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Save or borrow? We must relearn the value of public investment

Vehicles pass a highway construction site on Interstate 80 in Sacramento. The nation’s infrastructure is in need of repair and improvement. On that, politicians generally agree. Harder to answer: How to pay for it, and which projects should take priority? A reliable infrastructure system is important for the nation’s economy, safety and quality of life.
Vehicles pass a highway construction site on Interstate 80 in Sacramento. The nation’s infrastructure is in need of repair and improvement. On that, politicians generally agree. Harder to answer: How to pay for it, and which projects should take priority? A reliable infrastructure system is important for the nation’s economy, safety and quality of life. AP

Trade-offs often are similar regardless of the scale of the organizations. That was evident reading my hometown weekly’s report on a county board meeting.

Everyone — a business, a government, a household — faces the question of whether to borrow versus save for a purchase.

At the local meeting, one commissioner was weak on economics. A county should never borrow, he asserted categorically, except in dire emergency.

No public finance economist would support that.

It is true that thrift is good. No entity should borrow carelessly. But requiring that all purchases be funded out of current-income savings would make the global economy sharply smaller and people poorer.

Indeed, the development of capital markets during the Renaissance was the main reason per capita incomes began to rise after millennia of life just above subsistence.

Capital markets, which now include municipal bonds, facilitated flows of saved value from those who did not need the money right then to others who did. Helping capital move to where it is needed increased total output and enabled higher living standards.

Consider a friend getting his life together after rehab. A skilled carpenter, he can earn a lot as long as he can get to job sites, but he has no car. Should he take a coffee shop job at $10 an hour and save for a car? Or borrow $1,500 for a basic used car to get to building sites where he will earn three times as much?

He is better off borrowing and getting higher pay immediately. This reflects a fundamental fact: He produces more value for society building houses than busing tables. If borrowing money for a car gets him building houses right away, then he is better off, and so is society as a whole.

Similarly, if a county or state has road projects that will make the economy more productive, it may be wise to borrow now rather than wait. That nearly all businesses borrow at some time for new equipment teaches us something.

Another commissioner felt differently. He advocated borrowing if the cost of waiting until later was higher than the cost of borrowing today. That nears the way a public-finance professor would see it: Borrow if the rate of return from the new investment is greater than the interest rate and greater than the return from alternative activities in the private sector.

The knotty question, in both government and business, is predicting the return on an investment. Especially if that return is “to society,” rather than a person or business.

We cannot know exactly what 20 miles of new blacktop will do to speed grain to an elevator or reduce wear and tear on feed trucks and school buses. Nor does a metal stamping company know exactly how much a new press will save. But in both cases, there are methods to make good estimates.

To appreciate the benefits of public infrastructure, it helps to experience what its lack entails. In 1936, my mother drove her Model T 72 miles from where she taught a one-room school in Iowa to the home farm in Minnesota. She had to pulled out of the mud seven times, and the trip took 11 hours. In 1969 in Brazil, when I traveled from the Argentinian border back to Rio de Janeiro, the bus spent six hours without ever getting over 20 mph because soybean trucks created great potholes in the unpaved clay road.

We would have been richer in the United States if we had borrowed to build farm-to-market roads 20 years before we actually did. Not spending the money kept us poorer for longer. And Brazil, with a tremendously dynamic farm sector, still throws away much of that productivity with terrible rural roads.

Yes, state and local government borrowing always needs a prudent tie to future tax revenues.

Yes, the return to public investment always needs comparing to what would happen if the money was left in the private sector.

Yes, borrowing for current operations is quite different than for infrastructure.

But history and theory both show we are under-investing in things like transportation infrastructure right now.

A representative of the state transportation department made a liaison visit to that county board meeting. She informed the board that our DOT “in an asset-management and preservation mode.” That means it is like a South Bronx tenement owner trying to keep his tenement from deteriorating too fast. We are living off past generations’ investments.

The board did discuss historic low interest rates. Whether these benefit the country as a whole is debatable. But for any single country or city, with current low rates it makes more sense to borrow for a road project in 2016 than it did in 2006.

No one in the news article mentioned another key consideration: By exempting interest earned on “municipal” bonds from taxation, the federal government subsidizes state and local government. If a county never borrows, it leaves that federal money on the table. Its citizens are that much poorer as a result. Doing that in the name of fiscal prudence and good government is a waste.

Past leaders knew the benefits of public investment. We are all richer as a result. But many have forgotten that lesson.

St. Paul economist and writer Edward Lotterman can be reached at boise@edlotterman.com.

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