The story is told of three professors — a chemist, a physicist and an economist — who find themselves shipwrecked with a large supply of canned food but no way to open the cans. The chemist proposes a solvent made from native plant oils. The physicist suggests climbing a tree to just the right height, then dropping the cans on some rocks below.
"Guys, you're making this too hard," the economist interjects. "Assume we have a can opener."
Keep that old chestnut in mind as you evaluate the International Monetary Fund's latest recommendation to kick-start the global economy: a big increase in public infrastructure spending, financed by government borrowing.
The fund's World Economic Outlook, published last month, argues that such a building boom could boost both short- and long-term growth while actually reducing public debt burdens over time. No less an economic expert than Harvard's Lawrence H. Summers hails the report as possible proof that the elusive free lunch exists.
The IMF's scenario is certainly plausible. Government-financed road and bridge building can indeed boost an economy in the short run by giving idle workers jobs and wages; their extra spending then has a multiplier effect through the rest of the economy. Over the long run, it's potentially pro-growth, too, because business can operate more efficiently when you fix overcrowded ports, potholed highways and other bottlenecks.
What's more, the IMF team argues, these growth-boosting effects can be especially strong at times, like the present, of "substantial" economic slack (i.e., idle labor and capital), coupled with low interest rates for government borrowing.
The ultimate payoff of extra growth is more revenue for government than it would have had otherwise; thus a short-term debt increase leads to long-term debt reduction.
A careful reading of the IMF report, however, reveals that this happy scenario hinges on at least two big "ifs."
The first is how to quantify slack in the U.S. economy, one of the hottest controversies in economics today. The official unemployment rate has lost much of its explanatory power as it has dropped below 6 percent amid many other indicators that the economy is not firing on all cylinders. At last check, Federal Reserve economists were wrestling with this issue but had not yet produced answers that satisfy everyone.
The second, and more crucial, "if" is the IMF report's acknowledgment that stimulative effects of infrastructure investment vary according to the efficiency with which borrowed dollars are spent: "If the efficiency of the public investment process is relatively low — so that project selection and execution are poor and only a fraction of the amount invested is converted into productive public capital stock — increased public investment leads to more limited long-term output gains."
That's a huge caveat. Long-term costs and benefits of major infrastructure projects are devilishly difficult to measure precisely and always have been. The C&O Canal was supposed to revolutionize U.S. commerce; it ultimately proved a bust because its proponents (including George Washington) failed to anticipate the true hazards of building it or the advent of the railroad.
Today we have "bridges to nowhere," as well as major projects plagued by cost overruns and delays all over the world — and not necessarily in places you think of as corrupt. Germany's still unfinished Berlin Brandenburg airport is five years behind schedule and billions of dollars over budget, to name one example.
Bent Flyvbjerg of Oxford's Said Business School studied 258 major projects in 20 nations over 70 years and found average cost overruns of 44.7 percent for rail, 33.8 percent for bridges and tunnels and 20.4 percent for roads.
Even popular projects, like New York City's subway, often require operating subsidies after completion. To be sure, that system yields abundant "positive externalities"; the Big Apple wouldn't be livable without it. How that pencils out in macroeconomic terms, though, is anyone's guess.
In short, an essential condition for the IMF concept's success — optimally efficient investment — is both difficult to define and, to the extent it can be defined, highly unrealistic.
As Flyvbjerg explains, cost overruns and delays are normal, not exceptional, because of perverse incentives — specifically, project promoters have an interest in overstating benefits and understating risks.
The better they can make the project look on paper, the more likely their plans are to get approved; yet, once approved, economic and logistical realities kick in, and costs start to mount. Flyvbjerg calls this tendency "survival of the unfittest."
Obviously, the U.S. and world economies need first-class roads, harbors, airports and electrical grids.
Equally obviously, they must be upgraded to accommodate and facilitate growth, and it can be worth risking public funds, including, at times, borrowed funds, to make that happen.
But this is an inherently imprecise business. Governments that invest in infrastructure on the assumption it will pay for itself may find out that they've gone a bridge too far.