Resist the Siren Song of ‘Cheap’ Government Spending

Investment in public works requires a strategy, not just an impulse, to have maximum growth impact. Private investors can help.

Many international organizations and economists emphasize the benefits of investment in boosting demand and counterbalancing excessive savings. Governments should step in with more spending, they argue, especially in countries with external surpluses.

This line of argument misjudges three things: the role of governments in overall investment; the ability of governments to manage projects economically; and the ability of governments to fine-tune demand.

What we need isn’t more money and debt. The best way to stimulate growth is through a sound investment strategy. This requires, first of all, the right set of priorities that focus on facilitating investment in the private sector.

In a market economy, the private sector is responsible for the vast majority of total investment, typically between 80% and 90%. Given the sheer size of private investment, institutional improvements will have the largest effects on investment and growth. And they cost less, too, due to a smaller bureaucracy.

Some economists argue that private investment needs be boosted with cheaper finance and more public support. But financing costs are already extremely low and a lack of public money is typically not the problem. The European Union has a huge new fund for leveraging private investment. International and national banks are also very active in supporting investment.

But private investors want a well-functioning institutional framework before committing their money. This includes the clear rule of law with strong property rights, enforceable contracts, an efficient judiciary as well as predictable and unobstructive regulation.

Investors hold back when the risks are too high or the expected returns are too low. They need to have confidence in a country’s institutions and the sustainability of its current policies.

A good investment strategy also realizes that the private sector can play a lead role in public-works investment. Private management and financing is often much more efficient than that of the government, which frequently encounters cost overruns and delays. Privately financed and managed public works can also go wrong, but contrary to what some naysayers claim, 30 years of various countries’ experiences with public-private partnerships or private-infrastructure agencies across the globe give sound options for success.

Many economists, including those at the International Monetary Fund, have recently tried to make the case for using the zero-interest-rate environment—“free money”—to boost public spending. But infrastructure projects need time to prepare. The risk is that this free money will lead to picking politically motivated, ill-prepared and inefficient projects, only later to learn that the returns are below expectations and the infrastructure little improved.

Which brings us to the third criteria of a good investment strategy: It should limit government only to those tasks it can deliver on. Taxpayer money and limited public-management resources should focus on what the private sector won’t do, such as the creation of infrastructure networks that span across borders, or providing public support for social or regional policy objectives.

The financing of such tasks should be part of a country’s medium-term budget strategy. This allows efficient planning and steady financing. Cyclical spending, by contrast, is deadly for the long-term planning that infrastructure investment needs. And given that investment is the first thing to be cut during a downturn, public investment has a tendency to reinforce rather than moderate economic cycles.

It’s time to say goodbye to the mantra of more public spending. We need investment strategies that set the right priorities. Institutional frameworks, not public support, are essential to investment. Much of the infrastructure, including telecom, roads, energy and social housing, can be provided privately, with governments using their money wisely.

Many countries increasingly follow this approach. Germany plans to create a privately managed highway-infrastructure agency to counteract the crumbling of its autobahn network.

It has created an agency to advise local communities on project preparation and financing.

Nonetheless, public investment spending is the most dynamic expenditure component in our 2020 budget framework. That way, public money can work where it is really needed, such as rural broadband access or financially strapped local communities.

This isn’t perfect. Even better institutional frameworks and more private-sector involvement are needed. The G-20 nations are pushing for progress in this regard. During the current Chinese presidency and the German presidency to follow, we and our partners will continue to support and implement such an approach. Boosting investment needs a strategy, not impulse spending.

Mr. Schuknecht is the chief economist for Germany’s ministry of finance.

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