Inside the highway and bridge industries

Big Bang Theory for Federal Highway Giants

By John Latta, jlatta@randallreilly.com

A new report from the Federal Reserve Bank of San Francisco suggests that highway grants play a very positive short-, mid- and long-term role in building state gross product. And “stimulus” dollars do some of the best work.

Federal highway grants to states appear to boost economic activity in the short and medium term. The short-term effects appear to be due largely to increases in aggregate demand. Medium-term effects apparently reflect the increased productive capacity brought by improved roads. Overall, each dollar of federal highway grants received by a state raises that state’s annual economic output by at least two dollars, a relatively large multiplier.

The bank’s research springs from its observation that while public infrastructure spending programs, from the Depression-era Works Progress Administration and Tennessee Valley Authority through to the American Recovery and Reinvestment act of 2009 (a.k.a “The Stimulus”), “surprisingly little empirical information is available about the effect of public infrastructure investment on economic activity over the short and medium term.”

The report delves into the dynamic effects of public investment in roads and highways on gross state product (GSP). A key value in this approach is that uses the federal highway grants processes to examine how transportation spending affects economic activity.

And what did the big bank find?

“We find that unanticipated increases in highway spending have positive but temporary effects on GSP, both in the short and medium run. The short-run effect is consistent with a traditional Keynesian channel in which output increases because of a rise in aggregate demand, combined with slow-to-adjust prices.

“In contrast, the positive response of GSP over the medium run is in line with a supply-side effect due to an increase in the economy’s productive capacity.

“We also assess how much bang each additional buck of highway spending creates by calculating the multiplier, that is, the magnitude of the effect of each dollar of infrastructure spending on economic activity. We find that the multiplier is at least two. In other words, for each dollar of federal highway grants received by a state, that state’s GSP rises by at least two dollars.”

The multiplier effect

The multiplier effect helps gauge the effectiveness of government spending by measuring the dollar change in economic output for each additional dollar of government spending. A multiplier of two implies that when government spending increases by one dollar, economic output rises by two dollars.

According to the San Francisco study, “multipliers for federal highway spending are large.” The report finds that when it come to highway grants and GSP:

• On initial impact, the multipliers range from 1.5 to 3.

• In the medium run, the multipliers can be as high as eight.

• Over a 10-year horizon, there is an average multiplier of about 2.

The bank was actually surprised to find that these numbers were noticeably larger than those typically found in the literature on the effects of government spending.

Stimu-dollars

So just how did the infusion of $27.5 billion in federal highway grants to states as ARRA stimulus money affect state GSPs?