Public investments boost economy more than private ones

A new round of research in the last decade confirmed the large impact of
public investment on productivity growth. At the same time, the
contribution of private investment to productivity growth seems to be
fading. The surest route to returning to the productivity growth we
enjoyed in the 60 era and again in the 2000s requires a substantial
increase in public investments.
Investments in public capital have significant positive impacts on privatesector productivity, with estimated rates of return ranging from 15 percent
to upwards of 45 percent. Our estimate is 30 percent, which coincidentally
is roughly equivalent to the rate of return on investment in information
and communications technology.
A significant increase in public investment spending would boost jobs in
the short run and pay enormous dividends in more rapid productivity
growth in coming decades. In contrast, the payoff to spending cuts would
be depressed job growth in the next few years and foregone productivity
gains in the longer run.
In the short run, while the economy continues to operate well below
potential, the public investment should be debt-financed to maximize job
creation. In the long run, as the economy returns to potential, the proper
financing for these projects will depend on the economic circumstances
prevailing at the time. If the returns to public investment are large
enough, then they can unambiguously improve the welfare of both
present and future generations even if they are debt-financed. What is
even more important over the long term than how they are financed,
however, is that they get done.
Policy debates today are dominated by claims that the budget deficit
needs to be substantially reduced. The decrease of economic growth in
these last years has been so slow and difficult, is shown to public debt and
performing loans that are in the worst position of historic values in the last
two decades.

Given the fact that economy is operating far below potential, and is likely
to do so for years to come absent aggressive policy measures to boost it,
such rapid fiscal contraction is extremely unwise.
But, the big concern for the budget it is the lack of money, because of old
debts problem and also because of not good performance of revenues
collection.
In fact the latest experience of budgetary concerns shows that more is the
situation like this, more the countries think to solve the obstacles of
funding with the overt money financing instrument.
Overt money financing seems to be more effective because it does not
leave the budget struggling with the question of what to do about future
public debt burdens, nor create the danger that the anticipation of those
future debt burdens will induce a Ricardian equivalent offset to nominal
demand stimulus today.
The introduction of this extraordinary instrument need to be part of broad
debate between financial institutions, Bank of Albania and Ministry of
Finance. All the process should be analyse the pros and cons of the better
policies to solve the problem of lacking public funds for investments and
social bills, and also to see whats next for the public debt.

But, lets see what about the investment issues.

Further, if public investment is a casualty of this rush to cut spending, as it

almost surely will be, then this policy trajectory is even more perverse.
Consider the standard economic rationale that justifies reduction of
budget deficits. When an economy is operating at or near potential,
reducing budget deficits should lead to downward pressure on interest
rates, as the public sector is no longer competing with the private sector
for loanable funds. Lower interest rates should then allow private firms to

undertake more investment in plants and equipment, and this subsequent

capital deepening should boost productivity.

Too often, discussions of investment, capital stocks, and productivity

assume that private-sector decisions are the dominant force behind the
movement of these variables. Note first the overwhelmingly large
importance of education, a sector funded significantly by the public sector.
Note also that public capital accounts for more than a third of all
nonresidential structures and equipment capital. In short, the wealth of
the nation (i.e., the human and physical capital that can be mobilized to
produce

goods

and

services)

is

crucially

dependent

upon

public

investments and public capital.

Allowing these public capital stocks to wither so that funds can be
available for private capital formation would be a calamitous assault on
productive capacity, productivity, and competitiveness.
It is sometimes argued that even if increased public investment can
increase an economys growth performance, the necessary financing of
the investment may introduce economic distortions that reduce growth. If
so, it matters not just how much public investment is undertaken but also
how it is financed.

The concern is that, if these investments are financed with increased debt
or higher taxes, the efficiency losses induced by the crowding-out of
private-sector investment, or by higher tax rates, may produce a net loss
to economic growth. But there is little cause for this concern, for several
reasons.

A big program of public investment can achieve a big push itself or can
stimulate numerous further private investments that together constitute a

big push. On the other hand, there are reasons to expect the opposite, a
lower impact of the booms than the average. One is a perverse selection
effect.
The on-the-shelf government investment projects that are pulled off-theshelf once a major increase in spending is announced may be precisely
those that were previously rejected on grounds of low impact. Hence a
surge may select relatively-poor public investments. Rejected projects are
likely to have the advantage of having already passed the feasibility stage
of analysis and can thus be implemented quickly. More important, they are
likely

to

still

have

constituencies

that

favored

them

within

the

bureaucracy.
The second reason for lower-than average impact of booms is that booms
can change the behavior of governments. A government that rationally
analyzes investments when the money is tight has less incentive to do so
when money is loose. Special interest group pressure can be more
influential as other constraints become less binding, such as the budget. A
third reason to expect that the impact of changes is different is
diminishing returns to additional capital. Additional roads added to a basic
road network may have less impact that the initial roads that opened up
access to major regions of the country.
The general idea is that if a critical mass of small investments is
undertaken simultaneously the average social return will be much higher
than the average private return, because they will create demand for each
other, and overcome coordination failures that keep private market
economies in a low-income equilibrium.
November 2016,
Tirana, ALBANIA
Eduart GJOKUTAJ