This note sheds new light on the dynamic properties of maintenance and repair and examines the behavior of an additional form of capital spending-that of improvements. The analysis examines a unique long-run data set on Swiss road spending.Capital

Andreas M. Fischer

Michael J. Dueker

English

Research Papers in Economics

WORKING PAPER SERIES
Fixing Swiss Potholes
The Importance of Improvements
Michael J. Dueker
and
Andreas M. Fischer
Working Paper 2001-025B
http://research.stlouisfed.org/wp/2001/2001-025.pdf
December 2001
Revised January 2003
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St. Louis, MO 63102
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Photo courtesy of The Gateway Arch, St. Louis, MO.   www.gatewayarch.comFixing Swiss Potholes*
The Importance and Cyclical Nature of Improvements
November 2002
Michael J. Duekerz
and
Andreas M. Fischery
Abstract
This note sheds new light on the dynamic properties of maintenance and repair and
examines the behavior of an additional form of capital spending—that of improvements.
The analysis examines a unique long-run data set on Swiss road spending.
Keywords: Maintenance and Repair, Improvements, Capital Utilization.
JEL Classiﬁcation Number: E22, E30.
* The authors would like to thank Samuel Reynard and an anonymous referee
for valuable comments.
z Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166, USA.
Telephone: (+1 314) 444 8594
FAX: (+1 314) 444 8731
email: michael.j.dueker@stls.frb.org
y (corresponding Author) Swiss National Bank and CEPR, Postfach, 8022 Zurich,
Switzerland.
Telephone: (+41 1) 631 32 94
FAX: (+41 1) 631 39 05
email: ﬁscher.andreas@snb.ch
11. Introduction
Standard macroeconomic models allow capital to be either employed in production or
idle. Recent studies, however, by McGratten and Schmitz (1999), Collard and Kollintzas
(2000), and Licandro and Puch (2000) consider that capital can also spend time undergoing
maintenance and repair. They ﬁnd empirically that maintenance and repair expenditures
are large and that if this form of spending aﬀects the rate of capital depreciation, then the
dynamic eﬀects of maintenance and repair in model economies are also large. In particular,
such time-varying depreciation rates help model economies capture important dynamics
observed in the U.S. labor market.1
Empirically, private spending on maintenance and repair appears to be countercyclical,
whereas investment in new capital is highly procyclical. Until now, the empirical evidence
that maintenance and repair spending is countercyclical to GDP is limited to McGrat-
ten and Schmitz’s (1999) study using Canadian data. The rationale for maintenance’s
countercyclical behavior is that it is cheaper for the ﬁrm to repair and maintain machines
during periods of lean demand. One avenue we explore here is to examine the cyclicality
of spending on maintenance of public infrastructure, roads in particular.
In this note, we also consider an additional form of capital spending: outlays for im-
provements, which expand the functions or capabilities of existing physical capital. Exam-
ples include the addition of a lane or rest stops on an existing highway or the introduction
1See Ambler and Paquet (1994), Burnside, Eichenbaum and Rebelo (1992, 1996) and King and Rebelo
(2000) for related research.
2of new ﬁlters in engines to improve air or water quality. A priori, it is not clear how
improvements should behave over the business cycle. On one hand, improvements may
increase the productivity of a machine and help expand production during an economic
upswing. On the other hand, improvements, as in the case of maintenance and repair, re-
quire brief periods of shutdown to conduct the upgrades. The opportunity cost of carrying
out improvements might be lower during periods of economic slowdown. Alternatively in
the case of improvements to public infrastructure, the cyclical trade-oﬀ for governments
is that tax revenues are highly procyclical, encouraging spending on improvements during
booms; a countervailing force is that governments often wish to stimulate the economy in
a countercyclical fashion, in which case discretionary spending on improvments might be
countercyclical.
The objective of this note is two-fold; (i) to document the size of improvements relative
to the other forms of capital spending and (ii) to determine whether improvements have
similar cyclical properties as maintenance and repair. To shed some light on these issues,
we look at a unique data set on Swiss road spending. The data are broken down into new
roads, road improvements, and road maintenance and repair (hereafter road maintenance).
The long-run evidence ﬁnds that spending on road improvements is larger in size than
spending on road maintenance and that its cyclical behavior vis-a-vis GDP varies over
time, although both improvements to and maintenance of this type of public infrastructure
are predominantly procyclical.
32. Maintenance, Improvements, and New Roads
The annual data on Swiss road costs are from the Bundesamt f¨ ur Statistik (BfS) and
cover the years from 1927 to 1984.2 Spending on national and cantonal roads is divided
between road maintenance, road improvement and new roads. New road investments rep-
resent new road and tunnel projects, road improvements include the building of rest stops,
additional highway lanes, and safety improvements, and maintenance involves mainly road
resurfacing. The road data are constructed by time of expenditure.
Table 1 shows that our measure of road spending averaged 1:6% of GDP during 1963-
1984 compared to 5.8% for education and 2.8% for research and development for the same
period. The addition of local roads, a component not included in our road measure, would
have increased the percentage to 2.2%.
To gain a sense of the size of road improvements relative to other road outlays, Figure
1 plots spending on road maintenance and road improvement relative to investment in
new roads. The ﬁgure shows that spending on road improvements is larger than road
maintenance for each year except for the WWII period 1940-47. The average percentage
diﬀerence between spending on road improvement and new roads is 29.0 over the full
sample, whereas it is only 16.1 for road maintenance.
Another feature of Figure 1 is that spending on improvements and maintenance relative
2The publication of this information was discontinued after 1984. The data for improvements and
maintenance were not published separately before 1927.
4to new roads shifts over time. During the ﬁrst 30 years of the sample, road improvements
and road maintenance ﬂuctuate considerably and both are larger than new road investment.
In the second half of the sample, new road investment dominates spending on improvements
or maintenance. In particular, new road spending increased substantially in the 1960s
because of expensive freeway and tunnel projects.
Next, to examine business cycle movements in real Swiss GDP and real road spending,
we detrend each series by taking logs and subtracting the trend using the Hodrick-Prescott
ﬁlter to obtain our measure of cyclicality.3 Because the long-run series reveal changing
dynamics, our remarks are aided by rolling standard deviations and correlation, which are
plotted in Figures 2 to 5. The ﬁrst observation concerning the ﬁltered data regards the
low cyclical volatility of road maintenance. Figure 2 shows the rolling 15-year standard
deviation of GDP and the diﬀerent forms of road spending. Road maintenance exhibits the
lowest cyclical volatility, whereas new road investment has the highest.
The second observation concerns the procyclical behavior of Swiss road spending. To
examine the cyclicality, we calculated rolling 15-year correlations of the three types of road
spending with GDP. In evaluating the movement in the rolling correlations, it is useful
to recall Loretan and English’s (2000) caveat that sub-sample and rolling correlations can
change systematically with time-varying conditional volatilities. Suppose that GDP and a
class of road spending have a constant unconditional correlation structure and covariance
3The oﬃcial BfS series for nominal GDP (1948-1984) is linked with the estimated series from Andrist
et al. (2000). Annual CPI is used to deﬂate the nominal variables. The weight on the squared second
diﬀerence of the growth component in the H-P ﬁlter is set to 100.
5matrix, where x is cyclical GDP and y is cyclical road spending:
x = x + xu;
y = y + yu + (1  
2)
0:5yv; (1)
where u and v have unconditional distributions that are independent standard normals,
although they may have time-varying conditional volatilities within the sample.
The conditional correlation coeﬃcient between x and y would vary from its constant
unconditional value  within the sample period according to the conditional volatilities 2
u;t
and 2
v;t:
t =
u;t
(22
u;t + (1  2)2
v;t)0:5: (2)
We take the data x and y and sample-wide unconditional values of (x;y;;x;y) to
derive from equation (1) a time series of values of u and v. From these vectors, we calculate
15-year rolling estimates of (u;t;v;t) and arrive at an estimate of t from equation (2).
To the extent that the time series t can match the rolling correlation coeﬃcients, we
could attribute the movement in the rolling correlation coeﬃcient to conditional volatilities
temporarily deviating from their unconditional values.
Figures 3, 4 and 5 depict the rolling 15-year correlations with the values implied by their
rolling conditional volatilities. Figure 3 shows the correlations for road improvements. Road
improvements have a correlation coeﬃcient with GDP in the neighborhood of 0.5 for most of
6the sample, except between the late 1950s and 1965. In that period, the rolling correlations
become negative, which cannot be explained by a change in relative volatilities and a
constant . For most of the sample period, however, the rolling correlations between road
improvements and GDP are well-explained by a constant underlying correlation structure
() and time-varying conditional volatilities. Road maintenance also experiences negative
rolling correlations with GDP from the late 1950s to 1965. Yet, compared with road
improvements, road maintenance has a much less stable cyclical relationship with GDP.
The rolling correlation between road maintenance and GDP depicted in Figure 4 does not
remain at its volatility-implied level after 1965. Instead, the rolling correlation exceeds
0.8 by the mid-1970s and remains high. We postulate that as the Swiss roadway system
became more complex by the 1970s, planning horizons increased for improvement projects,
making improvement spending less cyclical relative to maintenance spending.
Figure 5 shows that cyclical spending on new roads has the most stable cyclical rela-
tionship with GDP, in that the rolling correlations conform closely to the volatility-implied
levels. Figure 2 shows that the conditional volatilities of both GDP and new road spend-
ing are high at the beginning of the sample, where the Depression ﬁgures prominently,
resulting in a high volatility-implied correlation that matches the actual rolling correla-
tion. The volatility-implied correlation is relatively low from the mid-1960s until the late
1970s, a period when idiosyncratic volatility in new road construction (v;t) holds down
the implied correlation in a way that matches the actual rolling correlations. Thus, the
cyclical correlation between new road spending and GDP is the most consistent with a con-
7stant underlying correlation structure that is perturbed temporarily by volatility changes.
This analysis indicates that road improvements lie between new road spending and road
maintenance in terms of having a stable cyclical relationship with GDP.
3. Concluding Remarks Regarding Improvements
The long-run data on Swiss road spending allow us to make some comparative state-
ments concerning the ﬁndings of the Canadian survey data documented in McGratten
and Schmitz (1999). First, maintenance expenditures do not show tremendous cyclical
volatility, as found previously in the Canadian government, household and business sector.
Nevertheless, the stability of the cyclical correlation between road maintenance and GDP
appears to be lower than that of improvements and new roads. Second, Swiss spending on
road maintenance and on road improvement as a percentage of spending on new roads shifts
substantially over time. McGratten and Schmitz (1999) ﬁnd that the ratio of maintenance
and repair to new physical capital is trendless for the post-1960 period. Our long-run data
shows that this is only true for the period considered in McGratten and Schmitz (1999).
Prior to 1960, Swiss spending on road improvement and road maintenance was much larger
in size than new road spending. This latter result strengthens the view of McGratten and
Schmitz (1999) that spending on maintenance and capital improvements are too large to
be ignored in business cycle analysis.
8References
Andrist, F., Anderson, R.G., Williams, M.M., 2000, “Real Output in Switzerland: New
Estimates for 1914-47,” Federal Reserve Bank of St. Louis Review, 43-70.
Ambler, S., Paquet, A., 1994, “Stochastic Depreciation and the Business Cycle,” Interna-
tional Economic Review 35, 101-116.
Burnside, C. A., Eichenbaum, M.S., Rebelo, S.T., 1992, “Labor Hoarding and the Business
Cycle,” Journal of Political Economy 101, 245-273.
Burnside, C.A., Eichenbaum, M.S., Rebelo, S.T., 1996, “Sectoral Solow Residuals,” Euro-
pean Economic Review 40, 861-869.
Collard, F., Kollintzas, T., 2000, “Maintenance, Utilization, and Depreciation along the
Business Cycle,” CEPR Working Paper No. 2477.
King, R.G., Rebelo, S.T., 2000, “Resuscitating Real Business Cycles,” In: Taylor, J.,
Woodford, M. (Eds.), Handbook of Macroeconomics, Vol. 1C. Elsevier.
Licandro, O., Puch, L.A., 2000, “Capital Utilization, Maintenance Costs and the Business
Cycle,” Annales d’Economie et de Statistique 58, 144-164.
Loretan, M. and English, W.B., 2000, Special Feature: Evaluating Changes in Correlations
during Periods of High Market Volatility, BIS Quarterly Review, June 2000, 29-36.
McGrattan, E.R., Schmitz Jr, J.A., 1999, “Maintenance and Repair: Too Big to Ignore,”
Federal Reserve Bank of Minneapolis Quarterly Review, 2-13.
9Table 1: Type of Activity as a Percentage of GDP (1963-1984)
Public Road Spending (national, cantonal, and local roads) 2.2%
National and Cantonal Road Spending 1.6%
Education 5.8%
Research and Development 2.8%
10-80
-40
0
40
80
120
160
30 35 40 45 50 55 60 65 70 75 80
ln(improv./new roads)*100 ln(maint./new roads)*100
Figure 1: Spending on road improvements and
maintenance relative to new roads (in percent).00
.02
.04
.06
.08
.10
.12
45 50 55 60 65 70 75 80
GDP
IMPROV.
MAINT.
NEW ROADS
Figure 2: Rolling 15-yr. std. devs. of cyclical GDP,
improvements, maintenance and new roads-.8
-.6
-.4
-.2
.0
.2
.4
.6
.8
45 50 55 60 65 70 75 80
ROLLING 15-YR CORR. VOLATILITY-IMPLIED
Figure 3: Rolling correlations between cyclical GDP and
cyclical road improvements and values implied by
volatility changes alone-0.8
-0.4
0.0
0.4
0.8
1.2
45 50 55 60 65 70 75 80
ROLLING 15-YR CORR. VOLATILITY-IMPLIED
Figure 4: Rolling correlations between cyclical GDP and
cyclical road maintenance and values implied by
volatility changes alone0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
45 50 55 60 65 70 75 80
ROLLING 15-YR CORR. VOLATILITY-IMPLIED
Figure 5: Rolling correlations between cyclical GDP and
cyclical spending on new roads and values implied by
volatility changes alone

Fixing Swiss potholes: the importance of improvements

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Fixing Swiss potholes: the importance of improvements

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