The government has released its revised National Development Plan for the period to 2016. The documentation includes a short leaflet, Investing for Growth and Jobs: Infrastructure Investment Priorities 2010 – 2016. With a bit of chutzpah, the document claims the 40 percent cut in capital spending as “stimulus” for the economy. The emphasis is on new priorities and not on the overall cuts. Fortunately, the Department of Finance has also released Infrastructure Investment Priorities 2010 – 2016: A Financial Framework, which makes a more sober case for the shift in strategy (see, in particular, Chapters 2 & 3). The arguments of Colm McCarthy for just-in-time infrastructure provision (based on the time value of money) and more broadly for cost-benefit analysis – as championed on this site and elsewhere by Edgar Morgenroth – would appear to have been influential in the overall approach. Of course, the precarious state of the public finances looms large behind the change in strategy.
One of the most common complaints about post-2000 fiscal policy is that it was pro-cyclical. This will continue with a vengeance in the down phase of the cycle. While infrastructure spending should not be used to fine-tune demand management, counter-cyclical considerations should be relevant in the context of large output gaps. There is some discussion of the direct employment consequences of different types of capital spending in the DoF document. But on the whole the demand-side implications of the timing of capital spending is absent from the analytical framework. With apologies for stating the obvious, counter-cyclical fiscal policy is about more than just about taking the heat out of an over-stimulated economy.
The document emphasises the large fall in tender prices, down an estimated 30 percent. However, the demand curve for public capital is presumably downward sloping. All else equal, we should want more roads, hospitals, schools, etc., if the relative cost of that capital is lower. To be concrete, suppose the elasticity of the demand for public capital is -1. Moreover, assume that the relevant price is the price of public capital deflated by the GDP deflator. Then decreases in the relative price of public capital should lead to constant real expenditure on public capital. There should be increases in public capital output when that capital becomes cheaper relative to other prices in the economy. Of course, all else is not equal. But a more complete analysis would have dealt more robustly with the reasons for sustaining capital spending as well as the reasons for cutting.
The economic case for cutting capital spending in a recession is shakier than the government would have us believe.