Next week the Chancellor will deliver a much-anticipated budget. With calls for tax cuts, tax rises and regulatory reform, the line between politics and economics will be a difficult one to tread. However, many commentators and politicians seem to be in agreement on one thing: that ‘infrastructure investment’ would be a boost to the economy, reinvigorating the construction sector and adding to the nation's productivity. Hence we have projects such as HS2 and £6 billion announced in the last year’s autumn statement for roads and other rail projects. These measures are supposed to create jobs in the short- and the long-term whilst bringing the country's transport infrastructure into the 21st century. In the US, too, President Obama has been keen to point to ‘shovel ready jobs’ available through government infrastructure spending.
We should all be worried when politicians start spouting platitudes about the highly unrealistic benefits of these projects. The great myth of the success Roosevelt’s New Deal no doubt lingers in the minds of policy makers. But the truth about government infrastructure is wildly different from the conventional wisdom.
It is a fallacy to believe that the government can allocate resources effectively to meet future economic needs, instead of entrepreneurs. What advocates of state infrastructure spending fail to grasp is that government cannot suddenly acquire the knowledge as to which parts of the UK’s infrastructure either needs repair, replacement or, indeed, which new projects should be undertaken. The economy is dynamic and never static. The government cannot predict what it will look like in 30 years time, whether there will be an increase of manufacturing jobs in the northeast or high tech in the midlands. This is simply not possible to anticipate into the next twenty or thirty years.
The argument commonly made for infrastructure spending is that it will have a kind of Keynesian multiplier effect. Private construction firms will be employed, idle resources will be put to use and money will start to circulate through the economy as people spend their newly earned wages. But this, again, is untrue. Government infrastructure drains the economy of resources and, even in the short term, stops resources from being used elsewhere. These decisions are difficult even for the private sector, which relies on price signals. Sometimes the private sector fails, sometimes it succeeds, but because it is the investor's money that is on the line it has a reason to act rationally. Government lacks the information to act wisely, and the incentives to act prudently.
In Japan, large government infrastructure projects have failed to lift the country out if its low growth high debt slump. In the UK, many cities have built tramlines, which have almost universally turned out to be loss makers and failed to promote growth.
Entrepreneurs, not state bureaucrats, will be best to judge whether a particular project is worth the risk. The history of white elephant infrastructure projects is one that seems to repeat itself with each new administration. Let us hope that the politicians fail to match their rhetoric with our money.