A land built by economists?

Last week I took part in a workshop organised by the National Infrastructure Commission on the economics of infrastructure and growth. It was fascinating, and particularly for illuminating a dilemma for economists thinking about the newly-prominent issue of infrastructure investment. It’s a Good Thing – but how much is needed, and which investments? How should the NIC advise on the choices most likely to increase economic welfare and growth?

There is some well-understood machinery for answering such questions, in the form of appraisals (or post hoc evaluations) using cost-benefit analysis. The trouble is that although the technique, firmly embedded in policy advice, is useful for assessing relatively small changes, it is next to useless in the context of big investment projects that involve externalities such as environmental costs and benefits or network effects, might change people’s behaviour significantly, or might have non-linear impacts which accelerate beyond a point of critical mass. These are, of course, situations that might often arise with big infrastructure projects. And the challenge is all the greater because different kinds of infrastructure will affect each other (transport and communications networks will be complementary, natural capital and flood defence schemes will interact). To cap it all, there is an economic geography dimension to this, and infrastructure will affect the distribution of economic activity over space, which will also affect the distribution of economic opportunities and incomes.

So these questions are difficult, and nobody thinks economics can answer them. What was interesting about the discussion and subsequent emails was the emergence of a basic dilemma. One of the strengths of the conventional economic approach is the intellectual discipline it enforces. Cost benefit analysis looks at the direct benefits of a project to users, and converts them into a single unit of measurement, money (although it could be owls, or happy faces). It is a powerful brake on wishful thinking.

Economics also sets out the circumstances in which wider benefits might need taking into account: when there is good reason to believe that resources are misallocated so the investment might lead to a more efficient outcome (land use in the UK would be an example – the planning system enforces many inefficiences); when there is good reason to expect a project will bring about agglomeration externalities, the additional productivity arising from there being more people in one area because there is a deeper pool of labour and skills, and know how can spread more easily; when there is reason to be confident there will be non-marginal benefits that private investors will not capture; and when infrastructure can act as a mechanism to co-ordinate private investment decisions. The latter is interesting because it suggests the prospect of multiple equilibria depending on which place or project is selected as the focal point for co-ordination.

I would add another complication, which is the scope for small changes in transactions costs or frictions to bring about big changes in behaviour. In some contexts a time saving of 10 minutes will be marginal but in others it might tip a lot of people changing their commuting or house purchase patterns. A past example is the switch from dial up internet to broadband; many economists thought this would be a small change, but it turned out to be revolutionary. The behaviour change point makes post hoc evaluations tricky, because the behaviour is endogenous to the infrastructure choices.

Everybody in the workshop broadly agreed about the basic intellectual framework (well, we were almost all economists) but the dilemma is whether it is ever feasible or sensible to allow consideration of the wider benefits. The case against – and in favour of sticking to narrow, conventional cost benefit analysis – says stick to situations where there are clear signals from market prices. For example, is there a big difference in land prices indicating resource misallocation? Otherwise, there is a danger of the kind of mistakes that have always come with ‘picking winners’ in the past. The opposing case for being more open to trying to estimate wider benefits is to ask: what would the country look like if built by economists? It would be a dreary place of functional concrete boxes in a mesh of motorways. The Victorian infrastructure we still rely on would never have been built if subject first to a cost-benefit analysis. Britain used to be considered a world leader in infrastructure but then the use of cost-benefit analysis spread widely, and now we are clearly laggards.

I’m firmly in the camp that we should be looking to develop new techniques and data to inform a wider approach. The UK economy needs infrastructure investment that will make a big difference to productivity and growth, given the self-inflicted economic headwinds we face. We need faster growth in the great provincial cities, and significant investments that will make a step-change difference in the economic well-being of people around the country in terms of air quality, flooding etc. The NIC faces quite a challenge, but also a tremendous opportunity.

My favourite books about infrastructure are Brett Frischmann’s Infrastructure: The Social Value of Shared Resources; and my colleague Richard Agénor’s (more wide-ranging) Public Capital, Growth and Welfare. Ricardo Hausmann has written about the distributional impact of infrastructure (along with natural capital, the most significant capital people on low incomes have access to).

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Standards, interoperability and innnovation in infrastructure

A request via Michelle Brook on Twitter: what has been written about the relationship – in the context of large scale infrastructure – between standards/interoperability and innovation? A quick search via Google Scholar revealed a few papers, mainly about communications networks. Other than that, all I could think of was Pierre-Richard Agenor’s . Oh, and also business history case studies such as Bernard Carlson’s terrific biography, Jon Gernter’s , or maybe by Geroski and Markides. But if others have other suggestions, please do add them – or let Michelle, @MLBrook, know.

[amazon_image id=”0691155801″ link=”true” target=”_blank” size=”medium” ]Public Capital, Growth and Welfare: Analytical Foundations for Public Policy[/amazon_image]  [amazon_image id=”0691165610″ link=”true” target=”_blank” size=”medium” ]Tesla: Inventor of the Electrical Age[/amazon_image] [amazon_image id=”1594203288″ link=”true” target=”_blank” size=”medium” ]The Idea Factory: Bell Labs and the Great Age of American Innovation[/amazon_image]  [amazon_image id=”0787971545″ link=”true” target=”_blank” size=”medium” ]Fast Second: How Smart Companies Bypass Radical Innovation to Enter and Dominate New Markets (J-B US non-Franchise Leadership)[/amazon_image]

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Let cities borrow to build new infrastructure

The blurb introducing by Dag Detter and Stefan Folster begins: “We have spent the last three decades engaged in a pointless and irrelevant debate about the relative merits of privatization or nationalization.” Yup. And that futile framing of the issues could intensify now that Labour Party members have elected Jeremy Corbyn, a cheerleader for old-style nationalization, as their leader. Which is a shame, because this book makes a persuasive argument that it is not the ownership of assets that determines how well they perform, but instead how they are managed.

[amazon_image id=”1137519843″ link=”true” target=”_blank” size=”medium” ]The Public Wealth of Nations: How Management of Public Assets Can Boost or Bust Economic Growth[/amazon_image]

Specifically, the authors argue for the creation of sovereign wealth funds or holding corporations, with independent, non-partisan governance structures, to manage public assets. As Dag Detter used to run the Swedish government’s holding company, he has some direct experience of how such structures might operate and there is plenty of practical advice in the book. It focuses on publicly-held commercial assets, and argues for the state holding them (as opposed to privatizating them) but with independent management protected from short-term politics, and delivering a reasonable commercial return to the government. The role of politicians is to act as advocates for the public interest.

A short final chapter turns to infrastructure, and argues for state entities investing in infrastructure projects, but it does still presume that these should all be expected to deliver a commercial rate of return. So the book omits altogether the public good case for non-commercially viable state activity, which seems an odd – and large – gap.

It’s hard to argue with the general thrust of the argument for professionalising the management of sovereign wealth funds or state corporations, and shielding them from political short-termism; but the privatization/nationalization debate is not merely about commercial efficiency but also about the purpose of the entities involved and how they serve the broader public interest. The authors write: “Public wealth should aim to yield financial returns similar to comparable assets in the private sector.” Well, sometimes, perhaps even often, but not always – especially when the reason they are in the public sector is that there are not comparable market assets. Nor does the book tackle any political economy questions about how to move toward such a different kind of governance structure for public assets.

Lots of economists would like to see more infrastructure investment, with the real interest rate the government would have to pay to borrow the money so low. (Few think paying for it by ‘printing money’ or so-called ‘people’s QE’ makes any sense; if not financed by borrowing, then raise taxes.) However, it seems unlikely to happen unless either the Conservative government has a change of heart, and separates out capital spending from its deficit targets; or the borrowing and investment decisions for some infrastructure investment are devolved to the newly empowered city regions.

I can’t see any problem at all with experimenting on a modest scale with municipal bonds, and surely Manchester would leap at the chance to pilot this to go ahead with the upgrade of the trans-Pennine rail route, and much more. Clearly national politics has become a circus, but perhaps city politics will be relatively unaffected by the national Punch and Judy show. Let’s hope so. But the new political context means transparency, accountability and professionalism in investing in and managing public assets will be all the more vital. For all its narrow market efficiency pespective, the point the book makes about the sound management and independent governance of any new or existing public investments is an important one.

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