In theory, investment in infrastructure has tremendous potential to promote recovery. Improved transport links can reduce journey times and deliver significant productivity gains. Businesses can pass on their savings to customers in the form of lower prices, which in turn boost demand for their products and services. Transport investment can also increase productivity by lowering the costs of trade, which in turn promotes competition and specialisation, as well as facilitating greater economies of scale.
Energy investment can be similarly beneficial. Lower energy bills reduce business costs and increase productivity by enabling greater use of labour-saving technology. The released labour can then be put to other productive uses.
The policy of increasing infrastructure spending during a slowdown is therefore very appealing; however, there is one major problem: politics.
Politicians and senior government officials have very poor incentives to invest efficiently. Instead, they are likely to allocate resources in order to boost their own positions. Politicians may seek to satisfy special interest groups and increase their chances of re-election; senior officials may seek to enhance their power and status by consolidating their department’s influence over policy. In addition, ideological considerations – such as a focus on ‘fairness’ or the environment – may trump economics when it comes to investment decisions.
Read the rest of the article in the PPP Journal.