When the state spends money on roads and railways, we call it “investment”. When the state spends on nurseries, school meals or health care, we call it social, educational and health spending. Yet like Jakub sawulski and Wojtek Paczos argue that the latter form of spending can generate a higher rate of return in the long run.
The Covid-19 pandemic has triggered a shift in the approach of policymakers to fiscal policy. Unlike the financial crisis that started in 2008, the state is expected to be very active and contribute high levels of spending to stimulate national economies as the pandemic emerges. Many of the projects that have been discussed so far have focused on investing in infrastructure and other drivers of economic development.
But an abundant and growing literature shows that when it comes to public spending, the highest rates of return are not necessarily obtained from spending considered to be investments in the traditional sense. Indeed, the most profitable investments of the state also include spending on early childhood care, education and preventive health care, that is, spending that can build capital. human.
Recent research by Nathaniel Hendren and Ben Sprung-Keyser indicates that the rates of return on public spending are strongly correlated with the age of the beneficiaries. The highest estimated returns were found for measures targeting children. This is coherent with previous research demonstrating that spending on preschool programs and education is extremely cost effective. The basic mechanism is simple: higher skills acquired in school translate into higher economic growth and higher wages in the future, and therefore also higher tax revenues.
But there are also more sophisticated effects, especially when the intervention covers children from low-income families. Children who receive a good education from an early age tend to commit fewer crimes and are less likely to receive social transfers in the future. So they ‘to reimburse” investment with a high efficiency.
Health care is another area of effective public investment, according to previous research. A recent review of the 52 studies that estimate the performance of public health interventions in advanced economies found that, in most cases, the average benefit of health interventions was several times the initial cost. Better health means higher productivity, more economic activity and reduced public transfers, for example with regard to sick leave or early retirement.
The public and private sectors are not rivals
Investment, in simple terms, is a use of resources to obtain future economic benefits. All of the types of public expenditure discussed above meet this definition. However, they are not recognized as such in official statistics. The formal definition of public investment only covers spending on physical capital – something we can see and touch. Thinking about investment in these narrow terms and not in a broader sense can distort our image of the public sector and can create the wrong incentives for public policies when investment spending is used to evaluate government activities.
The consequences may include an excessive focus on expanding and modernizing physical capital at the expense of spending in areas related to human capital development. Additionally, the tech-driven economy is all about non-material assets like software, which are the product of sheer brain power. This is also a reason why the World Bank has recently started to rank countries according to their approach. to human capital rather than their business model.
We take this broader approach and look at data on public and private spending in the 27 states of the European Union (plus the UK). For simplicity’s sake, we assume that public investment in human capital includes spending on education and health. We take a conservative approach and exclude hospital services, assuming they are closer to the function of “saving” human health than “building” human capital through health. So the measure we get is a lower estimate of the rate of investment in human capital.
The main message from our data is that the public sector holds the leading role in building human capital in the economy. On average, public investment in human capital is three times higher than public investment in physical capital. It is also four times higher than investment in human capital in the private sector, as shown in the figure below.
Figure 1: Private investment vs public investment in the EU as a percentage of GDP (2009-19 average)
Source: Compiled by the authors using Eurostat data.
There is another important finding from this data: the public and private sectors are not rivals. While the public sector is more responsible for investing in human capital, the private sector uses this capital to create added value and strengthens it by developing physical capital. Each of these elements is necessary for the success of the economy.
Changing the definition of public investment
The current definition of investment should be broadened to include investment in human capital. Reaching this point will be a long journey. This will require a renewed debate which can hopefully result in a unified approach to what constitutes investment in human capital. This debate will also need to be followed by fundamental but necessary changes in national statistics and the system of national accounts.
The argument we have presented here is a first step towards stimulating this debate. Our hope is that international development agencies will use this approach more often in the future. We believe that a good quantitative understanding of the role of the public sector in the economy is essential for the development of our societies in the 21st century. Development is no longer just a matter of physical infrastructure – intangible intangible assets are just as important as railways and roads.