Natixis: Flash Economics Economic Research, March 2013.
While austerity measures have failed to bring the expected sustainable consolidation in public finances, the challenge for policymakers is becoming more and more to promote growth as an objective to ease debt to GDP ratios. But with budget constraints being extremely tight, priority has to be given to public spending with the highest multiplier effects. In this flash, we focus on euro area government infrastructure investment, i.e. capital formation in the transport sector:
- Estimating a VAR model for the four largest euro area economies, we find that an increase in public infrastructure investment is associated with higher output, private investment and employment in the quarters following the expenditure shock. Moreover the positive effect lasts twice as long in less developed economies as in mature economies. This suggests that infrastructure investment not only drives positive demand shock but also raises factor productivity.
- We find that output elasticities with respect to transportation infrastructure investments are very large (0.18 after 5 years). In addition, as higher output implies higher tax revenues over time, infrastructure investment is likely to pay for itself.
- At last, estimating the multiplier for different economic regimes, we find that infrastructure investment has a higher impact on activity in economic bad times than in economic normal times (four times larger in the case of France).
All these findings suggest that infrastructure investment is highly recommendable as a policy lever to augment GDP and reduce the public debt burden, in the current context more than ever.