It's the Marignal Cost, stupid!

Largely forgotten in the Great Stimulus Debate (latest broadsides here and here) has been the question of public goods creation. Or rather, the academic economists have forgotten it, immersing themselves in historical arguments about the Depression and highly technical quibbles about the "multiplier effects" of tax cuts vs. highway spending. The mainstream media, in contrast, has not forgotten the existence of public goods. The plain fact of it is that tax cuts basically leave the government with long-term liabilities (debt) only, while public goods spending at least can leave us with both long-term liabilities and long-term assets. Jia Lynn Yang makes this point when comparing Obama's stimulus proposal with Japan's dubious stimulus efforts in the 90s:

Conservative critics like the Wall Street Journal's editorial board have been using Japan's experience as evidence to be wary of stimulus packages altogether...However, as in any reading of history, the closer you look the more nuanced the lessons. For many, the moral of the story isn't that Japan erred in deciding to use fiscal policy to fix their economy -- its failure was in the execution...

For one thing, there was dubious logic behind too many of Japan's infrastructure projects. "It was the epitome of bridges to nowhere," says economist Ed Lincoln, director of the Center for Japan-U.S. Business and Economic Studies at New York University. "There was apparently a $2 billion bridge built to an island of 800 people."

And even before the financial crisis hit, Japan was wasting money on pork-barrel projects, so by the time the Japanese ramped up spending in the 1990s, they had run out of worthy projects to fund. The United States, by comparison, has a long list of needy spots. (Witness the Minneapolis bridge collapse in 2007.)

Lincoln adds that at its peak in the 1990s, the government was spending 8% of GDP on public works projects. By comparison, the United States now spends about 3% - even several hundred billion dollars in proposed projects would not get the United States to Japan's peak.

In other words, if you already have a ton of well-working infrastructure, then infrastructure investments are money down the drain. But if your country actually needs more infrastructure, the spending is not wasted. It's all about marginal cost vs. marginal benefit.

When they compare highway spending to tax cuts, economists like Greg Mankiw are implicitly assuming that the marginal benefit of new infrastructure is zero.

Maybe in 1990s Japan, it was. But the other extreme example is late 1990s China. Buffeted by the Asian financial crisis, China hit the skids, with the private sector dropping from 12% growth straight into recession. But China's goverment jumped into the breach, building the highways and ports and airports that the country then lacked, targeting the worst bottlenecks (i.e. where marginal benefit is highest). And whaddya know - after the crisis was over, that efficient new infrastructure allowed China to keep growing at double digits, while countries like India that still suffered from massive infrastructure bottlenecks struggled to bost their own manufacturing. In other words, China's stimulus worked BIG.

As Yang points out, the U.S. is somewhere between the Japan and China extremes - we already have lots of highways and ports and airports and bridges. But many of these are in need of repair. And we desperately need a national power grid and more rail transit. These are areas where the marginal benefit of public goods probably - there's no way to know for certain - far exceeds their marginal cost. That means that stimulus spending on those projects will not just offset today's recession, but will boost long-term growth.

Whether you care about the cycle or the trend, that's a damn good deal.

PS - This means that replacing rail investments with tax cuts is very bad. Stop caving, Obama!

Update: Caving never works, Obama.