Canada needs more infrastructure spending, but not as short-term stimulus

Christopher Ragan: Experience has shown that spending vast sums of public money on infrastructure both quickly and effectively is almost impossible
Christopher Ragan
COVID Infrastructure 20200408
Workers are shown at a construction site in Toronto on Wednesday, March 18, 2020. Cities and construction groups are asking the Trudeau Liberals to relax rules or directly fund expected cost overruns from infrastructure projects facing delays from the COVID-19 pandemic. THE CANADIAN PRESS/Frank Gunn

Christopher Ragan is the Director of the Max Bell School of Public Policy and was a member of the federal government’s Advisory Council on Economic Growth.

With the policy priorities announced in last week’s Speech from the Throne, the federal government says it is focusing on what needs to be done to beat the COVID pandemic and get the economy back on track. Massive spending on public infrastructure will apparently be an important part of the policy package.

Public spending on Canadian infrastructure projects is a good idea. It was a good idea 10 years ago and will still be a good idea 10 years from now. Such spending can lead to long-lasting economic and social benefits for millions of Canadians. But it is not easy to do well, or quickly, especially in large amounts. Projects that are rushed into completion, and that are driven by short-term political considerations, often become the “white elephants” that are the subject of scathing reports.

Our federal policymakers should resist the temptation to rush into massive spending as a way of providing immediate stimulus to our economy. The nature of our current “pandemic recession” adds little to the solid case for infrastructure spending. The government should be patient and take the long view—determining which projects deliver the greatest potential benefits to Canadians, and then making sure that the projects are planned and implemented carefully so they live up to that potential. It is unfortunate how seldom such care is taken.

READ: Five key takeaways from the Throne Speech

The best time for public infrastructure spending

The best time for governments to spend on major infrastructure projects is when the long-term benefits are high and when the cost of financing the projects is low. Both of these conditions apply today, and likely will for several more years.

High long-term benefits: Our needs for more and better infrastructure spending can be assessed by examining what we are lacking to satisfy our current needs and also at what we will need in the future as our population and economy continue to evolve.

Most of Canada’s physical infrastructure—roads, bridges, water and sanitation systems, sports facilities, libraries—is owned and managed by municipalities. Other important infrastructure such as highways, hospitals, and universities are owned and managed by provincial governments. For many years in Canada there has been discussion of our “infrastructure deficit”, the amount of spending needed, both in repairs and in new construction, to bring the total stock of infrastructure up to the appropriate level. This deficit is the result of many years of population growth combined with under-spending by governments. According to a 2017 report from BCG Consulting, estimates of the deficit “range from $50 billion to $570 billion with most averaging between $110 billion and $270 billion.”

Other kinds of infrastructure, not included in this estimated deficit, will be needed as our economy evolves. Expanded and improved medical and elderly-care facilities will be a crucial longer-term policy response to the current pandemic. Better port facilities will be needed if Canada is successful in expanding its trading relationships with other countries. Better public transit will be required if cities continue to attract the lion’s share of a growing population. If we are serious about driving a long-term transition in our energy system, away from fossil fuels and toward lower-carbon energy sources, expanded east-west electricity grids will be required to assist some provinces in reducing their current reliance on coal-fired electricity. Along the same transition path, a much larger network of charging stations may be required in order to induce more consumers to make the move toward electric vehicles.

READ: With a second wave underway, Trudeau lays out his vision

Low financing costs:Government debt incurred today implies costs for future taxpayers who must service and repay the debt. From the perspective of “inter-generational equity”, many argue that budget deficits should be avoided for this reason. But borrowing to finance long-lasting infrastructure is quite acceptable on these grounds; if well-built infrastructure delivers sustained economic or social benefits to future generations, it is appropriate for those same generations to pay some of the costs. Based on this logic economists have long pushed governments to adopt “capital budgeting” in which current tax revenues are used to finance current program spending while public debt is used to finance good investments in long-lasting infrastructure. In other words, there is nothing wrong with government budget deficits if they are incurred to finance sound long-term investments.

Government borrowing rates are currently at an all-time low, and have been very low for over a decade. Today the Canadian government can issue 10-year bonds with an annual yield of below 0.6 percent; this is well below the 1.5 percent from one year ago and far below the longer-term average of about four percent.

Today’s low interest rates are partly the result of the central-bank responses to the 2008-09 Global Financial Crisis and partly due to the current pandemic recession. But there are also strong longer-run forces at play, as Harvard’s Lawrence Summers has been arguing for several years. The ongoing changing nature of capital investment—less physical and more digital—has driven what amounts to a reduction in the growth of investment demand. The evolving demographic forces—especially the aging of the population and rising income inequality—has led to an increase in the growth of saving. The combination of these forces has led to significant reductions in what is often called the “neutral” interest rate, the rate which exists when economies are operating at their productive capacities.

Put differently, the interest rates at which governments can borrow have been falling even absent recent recessionary events. The excess of planned saving over desired investment leads to what Summers calls “secular stagnation”, a sustained period of low investment and low economic growth. This is an ideal time for governments to borrow to finance long-lasting infrastructure. And history shows that such investment generally drives productivity and long-run economic growth.

What about short-run economic stimulus?

Doesn’t the current recession further strengthen the argument in favour of public infrastructure spending? After all, public spending on infrastructure projects is often held up as a classic example of how governments can use their fiscal policy to provide short-run stimulus for a slumping economy.

For three reasons, however, this argument is weaker than many are currently suggesting. One reason is more general to public spending; two reasons are specific to our current fiscal and economic situation.

The difficulties of spending quickly: Textbooks in macroeconomics have long argued that “discretionary” fiscal stabilization policy—such as massive spending programs designed to dampen a recession—are complicated by various kinds of real-world lags. The recognition of an economic downturn, the assessment of its magnitude and likely duration, the design of a fiscal stimulus plan, the implementation of this plan, and the actual impact of the new spending on economic output and employment—all take time, measured in months and sometimes years, rather than weeks. These lags introduce the possibility that the overall impact of the spending may actually occur well after the worst effects of the recession have disappeared. The lags may even be so long that the fiscal stimulus ends up destabilizing the economy, in contrast to the intent of those designing the policy.

The difficulties of designing successful short-run fiscal stimulus packages lead to one fact that is well-recognized by all practitioners of fiscal policy: when spending large amounts on public infrastructure projects, it is very difficult to do it both quickly and effectively. Money that is spent very quickly is often wasted on projects that deliver little value in the long run, and perhaps not even in the short run. In contrast, public spending that delivers serious benefits to many people needs to be carefully planned, designed, and implemented. And this level of deliberation makes it almost impossible to be done quickly.

During the 2009-10 period I had the good fortune to serve as the Clifford Clark Visiting Economist at Finance Canada and lived through two remarkable federal budgets. The Global Financial Crisis had begun only a few months before my arrival and the federal budget for 2009 was moved up a few months. Each of the 2009 and 2010 budgets contained a large fiscal stimulus, especially on “shovel-ready” infrastructure projects. The difficulty of spending large sums of money both quickly and effectively was soon apparent, and the government received considerable criticism for its inability to “get the money out the door” fast enough. This same criticism has been applied to the current federal government in terms of its own difficulties in implementing its 12-year $180 billion infrastructure plan, which was launched in 2016, long before the start of the 2020 COVID recession. This difficulty needs to be kept in mind, and should dampen the enthusiasm of those who advocate bold spending programs.

READ: Canada’s economy may never return to what it once was

The high-spending bandwagon: Another recollection from the 2009-10 period involves the mindset of cabinet ministers when the government begins designing a large fiscal stimulus package. Finance ministers who are usually the first to reject spending proposals now invite their cabinet colleagues to submit projects for approval. This is an invitation that few can believe and none can reject, and the result is a flood of spending proposals—many of which have dubious value for the public at large. I recall reading through dozens of pages of hundreds of spending proposals, ranging in cost from a few million dollars to several billion. Fortunately, the finance minister at the time, the late Jim Flaherty, was instinctively suspicious of the dangers of this spending bandwagon and he was able to offer some effective resistance.

Over the past eight months, the federal government responded to the pandemic with a massive increase in public spending, mostly designed to provide financial relief to millions of individuals and businesses until their income streams are restored. I share the view of many that this spending was required, given the nature of this public-health crisis. But these spending programs have a serious fiscal cost which must be recognized and, eventually, repaid.

Before any new commitments were announced in the Throne Speech, the federal budget deficit was on track to be roughly $380 billion for the current fiscal year, and could easily be much higher if a second or third wave of COVID leads the government to further extend its pandemic-related spending. As Paul Boothe and I have argued recently, however, given the political and economic difficulties of reducing spending once the financial flood gates have opened, budget deficits usually last several years beyond the first few intended. The federal debt-to-GDP ratio, which last year was 31 percent, will be 50 percent or higher by this time next year. Former Bank of Canada Governor and Deputy Minister of Finance David Dodge has also expressed the need for the government to ensure that its borrowing does not get out of control – and his experience at the heart of Canadian fiscal policy during the mid 1990s gives him an unequalled vantage point.

The enormous increase in federal spending, and the associated increase in the public debt, should be an antidote to this bandwagon mentality, and should lead to considerable fiscal prudence on the part of the federal government. With its new Throne speech, however, the government is signaling its intent to spend even more in the years ahead. One can only imagine the hundreds of spending projects that federal ministers will be preparing and submitting to Finance Canada or the PMO over the next few months. After all, what’s an additional few billion dollars when the government is already planning for such an enormous increase?

Unfortunately, when it comes to major infrastructure projects, short-term political expediency often trumps a more sober assessment of longer-run costs and benefits, even when these are broadly defined to capture social impacts. Mario Iacobacci from Deloitte has shown that across Canada the majority of major projects (especially public transit projects in major cities) either involve no serious cost-benefit analysis (CBA) before being launched or proceed even though these analyses indicate benefits barely above costs, and close enough so that even modest cost overruns would lead the project to fail the CBA criterion. Perhaps even more important, he shows that major projects almost never have CBA evaluations after the fact which can assess whether the initial assumptions were at all realistic. Without these ex post evaluations, there is little scope for learning from our mistakes.

Addressing these problems when building major infrastructure projects was an important motivation for creating the Canada Infrastructure Bank. The report from the Advisory Council on Economic Growth which initially recommended the creation of the Bank stressed the importance of infrastructure in driving long-run economic growth but also emphasized the importance of ensuring that projects were undertaken in a professional manner, as independently as possible from the political process. If the Bank eventually lives up to this potential – and this is by no means guaranteed – it will be an important instrument for Canada’s long-term economic health. But if it becomes overwhelmed by short-term political thinking, it may simply entrench and even exacerbate the existing problems Iacobacci has described.

READ: Has enthusiasm for the CERB paved the way for a universal basic income?

This recession is different: The final reason why the federal government should resist the temptation to engage in massive infrastructure spending in the name of promoting a short-term economic recovery is that this pandemic recession is quite different from conventional ones. Most recessions are caused by a lack of aggregate demand. Examples are when foreigners decide to reduce their purchases of Canadian exports or Canadian businesses decide to reduce their spending on domestic investment projects. In such situations, public policies can be used to encourage demand and put the economy back on track. The central bank can reduce interest rates and thereby induce firms and households to increase their borrowing and spending. The government can increase its spending on goods and services, thereby adding directly to aggregate demand. There remains plenty of debate about how effective such policy actions are, and how best to design them, but there is little disagreement that such actions can help to restore aggregate demand when it is needed.

But our current recession is a different beast altogether. Most of the decline in our overall level of economic activity has been caused by an intentional shutting down of productive capacity associated with workers safely isolating at home. Many people can continue working (and receiving their income) from home, but those in the construction, retail, entertainment, hospitality and other sectors are unable to do so. It is no surprise that Canada’s GDP (total output) fell so sharply in the second quarter of 2020; if an average of 30 percent of workers remain home (and not working) for three months, GDP will fall by roughly the same amount. The economy has recovered considerably since May, but overall production and income is still well below its level from February. Canada’s lost output can be fully restored only once Canadians are safely able to work in close proximity with others; but the longer social distancing is required for public-health reasons, the longer it will take before Canada’s productive capacity can be fully utilized.

Given this context, how will public spending on infrastructure help to drive an economic recovery? New public demand for roads or bridges or sanitation systems or recreation facilities will indeed increase aggregate demand. But this will only translate into higher GDP if the new demand can be satisfied with new production. The new construction projects will be carried out, but if social distancing is still required then the construction sites will have fewer workers than normal and thus be less productive than normal, thus taking longer to complete. The incomes earned by the construction workers will be spent on various goods and services, but the continuation of social distancing will result in less of this income being spent in retail establishments, restaurants, entertainment facilities, and so on. In short, while the new public infrastructure spending will still lead to an increase in GDP, the usual “multiplier” effect of this spending will be much smaller than is normally the case.

In other words: in a normal recession, infrastructure spending can be used (if it is done quickly and effectively) to drive an economic recovery precisely because its multiplier effect is considerable; in today’s pandemic recession, however, the multiplier effect is reduced by the fact that continued social distancing prevents the economy’s hampered productive capacity from fully responding to any increase in demand.

Rather than using infrastructure spending in an attempt to provide short-run stimulus to the economy, the government should be designing policies that permit people to get back to work safely and productively. How can we make our schools function safely so that students can learn and parents can return to work? How can we reconfigure restaurants and retail stores so that servers and customers can safely interact? How can our shop floors be modified so that workers can gather and produce in safety? How can public-transit systems be altered to transport many travelers safely and efficiently? And which specific public policies can encourage all of these changes?

For public servants who have never before faced a pandemic recession, it will not be easy to invent such policies and make sure they are effective – but the need is certainly there. New spending programs for public infrastructure, no matter how familiar or appealing they feel for those who design them, won’t address the underlying problem that we face during this pandemic recession.

Priorities over politics

I have not argued that the federal government should avoid spending large amounts on public infrastructure. On the contrary, given our current “infrastructure deficit” across the country, as well as the many kinds of new infrastructure that will be needed in the future, there is a compelling case for increased public infrastructure spending. And there is no doubt that with today’s low interest rates, this is an excellent time for governments to be using borrowed money to finance such projects. Our long-term economic health will improve as a result.

In addition, we should keep in mind that public infrastructure is not only a means to a better economic future. There are many broader social benefits that also result; public libraries, museums, art galleries, community centres, recreation facilities, and national parks are unlikely to have much of an impact on our productivity and material living standards, but they can play a crucial role in improving our overall quality of life and sense of social inclusion. In the late 1950s, the Canadian-born but U.S.-based economist John Kenneth Galbraith wrote famously in The Affluent Society about the societal problems that arise when there is a gradual decline in our collective commitment to building and maintaining public goods. He lamented the “atmosphere of private opulence and public squalor” that was so prominent in the United States at that time. It is difficult to believe that he would assess today’s situation any more positively, in either of his home countries.

In short, there is undoubtedly a strong case for the federal government to use borrowed funds to finance long-lasting infrastructure to generate sustained economic and social benefits to Canadians.

My central point, however, is that today’s strong case for infrastructure spending is not further strengthened by the fact that we are experiencing a severe economic recession caused by the need for millions of Canadians to isolate away from their workplaces. Experience has shown that spending vast sums of public money on infrastructure both quickly and effectively is almost impossible. The current volume of government spending, and the implications for rising public debt suggest a greater need to make sure that only high-priority spending is pursued, rather than projects which are politically expedient. And there is good reason to think that the stimulus generated by major infrastructure spending will be far less than what occurs during a more conventional recession. The different source of this recession demands a different kind of policy response; conventional economic stimulus doesn’t fit the bill.

In 2016 the government launched a major infrastructure plan aimed at spending $180 billion over the following 12 years. It is easy to argue that there will be even more needs in the future and that this plan should be expanded. But the 2016 plan was not launched as a short-run economic stimulus plan, for good reason. Any expansion of this plan should equally take the long-term view.

It is natural for government ministers to seek the publicity that comes from announcing projects designed to provide fast relief to an economy that is suffering greatly. But the truth is that our real infrastructure needs are long-term ones, and to maximize their economic and social value they must be assessed and planned thoroughly and dispassionately, away from the daily ebb and flow of the political tides. Though it is more difficult for government ministers to be patient, plan carefully, and resist the lure of the quick win, the country would benefit enormously from such an approach.