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Our Quasi-Soviet Fiscal Policy

Kevin Villani

“It’s like deja vu all over again.”

Do Yogi Berra‘s words of wisdom apply to the “new” trillion dollar “public infrastructure” program? The last program, still unpaid, focused on “shovel-ready” projects but somehow missed most potholes. Meanwhile, private companies are prepared to spend $100’s of billions on a new fiber optic internet super highway.

Is the current proposed public spending program more likely to pay off for taxpayers than the last one?

Historical Precedent

When the hammer and sickle flag was lowered for the last time in Moscow on December 25, 1991, the international finance agencies created in Bretton Woods in 1944, led by British economist John Maynard Keynes and the Undersecretary of the U.S. Treasury Harry Dexter White, found a new mission.

Russia’s capital stock was in poor condition, but not for lack of funding.

The International Monetary Fund (IMF), which is a “bank” according to Keynes, provided the financial infrastructure for international trade. The World Bank (WB), or a “fund” according to Keynes, was promoted by, known communist and accused Russian spy, Undersecretary White to help reconstruct European infrastructure, but primarily Russia’s infrastructure, in the wake of WW II destruction.

The IMF lost its raison d'être in 1971 after President Nixon eliminated dollar convertibility into gold, ending the Bretton Woods function. Russia turned down World Bank membership, so the Bank turned to lending for infrastructure projects in the “underdeveloped” nations, which by 1991 faced overwhelming political obstacles.

Assisting in the conversion of formerly centrally planned economies into capitalist market economies became the finance agencies’ new post-Soviet mission. However, few people had much of an idea of how to accomplish this. It had never been done before, and the IMF and WB were particularly ill-equipped as their charter limited them to lending only to governments. They were essentially statist organizations with little experience with (or sympathy for) competitive private markets (which helps explain why they remain chronically underdeveloped).

Russia’s capital stock was in poor condition, but not for lack of funding. The saving rate was about six times that of western democracies (albeit by force), but the return to state-allocated investments was decidedly negative, as continues to be the case in China (where the resulting credit bubble may soon burst).

Zero Productivity, Raises for Everyone

In early 1992, I found myself on a WB mission. The intention was to help create housing markets in Russia, where the housing stock was poorly located and maintained, that quickly morphed into a government plan to build housing for returning Afghan war veterans (who were armed and potentially dangerous, hence an important political constituency).

The first problem we faced was in obtaining building materials. In particular, there was a serious shortage of sheet rock for interior walls. My interview with the “President” of one of the few production organizations, a recently “self-privatized” state enterprise, went something like this:

Me: So, how is it going?

If the purpose of government spending is to “create high paying jobs” then the sheetrock firm was a smashing political success.

President: Spectacular, I gave all the employees a 100 percent raise.

Me: But there are no workers.

President: That is because that stupid West German machine still isn’t working.

Me: Why not? They are usually of the highest quality.

President: It needed oil!

Me: So?

President: Who can afford oil when labor costs so much?

When I returned six months later, I got the same story; wages up another 100 percent but still no oil–and no sheet rock.

Failing Infrastructure

Crazy, right, but it can’t happen here? Well, if the purpose of government spending is to “create high paying jobs” then the sheetrock firm was a smashing political success.

State and local governments in the U.S. already do that all too well. “It is routine now for firefighters to be up over $200,000, $300,000,” said Mark Bucher, chief executive officer of the California Policy Center, a public policy think tank. That doesn’t count pension costs, which exceed wage costs for many municipalities in spite of the fact that, several years ago, unfunded pension liabilities were estimated at $3.0 trillion (and I would double that).

Fiscal federalism is intended to further reduce or eliminate public accountability and control.

The growing public sector wage bill doesn’t produce or maintain public infrastructure. For decades the American Society of Civil Engineers has been warning that deferred maintenance creates ever greater problems. By 2013 the national grade was D+, and is expected to decline with this year’s quadrennial report. The situation isn’t much different at the federal level, where Labor costs are artificially lowered by sub-contracting.

Nobody likes a flunking infrastructure grade. But the problem isn’t insufficient total state and local taxation: total annual tax revenue is about $3.4 trillion. Nor is it a problem of financing, i.e. the inability to issue general obligation or revenue bonds: there is about $3 trillion in outstanding debt, about two-thirds of which is revenue bonds. Fixing the infrastructure shouldn’t be about “creating American jobs:” Soviet state enterprises could do that.

We have a principal-agent problem like that of the Soviet factory manager. State and local employees have undue control of their governments. Taxpayers simply don’t have enough control over their political agents to prevent the diversion of public funds.

Fiscal federalism, a system resembling the Soviet distribution of funds from the center to the oblasts (and on to state-owned enterprises), is intended to further reduce or eliminate public accountability and control.  

If at First You Don’t Succeed

Past initiatives for “public improvements,” which go back to the Nation’s founding, have flooded the swamp. Democrats since the Clinton Administration have advocated for a national infrastructure bank, another government-sponsored enterprise, that is more like the WB in its practice of lending and accountability (or lack thereof). Now political advocates demand direct control that favors their labor and Wall Street constituents.

President Trump plans to provide accountability for new infrastructure projects with public-private partnerships and opaque tax subsidies. That is not unlike Fannie Mae and Freddie Mac’s model of public risk for private profits that subsidized the subprime lending bubble. To ensure that infrastructure investments are “good deals” for the public, the government should avoid bailing out states that are filling the swamp, stick to purely federal infrastructure improvements and calculate the ROI to taxpayers as a business, or better still, finance it themselves.

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