Eat More Cake!
Imagine finishing a medical checkup after a serious illness and your doctor stares at your chart, scribbles some notes and then tells you that adding chocolate cake to your daily diet will help speed recovery.
The global economy’s doctor, the International Monetary Fund, has just done the macroeconomic equivalent as it convenes for its annual meetings this week. The message for this time of low rates and high uncertainty is to spend more now—precisely because of the low rates and high uncertainty. Not only is the debt cheaper, but resolute public plans will encourage private spending and investment.
Of course, the recommendation is more nuanced, targeting countries that can tap into capital markets to borrow in their own currency and know how to design and manage sound infrastructure projects. Yet it still turns heads coming from an organization that spends so much time preaching budget responsibility that its initials were once said to stand for “It’s Mainly Fiscal.”
“The Great Lockdown,” in the Fund’s estimation, has now turned into “The Long Ascent” and forecasts of a 4.9% global contraction this year will be upgraded slightly this week. Still, the scarring from job losses, likely bankruptcies and disruptions in education will make the recovery “long, uneven and uncertain” in the words of Kristalina Georgieva, the IMF’s Managing Director.
This painful path comes in spite of a whopping $12 trillion in global fiscal spending, with public debts reaching roughly 100% of GDP.
And yet, the IMF recommends still more cake.
Specifically, the focus is on public expenditure that spans traditional bridges, tunnels and sewer systems, but also extends to education and training that upgrade human capital. This spending has been slowing for three decades, by the IMF’s estimation, with the notable exception of China, and there’s plenty of room to catch up.
PUBLIC CAPITAL STOCKS (RATIO TO GDP, LEFT SCALE; RATIO TO PRIVATE CAPITAL, RIGHT SCALE)
Note: The high ratio in low-income countries could hide statistical issues with the construction of a stock variable by cumulating flows, especially with inefficiencies in public investment management systems. “Public investment” refers to gross fixed capital formation by the general government.
First and foremost should be more money spent on maintenance. In the United States alone, the one-time expenditure required to cover the backlog of bridge and tunnel repairs is about 3.5% of GDP. One quarter of France’s drinkable water pipes have reached their maximum life spans.
Second, as common sense would dictate, projects need to be developed carefully and managed closely. The economic literature confirms common sense: too much public spending at once leads to bottlenecks, delays, corruption and higher costs.
Third, the IMF recommends that capital spending should drive the transformation to greener buildings, transportation systems and energy grids, while acknowledging that such projects do not always create lots of new, well-compensated jobs. Windmill design and installation benefit a very different group of workers from those who plant trees.
Job creation, of course, lies at the heart of these arguments, and this is where the fund’s conclusions may surprise. Of course, low rates mean governments have much less trouble finding projects that deliver a return and boost growth potential. The crisis itself, however, and the economic uncertainty around the future recovery may actually increase the economic multiplier—essentially the effectiveness—of government spending.
During periods of high disagreement among economic forecasters across 72 developed and developing countries, the fund found that output, investment and job creation all respond better over a two-year period to unanticipated shocks to public investment. The reason? “[P]ossibly because they signal a government’s commitment to growth and stability. By raising confidence, a push in public investment is also likely to foster investment from businesses that would otherwise remain cautious in their hiring and investment decisions.”
UNCERTAINTY AND THE FISCAL MULTIPLIER OF PUBLIC INVESTMENT IN ADVANCED AND EMERGING MARKET ECONOMIES (EFFECT, IN PERCENTAGE CHANGE, OF AN UNEXPECTED INCREASE OF PUBLIC INVESTMENT BY 1 PERCENT OF GDP)
Source: IMF Estimates.
Note: One and Two-year fiscal multipliers of public investment.
This is where investors should tune in. China has already demonstrated the economic benefits of a robust public investment program, and the European Union’s “Recovery Fund” promises extensive help to member states, especially on digital infrastructure and climate-related projects.
The outlook for U.S. infrastructure spending remains uncertain even though both main presidential candidates tout ambitious goals. Republican plans often emphasize privatization and rely heavily on leveraging capital markets in public-private partnerships. Democrats tend to focus on direct government spending, especially where there are no tolls or revenues to attract private investors.
“The message for this time of low rates and high uncertainty is to spend more now—precisely because of the low rates and high uncertainty. Not only is the debt cheaper, but resolute public plans will encourage private spending and investment.”
For both, however, public capital spending often flounders on delays securing permits from the Army Corps of Engineers, the Environmental Protection Agency and regulators at all levels of government. Strained state and local budgets also slow progress when costs are to be shared. All of this makes long-term planning difficult and raises the risks for investors.
This is part of what makes the doctor’s advice so welcome right now and why infrastructure spending will be crucial to reinforce whatever stimulus package may come. Unexpected and resolute action gets investors’ attention and helps jump-start a sluggish recovery. Cake isn’t right for everyone, nor is too much cake ever the answer. But the right kind of sugar rush, as part of a balanced diet, can work wonders.