Debt for infrastructure – and the issue is?
Posted August 6, 2008
on:There has been a lot of talk (here, here, here, here, here, and here) about the a potential National government taking on debt for infrastructural investment. Now I’ve got no problem with this, and Roger J Kerr says here we could view it as an intergenerational issue – borrowing allows us the stagger the cost of the capital over time in the same way that the benefits from the capital investment occur over time.
Furthermore, borrowing allows us to fund expenditure that provides economic growth, without having to introduce taxes that limit this growth (although note that future taxes would have to be higher to pay for the borrowing – so we only have a net benefit if growth stemming from the capital investment exceeds the cost of the eventual tax increase!).
However, there are a couple of issue that I hope any government will remember before going into debt to build up infrastructure.
- Only the “right sort” of investment will be beneficial. Fundamentally, the rate of return must be high enough to justify the debt AND the government must be aware of how their investment activity will crowd out private investment.
- Ultimately the tax system still has to be balanced over the economic cycle.
Right sort of investment?
One of the difficulties with government investment is that they don’t see the price signals associated with the optimal level of investment, in the same way that private firms do. As a result, government’s have the propensity to over or under invest, depending on the often fluffy goals that they lay down.
However, the advantage of government investment stems from their ability to improve outcomes when we have a “public good“. As private firms will underinvest in the case of public goods, then the degree of “crowding out” associated with government action is lower (it solely relies on the impact that government involvement has on the price of building inputs). So as long as the rate of return on this investment is high enough to pay for the debt, this is fine.
Balanced tax system?
A balanced tax system is a set of taxes where the government runs a balanced budget over each individual “economic cycle”. This does not mean that the government will always run a balanced budget – in fact, when output is above trend the government should run a surplus, and when it is below trend it should run a deficit. In this (demand driven) view of the economic cycle a surplus or deficit are not an issue – as long as it all balances in the end.
This implies that the government in power needs to realise that there is no free lunch – the debt will need to be paid off in the future. If we are truly borrowing for infrastructure that is fine (given that our first requirement holds), however if we will have to, on average, borrow because spending exceeds taxes, then something has to give!
Another way of viewing a balanced budget is through the lens of supply side shocks. In this case there is no real economic cycle, just a random assortment of supply shocks that give the appearance of a cycle. Here, the positive supply side shocks cause surpluses while the negative ones cause deficits and the tax system does need to adjust to put things back in order. However, from the current standpoint, we do not know whether there will be positive or negative supply shocks in the future, so the best thing to have is a balanced budget.
In truth it is a mix of the demand and supply stories that describes reality – implying that the tax system should remain stable over time, until a sufficiently number of supply shocks force us to move. In a sense this is what Dr Cullen did (although he was effectively increasing taxes by not indexing the them to inflation – thereby breaking this rule!), given the level of expenditure that he wanted to put into place.
As long as National takes this lesson to heart as well then I am sure that no matter which party wins the election, the government finances will remain in good order.
13 Responses to "Debt for infrastructure – and the issue is?"
My only caution on balanced budgets over the cycle: careful that you don’t word the rules such that budgets need only be balanced on average over the medium term. We know where that leads.
I agree with BH about it being nice if we could get some higher quality debt offerings in NZ. Something which pays a slight premium above government stock, is very liquid, and that has a very long duration. It would really help with retirement planning.
Although I agree with you Matt, I would be tempted to describe some sectors of the NZ debt market as suffering from large amounts of market failure (brought about by information asymmetry). Better informed investors would have gone nowhere near a lot of finance companies at the rates being offered. So “crowding out” investment from finance companies and into council debt probably would be welfare enhancing for the average investor.
I believe the stigma of public borrowing may be too high in NZ at the moment, and positive net present value projects never get off the ground. So i would cautiously endorse moves to encourage greater use of borrowing for infrastructure.
“I am sure that no matter which party wins the election, the government finances will remain in good order.”
In the sense of compared to the rest of the world, or compared to 15 years ago, the government finances are in good order. But the 2008 budget is projecting cash deficits that lead to a steady increase in net debt (a more relevant metric than gross debt) as a % of GDP, even with the economy back at a steady-state growth rate. So something has to give: higher taxes, less spending growth, or less investment/Cullen fund. It seems unlikely that National’s policies will improve this situation.
Practice has a logic which is not that of the logician.PierreBourdieuPierre Bourdieu, French sociologist
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1 | Bernard Hickey
August 6, 2008 at 9:54 am
I think a big issue in the infrastructure debate is the funding mechanism. I would love to see easily accessible and quality infrastructure bonds or sem-government debt that Mums and Dads could invest in …. instead of some of the riskier options chosen over the last 5 years that invested in residential property.
I think there’s a case for a single local government bond issuance vehicle to fund this NZ$30 bln of local infrastructure needed over the next decade.