November 11, 2016 1:59PM

A Message for Trump: Basel IV Will Kill Dreams of an Infrastructure Boom

Ever since the Financial Crisis, regulators have tightened their grip on banking activities (read: beaten up on banks) without taking note of unintended consequences. Prominent amongst these misguided regulatory interventions have been the Bank for International Settlements (BIS) mandates, which are touted as promoting global financial safety and economic stability. John Dizard of the Financial Times has seen through the Basel Committee on Banking Supervision’s smoke and mirrors display and correctly concludes that the proposals provide background noise for the next crisis.

First, the new “Basel IV” reforms will dampen economic growth globally. The European Banking Federation claims that increased capital requirements will cause European Banks to raise an additional €850bn of capital. This will exacerbate the credit crunch because banks can increase capital-asset ratios by either shrinking assets or raising capital. In both scenarios, deposit liabilities are reduced and money is destroyed. Slower growth in the money supply, broadly measured, slows the expansion of nominal GDP. The implications are dire because Basel IV seeks specifically to increase capital requirements on project lending and banks account for 80 percent of lending to the real economy in Europe.

Second, Basel IV’s push to standardize risk weighted asset calculations will actually increase risky activities. Unbelievably, Dizard reports, “under the current version of the Basel ‘standardized approach’, unsecured lending to a non-public, below investment-grade corporate borrower requires the same bank capital commitment as project financing secured by assets, liens on equity and cash lockbox arrangements.” With all corporate risk considered the same, incentives will exist for bankers to lend for a risky, high-yield project instead of a safer, more productive one. The result will be a push away from revenue-producing infrastructure projects. 

The secretive Basel Committee on Banking Supervision continues to create systemic risks, which threaten to plunge the world into a slump. Thanks to the BIS mandates, we might experience the horrors of Quantitative Tightening (QT).

October 19, 2016 2:56PM

Infrastructure Investment: A Look at the Data

Hillary Clinton says that “we are dramatically underinvesting” in infrastructure and she promises a large increase in federal spending. Donald Trump is promising to spend twice as much as Clinton. Prominent wonks such as Larry Summers are promoting higher spending as well. But more federal spending is the wrong way to go.

To shed light on the issue, let’s look at some data. There is no hard definition of “infrastructure,” but one broad measure is gross fixed investment in the BEA national accounts. 

The figure below shows data from BEA tables 1.5.5 and 5.9.5 on gross investment in 2015. The first thing to note is that private investment at about $3 trillion was six times larger than combined federal, state, and local government nondefense investment of $472 billion. Private investment in pipelines, broadband, refineries, factories, cell towers, and other items greatly exceeds government investment in schools, highways, prisons, and the like.

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One implication is that if policymakers want to boost infrastructure spending, they should reduce barriers to private investment. Cutting the corporate income tax rate, for example, would increase net returns to private infrastructure and spur greater investment across many industries.

Let’s drill down on the federal portion of infrastructure investment. The largest piece is investment in intellectual property at $88 billion, which mainly includes research spending by agencies such NIH and NASA. Terence Kealey argues against government research spending, but let’s put that aside for this blog.

The rest of federal investment spending is on structures and equipment, which includes direct federal investment of $32 billion (for items such as post office buildings) and aid to the states of $72 billion (for items such as highways). Note that total state and local investment spending would include the $72 billion plus the $280 billion that state and local governments funded themselves.

Now let’s switch to OMB data, which is more detailed but is measured a bit differently. The table below shows federal spending on “physical capital investment” broken out between direct spending and aid to the states.

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I contend that most federal spending on physical infrastructure should be instead funded by state and local governments and the private sector. In the table, I indicate that about three-quarters of federal nondefense investment in 2016 ($92 billion out of $121 billion) should be handed over to the states and private sector.

Why devolve infrastructure funding? Experience shows that federal investments are often misallocated and mismanaged. Decentralized decisionmaking in the states and the marketplace is superior to central planning from Washington. Infrastructure investment has both costs and benefits, and so trade-offs need to be made. Those trade-offs can best be made by local decisionmakers directly responsible for both the financing and spending sides of the investment process.

These themes are explored in essays at Downsizing Government, such as here and here.

Whoever wins the election, we are likely to have a debate on infrastructure next year. I hope that we can get beyond simple cheerleading for more federal spending. Improving America’s infrastructure is about more than spending. It’s about efficiency, innovation, and sound management of investments, and when you consider those factors, a decentralized approach is the best way to go.  

September 23, 2016 3:28PM

Infrastructure Spending and the Charleston Seaport

George Will’s oped the other day argued that Congress should hurry up and fund an expansion in the Charleston, South Carolina, seaport. But his piece revealed why the federal government should reduce its intervention in the nation’s infrastructure, not increase it, as Clinton and Trump are proposing.

The Charleston seaport has become crucial to South Carolina’s economy. Will notes that “1 of every 11 South Carolina jobs — and $53 billion in economic output are directly or indirectly related to Charleston’s port.”

There is a problem, however. The Charleston seaport:

needs further dredging in order to handle more of the biggest ships, which is where Congress enters the picture: Unless it authorizes the project and appropriates the federal portion of the $509 million cost to augment South Carolina’s already committed $300 million, the project will be delayed a year. The deepening project is only 14 percent of the $2.2 billion South Carolina is investing in its port facilities and related access.

The biggest ships pay more than $1 million to transit the [Panama] canal; if they miss their transit time, their fee is doubled. Until the port is deepened, too few can be handled here simultaneously, and they can enter and leave the port only at high tide.

Right. It is crucial to South Carolina’s economy to expand the seaport right now without delay. So one would think that state politicians and port-dependent businesses would be springing into action and funding the full port expansion themselves. But they don’t because they are waiting for federal subsidies. Federal intervention into the seaport industry is apparently slowing progress, not speeding it up.

Will says:

There is no controversy in Congress about this project. But unless Congress acts on it before the end of the year, the deepening will not be in the president’s 2018 budget and will be delayed, with radiating costs — inefficiencies and lost opportunities. This a mundane matter of Congress managing its legislative traffic, moving consensus measures through deliberation to action. It will illustrate whether Congress can still efficiently provide public works to enhance private-sector efficiency.

I’m surprised that the astute and pro-market Will missed the obvious solution to the problem he laid out. The federal government is in deep gridlock, and probably will be for years to come. It cannot “efficiently provide public works,” and it rarely has in the past. There never was a golden era of federal efficiency. Army Corps of Engineers infrastructure investment, for example, has been pork barrel for more than a century. And today, we see similar investment-delay problems with numerous areas of federal infrastructure involvement, such as air traffic control.

The solution to the inefficiency that Will rightly criticizes is devolution of infrastructure spending and control out of Washington, optimally to the private sector. Margaret Thatcher privatized most British seaports, and Tony Blair privatized British air traffic control. Privatization is a good way to meet America’s infrastructure challenges as well. Charleston’s seaport is “booming” according to Will, and thus it should have no problem attracting private financing for expansion.

For more on privatization, see here.

September 22, 2016 2:02PM

Protectionism Is Crippling Atlantic and Gulf Coast Ports

George Will writes in his column today about the importance of the Port of Charleston – and by extension, trade – to the economy of South Carolina. Recent completion of the 10-year project to widen the Panama Canal to accommodate more traffic and passage of a new class of container ships with nearly triple the capacity of their immediate predecessors has exposed a logistics snafu that could cost South Carolina’s economy billions of dollars: Charleston Harbor is too shallow to accommodate these much larger, “Post-Panamax” ships efficiently (only limited sections of the harbor are deep enough and only during high tide).

According to the American Society of Civil Engineers, these vessels can lower shipping costs from 15-20 percent, but harbors need to be at least 47 feet deep to accommodate them. The U.S. Army Corps of Engineers reports that only seven of the 44 major U.S. Gulf Coast and Atlantic ports are “Post-Panamax ready.” American ports must be modernized if the United States is going to continue to succeed at attracting investment in manufacturing and if U.S. companies are going to compete successfully in the global economy.

As I wrote in the Wall Street Journal last year:

The absence of suitable harbors, especially in the fast-growing Southeast, means fewer infrastructure- and business-development projects to undergird regional growth. It also means that Post-Panamax ships will have to continue calling on West Coast ports, where their containers will be put on trucks and railcars to get products from Asia to the U.S. East and Midwest—a slower and more expensive process.

The problem can be traced to one major issue: funding.  And that issue is made more complicated by another problem: protectionism.  Most funding of infrastructure inevitably come from federal and state budgets – taxpayers, who should have a voice in the debate about whether these infrastructure projects constitute wise public investments.  But a couple of long-standing, though obscure, protectionist laws have conspired to reduce capacity in dredging services, ensuring that projects take twice as long and cost twice as much as they should.

As I wrote in the WSJ:

This capacity shortage is the result of the Foreign Dredge Act of 1906 and the Merchant Marine Act of 1920 (aka the Jones Act). These laws prohibit foreign-built, -chartered, or -operated dredgers from competing in the U.S. The result is a domestic dredging industry that is immune to competition, has little incentive to invest in new equipment, and cannot meet the growing demand for dredging projects at U.S. ports.

For the next few years, federal, state and local government spending on dredging is expected to be about $2 billion annually. That spending will be supplemented by investments from U.S. ports and their private terminal partners to the tune of $9 billion a year to build and upgrade harbors, docks, terminals, connecting roads and rail, and storage facilities, as well as to purchase cranes and other equipment. There would be a lot more of these job-creating investments if European dredging companies were allowed to offer their services.

The Transatlantic trade talks offer a great opportunity to fix this problem. The best dredging companies in the world are European, mainly from the low-lying countries of Belgium and the Netherlands, where mastery of marine engineering projects has been developed over the centuries.

Industry analysts at Samuels International Associates estimate that European dredgers could save U.S. taxpayers $1 billion a year on current projects, and enable more projects to be completed more quickly. The European Dredging Association boasts that its member companies win 90% of the world’s projects that are open to foreign competition.

In a global economy where capital is mobile, workforce skills, the cost of regulation, taxes, energy costs, proximity to suppliers and customers and dozens of other criteria factor into where a company will invest. And for companies with transnational supply chains, transportation costs are crucial considerations.

Today the U.S. is falling behind…

Over at Café Hayek today, Don Boudreaux assesses Will’s piece and offers an excellent analogy between administrative protectionism (tariffs and the like) and physical protectionism (harbor disrepair), which reminded me of this masterful passage from Fredric Bastiat equating tariffs and physical impediments to trade with sweeping brilliance and simplicity:

Between Paris and Brussels obstacles of many kinds exist. First of all, there is distance, which entails loss of time, and we must either submit to this ourselves, or pay another to submit to it. Then come rivers, marshes, accidents, bad roads, which are so many difficulties to be surmounted. We succeed in building bridges, in forming roads, and making them smoother by pavements, iron rails, etc. But all this is costly, and the commodity must be made to bear the cost. Then there are robbers who infest the roads, and a body of police must be kept up, etc. Now, among these obstacles there is one which we have ourselves set up, and at no little cost, too, between Brussels and Paris. There are men who lie in ambuscade along the frontier, armed to the teeth, and whose business it is to throw difficulties in the way of transporting merchandise from the one country to the other. They are called Customhouse officers, and they act in precisely the same way as ruts and bad roads.

September 13, 2016 9:45AM

The Who‐​Gets‐​to‐​Decide Crisis

"There is now a consensus that the United States should substantially raise its level of infrastructure investment," writes former treasury secretary Lawrence Summers in the Washington Post. Correction: There is now a consensus among two presidential candidates that the United States should increase infrastructure spending. That's far from a broad consensus.

"America's infrastructure crisis is really a maintenance crisis," says the left-leaning CityLab. The "infrastructure crisis is about socialism," says the conservative Heritage Foundation. My colleague Chris Edwards says, "There is no widespread crisis of crumbling infrastructure." "The infrastructure crisis . . . isn't," the Reason Foundation agrees.

As left-leaning Charles Marohn points out, the idea that there is an infrastructure crisis is promoted by an "infrastructure cult" led by the American Society of Civil Engineers. As John Oliver noted, relying on them to decide whether there is enough infrastructure spending is like asking a golden retriever if enough tennis balls are being thrown.

In general, most infrastructure funded out of user fees is in good shape. Highways and bridges, for example, are largely funded out of user fees, and the number of bridges that are structurally deficient has declined by more than 52 percent since 1992. The average roughness of highway pavements has also declined for every class of road.

Some infrastructure, such as rail transit, is crumbling. The infrastructure in the worst condition is infrastructure that is heavily subsidized, because politicians would rather build new projects than maintain old ones. That suggests the U.S. government should spend less, not more, on new infrastructure. It also suggests that we should stop building rail transit lines we can't afford to maintain and maybe start thinking about scrapping some of the rail systems we have.

Aside from the question of whether our infrastructure is crumbling or not, the more important assumption underlying Summers' article is that infrastructure spending always produces huge economic benefits. Based on a claim that infrastructure spending will produce a 20 percent rate of return, Summers says that financing it through debt is "entirely reasonable." Yet such a rate of return is a pure fantasy, especially if it is government that decides where to spend the money. Few private investments produce such a high rate of return, and private investors are much more careful about where their money goes.

For every government project that succeeds, a dozen fail. Funded by the state of New York, the Erie Canal was a great success, but attempts to imitate that success by Ohio, Indiana, and Pennsylvania put those states into virtual bankruptcy.

The 1850 land grants to the Illinois Central Railroad paid off, at least for Illinois, but similar subsidies to the First Transcontinental Railroad turned into the biggest political corruption scandal of the nineteenth century. The Union Pacific was forced to reorganize within four years of its completion, and it went bankrupt again two decades later. The similarly subsidized Northern Pacific was forced to reorganize just a year after its completion in 1883 and, like the Union Pacific, would go bankrupt again in 1893.

The Interstate Highway System was a great success, but a lot of transportation projects built since then have been pure money pits. It's hard to argue that any of the infrastructure spending that came out of the American Recovery and Reinvestment Act did anything to actually stimulate the economy.

Think the Atlanta streetcar, whose ridership dropped 48 percent as soon as they started charging a fare, generates economic development? Only in a fantasy world. Japan has used infrastructure spending to stimulate its way out of its economic doldrums since 1990. It hasn't worked yet.

In the Baptists and bootleggers political model, Keynesians such as Summers are the Baptists who promise redemption from increased government spending while the civil engineers, and the companies that employ them, are the bootleggers who expect to profit from that spending. Neither should be trusted, especially considering how poorly stimulus spending has worked to date.

Making infrastructure spending a priority would simply lead to more grandiose projects, few of which will produce any economic or social returns. In all probability, these projects will not be accompanied by funding for maintenance of either existing or new infrastructure, with the result that more infrastructure spending will simply lead to more crumbling infrastructure.

Almost as an aside, Summers adds that, "if there is a desire to generate revenue to finance infrastructure investments, the best approaches would involve user fees." That's stating the obvious, but the unobvious part is, if we agree user fees are a good idea, why should the federal government get involved at all? The answer, of course, is that politicians would rather get credit for giving people infrastructure that they don't have to pay for than rely on user fees, and the controversies they create, to fund them.

Instead of an infrastructure crisis, what we really have is a crisis over who gets to decide where to spend money on infrastructure. If we leave infrastructure to the private market, we will get the infrastructure we need when we need it and it will tend to be well maintained as long as we need it. If we let government decide, we will get too much of some kinds of infrastructure we don't need, not enough of other kinds of infrastructure we do need, and inadequate maintenance of both.

February 10, 2016 11:11AM

In Africa, Institutions Matter More than Infrastructure

Washington Post article recently highlighted the impressive but uneven progress that Africa has made in its struggle against poverty. The article looked at questions pertaining to material wellbeing, including “the number of times that an average family had to go without basic necessities.” On that measure, Cape Verde saw the most rapid improvement. And so the article asks, “What did Cape Verde do right?” 

Cape Verde’s superior infrastructure, the Washington Post explains, is partly responsible for that country’s economic progress. Surely that cannot be the full answer. The United States did not have an interstate road network till the Eisenhower Administration – decades after the United States became the richest and most powerful country in the world. Similarly, Germany was the most powerful and richest country in Europe a long time before constructing its famous autobahns. 
  
In fact, it is Cape Verde’s policies and institutions that we should look to as reasons for that country’s superior performance relative to, say, Liberia, where poverty increased the most – according to the Washington Post. According to the Center for Systemic Peace, Cape Verde is a democracy. Liberia, in contrast, is far behind.

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Freedom House, similarly, gives Cape Verde a perfect score on political rights, while Liberia is two points behind them on a seven-point scale.

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The Economic Freedom Index only began tracking Cape Verde in 2010, but in that time, its freedom to trade has practically caught up with the United States, where freedom to trade is sadly declining.

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The Washington Post’s omissions matter. Focusing on infrastructure development while ignoring political and economic freedoms can lead to what economist William Easterly calls authoritarian development. On this theory, simply furnishing dictators and corrupt governments with technical expertise and aid money will improve conditions for the poor. Evidence shows that this approach to development chiefly empowers dictators while the poor continue to suffer. 

Free development, instead, focuses on establishing or strengthening political and economic freedoms for the poor. If given the freedom to do so, ordinary people have a remarkable ability to hold their governments accountable and to improve their lot through production and exchange. 

Liberia’s political institutions are moving in the right direction, but have some catching up to do. Cape Verde, on the other hand, is an excellent example of rapid development under conditions of relative political and economic freedom.  

November 6, 2015 3:29PM

Highway Bill Extends Big Spending

Here is the first paragraph of an Associated Press story about the new House highway bill:

Despite years of warnings that the nation's roads, bridges and transit systems are falling apart and will bring nightmarish congestion, the House on Thursday passed a six-year transportation bill that maintains the spending status quo.

Yet some of the government’s own data—as I cite here—shows that, rather than “falling apart,” the nation’s bridges and Interstate highways have steadily improved in quality over the past two decades.

I wish reporters would explore the data themselves, rather than just parroting what the transportation lobby groups say. I also wish they would use their imaginations a bit and realize that if bridges and highways were actually nightmarish and falling apart, then state and local governments—who own the bridges and highways—have the responsibility and full capability of fixing them themselves.

As for the “spending status quo,” that status quo has included steady increases over the past two decades. The chart shows total highway trust fund spending using Federal Highway Administration data for 1990 to 2014, and the Congressional Budget Office baseline projection for 2015 to 2021. The new House highway bill would spend this baseline amount over the next six years, while the Senate bill would spend somewhat more.

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