Do we need a massive influx of federal money to fix infrastructure?

One dramatic example to illustrate the seriousness of the infrastructure crisis in the US is the recent problem with lead in the water supply of the city of Flint, Michigan. According to one estimate, fixing the entire water infrastructure in Flint so that everyone could get safe drinking water from their faucets would cost about $1.5 billion or approximately fourteen thousand dollars per resident.  Combining this with the needs of other cities and with work that needs to be done on transportation and other infrastructure, it is easy to see how Trump’s proposal to invest a trillion dollars in infrastructure could be justified.  Spending huge amounts from the federal government budget, however, is not an efficient or cost effective way to respond to infrastructure problems.

The prospects of solving infrastructure problems in a much more cost effective way can also be illustrated by considering the case of providing clean drinking water for the residents of Flint. This illustration is based on an article by Charles Marohn, recently posted on the Strong Towns website.

Marohn points out that “the primary function of the water system in your city is not — as is widely believed — to provide you safe drinking water.” The existing system in most cities including Flint, made up of eight-inch water pipes, was designed to provide enough water for fire-fighting. If the only purpose was to provide water for household needs like drinking and bathing, much smaller pipes would suffice. This is the approach used by rural water systems in some small towns and agricultural areas where clean well-water is not readily available. These smaller pipes make it possible to provide safe drinking water at a lower cost per resident than with conventional urban water systems.

Instead of replacing the entire water system in Flint, where many pipes may be able to last 20 years or longer, the city could build a less expensive parallel system of small pipes. The existing system of lead pipes could be left in place for fire-fighting purposes only. This is but one example of how innovative and unconventional approaches could be used to fix infrastructure for a lower cost.

In many cases, entrepreneurs could devise private innovative solutions that are much more cost effective for replacing and repairing infrastructure. When a pot of federal money is available, cities and towns focus their efforts on getting as large a share of that money as possible, not on finding low cost ways to fix their problems. If instead, cities had to pay most of the costs of fixing infrastructure themselves, they would have a much bigger incentive to find the most cost effective way to do so.

 

 

Why the Bush tax cuts should not be allowed to expire

Because I am concerned about fiscal responsibility, I am hesitant to advocate keeping taxes low. Nevertheless, as my colleague Shawn Ritenour emphasized in his blog, restoring fiscal responsibility while also promoting a prosperous economy requires cutting government spending, not raising taxes.

Raising taxes from the current level would have harmful consequences in any case, but those consequences are exacerbated by the fact that we are in a severe recession (some say depression). The main problem with raising tax rates is not that it will lead to a reduction in consumption and demand. If anything it will lead to increased consumption, though by government agencies and recipients of government transfer payments instead of the people who earned the money through their labor.

The more serious problem for the economy is how taxes influence production. When a greater share of each dollar earned is taxed away, it reduces the incentive to earn, whether through working additional hours, hiring more workers, or investing in capital. This problem is more serious for those in higher tax brackets, who are more likely to own businesses and have discretionary time and money that they could invest producing more goods and services. It is not spending that leads to economic prosperity, but greater production of what people value, which depends on entrepreneurs having confidence about the future direction of the economy and an expectation of being rewarded for taking risks. This is the key to an economic recovery that will restore prosperity while preserving freedom.

It is doubtful that raising tax rates on individuals with incomes over $200,000 ($250,000 for married couples), as proposed by the president, would lead to a reduction in tax revenue, but it will not lead to a very big increase. Thus if the big spenders currently in control of Congress really care about fiscal responsibility they will let the lower tax rates on the middle class expire as well. This would lead to an increase in revenue that is at least two or three times as large as from increasing taxes only on the those earning more than $200,000, who make up less than 5 percent of households.

Raising taxes on the middle class may actually have a less harmful effect on economic growth and prosperity in the long run than raising taxes on the wealthy, since work and investment by the middle class is likely less responsive to tax rates than that of the wealthy. Nevertheless, uncertainty about which tax rates will be allowed to increase and which will not also hinders economic recovery. Even if the president and Congress say they do not intend to raise taxes on the middle class, their unwillingness to bring spending under control leaves many of us expecting that Congress might raise those taxes out of fiscal necessity. This uncertainty discourages entrepreneurs from investing in capital to expand production of goods and services demanded by the middle class.

A clear commitment on the part of Congress and the administration to extend the Bush tax cuts across the board would remove some of the uncertainty and lead to greater investment and job creation. While such a commitment is not sufficient to address the looming fiscal problems faced by our government, it would be a step in the right direction.

Restricting Trade with China will not hasten Economic Recovery

With the unemployment rate stuck at 9.5 percent, some economists, such as Richard Posner, maintain that we are experiencing a depression. Clearly we have not experienced much economic recovery, and the future does not look promising. Why has the US economy been recovering so slowly? Some economists, such as Paul Krugman, place part of the blame on China and other countries that are running large trade surpluses with the US. The US trade deficit soared to $49.9 billion in June and $26.2 billion of this deficit was with China. We also ran a $3 billion trade deficit with Germany in June, and Germany’s trade surplus rose 30 percent compared to 2009.

By undervaluing its currency, the Yuan, China is effectively taxing imports and subsidizing exports. This contributes to the US importing much more from China than it exports to China. Krugman says that this policy benefits China while hurting the US. He argues that the US should threaten to impose sanctions on China if it does not allow the Yuan to rise in value. This may result in a trade war between China and the US. Krugman believes that if conflict results in reduced trade between the US and China, Americans could actually benefit. He argues that because we are in such a severe recession, if the government restricts trade, more will be spent on goods produced in the US, more jobs will be created and we will be better off. This view of trade policy, of which most economists are critical, is known as mercantilism.

Krugman’s assessment of Chinese exchange rate policy is backwards. Rather than benefitting China, it makes Chinese residents worse off while benefitting Americans. For a detailed explanation of this, read the article on China’s currency manipulation by Jonathan Catalan in Mises Daily (mises.org/daily/4256). In short, by holding the value of its currency down, the Chinese government is reducing the number of dollars received by its exporters for each item that they sell. This in turn, raises prices and reduces the purchasing power of the Chinese currency for all Chinese residents. Americans, on the other hand, benefit from being able to buy Chinese goods at a lower dollar price than otherwise.

Mercantilism and Keynesianism have much in common and represent a faulty understanding of how an economy works. The large US trade deficit is not the cause of high unemployment in the US. Trade deficits mean that instead of buying US goods with the dollars they obtain from trade, foreign citizens or their governments are purchasing US financial assets. The Chinese government uses the dollars it accumulates from trade surpluses to buy US government securities. This increases the supply of savings in the US, which, by reducing interest rates, should lead to more investment. Krugman argues from the paradox of thrift, that in a time of mass unemployment, if anyone (including the Chinese government) tries to save more, demand and investment fall because there is excess capacity in the economy.

Reduced trade with China would result in lower standards of living for Americans and would not lead to a net increase in jobs in the US. If the Chinese government responded to the threat of trade sanctions by raising the value of its currency, would that hasten the economic recovery? Not necessarily, because in order to raise the value of the yuan, the Chinese government must sell US government securities, which would lead to higher interest rates in the US and less capital investment. The reduction in investment would offset the increase in exports. The Federal Reserve could keep interest rates from rising and investment from falling by increasing the money supply. This, however, would lead to more price inflation.

It would be a good thing for the Chinese people, if the Chinese government allowed their currency to appreciate. It might even result in a small short term reduction in unemployment in the US as the Chinese buy cheaper American goods and Americans buy fewer Chinese goods. It would also make it harder for the US government to fund its deficits and would not cure the fundamental problem that is hindering economic recovery in the US- uncertainty about the rules and tax policy that will determine the profitability of investment projects. A return to full employment and prosperity requires a stable market economy where entrepreneurs have the confidence to invest in anticipation of future profits. This is more likely if instead of taking over health care and a greater share of the economy, government reduces its role, ending bailouts and unsustainable government spending.