Wednesday, October 26, 2011

Borrow and Build No Sure Bet for Highways

Perhaps the most frequent argument of those who support taking on more debt for highways is that when we  tried a similar debt program in 1999 we "won" because highway construction costs shot up from 2000-2004 at an inflation rate that was in excess of the interest rate we paid on the bonds.   My counterargument has been that they are fighting the last war.   Even if they are correct that they "won" in 1999 using a strategy of borrow and build, it does not mean that the same bet will be a winning one for the next five years.  If you won, great.  Now walk away from the roulette wheel.   This is not a time for us to borrow money to give you more chips.

I used data from Oregon because they had a handy set of graphs, but I could have used data from Washington or many other places.  The pattern is pretty clear.  While over the course of decades there has been inflation ever since we left the gold standard, there are ups and downs over the course of a single decade.   From 2000-2006 we were in a liquidity fueled boom and had significant inflation in road construction costs.   In 2007 the wheels started to come off the economy due, and that accelerated in 2008 and continued at the beginning of 2009.   Obama's stimulus road money helped jump-start surfacing costs in 2009, but that money is mostly spent now.  One could expect downward cost pressures to resume.   The underlying problem in our economy of too much bad debt has not been solved.

So that same "borrow and build" strategy that they argue "worked" from 1999 to 2004 would have been a disaster from 2008 to present (with Obama's stimulus spending only partially masking the scale of the disaster).   It would have left us paying interest with construction costs that would have been if anything higher than if we had waited a year or two.  

There are other variables to consider as well.   Example: Consider the growing use of oil resources from oil shale and oil sands.   It is very heavy oil.   That means to get a given number of gallons of gasoline, they produce a larger amount of asphalt than they have in the past using say, West Texas Crude.   And that could mean a growing glut of asphalt on the market.    I expect the price to continually drop in the coming years relative to dollars adjusted for bond interest rates.

My position is that they are not smart enough to know which outcome will prevail over the next five years.  It is risky, not conservative, to borrow on the idea that our government officials can repeatedly out-nimble the market with regard to hitting the sweet spot between swings in construction costs and swings in interest rates.  Bear in mind, they cannot even issue all of the bonds for about three years.   We cannot know today what the situation will be then either with regard to construction costs or interest rates.  To believe otherwise is to have a naive faith in the abilities of government officials- again far from the conservative position of healthy skepticism about the good things government can do with more OPM.


Blogger Mark Moore (Moderator) said...

If borrowing to the max and spending up front is really the most cost efficient way to go, then why are a bunch of road contractors funding the group trying to get the debt passed?

It is clear they can bid higher and make more money if a bunch of jobs go up at once rather than have them stretched out a bit.

If you have five firms in a region with X capacity for building, then floating 8x capacity worth of jobs in a short stretch allows them all to make higher bids knowing that if they lose the early bids they will get one of the later ones because the competitors who won the early bids have no capacity to compete on later bids.

12:40 PM, October 26, 2011  

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