While interest rates remain low, should governments borrow to fund infrastructure?

Tony Makin

Professor Tony Makin

By Tony Makin, Professor of Economics, and Director, APEC Study Centre, Griffith Business School

While murmurs from market hawks grow louder that the Reserve Bank of Australia should raise the cash rate from its historic lows, an overwhelming majority of ESA panellists agree governments should be spending more on infrastructure funded by additional borrowing.

On the weighted response measure, 75 per cent strongly agreed or agreed, whereas only 16 per cent strongly disagreed or disagreed, with the remaining 9 per cent unsure.  The question elicited an interesting set of insightful comments.

Infrastructure includes the provision of electricity, telecommunications, water, roads, highways, railways, ports and airports and has both microeconomic and macroeconomic implications.  At the micro level, it can improve household welfare by, for instance, reducing time wasted commuting, improving telecommunications connectivity, as well as lifting multifactor productivity at the firm and industry levels.  

At the macro level, it adds to aggregate demand, while simultaneously augmenting the capital stock, which can increase economy-wide productivity and potential output per capita as the population grows.  In that regard, Australia’s relatively high immigration rate was cited as a justification for infrastructure expansion (Dollery and Page).

Most of the panellists’ comments were micro-oriented.  A common theme across the response spectrum was that extra infrastructure had to be quality investment (Piggott, Abelson, Bloch, Butlin, Carmignani, Corden, Dungi, Eslake, Freebairn, Kingston, Menezes, McTaggart, Davis, Toth, Ong, Roy and Gangadharan), with satisfactory cost-benefit ratios frequently proposed as the best means of gauging this.  That would conceivably result in “good debt” rather than “bad debt”.

Some panel members implied scope existed for private sector involvement to minimise the cost to government (Kingston, McTaggart, Sibly and Toth) which would reduce public debt growth.

It was also suggested that different budgetary circumstances and practices across tiers of government should be taken into account (Booth and Silver).  In that regard, it is worth adding that the States generally have much stronger balances sheets (asset values well above public debt, yielding positive net worth) than the federal government, whose net worth is around minus 16 per cent of GDP,  meaning the federal government has considerable work to do to reduce its “bad debt” (Makin and Pearce 2016).

State governments, traditionally the major providers of infrastructure, are therefore better placed (some more than others) to expand infrastructure than the federal government, whose credit rating remains precarious.

Macro-oriented comments (Corden, Webster, Dulleck and Morley) raised the business cycle implications of increased infrastructure, although views differed about timing and impact.  In this context, the international macroeconomic consequences of expanding infrastructure should also be considered.  

Standard theory says more government spending, mostly on non-tradables, puts upward pressure on the nominal and real exchange rates in the absence of accommodating monetary policy.  Other things equal, that worsens Australia’s competitiveness (Makin and Ratnasiri 2015), crowding out net exports.  Whether positive supply side effects from productive infrastructure offset this net export crowding out is an empirical question.

Infrastructure should also generate an economic and societal return above prospective foreign interest rates since increased spending adds to external borrowing and level of foreign public debt.  The cost of servicing federal foreign public debt is currently an $11 billion per annum (and rising) drain on national income, exceeding federal outlays on either unemployment benefits or higher education, and is a multiple of Australia’s foreign aid.  

Although Australia’s interest rates are currently low, they will inevitably rise as the United States Federal Reserve and other central banks tighten monetary policies.

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