Markets Will Wish Infrastructure Was the Priority
President Donald Trump has hinted that the administration plans to release a detailed set of principles this month for “a trillion-dollar infrastructure bill” to upgrade roads, bridges, airports and other public works. Too bad the recently enacted tax cut legislation will increase the large projected fiscal deficits over the next decade and severely limit the federal government’s ability to fund a large and multiyear infrastructure plan.
In the parlance of financial markets, this is what’s known as a missed opportunity, and the current euphoria among investors over lower corporate taxes could soon fade. The economic lift from the tax plan will be positive, especially in the early part of 2018 as the cuts take effect. However, sustained growth in gross domestic product of greater than 3 percent needs all sectors of the economy to be growing, and that includes public investment.
The current economic expansion has been characterized as the weakest on record, and it is. Yet, even though overall GDP growth has averaged a little more than 2 percent a year, it’s not because of weakness in the private sector or even business investment, the main beneficiaries of the tax cuts.
During the current eight-year-long expansion the private sector has grown almost 3 percent a year. And, in comparison to the 2000s growth cycle, the private economy growth rate has been slightly faster by about 20 basis points per year. What may be more surprising is that real business fixed investment has averaged 4.25 percent in the current economic growth cycle, double the growth rate of real GDP and almost double the rate of growth in business investment during the last decade.
The weak link in the current cycle is in the public sector. Over the past eight years, real public sector spending and investment has declined about 1 percent a year. That is in sharp contrast to the historic average of roughly a 2 percent increase a year during previous economic expansions. No other period of growth in the postwar era has experienced such a large and sustained drag from the public sector, especially public investment.
In the third quarter of 2017, public investment, which includes all investment in equipment and structures by state and local governments as well as the federal government, stood at $550 billion. That’s roughly $100 billion below the peak level of public investment spending during the growth cycle of the 2000s. The scale as well as the duration of the decline in public investment is unprecedented.
Improving the nation’s infrastructure should be the priority as it not only directly boosts economic activity and increases jobs but it better enables companies to move goods and services across the country and to foreign destinations. Investing and upgrading the public infrastructure is as important, if not more so, to improving the country’s competitiveness and economic growth as is tax reform.
In the short run, the broad momentum in the private economy, which is most evident in business surveys for manufacturing and private service sectors, indicates that the economy should continue on a solid 3-percent-plus growth path. That should keep a positive glow on the equity markets, lift commodity prices, and put upward pressure on bond yields.
Yet the big question for investors is: How does the Trump administration’s infrastructure plan get off the ground, or does it at all? If the federal government is forced take on the task alone and increase budget deficits even more, the dollar would be at risk, as investors and even the credit ratings firms would question the creditworthiness of the U.S. with the debt-to-GDP ratio rising to new heights. And if the plan stalls, when does the lack of a proper functioning public infrastructure start to hamper or impede growth in the private sector? The timing as well as the scale of the recently passed tax reform legislation could force a rethink of fiscal and budget priorities at some point.
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Robert Burgess at email@example.com