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Governments must restore the capacity to allow them to run large infrastructure projects effectively

Summary:
One of the major complaints that Milton Friedman and his ilk made about the use of discretionary fiscal policy was that time lags made it ineffective and even dangerously inflationary. By the time the policy makers have worked out there is a problem and ground out the policy intervention, the problem has passed and the intervention then becomes unpredictable in consequence (and unnecessary anyway). The Financial Times article (March 29, 2021) – To compare the EU and US pandemic packages misses the point – written by Ireland’s finance minister reminded me of the Friedman debate in the 1960s. Apart from the fact that the article is highly misleading (aka spreading falsehoods), it actually exposes a major problem with the way the European Commission operates. If Friedman’s claim ever had any

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One of the major complaints that Milton Friedman and his ilk made about the use of discretionary fiscal policy was that time lags made it ineffective and even dangerously inflationary. By the time the policy makers have worked out there is a problem and ground out the policy intervention, the problem has passed and the intervention then becomes unpredictable in consequence (and unnecessary anyway). The Financial Times article (March 29, 2021) – To compare the EU and US pandemic packages misses the point – written by Ireland’s finance minister reminded me of the Friedman debate in the 1960s. Apart from the fact that the article is highly misleading (aka spreading falsehoods), it actually exposes a major problem with the way the European Commission operates. If Friedman’s claim ever had any credibility, then, they would fairly accurately describe how the European Union deals with economic crises. Always too little, too late … and never particularly targetted at the problem. The debate remains relevant though as governments move away a strict reliance on monetary policy and realise that fiscal policy interventions are the only way forward. Most governments around the world are talking big on public infrastructure projects. However, the design of such interventions must be carefully considered because they can easily be dysfunctional. Further, thinking these projects are a replacement for short-term cash injections is also not advised. I consider these issues in this blog post.

On the FT article – it is just typical Europhile spin. Even at the depths of gloom, the officials are out there telling the world what a success the monetary union has been.

Their spin reminds me of this – Life of Brian – segment, where the EC is the Black Knight:

The point is that the European Union stimulus is yet to be fully implemented some 16 months after the crisis began. The bickering between Member States and the underlying resistance to allowing fiscal deficits to expand to the levels required has meant that when the spending finally flows, it will be too little and too late.

Needless suffering will be the legacy.

I cannot understand how any progressive thinker can continue to support this dysfunctional mess that is leaving millions of people unnecessarily in dire circumstances.

Big infrastructure spending plans

The new US President is trying to get a $US2 trillion infrastructure package – The American Jobs Plan – through the Congress at the moment.

It recognises that “The United States of America is the wealthiest country in the world, yet we rank 13th when it comes to the overall quality of our infrastructure.”

The consequences of that neglect are clear – “roads, bridges, and water systems are crumbling. Our electric grid is vulnerable to catastrophic outages. Too many lack access to affordable, high-speed Internet and to quality housing.”

The Plan aims to do typical large-scale infrastructure things:

– Roads, bridges, ports, airports, transport

– Fix water utilities, renew electricity grids, develop high-speed broadband

– Addressing housing shortages and quality, school rehab, child care expansion etc.

And more.

I haven’t yet done the analysis to see whether this plan would require offsetting tax hikes or other spending diversions to avoid hitting an inflationary ceiling.

At first, I am thinking about whether it addresses the variety of problems that the US faces in a temporal sense.

Which is why I have been thinking about policy design and lags.

There is also a debate going on in Australia about similar infrastructure issues after years of fiscal-surplus-obsessed neglect of public investment.

The UK Guardian article (April 1, 2021) – Public investment in infrastructure would be a much needed boon to the Australian economy – by Greg Jericho, shows that most of the jobs growth in Australia over the last year has been in public administration (particularly dealing with the pandemic), which shows how false the claim by conservatives that governments don’t create employment is.

He argues that there is a crying need for new projects covering “road, rail, bridges, telecommunication and sewerage” in Australia:

… while private investment remains down, the public sector needs to fill the hole …

He ties the need for public infrastructure spending to the need for a short-term boost to work.

Once again this gets us thinking about lags and whether public infrastructure projects are the best way to deal with a sudden collapse in employment.

Friedman on fiscal policy

On May 2, 2000, John B. Taylor from Stanford University conducted an – Interview with Milton Friedman – which was subsequently published in the journal, Macroeconomic Dynamics Vol. 5, No. 1, pp. 101-131.

As an aside, he tells Taylor about his younger days and said:

I probably would have described myself as a socialist …

He apparently wrote an essay at the end of university which he stored away which described these views. Later in life, he tried to find it but couldn’t.

He said:

I’m pretty sure I did not have the views I later developed.

But the purpose of citing that Interview here is that Friedman was asked to reflect on his “two early articles on stabilization policy, the first one is on fiscal policy rules … and the second one focussed more on money growth rules …”

His first article (1948) outlined what was almost the orthodoxy at the time and is still professed by progressives who do not understand macroeconomics.

He said:

Rules for taxes and spending that would give budget balance on average but have deficits and surpluses over the cycle could automatically impart the right movement to the quantity of money.

By the time he wrote the second article (1968), he had shifted his position:

… you really didn’t need to worry too much about what was happening on the fiscal end, that you should concentrate on just keeping the money supply rising at a constant rate.

He claimed he now knew that “the link from fiscal policy to the economy was of no use.”

Taylor asked him to comment on the debate between Keynesians and the emerging Monetarists and he replied:

It’s over, everybody agrees fundamentally.

The academy shifted sharply in the late 1960s towards Friedman’s view.

The debate over ‘rules versus discretion’, which meant, on the one hand, that monetary policy rules were more reliable than relying on the discretion of the policy maker.

Friedman and Co. pointed to the so-called lags in policy that rendered interventions ineffective or dangerous.

They identified an overarching implementation lag – something bad happens but it takes time to recognise the issue and then administrative constraints delay the intervention.

By the time, the initiative, say an increase in government spending, is flowing, the issue has been resolved by the ‘market’ (private spending recovers) and the extra public spending becomes pro-cyclical and inflationary.

This lag is made up of two lags:

1. Recognition lag – detecting the problem.

2. Response lag – actually doing something about the problem.

So Friedman believed it was much better to have automatic rules that were beyond the daily discretion of policy makers that would sustain stable prices.

Of course, as soon as central banks started applying his fixed money supply growth rules (Bank of England first in the early 1970s) they found that they were actually not able to control the money supply as the mainstream textbooks claimed (and still do)

Lags in Infrastructure projects

In October 2020, the IMF published its – Fiscal Monitor – and – Chapter 2 Public Investment for the Recovery – contains some relevant analysis.

It notes that the immediate challenge of the pandemic was to “address the health emergency and provide lifelines for vulnerable households and businesses.”

That is, speedy and targetted cash injections were required.

But government should not abandon its responsibility, just because it has outlaid such amounts on temporary cash support, on facilitating:

… transformation to a post-pandemic economy that, with the right policies, can be more resilient, more inclusive, and greener.

In other words, fiscal policy design has to have temporal considerations – some tools are good for short-run, emergency stimulus, while other tools are better for achieving longer-term objectives.

Trying to mix these temporal characteristics runs the danger of falling into Friedman trap.

The IMF narratives about now is the time to engage in large-scale infrastructure spending by governments because interest rates are low is to be ignored.

These large-scale projects should be undertaken if there is a functional need identified which will deliver socio-economic benefits over a long period of time and transform economies towards the green future.

The idea that they are ‘cheaper’ for government when interest rates are low misconstrues what the ‘cost’ of the project actually is. It is the real resources that are used to complete the project, including those diverted and not available for other uses, that has to be considered.

The financial outlays are largely irrelevant.

The IMF is obsessed about “worsening debt dynamics” etc and “sovereign spreads” – which just goes to show they haven’t really made a transition across the line yet.

What they do get right though is recognising that:

With ample underused resources, public investment can also have a more powerful impact than in normal times.

The IMF try the ‘crowding out’ story which is another one of those myths.

But, clearly, as an economy approaches full capacity, the impact of increased spending on real output will decline and price adjustments will become the norm.

That is the constraint that has to be taken into account.

The Fiscal Monitor Chapter contains an interesting graphic – Figure 2.5 Duration of Infrastructure Projects – which I repeat here:

Governments must restore the capacity to allow them to run large infrastructure projects effectively

Why is that important?

It is important because it tells us:

1. These projects have long gestation periods.

2. They require government departments be forward thinking rather than reactive.

3. Years of eschewing ‘planning’, outsourcing out critical public functions to consultants, and privatisations, has undermined the capacity of governments to implement these type of projects in an effective manner.

4. A progressive agenda has to be to restore those capacities to the public sector as a matter of urgency.

The IMF note that:

… governments often hope to rely on “shovel-ready” projects that can be kick-started within a few months. Yet countries may find they have few such projects and thus may not be able to increase public investment in time to fight the current recession

And the reason for that is that under neoliberalism the capacity to plan and implement complex public policy interventions has been hollowed out by the move to convert public policy departments delivering services and infrastructure development into contract brokerage and management agencies.

The myopia of neoliberalism again on show.

The IMF lists four steps that:

… should be taken immediately: (1) focus on maintenance of existing infrastructure, (2) review and reprioritize active projects, (3) create and maintain a pipeline of projects that can be delivered within a couple of years, and (4) start planning for the new development priorities stemming from the crisis.

It is a bit rich of the IMF to now be telling governments this when they have been leading the charge in destroying these capacities in governments over the last several decades, particularly in less advanced nations.

There is a need for “smaller, shorter-duration projects” like maintenance, which can “be deployed quickly and has major economic benefits”.

Once again, it is a bit rich of the IMF to now admit that government spending can have “major economic benefits” after decades of demanding austerity and a run-down of capital spending by governments.

But, better late than never.

The crucial need for governments now and into the future is to restore their planning capacity – to take longer term positions so they can create a “pipeline of projects”.

The IMF say:

Governments should prepare a pipeline of carefully appraised projects that can be selected …

They talk about a 24 months time horizon, whereas I would be talking about a 20-year time outlook or longer.

It is clear that nations require long-lived public infrastructure – which means capacity which endures for decades rather than a few years.

Government planning can define this need, design appropriate scaled modules which sum to an entire nation-wide project and then accelerate or decelerate the spending and project implementation according to the state of the cycle.

That is the art of policy planning. To have projects that are conceived, designed, all the planning permits sorted out etc, which are then ‘shovel ready’ for relatively quick operationalisation.

Only then can we avoid the time lags that render these projects less suitable for rapid, counter-cyclical response.

While the infrastructure projects can be rendered jobs rich, they should not be relied on to create substantial employment in a time of crisis.

This also depends on the nature of the nation. When I was working in South Africa on the Expanded Public Works Program, I supported large-scale, labour intensive road building projects that would use ‘old’ technology because it was the best way to maximise employment per km of tar laid.

Engineers who had studied this assured me that the quality of the tarmac was not determined by whether a capital-intensive or labour-intensive approach was deployed.

In other nations, where the need for job creation might be less, the projects can use best-practice technology, which will create less jobs.

There are many short-term projects that can be implemented quickly that can provide large numbers of jobs if needed in a sharp downturn.

Conclusion

The point is that Friedman’s observations about time lags was overstated when governments maintained internal planning capacity and took a forward-looking approach to nation-building.

As neoliberalism took its ugly grip on governments and destroyed a lot of that capacity, then it was valid to think about policy lags. Simply because the capacity to avoid them was decimated.

That doesn’t mean Friedman’s claims that discretionary fiscal policy should be avoided.

It just means we have to ‘Reclaim the State’ and reinstate the capacity that is necessary to make fiscal policy interventions work in an effective manner.

That is enough for today!

(c) Copyright 2021 William Mitchell. All Rights Reserved.

Bill Mitchell
Bill Mitchell is a Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at the University of Newcastle, NSW, Australia. He is also a professional musician and plays guitar with the Melbourne Reggae-Dub band – Pressure Drop. The band was popular around the live music scene in Melbourne in the late 1970s and early 1980s. The band reformed in late 2010.

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