Hoped-for boom in public investment risks paving road to nowhere

On the northern Japanese island of Hokkaido, the motorway from Honbetsu to Ashoro is engineered to the highest standards: stretches of dual carriageway for overtaking, a hard shoulder, and no minor intersections. What it lacks is vehicles.

Intended as the first stage of a highway reaching almost to the Sea of Okhotsk, the 13.2km stretch is used by about 1,300 vehicles a day, similar to a main road in Scotland’s remote Outer Hebrides.

The motorway marks the apex of Japan’s massive programme of public works in the 1990s and early 2000s — and as pressure mounts on other countries around the world to embark on major spending drives to combat the economic impact of coronavirus, it also offers a lesson in what can go wrong.

Last month the IMF urged advanced economies to spend big and quick on simple capital projects to boost demand and jobs, and then plan longer-term digital and green technology infrastructure to increase the future scope for growth. And governments should worry less about rising public debt, it said; higher growth would make it more sustainable.

It appears the message is being heard: US president-elect Joe Biden has pledged to “build, back, better” and the EU has promised “the largest stimulus package ever” with its planned €1.8tn budget and recovery fund.

But the lesson they should draw from Japan’s public spending is nuanced.

In the decade after the bursting of its financial bubble in 1990, Japan wrestled with sluggish demand and declining interest rates and fought back with public works.

Those projects left a legacy of concrete and easily-financed public debt — but they revived neither growth nor inflation.

“People thought there was a temporary fall in demand because of the bursting of the bubble and through economic stimulus they’d be able to get back to 5 per cent growth,” said Toshihiro Ihori, a professor at the National Graduate Institute for Policy Studies in Tokyo, and an expert on Japanese fiscal policy.

“There were short-term results but it didn’t produce a lasting revival.”

Veterans of the era point to a number of reasons for the failure. The spending packages were intermittent and seldom matched their headline size. Pork-barrel politics sent cash to the least productive projects in rural areas. Meanwhile the bad debt crisis in Japan’s banks festered, and the underlying pace of population and productivity growth continued to slow.

The question for any country now tempted to launch its own spending campaign is whether Japan made errors that can be learned from, or whether efforts at fiscal stimulus in a democratic system inevitably get channelled into less productive uses.

The broad academic consensus is that spending did stimulate the economy, said Prof Ihori. “Most of the applied work finds that the multiplier was a bit greater than one,” he said. The fiscal multiplier measures how much a unit of fiscal stimulus increases output. “With public works the multiplier is one almost by definition.”

But it did not spur a notable recovery in the private economy. Consumption rose a little but private investment went down and politicians periodically became alarmed about the budget deficit.

Meanwhile the efficiency of Japan’s public works packages declined — some of the new infrastructure was sparsely used and struggled to pay for itself with user charges, leading to complaints about “bridges to nowhere” and gratuitous concreting of the countryside.

Some of the money that went into construction may have been better spent on education or support for families, which might have relieved Japan’s declining birth rate.

What is important, said Randall Kroszner, former Federal Reserve governor and now deputy dean of the University of Chicago’s business school, is “getting the most bang for your buck” in terms of raising productivity. It is a mistake to assume that building infrastructure will ensure future growth, he said: “Japan illustrates that doesn’t work.”

On the face of it the EU, which has its own bridges and airports to nowhere, has heeded the lesson. It wants member states to use its new €750bn recovery fund to promote energy efficiency, low-carbon technologies and digital skills.

Infrastructure needs vary widely across the bloc; Germany and Italy, which ran tight budgets for a decade, need to invest in transport and broadband connections. By contrast Spain, the European economy hardest hit by the pandemic, has among the best high-speed rail, broadband and road networks on the continent.

But, said Alicia García Herrero, economist at Natixis and senior fellow at think-tank Bruegel, spending to raise productivity requires long-term planning which runs counter to the need for speed. She feared that European governments would turn to infrastructure investment because it is what they know well after decades of EU cohesion programmes.

Instead, governments should focus on supporting incomes and small businesses, she said: “This is a demand shock. No bridges are being destroyed. This is not a war. You don’t need to build more.”

The main lesson from Japan’s public works drive is that, eventually, Japan abandoned it.

But the lure of grand projects continued to be almost irresistible to politicians. In recent years under then-prime minister Shinzo Abe public works made a comeback, including the $85bn plan to build a maglev train from Tokyo to Osaka.

Across Europe and the US, this history shows how difficult it is for politics to stay focused on government investment that has the best return — rather than concrete, which is rapidly visible to the electorate. 

Source: Economy - ft.com