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Economic and Employment Crisis series: (3)
The usefulness of public investment reviewed:
enhancing its effectiveness as a means of stimulating employment and economic activity

February 20, 2009


There are growing calls for greater public investment as a means of stimulating economic activity and employment. The series of economic stimulus measures put forward last year also includes measures linked to public investment. However, in Japan, public investment has a deep-seated negative image and many doubt its effectiveness. This report therefore re-examines the validity of the major criticisms of public investment — (i) that it is ineffective as a means of boosting economic growth, (ii) that it does not bring benefits such as stronger growth potential and a higher standard of living and (iii) that it has a negative impact on efforts to restore soundness to government finances. The report's conclusion is that the criticisms leveled at public investment are not necessarily justified and that, depending on how it is implemented, public investment may be effective. The important thing is to implement public investment that strengthens economic growth potential and improves the national standard of living.

Assessment of Criticism (i): "Public investment does not boost economic growth"
Although the effectiveness of public investment in boosting economic growth has declined, it would be an exaggeration to say that it has been completely ineffective. It cannot be denied that, if public investment had not been increased as part of the economic stimulus measures of the 1990s, the employment situation at the time might well have deteriorated further than it did.

Assessment of Criticism (ii): "Public investment does not bring benefits such as stronger growth potential and a higher standard of living"
This notion is based on the assumption of the current pattern of allocation of investment. It should be possible to ensure the creation of highly useful social infrastructure by revising the allocation of investment. It is also important that the structure of government spending as a whole be revised, so that the range of social infrastructure projects qualifying for public investment is not limited to physical infrastructure projects but also includes "soft" assets.

Assessment of Criticism (iii): "Public investment has a negative impact on efforts to restore soundness to government finances
It is also important to take account of the impact on tax revenues of a severe or prolonged economic recession. If public investment is successful in priming the pump, and the economy begins to recover, tax revenues (especially in the form of corporation tax payments) can be expected to recover quickly, as was the case after the last recession. In this light, the use of public investment to underpin the economy is not necessarily off-target in terms of restoring soundness to government finances.

As public investment today is much lower than it was in the second half of the 1990s, it becomes easy to increase public investment in terms of volume.

Part of the significance of public investment is that it allows the facilities, resources and labor that would otherwise stand idle during a recession to be channeled into projects such as the creation of social infrastructure. Given the severity of the current recession, expanding public investment could be an appropriate policy, provided the targets of investment are carefully selected. In public investment, the government creates work directly by placing orders itself and, for this reason the benefits in terms of increased employment are likely to be felt sooner than with other policy measures such as tax cuts. It is possible for the government to boost expectations of growth in the private sector by setting out directions for the creation and improvement of social infrastructure geared to realizing its vision for the future (growth strategy, etc.), alongside the vision itself.

It is important that central government focus on the creation and improvement of social infrastructure stock that will enhance Japan's international competitiveness. Future economic growth and improvement in the standard of living, requires not only the creation of tangible assets, such as buildings, machinery and facilities, but also the accumulation of intangible assets such as technology and knowledge. The concept of social infrastructure should be expanded to include intangible assets and the emphasis in the allocation of public investment should be shifted.

Local governments should pursue initiatives geared to revitalizing local economies and improving the standard of living for local residents. One problem that has been identified with systems whereby central and local government each supply a share of the funding, as in "directly funded projects" and "subsidized projects", is that they make it more difficult for public investment instigated by local government to reflect local needs, and there is strong pressure from local governments for a review of such systems. Consideration should be given to reducing or even abolishing central local government's contributions to "directly funded projects" and central government's contributions to "subsidized projects". In conjunction with the reduction or abolition of subsidies, sources of funding should be transferred to local government under the title of ordinary sources of funding.

For more information on the content of this report, please contact Katsuhiro Hachiya, the Japan Research Institute, Limited.

Tel: 03-3288-4786

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