A Note on Infrastructure Investment and Government Debt

November 19, 2014
Jock Finlayson

The Business Council recently published a white paper on infrastructure policy and financing in British Columbia. One of the points made in the paper is that investing in certain categories of infrastructure assets – particularly transportation, communications and energy infrastructure – can help to strengthen the foundations for prosperity by boosting productivity, expanding the economy’s ‘supply side’ capacity, and improving the competitive position of local industries engaged in global commerce. This argument is advanced in some detail in the International Monetary Fund’s October 2014 World Economic Outlook publication. According to the IMF, there is often a positive supply side effect from public infrastructure investment, “as the productive capacity of the economy increases with a higher infrastructure capital stock.”

The government plays an important role in developing and financing infrastructure. The IMF notes that because the “social return” from investing in infrastructure typically is greater than the “private return” that would be generated if the investment were made by a for-profit owner, historically a substantial share of infrastructure “has…been provided by the public sector, public-private partnerships, or regulated private entities.” However, in recent decades, governments in many advanced economies have cut back on spending on infrastructure, with such spending falling by approximately one-quarter measured relative to the collective GDP of the major industrial countries. The benefit of a stepped-up pace of spending on infrastructure was a key theme at the recent G-20 Summit of leaders held in Brisbane, Australia. At the conclusion of the Summit, the G-20 leaders committed to a Global Infrastructure Investment Initiative that aims to address the estimated $5 trillion global need for infrastructure.

Closer to home, the BCBC paper documents the ongoing infrastructure-related pressures facing municipalities, the health care sector, and the lower mainland transportation system. Now would seem to be an opportune time for governments to allocate additional resources to building and rehabilitating infrastructure. There is still some slack in the province’s economy. More importantly, government borrowing costs, as proxied by yields on ten-year provincial (and national) government bonds, are running at less than 2.5%, even though expectations for future inflation are firmly anchored at about 2%. Finally, at 18% of GDP, the provincial government’s net debt is still relatively low; Ontario and Quebec, for example, are grappling with net debt/GDP ratios of 40% and 50%, respectively.

In today’s financial environment, the “real” or inflation-adjusted cost of borrowing for credit-worthy governments is in the vicinity of half of one percent (or less). Rarely in modern history have real borrowing costs been so low. Yet the BC government is planning to reduce capital spending over the next two years. The 2014 BC budget projects that tax-supported[1] provincial capital outlays will fall from $4 billion this year to $3.6 billion in 2015-16 and then $3.3 billion the following year.

BC Government Capital Spending
in the Current Fiscal Plan
($ millions)

2013-14 2014-15 2015-16 2016-17
Taxpayer-supported 3,466 4,030 3,665 3,282
Self-supported 2,500 2,590 2,215 2,013
Total 5,966 6,620 5,790 5,295
Source: February 2014 BC Budget.

A case can be made that the province should re-visit the capital spending portion of its three-year fiscal plan to take advantage of exceptionally low borrowing costs and accelerate needed infrastructure-related spending. We believe the same argument applies to the federal government. Most economic forecasters believe that, by the end of this decade, ten-year government bonds will be approximately twice as “expensive” as they are today, as measured by market yields. While policy-makers understandably want to maintain solid credit ratings and ensure that debt is carefully managed, it is also important to recognize that the era of astonishingly low interest rates will not last indefinitely. Why reduce capital spending on infrastructure projects that will be required within the next decade, when the cost of money is almost guaranteed to double within the next 3-4 years?

Of course, even in fields where governments have traditionally dominated in the provision of infrastructure, there is scope to tap outside capital and private sector innovation to help finance, develop and manage infrastructure. With Partnerships BC, the province is already recognized as a global leader in this domain. The emergence of large pension funds and other institutional investors with an appetite to invest in long-lived infrastructure means that jurisdictions looking to build new infrastructure have more funding options to consider than was the case 10 or 20 years ago.

Finally, for BC, the global economic shift to Asia creates a need and an opportunity to reinforce the competitive advantages that flow from being Canada's gateway to the dynamic Asia-Pacific region - including by making critical infrastructure investments to move goods and people. At the same time, the development of an increasingly knowledge-based economy also has implications for the kinds of infrastructure assets and services that will be necessary to ensure a prosperous future.

[1] Tax-supported capital spending and borrowing excludes BC Hydro, BC Lotteries, ICBC, and the Transportation Investment Corporation (which built and manages the Port Mann Bridge).

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