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Economic Insight To maximize benefits, Liberals must invest efficiently in infrastructure

During the campaign, Justin Trudeau’s Liberals pledged to add $5-billion in infrastructure spending this year.

Matthew Lloyd/Bloomberg

When the Bank of Canada decided Wednesday to hold off cutting interest rates until it sees the details of the new Liberal government's infrastructure spending plans in the federal budget, it essentially lobbed the ball for stimulating Canada's flagging economy into the government's court. That leaves Ottawa with a dilemma: Should it be focusing on near-term economic stimulus, or maximizing the long-term benefits of its ambitious infrastructure program?

The government's campaign pledge to double federal infrastructure spending should be able to deliver both. But there's no need to take its eye off the long-term goal to deal with the country's near-term economic worries.

"Infrastructure investment can be an effective form of short-term fiscal stimulus when and if required – but more importantly, it is a long-term structural necessity," the Conference Board of Canada's Daniel Muzyka and Glen Hodgson said in a commentary in The Globe and Mail last fall.

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In the near term, the anticipated federal government spending increase would provide an injection of public-sector capital investment that would help make up for the still-declining capital investment from the private sector. Business fixed investment looks to have fallen by something like $20-billion in 2015, mostly due to plunging investment in the oil patch; based on the Bank of Canada's estimates, it will likely fall by about half that amount, roughly $10-billion. This will subtract about 0.5 percentage points from gross domestic product growth this year.

If the Liberals stick to their campaign promise to add $5-billion in infrastructure spending this year, that would replace roughly half of the investment lost from the private sector. That suggests that this would provide an offset to GDP of about 0.25 percentage points. It's not huge, but it may be enough to lift the pace of the economy out of the danger zone for further Bank of Canada rate cuts.

In terms of this sort of short-term effect, it might not matter all that much where the government spent its money. Legendary British economist John Maynard Keynes argued that the government could hire workers to dig ditches only to then refill them, and the economy would still benefit because those workers would earn money that they would spend, boosting economic activity.

But where an infrastructure-focused fiscal stimulus really pays off is in the longer term. Once in place, public infrastructure enhances growth year after year by providing facilities that are used by private companies to run their factories, transport their raw materials and deliver their products to market. More and better public infrastructure allows businesses across the entire economy to produce more, faster, at a lower cost. This is how infrastructure boosts productivity – which, by extension, expands the economy's growth capacity.

When the government of Stephen Harper launched its stimulus budget during the financial crisis of 2009, it estimated that every dollar spent on infrastructure gives a $1 boost to GDP in the year it is spent – full value for the investment almost immediately. But, by the end of the second year, that dollar was generating $1.60 in GDP gains. The International Monetary Fund estimates that GDP gains of that scale continue for years after the investment.

And what are the right kinds of projects? Transportation should be at the top of the list – roads, bridges, public transit, ports and airports, the infrastructure that delivers products and labour where and when they are needed. "Anything that can feed the functioning of our economy," Mr. Hodgson said in an interview. But that assumes a certain amount of efficiency in identifying the best investments to enhance economic activity. And governments have a long track record of investing inefficiently – even when they aren't letting partisan politics colour their decisions.

"The instincts among most bureaucrats about what projects will have the most benefit often aren't borne out by a detailed cost-benefit analysis," said Benjamin Dachis, senior policy analyst at the C.D. Howe Institute, a private economic think tank.

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But doing the hard homework takes time, and Ottawa will be under pressure to get money flowing through the sluggish economy more quickly. The temptation will be to rush into a quick-fix spending spree that would almost certainly favour projects with shorter timelines, but almost certainly with less long-term benefit. Ditch-digging projects. Gazebo gambits.

So the big question for the government is, how desperately does it need to stimulate the economy right now, at the expense of a bigger bang for taxpayers' bucks over the long haul? The answer probably is, not very desperately at all.

Without any stimulus spending built into its calculations, the Bank of Canada projects economic growth of 1.4 per cent this year and 2.4 per cent next year. These aren't gangbuster numbers, but they're nowhere near a recession. There is no urgent need to flood the economy with government money to keep it from sinking into a deep freeze, as there was in 2009.

The government can afford to take its time and maximize the benefit of its infrastructure program, even if that does mean less of a lift to growth this year – and less of a helping hand to the Bank of Canada.

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