Good news: Public investment is remarkably effective
Government investment is frequently derided as wasteful and ineffective. And definitely worse than private investment. But is this true? A new study shows that public investments on average are a remarkably effective way to boost the economy.
The authors of the study collected macro data for 18 developed economies between 1965 and 2019 and estimated the impact of an increase in public or private investment.
Let’s start with the private side because here the picture is unequivocally positive. After 20 years, every additional dollar, pound, euro, etc. invested by private companies increases the GDP by about 2 dollars. In the US, the exact ratio is 1.99 dollars for every dollar of additional private investment which equates to an annual return of c.3.5%. In the UK the multiplier is somewhat lower at 1.89x for an annual return of 3.2%.
Marginal productivity of total investment after private investment impulse
Source: Afonso et al. (2024)
When it comes to public investments the picture becomes more complex. First, the direct return on additional public investment is more likely to be negative than in the case of private investments. This is because public investments are often made in unprofitable areas to attract private capital or boost nascent industries. In this instance, the government acts like an insurance company that takes the loss to provide a safety net for private investors to come in and boost the industry or region. The combined effect of private and public investments on economic output can then be positive even though the public investment itself had a negative return.
The second chart shows how good governments are in creating additional GDP from public investments and here I was surprised about two things.
First, I was surprised to see how diverse the outcomes are between the major economies shown. In the US, public investment really seems to be wasteful and destroy output. Or US public investment simply isn’t geared towards attracting private investments and boosting economic output because most of the economy is fully privatised leaving only areas that are intrinsically loss-making to the government. But outside the US, the multiplier is positive and higher than the multiplier for private investments (typically above 2x).
The second thing that surprised me was the tremendous multiplier of UK public investment on UK GDP. Every additional pound the government invests in the UK turns into 9.3 pounds of additional output after 20 years. That’s a return of 11.8% per year.
I really have no idea why the UK is such an outlier, but even if we ignore that, the results of this study are clear: Public investments work and are remarkably efficient in boosting long-term growth. In most countries more so than private investments. Now, all we need to do is convince the public that they should welcome additional government investment even if it means lower spending in other areas like welfare.
Marginal productivity of total investment after public investment impulse
Source: Afonso et al. (2024)
Very interesting! Perhaps part of the U.S. problem comes from its high defense investments, which don't have strong second-order effects. You build a road, it increases peoples' productivity on a day-to-day basis; you build missiles, and they just sit there.
In addition, maybe the U.S. has even more lobby capture in its public investments than other countries?
Hear, hear. Prof. Scott Galloway also recently made some excellent observations on this topic https://www.profgalloway.com/elon-musk-welfare-queen/ :
"Early-stage, future-leaning research is riskier and requires large amounts of patient capital. Private industry struggles to justify long-term, mammoth investments in deep science. The most enduring societies have one thing in common: Their governments play the long game. In the 1960s in the U.S., this meant computer and networking technology. At its peak, federal R&D spending approached 2% of GDP. The most cutting-edge work was done by the Defense Advanced Research Projects Agency (DARPA), which developed or funded the development of almost every building block technology of our tech infrastructure, from the internet and the mouse to graphical user interfaces and GPS. More recently, DARPA has been a major funder of AI projects, notably speech recognition — both Dragon and Siri spun out of DARPA. Speech illuminates the difference between government and private R&D: In the 1950s, private Bell Labs (aka the phone company) did pioneering work on speech recognition — but only on phone digits zero through nine."
"Fifty years from now, the field most likely to spawn more value than digital computing is genetics, and similar to digital computing, genetics is an Eagle Cap portfolio industry. The Human Genome Project cost U.S. taxpayers $3.8 billion, was completed under budget and two years ahead of schedule, and has generated $966 billion in economic activity and $59 billion in federal tax revenue. It’s estimated the federal government’s $3.3 billion in annual spending on genetics projects generates $265 billion in economic activity annually. This number doesn’t account for the improved health outcomes and quality of life flowing from genetic breakthroughs — which have an estimated value of $1 trillion per year and growing. One of Eagle Cap’s recent wins in this space: the Moderna Covid vaccine, the result of a $25m DARPA grant to the company for developing RNA vaccine technology."
Our societies appear to have a strong predilection for privatizing gains and socializing losses when it comes to financial sector bailouts. Similarly, there's a systematic effort afoot to vilify public investment and dismantle the government by the very same people who've built massive private fortunes on the back of extremely effective taxpayer-funded government investment:
"Elon Musk says we should “get rid of all” government subsidies, that “the government is the biggest corporation with a monopoly on violence,” and last week mocked Washington for hiring more employees at the IRS. Let’s be clear: Elon didn’t build an EV company in South Africa or start a rocket company in Canada. He built Tesla and SpaceX in the United States. And both continue to be heavily dependent on U.S. government support. There would be no SpaceX without NASA, its largest customer. Tesla built its Fremont factory with a $465 million DoE loan in 2010, and its first 200,000 cars benefited from tax credit subsidies of up to $7,500. For years the company was able to report profits thanks to the “sale” of emissions credits to other carmakers. All told, the company has accepted an estimated $2.5 billion in government support."
"The Democrats are the party that says government will make you smarter, taller, richer, and remove the crabgrass on your lawn. The Republicans are the party that says government doesn't work and then they get elected and prove it." -- P. J. O'Rourke