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Government investment is remarkably effective

Government investment is frequently derided as wasteful and ineffective. And definitely worse than private investment. But is this true? A new study shows that public investments on average are a remarkably effective way to boost the economy.

The authors of the study collected macro data for 18 developed economies between 1965 and 2019 and estimated the impact of an increase in public or private investment.

Let’s start with the private side because here the picture is unequivocally positive. After 20 years, every additional dollar, pound, euro, etc. invested by private companies increases the GDP by about two dollars. In the US, the exact ratio is 1.99 dollars for every dollar of additional private investment which equates to an annual return of around 3.5%. In the UK the multiplier is somewhat lower at 1.89x for an annual return of 3.2%.

Figure 1: Marginal productivity of total investment after private investment impulse

Source: Afonso et al. (2024)

When it comes to public investments the picture becomes more complex. First, the direct return on additional public investment is more likely to be negative than in the case of private investments. This is because public investments are often made in unprofitable areas to attract private capital or boost nascent industries. In this instance, the government acts like an insurance company that takes the loss to provide a safety net for private investors to come in and boost the industry or region. The combined effect of private and public investments on economic output can then be positive even though the public investment itself had a negative return.

The second chart shows how good governments are in creating additional GDP from public investments and here I was surprised about two things.

First, I was surprised to see how diverse the outcomes are between the major economies shown. In the US, public investment really seems to be wasteful and destroy output. Or US public investment simply isn’t geared towards attracting private investments and boosting economic output because most of the economy is fully privatised leaving only areas that are intrinsically loss-making to the government. But outside the US, the multiplier is positive and higher than the multiplier for private investments (typically above 2x).

The second thing that surprised me was the tremendous multiplier of UK public investment on UK GDP. Every additional pound the government invests in the UK turns into 9.3 pounds of additional output after 20 years. That’s a return of 11.8% per year.

I really have no idea why the UK is such an outlier, but even if we ignore that, the results of this study are clear: Public investments work and are remarkably efficient in boosting long-term growth. In most countries more so than private investments. Now, all we need to do is convince the public that they should welcome additional government investment even if it means lower spending in other areas like welfare.

Figure 2: Marginal productivity of total investment after public investment impulse

Source: Afonso et al. (2024)

 

Joachim Klement is an investment strategist based in London. This article contains the opinion of the author. As such, it should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of the author’s employer. Republished with permission from Klement on Investing.

 

16 Comments
James
May 27, 2025

Still waiting to see the return on investment of the billions and billions spent on education in this country! Seems to be an inverse relationship. Anyone really going to claim that our children are getting smarter? What about the billions spent on indigenous causes. More and more tax payer money doesn't seem to make much difference. Again that weird inverse relationship. Wouldn't have anything to do with government not being a good allocator of capital though, would it!? Is our un-costed, opaque, not fully disclosed investment in renewables making power more reliable and cheaper? Will electricity ever be cheaper as promised? Why is it so expensive to do or build anything of scale in Australia? Nothing to do with the cosy arrangement of Labor governments and the likes of the CFMEU (who have a stranglehold on government infrastructure), especially in Victoria. $240 k to hold a Go/Stop sign anyone? But no government are good allocators of capital it seems! What alternative reality is this?

Former Treasury policy maker
May 27, 2025

OK James, perhaps try this counter-factual. What would our economy look like if we'd not spent money on education? If kids never went to school?
There's your return in investment right there - we are an advanced nation. Could be better, but we are a capable and productive economy.

James
May 27, 2025

Now you're just being silly! Nowhere did I suggest not spending money on education. I questioned the efficacy of the huge uptick in spending! 

Laurent
May 28, 2025

Now you're just being silly !
1. Everybody wants the best education for their children and is ready to pay a lot of money for it.
2. I agree that education for Australian children should be paid for by the taxpayer. This would make sure that every child gets an education regardless of their parents' income.
3. The key question is WHY should education be public and not private ? Why should schools be run by the government rather than by private entrepreneurs ? Why do we have 65% of Australian children enrolled in public (government) schools, and only 35% in Catholic and independent (private) schools ?
My preference goes to EDUCATION CHECKS that would be taxpayer-funded and handed over to parents to be used for their children's education into schools of their choosing. My guess is that, for the same cost, private schools are more efficient at educating children than public schools. NAPLAN results would show how public/private schools compare.

Former Treasury policy maker
May 28, 2025

OK James. It was not at all clear that's what you meant. Although I'm still not clear what you mean. What "huge uptick" and over what time period are you talking about? The return on education spending comes back over decades so you must have in mind something done by the Hawke-Keating government or earlier.

Seriously
May 26, 2025

Another expert report which defies real world outcomes. We have all witnessed epic government failures and misallocation of taxpayer funds.

If the UK has achieved such stellar economic multipliers how come it has been an economic basket case since the GFC? its not like the public sector is underdone and not omni-present.


Former Treasury policy maker
May 26, 2025

So, "Seriously", your casual look at government projects is more reliable than a proper study? You can't be serious!

Hugh A
May 25, 2025

Perhaps the key is how well it’s done - how could Australia have developed without government investment in ports, towns, roads, railways, dams? It was a capable long-term investor in essential infrastructure - what private investor could have done it and how many private investors would hold patiently rather than flipping the asset to another(foreign-owned ?) investor at an early opportunity? To repeat, maybe it’s how well it’s done rather than who does it.

John
May 24, 2025

The government’s investment in steel production in SA and venturing into solar panel production in the Hunter should be interesting and provide further data for this study.

Trevor
May 24, 2025

I like how the NSW government built sections of WestConnex and then sold them off to fund the construction of further sections.

Former Treasury policy maker
May 23, 2025

NDIS is not an investment- not intended to be and in economic terms it isn't. Always intended to be a health cost. The cost has blown out for all sorts of reasons, but it's not relevant to this article.

Neil
May 23, 2025

Are Snowy Hydro, NBN and NDIS examples of good govt "investment"?

Theo R
May 23, 2025

Ah Neil,

And yet by far the largest infrastructure project ever undertaken, the Snowy Mountains Scheme, then costing 15% of annual GDP, was an overwhelming success.

Nice try though.

Paul
May 23, 2025

I don’t think an example from over 60 years ago disproves that many more recent government funded schemes in the last few decades have blown out by double or multiples more. The Snowy mountains hydro power scheme from the 1950’s has nothing to do with Snowy Hydro which was a boondoggle created by the Turnbull government trying to straddle the climate deniers and being seeing to do something.

Theo R
May 22, 2025

Daryl,

That doesn't prove anything and certainly doesn't disapprove the study.

Love the cherrypicking though.

Darryl Middleton
May 22, 2025

Is the Vic Govs 'investment' in hosting the Comm Games remarkably effective?

 

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