International Monetary Fund provide programs and loans to encourage growth and development. Once again, though, there is a question of how to best encourage the process of growth and development.


Primary Resources and Data

  • Paul Romer, "Economic Growth"
    Paul Romer, provides a very good introduction to the importance of economic growth. In this online version of his article in The Fortune Encyclopedia of Economics, Romer discusses the importance of innovations and applied research on economic growth. (To view this document, the Adobe Acrobat viewer plugin is required. You may download this viewer by clicking here.)

  • Economic Growth Resources
    This site, maintained by Jonathan Temple, a Research Officer at the Institute of Economics and Statistics at the University of Oxford, contains an extensive collection of links to economic growth resources on the Internet.

  • Macroeconomics and Growth
    This page, provided by the World Bank, contains links to a variety of published articles and data sets that are relevant to the study of economic growth.

  • Independent Evaluations Group - World Bank
    The Independent Evaluations Group of the World Bank evaluates the success of alternative programs designed to aid economic growth and development in less-developed economies. This web site contains links to online reports on these programs.

  • International Monetary Fund
    While the primary purpose of the International Monetary Fund is to ensure the stability of international currency markets, it conducts studies of the state of the economies in participating countries and provides recommendations designed to enhance economic growth and development. Loans are given to economies experiencing balance of payments difficulties. When the IMF issues these loans, however, it generally requires economic reforms designed to improve the condition of the recipient economy. The web site of the IMF contains information on current and recent IMF programs.

  • J. Bradford De Long, "What Do We Really Know About Economic Growth?"
    In this online article, J. Bradford De Long provides a good summary of contemporary economic models of economic growth. Some of the analysis is a bit technical, but a careful reader should be able to understand the essentials of the arguments.


Different Perspectives in the Debate

  • Willis Peterson, "Overinvestment in Public Sector Capital"
    Willis Peterson, writing in The Cato Journal, argues that there has been too much investment in economic infrastructure and education and too little investment in private capital.

  • Harry Anthony Patrinos, "Notes on Education and Growth: Theory and Evidence"
    Harry Anthony Patrinos provides a discussion of the literature on education and economic growth. He mentions that numerous studies have found that the educational level of the labor force is an important determinant of economic growth. Patrinos notes that studies that only include the private rate of return to education are not capturing the full social return to education. He argues that externalities associated with education (the "diffusion of knowledge") is an important determinant of growth and development.

  • Human Development Department of The World Bank, "Investing in People: The World Bank in Action"
    This document presents the argument that the World Bank initially attempted to stimulate development by devoting resources to infrastructure improvements during the 1940s and 1950s, but eventually realized the importance of developing human capital as well. This article provides a description of current World Bank programs that are designed to improve the quality of the labor force in less developed economies.

  • Barry Bluestone and Bennett Harrison, "Why We Can Grow Faster"
    In this September/October 1997 article in American Prospect, Barry Bluestone and Bennett Harrison suggest that economists are too pessimistic about the prospects of growth. They argue that forecasts of low growth rates have become self-fulfilling prophecies. Bluestone and Harrison argue that increased public infrastructure investment will help to encourage a higher rate of economic growth.

  • Jeffrey A. Frankel, "Determinants of Long Term Growth"
    In this background paper, Jeffrey A. Frankel reviews the literature on the determinants of economic growth and concludes that there is substantial evidence that investment in both infrastructure and education are beneficial in stimulating economic growth. (To view this document, the Adobe Acrobat viewer plugin is required. You may download this viewer by clicking here.)

  • Preston J. Miller and James A. Schmitz Jr., "Breaking Down the Barriers to Technological Progress"
    In this article, Preston J. Miller and James A. Schmitz Jr. argue that cross-country studies have shown that deregulation and open markets encourage economic growth. It is suggested that the U.S. could gain by continuing to both deregulate industries and reduce trade barriers.

  • Vito Tanzi and Hamid Davoodi, "Roads to Nowhere: How Corruption in Public Investment Hurts Growth"
    Vito Tanzi and Hamid Davoodi examines the effect of corruption on public investment in this online International Monetary Fund article. They note that the political rewards associated with public investment projects may result in a bias resulting in overinvestment in some activities. This inefficient allocation of resources may result in a slower rate of economic growth. The corruption that is common in many less developed economies result in further distortions in resource allocation.

  • Paul M. Romer, "Beyond Classical and Keynesian Macroeconomic Policy"
    In this article, Paul M. Romer argues that government policy should place more emphasis on stimulating economic growth. He suggests that government should attempt to create an environment that is conducive to innovation by:
    • subsidizing research,
    • subsidizing education and training,
    • encouraging interaction between researchers in universities and firms, and
    • allowing firms and industries to fail.

  • Mark Potter and Marc Lee, "The Economic Impacts of the Information Highway: An Overview"
    In this July 1995 discussion paper, Potter and Lee investigate the case for government subsidies of the development of the Internet backbone. They argue that, in the absence of government subsidies, the existence of externalities and spillover benefits would result in the underprovision of this network. Potter and Lee suggest that an investment in this type of infrastructure would encourage economic growth.

  • Edward M. Gramlich, "Infrastructure and Economic Development"
    Federal Reserve Board Governor Edward M. Gramlich discusses the relationship between infrastructure investment and economic growth in this August 3, 2001 speech. He argues that public infrastructure investments were very important in explaining U.S. historical economic growth. Gramlich suggests that public investment in the internet infrastructure has played a role in encouraging the recent increase in U.S. economic growth. He suggests, though, that the most useful roles for government include encouraging competition and helping to establish standards that allow network externalities to be exploited.

  • Cesar A. Calderon and Luis Servén, "The Effects of Infrastructure Development on Growth and Income Distribution"
    In this September 2004 Central Bank of Chile working paper, Cesar A. Calderon and Luis Servén investigate the effects of infrastructure development on economic growth and income inequality using data from over 100 countries during the years 1960 through 2000. They find that, when the endogeneity of infrastructure investment is taken into account, infrastructure investment increases economic growth and reduces income inequality. (Some parts of this discussion contain relatively technical analysis.) (To view this document, the Adobe Acrobat viewer plugin is required. You may download this viewer by clicking here.)

  • Johannes W. Fedderke and Zeljko Bogetic, "Infrastructure and Growth in South Africa: Direct and Indirect Productivity Impacts of 19 Infrastructure Measures"
    In this August 2006 World Bank working paper, Johannes W. Fedderke and Zeljko Bogetic examine the effect of infrastructure investments in South Africa. They note that previous studies have found that the effect of public infrastructure investment on economic growth to be ambiguous. They argue that this result is due to not controlling for the endogeneity of infrastructure investment. When they control for the endogeneity of infrastructure investment, they find that infrastructure investment has a positive effect on economic growth. (Some parts of this discussion contain relatively technical analysis.) (To view this document, the Adobe Acrobat viewer plugin is required. You may download this viewer by clicking here.)

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