Infrastructure as supply-side policy

Overview

How improved transport infrastructure raises aggregate supply, infrastructure improve the geographical mobility of labour and investment in digital infrastructure treated as a supply-side priority.

What you need to know

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Questions from this subtopic

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1. 1

   What is meant by infrastructure, and what does it include?

   Model answer

   Infrastructure is the network of large, long-lived capital assets that supports economic activity across the whole economy rather than serving a single firm. It includes transport such as roads, railways, ports and airports, energy generation and distribution networks, water and sewerage, and digital networks including broadband and mobile coverage. Some definitions also include the buildings that house health and education services, since these support the productive capacity of the workforce.

2. 2

   Explain how improved transport infrastructure raises aggregate supply, describing the diagram.

   Model answer

   Better roads and railways cut journey times and reduce congestion, so firms spend less on fuel, drivers' hours and vehicle wear, hold smaller stocks because deliveries are more reliable, and can serve customers over a wider area. Since costs per unit fall across the economy, firms can supply any given output at a lower price, so on a diagram with the general price level on the vertical axis and real national output on the horizontal, short-run aggregate supply shifts right from SRAS1 to SRAS2 and, because the effect is permanent and adds to capacity, long-run aggregate supply shifts right too. At the new equilibrium real output is higher and the general price level is lower.

3. 3

   How does infrastructure improve the geographical mobility of labour?

   Model answer

   Faster and cheaper transport widens the area within which a worker can reach a job without moving house, so someone living in a depressed area can commute to a growing one. This enlarges the effective labour market for firms and gives workers access to jobs that match their skills, reducing the mismatch that causes structural unemployment. Reliable digital infrastructure has a similar effect by allowing some work to be done remotely, so location matters less.

4. 4

   Why is investment in digital infrastructure treated as a supply-side priority?

   Model answer

   Fast and reliable connectivity lowers the cost of communication and of processing information for every business, allows firms in remote areas to reach national and international customers, and makes remote and flexible working possible so the labour market widens. It is also a precondition for adopting many productivity-raising technologies, so without it, other investments deliver less. Because the network has high fixed costs and the benefits spill over to users who do not pay for it, private provision alone tends to leave rural and low-density areas unserved, which is the case for public support.

5. 5

   How does the quality of energy infrastructure affect a country’s cost base?

   Model answer

   Energy is an input to almost every good and service, directly through the power used in production and indirectly through transport and materials, so the price and reliability of supply feed into costs throughout the economy. Adequate generating capacity and a robust network keep prices lower and prevent the interruptions that force factories to stop, while an inadequate network makes firms hold expensive backup capacity. Investment that lowers the cost or improves the reliability of energy therefore shifts aggregate supply right.

6. 6

   Evaluate the use of a large national infrastructure project as a supply-side policy.

   Model answer

   In favour, a well-chosen project can permanently lower transport or energy costs across the economy, improve the mobility of labour, attract private investment to the regions it serves, and provide a demand stimulus while it is being built. Against, such projects take many years to complete so the capacity benefit is very distant, costs frequently overrun, the resources absorbed have an opportunity cost in other public services, and the benefits may be captured by places that are already prosperous rather than the regions that need them. There are also environmental costs and disruption during construction. The judgement rests on whether the appraised benefits are genuine and on whether the project addresses a real bottleneck rather than a political ambition.

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