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The world around us is crumbling, literally. Every year economies around the world spend
trillions of dollars on providing services that do nothing to increase our day-to-day
wealth or prosperity, they simply slow down the failure.
The only way that an economy will ever become wealthy is if it invests in infrastructure.
Countries with better infrastructure are always going to be more prosperous than
countries with poor infrastructure, but this all comes with one major trade-off that neither
economists, policy makers or engineers putting this all together have a good answer to.
But there are plenty working on that solution, and if they find it,
they could easily double the wealth of the global economy in less than a decade and
probably make themselves the wealthiest person or group in history while doing it.
The largest and most profitable companies in the world which account for a significant
amount of total global output only exist because of investments made into universally available
goods and services like roads, ports, mail and even less physically obvious things like
education and defence. Governments around the world have obviously taken this advice on board.
Infrastructure development is rarely far from the lips of policy makers,
and entire countries have developed their economies around infrastructure projects.
In the USA, the new deal, a primarily ambitious infrastructure spending plan,
got the economy back on track following the great depression.
Today, following covid, it's the build back better plan.
It's not just the USA either, most of the greatest economic success stories in the past century
began with or were greatly assisted by big, decisive infrastructure development.
Normally, this stuff is provided by the government and is funded through taxpayer money.
In some rarer examples, like resource-rich countries,
these projects can be funded through other state revenues,
and sometimes these services are completely privatized.
There are genuine pros and cons to all of these systems,
but either way, either directly or indirectly, it's regular,
everyday people that end up paying for these tools, and no matter how it's funded,
they all have the same problem, maintenance.
Maintenance might sound like a boring part of infrastructure,
which is a boring part of economics, which to a lot of people is a boring field of science.
But the truth is that this is potentially the most important challenge in all of macroeconomics,
and it could fundamentally explain economic success stories and failures all over the world.
And it's not just us saying that.
Adam Smith, the founder of economics as its own discipline,
knew this, and he spent a large part of his seminal text, The Wealth of Nations,
talking about the importance of infrastructure in building, well, the wealth of nations.
While governments are happy to listen to the first part of his advice that talks
about the benefits of nation-building, they tend to ignore the warnings that,
like all things in economics, infrastructure has its own opportunity costs,
and when handled poorly, it can doom an economy just as easily as it provides that opportunity.
So, does infrastructure spending put a timeline on the economic prosperity of an economy?
Is there anything that can be done about this problem, and if not,
what does it mean for economies around the world today?
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Now before we get too far into it, infrastructure for the sake of economics is anything that
facilitates the production of goods and services, and normally economists reserve this definition
for physical structures, so a bridge would be infrastructure,
but a robust financial services sector wouldn't be.
In reality, economists probably overused this word to basically mean anything that
can be set up today to make life more prosperous tomorrow, so talks about financial infrastructure,
policy infrastructure, legal infrastructure are all common even though they wouldn't
technically fit the typical definition.
Any industry is going to require some level of infrastructure to be competitive,
even something that is mostly service-based like banking still utilizes internet infrastructure
or electronic infrastructure, and if we want to stretch the definition they also
benefit from national defence and education.
Companies could provide all of these services for themselves theoretically,
but it would be an enormous upfront expense, so they are going to be more competitive if
they don't need to pay for it and can instead benefit from most of these as public services
or privatized services.
An amazon van will drive on a public road where it will be protected by public law enforcement
after their customers place an order using an internet service that is either also public
or provided by another company.
Amazon is a big organization, but not even it would be able to provide all of the infrastructure
it uses to provide the goods and services that it does.
Looking at it like this it's easy to assume that infrastructure spending
is always a good investment because industries like this can either directly or indirectly
generate tax revenue which can pay for more infrastructure.
Infrastructure development is also a huge employer and it boosts economic output just
by itself, so for governments that want to kickstart their economy after a lull or perhaps
just to make things look better than they really are, infrastructure spending is the
old reliable solution.
The problem is that this only works when there is a genuine demand for the tools being supplied.
Sri Lanka is facing a major ongoing economic crisis at the moment following years of what
looked like an economic miracle.
The country grew its economic output rapidly between the mid-2000s and the mid-2010s,
making itself one of the fastest-developing economies in the region, which was a region
full of rapidly developing economies in its own right.
The reality behind this success though was that the country was just taking on a lot
of debt to build big infrastructure projects.
Now this by itself is not a problem, if Sri Lanka ever wanted to be a globally competitive
economy it was going to need roads and ports and electrical grids to support modern industries.
In the long term this could provide stable economic growth, but in the short term the
country got addicted to the rapid growth it could achieve by just investing into more
infrastructure.
If a country builds a bridge it's going to employ thousands of people to get that
done.
Everything from engineers and labourers all the way down to local business people hiring
extra staff to accommodate for the extra workers around the site.
The construction of a bridge also counts as economic output, as it should, which increases
GDP.
A country can borrow lots of money and use it to build infrastructure which will employ
lots of people and make the economy look like it's growing.
But once that construction project is done, that employment will shrink back down and
the economic growth of that year will appear as an outlier unless the economy produces
more to make up for the fact that it will no longer have produced a bridge.
A solution, but not necessarily the right solution, is just to keep on building.
Usually economists are supportive of developing countries in particular building more infrastructure,
so it's easy for these countries to get loans to fund these projects.
Nations can also feel perhaps overly comforted by the fact that if they are ever struggling
to pay off their debt they can just privatise part of their infrastructure, often making
more money than the infrastructure costs to build in the first place.
If a country like Sri Lanka borrowed 10 billion dollars to build an electrical grid it would
give it a 10 billion dollar boost to its GDP, employ a lot of people and provide electricity
to homes and businesses across the country to further increase economic output.
A Sri Lankan student might code the foundation for a multi-billion dollar company,
but they would never get that opportunity without readily available electricity.
More immediately factories that want to take advantage of lower wages in Sri Lanka could
open without having to supply their own generators which will make them much more competitive.
Whatever the exact mechanism this electrical grid also provides ongoing economic benefits.
The 10 billion dollars that the Sri Lankan government spent in this example is also not
wasted, and a lot of times in reality the value of that electrical grid could be significantly
more than the price it costs to put it in, because private companies will want to buy
it so they can make money off the growing country paying for electricity.
For this example, let's say it's worth 15 billion dollars if it got sold to an international
utilities company. This increases what economists call capital stock, or the combined value of
every piece of infrastructure in the economy. Investment either funded by savings or debt
will increase the value of this capital stock, preferably more than the value of the loan used
to make that investment. So this is great, the country made a potential profit while boosting
GDP and employment massively in the short term and helping it out consistently in the long term.
It becomes easy to see why countries want to keep on doing this.
The problem is that not every project is going to do you this much good.
Once Sri Lanka ran out of roads and utilities and bridges and ports it fell into the trap of
building stuff that it didn't need just to keep a growing number of people working in the
construction industry employed. I really wish there was a better analogy for it,
but it's a lot like someone sick being given medications by their doctor.
In the correct doses it can massively improve that person's health and get them up and running
sooner than they otherwise could. But it's easy to get used to the boost that these medications
can give and overdo it, becoming dependent on it at the expense of long-term health.
There is the assumption that public goods like these do not need to generate economic returns
because they are public goods. While this is true that they don't need to generate profits
in the traditional sense, it's still very important that major projects like this
eventually produce more value than they consume.
Sri Lanka in particular is a lower-income developing economy,
so lenders see it as much riskier to lend money to than say the United States,
and because of that they demand a higher interest rate.
If off the back of their building success with the electrical grid Sri Lanka decided to build
a stadium that also cost 10 billion dollars, that might be harder to generate a return on.
It would still boost GDP and employment, but long-term ticket sales and events might
struggle to make up more than the interest on the loans that were used to pay for it.
If the government does enough of these projects,
they could start to run into serious problems with paying their loans.
If that's then combined with a major economic shock like a global pandemic,
local political instability, or anything like that, then the government is going
to need to raise money fast. It can privatize its industries,
but if things have already gotten this desperate, the major companies that would
have once loved to invest into an electrical grid in an up-and-coming country might be less
excited about making that same investment into a country where people are now struggling with
mass unemployment and the government can't even pay back its loans.
Double-digit annual economic growth can be a great thing, especially when it's happening in
a country where that growth could pull millions of people out of poverty, but if it's not managed
in a sustainable way it can end up putting the economy in a worse position than when it started.
Now so far we've been picking on Sri Lanka because it's a recent real-world example of
exactly this kind of thing playing out, but this happens all the time,
and it might be happening on an even grander scale in the world's second-largest economy,
China.
China has also sustained some of the most intense economic growth in history,
and a large part of that was fuelled by infrastructure spending.
Given its massive population, strong geography, and lax industrial regulations,
for a long time the capacity of the country's industry was restricted by infrastructure,
although it hasn't been for a while now.
But the government in China had become used to the immense economic growth they had consistently
delivered.
Now as always we have to give the big disclaimer that economic statistics from China are notoriously
unreliable, but even figures that are barely more than propaganda are starting to paint a pretty
grim picture.
The government, government-run corporations, and private households have all taken on a
lot of debt to fuel a bubble of infrastructure development that is looking increasingly
unstable.
Governments at various levels in the country have developed entire cities with the anticipation
that an urbanising population will eventually move into them.
Since all land in China is owned by the national government and can't be purchased,
it's making a lot of money by renting these parcels of land to developers for 99 years.
Local governments benefitted from the spending that was done to connect these new developments
to basic utilities with infrastructure, the developers benefitted from selling expensive
apartments to the general public, and homebuyers benefitted from owning apartments that kept
on going up in value thanks to the economic growth of the country.
Unfortunately it was this system that was creating most of that growth, and eventually
China with its now shrinking population realised that there were only so many homes that people
needed.
Now in fairness China still had very strong export-focused and domestic industries to
support this whole system, but if anything that just allowed it to go on for longer than
it really should have.
Investment into this kind of infrastructure also came at the expense of investment into
industries that could have improved the long-term economic capacity of the country.
If anything, setting up all of these cities scattered around the country
pulled people away from the productive industrial centres on the coast.
All of this debt-fuelled spending may have increased output while it was happening,
and it did increase the country's capital stock, but it filled it with stuff that wasn't
really needed.
We have already made an entire video on just one example of this, the country's once
coveted high-speed rail network, which ran out of major cities to connect to, and so
just started connecting to regions that couldn't justify the volume of traffic that high-speed
rail needs to remain economically viable.
To make matters worse, the simultaneous development of the country's airports and local airlines
meant it was both cheaper and faster to fly between most of the more remote locations.
This was a clear example of overdevelopment that was done to maintain economic growth
and keep the various groups within the country happy.
But it's far from the only one, make sure to subscribe because we have a new video coming
out that's going to be an extensive deep-dive into the crumbling facade of the Chinese economy.
But for now, part of the reason that major projects in a lot of advanced economies around
the world never seem to go anywhere is because organisations exist to do feasibility studies
to make sure resources aren't wasted on infrastructure that won't provide an economic
return.
Once a country reaches a certain level of development, most projects won't contribute
that much additional value, and in richer, more developed countries, they're also
naturally going to cost more to build, further weighing down the cost-benefit analysis that
economists should be doing when this much money is at stake.
In the rare cases that exploratory planning commissions find something that could work,
assuming it also gets past the various other bureaucratic hurdles that government projects
have to do, there is the temptation to hold onto that plan until a downturn,
so the spending involved in it can be used as a stimulus measure.
Of course, there's no way to know for sure, but a lot of the projects announced in the
Build Back Better plan and similar infrastructure plans around the world probably fell into that
kind of situation.
Filling up a country's capital stock with lots of stuff that isn't really needed is a
waste of resources, and will inevitably cause major problems with debt if the country is
taking out loans to fund it.
But that's not even the biggest problem.
So far we've been working with the assumption that all of this infrastructure lasts forever,
and even if it doesn't do any good, it won't do any harm apart from the interest on the
debt that the country has to pay back.
But all of this requires maintenance.
Wear and tear, corrosion, damage due to extreme weather, and just plain old obsolescence are
not counted in most headline economic figures that people pay attention to, like GDP.
They do, however, subtract from this capital pool every year at a rate that can quickly
account for a large portion of total output.
Just corrosion, mostly brust on all of the infrastructure that is made out of steel,
costs the global economy approximately 3.5 trillion dollars every year,
about 3.5% of global GDP.
That is a larger number than the GDP of all but the 5 largest economies in the world.
Put another way, the entire country of India could dedicate its entire economic system
to just rust, and it still wouldn't cover all of the damage this does, slowly and silently,
from the second these new projects are finished.
Rust is also only one component of maintaining infrastructure.
Collectively, the resources that the world dedicates to just maintaining the resources
that it already has could conservatively be 6-7% of global GDP.
That's not a marginal improvement either.
If this issue was somehow fixed tomorrow with some revolutionary new building technology,
it would change the world more significantly than the internet or the steam engine.
Annual growth compounds, and if we weren't consistently losing value every year,
we would grow capital stock far faster than we could today,
even with dedicated and perhaps reckless investments.
If we discovered a technology that eliminated this waste at the turn of the new millennia,
just 23 years ago, the world would be three times wealthier than it currently is.
Of course, that's a big if, and we live in a tough world that is hard on the things that we build.
So until we find a miracle solution, the best that we can do is to make sure what we are
building is going to help with this race against a slow decay, rather than accelerate it.
Thanks for watching mate, bye.