Federal government spending on highways has a huge positive effect on local economy and that such effects are much larger than any previous estimates, find the latest paper on this subject by the San Francisco Fed researchers.
“[W]e found that highway spending shocks positively affect GDP at two specific horizons. There is a significant impact in the first couple of years and then a larger second-round effect after six to eight years. Yet, we find no permanent effect, as GDP is back to pre-shock levels after ten years,” write authors Sylvain Leduc and Daniel Wilson.
The fall in GDO one year after spending starts is “not statistically significantly” meaning that it may not be attributable to the spending. Moreover, absence of a permanent effect of the spending on the GDP does not imply that there is no permanent effect on the broadening of the economic base. In fact, authors find that the GDP base as measured by the population expansion does have a permanent effect.
“Interestingly, population is the only variable that appears to be permanently affected by the highway shock. A natural interpretation of this result is that highway/road improvements enable population growth as, for example, new housing developments are built around new or improved roads and as new commuting options are made possible. Such a response is consistent with Duranton and Turner’s (2011) recent finding that increases in a state’s road lane-miles cause proportionate increases in vehicle miles traveled,” note the authors.
And how does all this happen?
“Combining these results with the macroeconomic responses in Figure 6, particularly the increase in GDP per worker 6-8 years after the shock, the results point to a possible productivity effect of improved highway infrastructure. Under this interpretation of our results, an initial shock to federal grants leads to highway construction activity over the following 3 to 5 years and results in new (or improved) highway capital put in place around 6-8 years out. In turn, the new highway capital triggers higher productivity in transportation-intensive sectors, reducing goods prices and boosting demand. Ultimately, the increase in economic activity raises state tax revenues and increases state government spending as a result,” note authors.
These broad range effects can be measured via multipliers – the amount of subsequent effect of the initial spending level where anything over 1 means that spending has much greater impact then its original value.
Although all of the multipliers are well over 1, there is some difference as to the funding scenario.
For example, highway spending via federal grants has “the multiplier on impact is about 3.4, the peak multiplier (at 6 years out) is 7.8, and the mean multiplier is 1.7.”
This means that each dollar federal government spends on local highway has a $3.40 immediate impact, peaks at $6 and has an average life effects of $1.70.
This scenario, however, does not consider the “flypaper effect” or the extent to which federal spending forces local governments to spend on maintenance.
Multiplier effect is much smaller if highway spending is done by the state with the “impact multiplier would be 2.7, the peak multiplier 5.9, and the mean multiplier 1.3.”
“The bottom line is that based on the most sensible measures of government highway infrastructure investment, the GDP multiplier implied by our estimated impulse responses appear to be considerably larger than those based on defense or overall government spending as estimated in previous studies,” say the authors.
Authors also find that highway spending during a recession has a much larger impact then during an expansion.
“Interestingly, the initial impact of highway spending shocks are much larger when they occur in state-years experiencing a recession. The impact elasticity in recessions is 0.028 (s.e. = 0.015), which is statistically significant at the 10% level and about twice as large as the average impact response,” calculate the authors.
Spending effects during an expansion produce negative results but are negligible.
“The impact elasticity in expansions, on the other hand, is slightly below zero and statistically insignificant,” say authors.
Authors also use their methodology to calculate effects of the 2009 government bail-out spending known as the 2009 American Recovery and Reinvestment Act.
“We find that both the contemporaneous and the year ahead effects on GDP were significantly higher from highway shocks in 2009 than the average effect over the 1993-2010 sample,” say the authors.
Paper is available here.