The problem with trying to measure the effect of infrastructure spending is that in many areas, such as education, there is little connection between the amount of money spent on a project and the ultimate beneficial outcome. For example, building a shiny new university is an obvious positive for local construction companies, architects and ultimately service providers who supply the institution. However, if the quality of the teaching is poor and graduating students have fewer chances of attaining well-paid employment, then the initial investment has failed in its long-term aims. The example actually illustrates a common problem with infrastructure spending that is specific to the developed world: in a country where all the roads, railways, docks and universities have been developed, incremental improvements to economic performance are more about promoting productivity, rather than growth.
Public infrastructure investment has been falling as a percentage of output across the developed world for many years, but the differences between the developed and developing world are not actually that great. The IMF estimates that advanced economies devoted about 3.6 per cent to public investment compared with 3.9 per cent in the developing world between 1960 and 2000. Taken together, that investment generated real GDP growth of 3.4 per cent in developed countries and 4.4 per cent in developing nations. The extra growth kicker for developing economies highlights that infrastructure spending does boost growth, but what the IMF's figures also illustrate is the phenomenon of diminishing returns as economies mature.
In countries where public infrastructure makes up 60 per cent or more of GDP, the rate of economic growth slows quickly when extra spending is pumped in. That's because this must be paid for in higher taxes or borrowing, the effect of which is to dampen the output of the rest of the economy. Another important difference is that advanced economies have a much higher ability to absorb capital investment, which means the initial boost dissipates far more quickly. Infrastructure spending is therefore used as a way of managing demand during times when the business cycle turns down. In contrast, developing economies will feel the effect for far longer, perhaps more than five years down the road, the IMF said.
It also true that a country such as Germany can run its infrastructure down because in the long run it can afford to replace it. For example, an extra €6.5bn (£4.1bn) a year spent bringing infrastructure up to scratch is small change when the country is heading for a primary budget surplus of €28bn by 2017, according to the DIW institute. The benefits of that extra spending are largely implicit - better roads means Germany's Herr Doktors, Herr Direcktors and Herr Professors avoid sitting in traffic outside Dusseldorf. That means meetings with suppliers and customers can start on schedule, products are delivered where requested on time and workers can travel easily to where the jobs are. Small details, admittedly, but vital when an economy can only grow as fast as its overall rate of efficiency.
Chris Dillow is currently on annual leave.
