Perspectives



Economic Review and Outlook: Implications for the US

On the surface, recent encouraging news on the US economy leads one to assume an increasingly favorable environment for infrastructure investment across the country. There are several encouraging signs within the latest data. GDP grew at an annual rate of 4.6 percent in the second quarter (Box 1), which equals the strongest quarter of the five-year-old recovery. Growth has exceeded 3.5 percent for three of the past four quarters. If expansion greater than 3 percent materializes for the third quarter, that would mark the strongest stretch of economic growth since 2005, the height of the last decade’s expansion.

The US unemployment rate declined to 5.9 percent in September (Box 2), a six-year low, marking the 47th month of job gains post-recession. Labor Department data shows that employers added 248,000 jobs in September (Box 3) and the job growth figures for the second quarter were revised upwards. Starting in October 2010, the current streak of job growth has averaged about 190,000 jobs per month for a total of 9.1 million jobs added to the economy—one million more jobs than what were lost during the recession.

Exports saw strong growth in Q2 2014 with a seasonally adjusted annual rate (SAAR) of 9.6 percent (Box 4). The gain in exports was driven by capital goods such as telecommunications equipment, and the petroleum shortfall was the smallest since 2004. Demand from the nation’s trading partners is holding up even as the global economic expansion cools, giving American manufacturers a lift. Imports have been restrained as the US comes closer to energy independence than it has been in almost three decades, limiting the need for foreign oil.

The US manufacturing sector capped their strongest quarter in more than three years, helping the national economy withstand slower global markets. Resilient motor vehicle sales, spurred by more employment opportunities and a pickup in corporate equipment purchases, are at the crux of the strongest rate of production in four years.

Furthermore, record-low interest rates offer an opportune time to undertake major capital projects. The Federal Reserve has shown caution in raising interest rates, delaying any hikes until it is confident the US economy can withstand them and will likely only raise rates slowly once it starts. The Fed has kept short-term interest rates near zero since 2008, and has bought more than $3 trillion in bonds to push borrowing costs down further and to boost investment and hiring. For the month of September 2014, the federal funds rate stood at 0.09 percent, on the low end of the official target range of zero to 0.25 percent. The yield on the benchmark 10-year note is in the 2.3 percent territory (as of mid-October 2014). It marks the lowest closing level since Q2 2013. The 30-year bond’s yield declined to approximately 3.0 percent, which is also the lowest closing level since Q2 2013.

However, investment in US infrastructure continues to lag. For most of the post-World War II period, government spending on highway construction and maintenance was an important investment and averaged well above 2 percent of gross domestic spending. Now, public construction spending is just over 1.5 percent of GDP—the lowest share since 1993 (Box 5). By comparison, China spends 7 percent of its GDP on infrastructure and India spends 5 percent. As a result, US infrastructure now ranks 14th globally.

There is an immediate and acute need to further invest in our infrastructure. Throughout the country, many roads and highways built decades ago now carry far more traffic than originally expected and require constant emergency repair. Water and gas pipelines laid in the earlier half of the 20th century are failing, leading to explosions and floods. The American Society for Civil Engineers (ASCE), gave the US a D+ in its annual Infrastructure Report Card, citing the need to invest approximately $3.6 trillion by 2020 to upgrade the nation’s infrastructure. Economists have long argued that better infrastructure results in increased business investment and fosters economic development.

What is holding back investment? Digging a bit further into the often-reported figures shows a recovery that is highly uneven, which together with an intractable political environment and local and state fiscal conditions that are weak and fragile, have all contributed to a depressed environment for infrastructure investment.

The employment market, while improving, continues to show weak earnings growth and continued high underemployment, represented by workers stuck in part-time jobs, all of which contribute to depressed consumer confidence. The labor-force participation rate fell last month to a 30-year low of 63 percent, whereas before the recession it stood at 66 percent. The number of workers still searching for work is at 9.3 million, almost a third of them unemployed for six months or more. A broader unemployment measure including part-time workers who can’t find full-time jobs and those too discouraged to apply for work stood at 11.8 percent in September. Furthermore, wages still have yet to climb significantly to reflect GDP growth. Among private sector workers, average earnings have risen only 2 percent over the past year. Effectively, the economic growth in this recovery hasn’t translated into rising incomes for most Americans. This has clear fiscal implications, with government relying heavily on income-based taxes for revenue generation. Increasing corporate profits in the recovery have not made up for this deficiency, with the effective corporate tax rate at historically low levels due to tax shelters and tax havens.

Additionally, the political environment, particularly at the federal level, has not been conducive to investing and developing our infrastructure network. The Highway Trust Fund (HTF), a regular and important source of financing at the federal level that uses revenues from the federal gasoline tax, was renewed over the summer by a divided Congress only through a short-term measure to prevent it from becoming insolvent. The fund, which typically distributes approximately $40 to $50 billion per year for transportation projects, is not only restrained by dysfunctional federal politics. Federal gasoline tax receipts, the HTF’s primary funding source, are declining in real terms because the federal gasoline tax rate hasn’t been raised in more than 20 years, while the population is driving less and the vehicles they’re driving are more fuel-efficient.

But perhaps the most significant reason for infrastructure underspending is rooted to what is happening at the state and local government levels, where infrastructure projects are chosen and paid for. As of 2014, more than 90 percent of the spending by the public sector on construction was at the state and local levels, and about three-quarters of highway spending is financed by state and local governments. Which projects are chosen and how they are financed are left to states and municipalities that are not making infrastructure investment a priority. Box 6 shows how state and local infrastructure spending are at historic lows.

While fiscal balances for state and local governments have improved throughout the recovery, they remain heavily indebted, paying down debt acquired prerecession. Resources are being targeted to funding these debt obligations, along with other service provisions. Meanwhile, in some instances, taxes are even being lowered. A number of states are proposing tax cuts for 2015, but few states are planning significant infrastructure expansion. Beginning in 2007 the Government Accountability Office has published long-term fiscal simulations for the state and local government sectors. These simulations make clear the persistent and long-term fiscal pressures faced by the local legislatures. They point to rising health care costs and retirement benefits, as well as the nation’s overall fiscal difficulties as the primary divers of the these pressures. State and local expenditures on Medicaid and the cost of healthcare for government employees and retirees are both projected to grow faster than overall GDP (Box 7). Three-quarters of state liabilities are unfunded retirement benefits.

Another problem is that in the last few years, local and state governments are issuing less debt for new capital projects, such as roads, bridges, transit, and airports, despite the historically low interest rates (Box 8). The issuance of municipal bonds is down almost half from its peak in 2010. More than half of the debt being raised is for re-financing purposes rather than for new projects.

The issues highlighted here show that as the economic recovery moves forward, a corresponding increase in infrastructure investment is generally unlikely without major financial reforms and/or new funding initiatives. With the inevitability of interest rate increases, and the likelihood of further restrictions on states and municipalities to issue tax-exempt bonds, it is increasingly likely that the private sector will have to become a bigger player in infrastructure development. Public-private partnerships have financed many infrastructure projects across the country, and the current fiscal and political realities will necessitate the further expansion of this model.

 

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Image Header Source: US Department of Agriculture (Creative Commons)


Geographies: United States
Sectors: Other
Topics: Economics