The Productivity of Social Capital and the Effectiveness of Public Investment

ABSTRACT

The marginal product of social capital has fallen to approximately one-half over the past 30 years. This indicates that the public investment that creates social capital is not functioning effectively. The need for a reduction in public investment due to fiscal deficits and the accumulation of government debt is asserted, but the drop in productivity suggests not only quantitative problems but also the urgency of "qualitative reform" in public investment.

There are serious impacts on productivity associated with public investment being biased towards civil works and construction. Firstly, because the productivity of the construction industry is lower than that of the manufacturing industry, an expansion of the share of the construction industry results in a drop in overall productivity. In other words, this may be described as the evil of resources, such as capital and labor, being diverted from highly productive sectors and instead going to sectors with low productivity. The second reason is that in the construction industry R&D is lagging behind, which gives little hope for the medium to long-term growth through technological progress.

The bias toward civil works and construction is not only due to the rights and interests of politicians and bureaucrats. First, the production inducement effect of the construction industry, if limited to each prefecture and observed only in the short-run, appears to be larger than that of high-tech industry. There is therefore a tendency for local governments that lack a long-term strategy to rely on construction projects. Second, it is also problematic that policy makers tend to overburden public investment, needlessly expanding its roles and expecting too much from it.

In the current situation, the aims of public investment can be classified into the following four categories: (1) The provision of social capital, (2) Fine-tuning of the economy, (3) Stimulation of local employment, and (4) Redistribution of income between regions. However, too much emphasis on (3) and (4) has caused "a crisis in the productivity of social capital" through a bias towards civil works and construction. It is necessary to go back to (1), the original aim of public investment, and restrict (2) to the projects that achieve (1).

With regard to (1), the original aim of public investment, priority should be given to the provision of social infrastructure in cities and in the high-tech sector. It is known that constructing roads and railways is still productive in city areas. Additionally, in the high-tech sector, new public goods and services, such as ITS, the computerized government services, the provision of databases of intellectual information, are still too small, and are likely to have a large marginal benefit.