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Do Big Infrastructure Projects Boost GDP?

Monday August 25th, 2014   •   Posted by Craig Eyermann at 6:21am PDT   •  

13412372_S Does government spending on big infrastructure projects really increase economic growth in the long run?

That’s an important question, because governments will often borrow large sums of money for the sake of building major infrastructure projects as they sell taxpayers on the notion that they’ll be rewarded with higher economic growth over time  particularly if the projects are placed in regions where people earn low incomes.

A new paper from the International Monetary Fund (IMF) casts doubt on that promise after a careful statistical evaluation of real-world data from major government-financed infrastructure projects from a number of countries around the world. The IMF’s Andrew Berg and Catherine Pattillo write:

This paper separates out episodes of large public investment drives, also called investment booms, and tests whether economic growth was higher after those episodes than before. It also compares boom countries with those that never had such episodes. The paper considers alternative ways of identifying what constitutes a boom, and alternative ways of measuring booms. It considers evidence from World Bank projects, asking whether past surges in Bank lending were associated with improved project performance. Finally, the paper reviews case studies of five countries, three of which had major investment drives as defined above (Bolivia, Mexico, and Philippines), and two of which (many believe) used public investment successfully to spur development (Korea, and Taiwan province of China).

The econometric evidence reveals small positive and instantaneous associations between public investment booms and economic growth, but little long run impact. Several aspects of the evidence cast doubt on the idea that past booms triggered or accelerated GDP growth. Most of the positive association occurs immediately; a spending boom tends to be immediately associated with a rise in GDP this year, but not subsequent years. F-tests fail to reject that the long run impact, given by the sum of the coefficients on lagged investment booms, is zero. This runs counter to two ideas. One is that the booms had a causal impact, since this kind of evidence is consistent with reverse causality, from GDP growth to investment booms, as spending is cut in slumps and increased in good years. This evidence also runs counter to the idea that the data is picking up long term productivity effects, since, given the long construction periods of public investments, these effects should show up in the data with lags of three or more years, or the estimated long run impacts should be positive. In addition, the estimated associations are small, certainly not of the magnitudes suggested by big push models.

Overall it is difficult to find a clear-cut example that fits the oft-repeated narrative of a public investment boom followed by acceleration in GDP growth. If anything the cases of clear-cut booms illustrate the opposite – major drives in the past have been followed by slumps rather than booms.

To quickly summarize, the only significant economic growth that occurs as a result of the new public-infrastructure spending occurs during the year the project starts, which then peters out and all but statistically disappears as the project continues or is completed.

The authors go on to note that most of the loss of a project’s productive economic potential is built into public megaprojects (emphasis ours):

Does this mean that infrastructure and public capital is not potentially productive? Probably not; but it strikes a blow against the idea that large pubic capital expenditures alone will have a positive impact, and it casts doubt on the overriding importance of spillovers and positive externalities that motivate big push initiatives. Furthermore, the case studies reveal many problems with past investment drives – mainly deep incentive problems, agency problems, a pervasive avoidance of rational analysis and even difficulty obtaining or collecting the critical data that would underpin rational investment choices. These cases suggest that whether or not future public capital drives will be more successful than past drives hinges on whether these kinds of problems can be overcome in the future.

Examples of recent big infrastructure projects in the United States include things like the “Big Dig” highway tunnel in Boston or the San FranciscoOakland Bay Bridge. Both have been marked by exorbitant promises and equally exorbitant problems. For example, the Boston Globe has described the Big Dig as a “Road to Tragedy“:

The Big Dig, the $14.6 billion reconstruction of downtown Boston’s roadways, has been rife with troubles since construction began 15 years ago. Those problems have included a leaking tunnel, cost overruns, and most recently several tons of tunnel ceiling collapsing and killing a passenger in a car on her way to Logan Airport.

Meanwhile, the quality of construction of the Bay Bridge is so questionable that California state legislators are now actively calling for criminal probes into the project and its management.

The 1989 Loma Prieta earthquake revealed structural deficiencies in the eastern span of the San Francisco-Oakland Bay Bridge, and within a few years, then-Gov. Pete Wilson’s administration proposed a $1.4 billion replacement viaduct.

When the replacement opened two decades later, however, it had mushroomed into a $6.4 billion single-tower suspension span, plagued by reports, mostly in The Sacramento Bee, of long delays, cost overruns and construction deficiencies that were ignored or covered up.

This week, Senate Transportation and Housing Committee Chairman Mark DeSaulnier released an investigative report about the mismanagement.

It confirmed suspicions that the debacle is rooted in political hubris, including pressure from two mayors, San Francisco’s Willie Brown and Oakland’s Jerry Brown, and other politicians for route changes and redesigns to make the new section an artistic spectacle.

Not only did the radical design that resulted from political interference raise costs and add years of delay, but its complexity led to construction defects and alleged cover-ups.

“To be sure, some of the longest delays were not the fault of the bridge builders,” says the report. “Rather, they were the product of political infighting at the very highest levels of California state government.”

We’re afraid that these kinds of problems are never isolated incidents. If failure were not really an option, why do so many politicians and bureaucrats do all they can to ensure it?

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August 2014