Ways to bridge the gaps on infrastructure

It doesn't seem to have occurred to anyone - perhaps not even the man himself - to wonder how Tony Abbott can establish himself as an "infrastructure prime minister" and also get the budget back to surplus ASAP.

He's certainly right to imply we need to be renewing and expanding a lot of our infrastructure and that this can't be left solely to the state governments.

But as everyone knows, building new infrastructure can be very expensive. In principle, it can be paid for by increasing taxes, by cutting spending elsewhere or just by allowing the budget deficit to get bigger and borrowing to cover it.

Trouble is, from where Abbott sits, none of those possibilities looks attractive. He's spent four years railing against higher taxes, and though he's also promised to cut government spending by eliminating Labor's waste, in practice it's hard to get much agreement on what's wasteful and what's not. It's highly unlikely Abbott could identify sufficient waste to pay for much infrastructure as well as getting the deficit down.

But simply allowing the deficit to get bigger by borrowing to finance infrastructure spending is surely unthinkable. Leaving aside all Abbott and Joe Hockey have said about the Labor government's debt and deficit, wouldn't it involve living beyond our means and leaving our debts to be inherited by our children and grandchildren?

(There is a fourth possible solution, to use "public-private partnership" arrangements to get the private sector to pay for and build the infrastructure and then, in effect, rent it back to us. But even if you think the private sector is better at building and managing infrastructure than the government, this solution is still a way of hiding the debt by shifting it off the government's books onto those of the private sector. It involves creative accounting.)

So what about this notion of living beyond our means and burdening future generations? I'm sure this is a big part of the reason so many people agreed with the Liberals' attack on debt and deficit.

This is an issue to which economists have given much thought over many years (more thought, dare I say, that many of the people who readily accepted Abbott's argument).

For a start, economists and accountants have long drawn a distinction between day-to-day spending to maintain the operations of a household (or a business or a government) and spending of a capital nature, where you're building or buying some kind of asset that will last for many years, that will contribute to meeting your day-to-day needs for many years, and usually can be sold to someone else if circumstances change.

An accountant will tell you you're only living beyond your means if you're borrowing to cover day-to-day needs ("recurrent spending"), not if you're borrowing to buy an asset that will retain its value for many years. After all, do you regard a family that borrows to buy a home, thereby acquiring a mortgage usually many times greater than its annual income, as living beyond its means? Of course not.

But the analogy between households and governments shouldn't be pushed too far. A family and a government have very different sizes, obligations and powers. Governments, for instance, have the right to levy taxes, which is one reason their borrowings are regarded as low-risk.

And when it comes to borrowing by governments to finance infrastructure, economists have given the matter much thought. Two professors at the University of Melbourne, John Freebairn and Max Corden, argue in a paper this week that by focusing on the debt being left for the next generation we're seeing only half the story.

Their first point is that spending on needed infrastructure and other things of a capital nature benefits the economy we all live in. By increasing the economy's productivity, it leads to economic activity far greater than just that which is involved in building the infrastructure. This leaves the community better off, as well as generating increased tax revenue for state and, particularly, federal governments.

So were we to decide to build no more infrastructure than we could afford to pay for without borrowing, we'd also be deciding to keep the economy less productive than it could be and thus to leave for the next generation a less-productive economy than it could have.

That's the "economic efficiency" case for borrowing to fund infrastructure (and also such things as education and training, which add to the economy's stock of "human" capital). But next the profs outline the equity case, involving "inter-generational equity" - fairness between the generations.

Many people have become conscious that government debt may remain unrepaid and so become a cost imposed on our children. True. But in the case of spending on infrastructure and other forms of capital, which will deliver benefits to the community over periods of 30, 40 years or more, it's equally true that our children will enjoy the benefits.

As the profs put it, "these same future generations reap most of the investment benefits of a more productive economy and higher income levels". Sound unfair to you?

But, being economists, the profs are very much aware that some government infrastructure spending can be undertaken for short-term political gain, not long-term economic benefit. To guard against this, they outline two questions to be asked of every infrastructure proposal.

First, are there good reasons for government investment rather than leaving the decisions to the private sector and competitive market forces?

Second, have the chosen investment projects passed explicit, transparent and robust benefit-cost assessments? And then, if funds are limited (as they always are), have the higher yielding projects been selected?

They say a body with independence similar to the Productivity Commission's should be set up to evaluate projects and publish rigorous benefit-cost studies. Governments would be free to reject the body's advice, but would have to justify this to a better-informed public.