Why the Stimulus Failed to Boost Infrastructure in the US: A Comparison With China

The data are now clear. Despite its large size, the 2009 U.S. stimulus package failed to increase government infrastructure spending or other government purchases as its promoters had claimed it would. The large federal stimulus grants sent to state and local governments for infrastructure spending were mainly used to reduce borrowing and thus did not result in an increase in purchases. Here is a summary of my research with John Cogan. The explanation is that local governments in effect acted as many American households did: when they received the stimulus money, they saved it rather than purchased goods and services. This is what permanent income theory would predict. It is also what previous empirical studies of the 1970s stimulus packages found.

To better understand this explanation one can look at other countries, and in particular at China’s recent stimulus package. This week I went to China and explored the question.

Local governments in China apparently did increase infrastructure spending in 2009 following the stimulus package. Why didn’t these governments simply reduce borrowing as did U.S local governments? Professor Chong-en Bai of Tsinghua University gave me the best answer using simple economic reasoning: the local governments appeared to behave more like liquidity constrained households than permanent income households. In China, local governments do not have much access to capital markets. They get their funding mainly from the central government, including loans from the central bank, and of course only for projects that are approved by the central government. At any point in time local governments are submitting new infrastructure projects for approval; some are being rejected and some are being accepted. If the central government wants to increase infrastructure spending by the local governments all it has to do is lower the acceptance criterion, instruct the central bank to provide the funds, and the volume of projects increases. This is apparently how the stimulus worked in China.

Note that the mechanism is essentially built into the structure of the economy, with characteristics similar to an automatic stabilizer in which the criteria are raised and lowered administratively according to the state of the business cycle. Of course, if the criteria before the stimulus were appropriate, then the projects accepted during the stimulus were of more dubious quality.

This hypothesis has yet to be tested, however. The type of data published by the U.S. Bureau of Economic Analysis—which John Cogan and I used to study the stimulus in the United States—are not publicly available in China, so alternative empirical tests will have to be devised.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

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