Econintersect: Research at the Federal Reserve Bank of San Fransisco by Sylvain Leduc and Daniel Wilson has found that “surprise” infrastructure spending by the federal government has two positive impacts on the state economy where the money is spent. The first impact is in increased aggregate demand as the construction money is spent into the economy. The research found that highway spending in 2009 and 2010 had a multiplier effect during those years that was “roughly 4 times” the usual multiplier which has been measured at 0.5 to 1.5.
The multiplier refers to the amount of economic activity that is created for each original dollar of spending. The affect drives from that respending of the original money. For example, much of a dollar in wages is respent by the worker for food, clothing, fuel, housing, etc. and much
Consider a hypothetical: 50% of the money spent for a highway project ends up in the hands of people and firms who will spend it again. If the respending at 50% continues four times another $0.94 is added to the economy in addition to the original dollar. The multiplier in this case would be 1.94. That’s the original dollar + 0.50 respent, plus 0.25 spent again, plus 0.125 spent in the third level of transactions and then 0.0625 in the fourth = 1.9375.
But the original economic boost is not the end of the story. There is a second wave of economic activity due to increased productivity resulting from the improved infrastructure. The researchers found that the initial multiplier for highway construction amounted to 1.5 to 3.0 over the first two years (construction phase) and the following years saw a further multiplier affect that resulted to a ten-year average multiplier of 2.
Thus a $100 billion highway program would result in a $200 billion added to GDP over a ten year period. For a GDP of $20 trillion, that would be an average of 1.5% boost to GDP every year for ten years.
From the paper:
It is conceivable that highway spending during a major downturn, when productive capacity is underutilized, may affect output in a substantially different way than spending during more normal times. To test this, we examined whether unanticipated changes in highway spending in 2009 and 2010 had a different effect on GSP than in other years in our sample. We found that spending in 2009 and 2010 was roughly four times as large as the peak response shown in Figure 1. This suggests that highway spending can be effective during periods of very high economic slack, particularly when spending is structured to reduce the usual implementation lags.
Highway Grants: Roads to prosperity? (Sylvain Leduc and Daniel Wilson, Federal Reserve Bank of San Fransisco Economic Letter)