Public investments boost economy more than private ones

public vs. private investments

Public investments boost economy more than private ones

A new round of research in the last decade confirmed the large impact of public investment on productivity growth. At the same time, the contribution of private investment to productivity growth seems to be fading. The surest route to returning to the productivity growth we enjoyed in the 60th era and again in the 2000s requires a substantial increase in public investments.

Investments in public capital have significant positive impacts on private-sector productivity, with estimated rates of return ranging from 15 percent to upwards of 45 percent. The accepted estimate is 30 percent, which is equivalent to the rate of return on investment in information and communications technology.

A significant increase in public investment spending would boost jobs in the short run and pay enormous dividends in more rapid productivity growth in coming decades. In contrast, the payoff to spending cuts would be depressed job growth in the next few years and foregone productivity gains in the longer run.

In the short run, while the economy continues to operate well below potential, the public investment should be debt-financed to maximize job creation. In the long run, as the economy returns to potential, the proper financing for these projects will depend on the economic circumstances prevailing at the time. If the returns to public investment are large enough, then they can unambiguously improve the welfare of both present and future generations even if they are debt-financed. What is even more important over the long term than how they are financed, however, is that they get done.

Policy debates today are dominated by claims that the budget deficit needs to be substantially reduced. The decrease of economic growth in these last years has been so slow and difficult, is shown to public debt and performing loans that are in the worst position of historic values in the last two decades.

Given the fact that economy is operating far below potential, and is likely to do so for years to come absent aggressive policy measures to boost it, such rapid fiscal contraction is extremely unwise.

But, the big concern for the budget it is the lack of money, because of old debts problem and also because of not good performance of revenues collection.

In fact, the latest experience of budgetary concerns shows that more is the situation like this, more the countries think to solve the obstacles of funding the public debt and investments with the overt money financing instrument.

Overt money financing seems to be more effective because it does not leave the budget struggling with the question of what to do about future public debt burdens, nor create the danger that the anticipation of those future debt burdens will induce a Ricardian equivalent offset to nominal demand stimulus today.

The introduction of this extraordinary instrument need to be part of broad debate between financial institutions, Bank of Albania and Ministry of Finance. Through this process should be depth analyses with pros and cons for the better policies to solve the problem of lacking public funds for investments and social bills, and also to see what’s next for the public debt.

But, let’s see what about the investment issues.

Further, if public investment is a casualty of this rush to cut spending, as it almost surely will be, then this policy trajectory is even more perverse. Consider the standard economic rationale that justifies reduction of budget deficits. When an economy is operating at or near potential, reducing budget deficits should lead to downward pressure on interest rates, as the public sector is no longer competing with the private sector for loanable funds. Lower interest rates should then allow private firms to undertake more investment in plants and equipment, and this subsequent capital deepening should boost productivity.

Too often, discussions of investment, capital stocks, and productivity assume that private-sector decisions are the dominant force behind the movement of these variables. Note first the overwhelmingly large importance of education, a sector funded significantly by the public sector. Note also that public capital accounts for more than a third of all nonresidential structures and equipment capital. In short, the wealth of the nation (i.e., the human and physical capital that can be mobilized to produce goods and services) is crucially dependent upon public investments and public capital.

Allowing these public capital stocks to wither so that funds can be available for private capital formation would be a calamitous assault on productive capacity, productivity, and competitiveness.

It is sometimes argued that even if increased public investment can increase an economy’s growth performance, the necessary financing of the investment may introduce economic distortions that reduce growth. If so, it matters not just how much public investment is undertaken but also how it is financed.

The concern is that, if these investments are financed with increased debt or higher taxes, the efficiency losses induced by the crowding-out of private-sector investment, or by higher tax rates, may produce a net loss to economic growth. But there is little cause for this concern, for several reasons.

A big program of public investment can achieve a big push itself or can stimulate numerous further private investments that together constitute a big push. On the other hand, there are reasons to expect the opposite, a lower impact of the booms than the average. One is a perverse selection effect.

The on-the-shelf government investment projects that are pulled off-the-shelf once a major increase in spending is announced may be precisely those that were previously rejected on grounds of low impact. Hence a surge may select relatively-poor public investments. Rejected projects are likely to have the advantage of having already passed the feasibility stage of analysis and can thus be implemented quickly. More important, they are likely to still have constituencies that favored them within the bureaucracy.

The second reason for lower-than average impact of booms is that booms can change the behavior of governments. A government that rationally analyzes investments when the money is tight has less incentive to do so when money is loose. Special interest group pressure can be more influential as other constraints become less binding, such as the budget. A third reason to expect that the impact of changes is different is diminishing returns to additional capital. Additional roads added to a basic road network may have less impact that the initial roads that opened up access to major regions of the country.

The general idea is that if a critical mass of small investments is undertaken simultaneously the average social return will be much higher than the average private return, because they will create demand for each other, and overcome coordination failures that keep private market economies in a low-income equilibrium.

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