Steven P. Lanza

English

Research Papers in Economics

4  THE CONNECTICUT ECONOMY  SPRING 2009
By STEVEN P. LANzA
As the recession spirals downward, it 
is spinning off some new buzz words.   
Suddenly,  education  is  all  the  rage, 
and infrastructure is in vogue again. 
Connecticut  has  long  invested  in 
grade-school education at above-aver-
age levels, though its commitment has 
wavered  in  recent  years.    Moreover, 
the state has redoubled both current 
spending and capital investments at 
the post-secondary level, moving from 
the  back  to  past  the  middle  of  the 
pack.  Tight budgets threaten those 
gains,  but  the  governor  and  legisla-
ture are determined to preserve them.   
And  the  federal  stimulus  promises 
more  funding  for  human  and  public 
capital, raising hopes that increased 
spending can jumpstart the economy 
soon and boost its efficiency later. 
BACk TO BASICS
	 The	economic	crisis	is	spawning	a	
back-to-basics	movement,	as	everyone	
makes	do	with	less.		Families	are	switch-
ing	from	$5	lattes	to	home-brewed	Joe,	
repairing	 their	 old	 rattletraps	 rather	
than	buying	sleek	new	sedans,	and	set-
tling	 for	 fresh	 coats	 of	 kitchen	 paint	
instead	 of	 costly	 home	 makeovers.	
Firms	that	aren’t	announcing	layoffs	are	
returning	to	leaner	workforces	through	
attrition	 and,	 forswearing	 the	 latest	
in	 new	 technology,	 squeezing	 extra	
life	out	of	older	computers	and	other	
equipment.	
	 Government	 is	 getting	 back	 to	
basics,	 too.	 	 In	 a	 revival	 of	 old-time	
pragmatism,	policymakers	are	dusting	
off	 vintage	 tomes	 on	 Keynesian	 eco-
nomics,	with	its	emphasis	on	counter-
cyclical	fiscal	policy,	in	their	quests	for	
effective	responses	to	increasingly	dire	
economic	conditions.		
ECON 101
	 Education	 and	 infrastructure	
investments	 are	 a	 cornerstone	 of	 the	
Obama	 administration’s	 economic	
stimulus	package.		The	plan	includes	
more	than	$500	billion	in	new	spend-
ing,	most	of	it	targeted	at	improving	
infrastructure	and	education.		The	rest	
will	go	to	fiscal	relief	for	states,	health	
care,	and	income	support	like	unem-
ployment	and	food	stamps.		
	 Long	 out	 of	 fashion	 with	 the	
increased	 stability	 of	 the	 macroecon-
omy	 in	 recent	 years,	 Keynesian	 eco-
nomics	 stressed	 the	 demand	 half	 of	
the	 economy’s	 supply-and-demand	
balance.	 	 (Keynes	 was	 a	 Depression-
era	 British	 economist	 who	 advocated	
increased	 government	 spending	 to	
extricate	 economies	 from	 recessions.)	 	
On	the	demand	side,	goods	and	servic-
es	are	either	consumed	by	households	
(C),	used	for	investment	by	businesses	
(I),	procured	by	government	for	public	
uses	 (G),	 or	 sold	 to	 foreigners,	 after	
netting	 out	 our	 purchases	 of	 goods	
and	services	produced	abroad	(eXports	
-	iMports).		In	equilibrium,	aggregate	
demand	 (C	 +	 I	 +	 G	 +	 X	 –	 M)	 will	
equal	aggregate	supply	or	output,	more	
commonly	known	as	Gross	Domestic	
Product	or	GDP.		Currently,	with	both	
consumers	(-C)	and	businesses	(-I)	cut-
ting	back,	and	our	foreign	trading	part-
ners	in	economic	slumps	of	their	own	
(-X),	total	demand	is	sagging,	output	
has	been	reduced,	and	the	economy	is	
sinking	deep	into	recession.
	 The	classic	Keynesian	prescription	
for	 the	 current	 economic	 malaise	 is	
increased	 government	 spending	 (+G)	
to	offset	the	declines	in	C,	I	and	X-M.	
Moreover,	the	economic	kick	is	typi-
cally	not	limited	to	the	size	of	the	ini-
tial	increase	in	government	spending.	 	
Keynes Rules: Human and Public 
Capital Spending to the Rescue
Long out of fashion, 
J.M. Keynes stressed the 
demand half of the 
economy’s supply-
demand balance.Through	a	multiplier	process,	the	new	
spending	 raises	 the	 incomes	 of	 some	
who,	 by	 boosting	 their	 own	 spend-
ing,	 raise	 the	 incomes	 of	 others—a	
process	repeated	over	and	over	again.	 	
According	to	Moody’s	Economy.com,	
the	multiplier	for	infrastructure	spend-
ing	is	a	relatively	high	1.59,	meaning	
an	extra	dollar	of	spending	raises	total	
GDP	by	$1.59.		Aid	to	states	carries	a	
multiplier	of	1.38.		Tax	cuts,	in	con-
trast,	 can	 have	 multipliers	 of	 1.0	 or	
less,	as	much	of	the	added	income	is	
channeled	 toward	 savings	 or	 paying	
down	debt.
	 In	choosing	among	stimulus	mea-
sures,	however,	we	should	not	ignore	
the	supply	side	of	the	equation,	which	
emphasizes	 that	 how	 government	
spends	the	money	can	have	an	impact	
on	the	economy’s	future	productivity,	
once	the	economic	storm	has	subsid-
ed.
ThE IMpACT Of EDUCATION AND 
INfRASTRUCTURE ON gROwTh 
	 Economists	 commonly	 study	 the	
economy’s	 supply	 side	 using	 produc-
tion	function	models.		Just	as	a	recipe	
tells	 how	 to	 mix	 various	 ingredients	
to	create	a	finished	dish,	a	production	
function	describes	how	factors	of	pro-
duction,	chiefly	capital	and	labor,	are	
combined	 to	 produce	 economic	 out-
put.		The	amount	of	output	will	vary	
with	the	quantities	and	characteristics	
of	the	inputs	used	in	the	production	
process.
	 Output	indeed	varies	considerably	
across	 states.	 	 In	 2006,	 for	 example,	
per-capita	 GDP	 ranged	 from	 a	 high	
of	$64,000	in	Delaware,	to	a	low	of	
$24,000	 in	 Mississippi;	 Connecticut,	
at	$53,000	per-capita	ranked	second.	 	
And	much	of	the	variation	in	output	
traces	 to	 differences	 in	 the	 quantity	
and	quality	of	the	inputs	used	in	the	
production	process.
	 To	see	why	current	policy	propos-
als	are	putting	so	much	emphasis	on	
education	and	infrastructure,	it	helps	
to	 partition	 both	 the	 labor	 and	 the	
capital	 terms	 into	 two	 components.	
Labor	can	have	a	quantitative	dimen-
sion—the	share	of	the	population	in	
the	 workforce,	 for	 example—and	 a	
qualitative	 one,	 such	 as	 the	 educa-
tional	 attainment	 of	 the	 population.	
Similarly,	 we	 can	 divide	 capital	 into	
a	 private	 component—the	 plant	 and	
equipment	 used	 by	 businesses—and	
a	 public	 one—roads,	 bridges,	 and	
SPRING 2009  THE CONNECTICUT ECONOMY  5 
But in choosing stimulus 
measures, we should not 
ignore the supply side of 
the equation.
SPENDING ON SCHOOLING RAISES 
state educational attainment
Coefficient values measure the change in the dependent variable (in italics) associated with a change in the independent variables listed 
(in percent terms for per-capita GDP and unit terms for educational attainment).  The p-values are estimates of the likelihood that these 
coefficient values occurred by chance.  The smaller the p-value, the more statistically significant the result.
Variable Coefficient P-value Variable Coefficient P-value  
Intercept 5.86 0.00 Intercept 2.98 0.55
Labor 0.42 0.06 College Spending 
($000)  1.26 0.00
Percent B.A. 0.37 0.00 Grade School 
Spending ($000)
1.68 0.04
Private Capital 0.26 0.00 Percent Foreign Born 0.42 0.00
Public Capital 0.13 0.06 Percent White 0.08 0.09
HUMAN AND PUBLIC CAPITAL 
BOOST state gdp per capita
HOW FACTOR INPUTS CONTRIBUTE
 TO STATE ECONOMIC OUTPUT
SOURCE: The Connecticut Economy.
0.0
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t Variable Coefficient P-value Variable Coefficient P-value  
Intercept 5.86 0.00 Intercept 2.98 0.55
Labor 0.42 0.06 College Spending 
($000)  1.26 0.00
Percent B.A. 0.37 0.00 Grade School 
Spending ($000)
1.68 0.04
Private Capital 0.26 0.00 Percent Foreign Born 0.42 0.00
Public Capital 0.13 0.06 Percent White 0.08 0.09schools,	for	instance.	Assuming	these	
resources	are	indeed	productive,	we’d	
expect	that	raising	either	the	quantity	
or	 quality	 of	 labor	 or	 increasing	 the	
amount	of	either	type	of	capital	would	
boost	an	economy’s	output.
	 Let’s	test	that	idea	using	a	cross-
sectional	regression	model	of	per-capita	
output	across	the	fifty	states	for	2006,	
the	 latest	 year	 for	 comparable	 data.	 	
The	table	(p.	5,	left)	shows	the	results	
of	the	regression.	Each	of	the	four	fac-
tors	in	this	simple	production	model	
contributes	 to	 the	 output	 of	 goods	
and	 services,	 just	 as	 theory	 predicts.	
Together,	 the	 four	 variables	 explain	
almost	two-thirds	of	the	nearly	three-
fold	variation	in	state	GDP	per	capita	
found	in	the	2006	data.
	 In	 this	 simple	 model,	 the	 esti-
mated	coefficients	are	elasticities	that	
show	the	sensitivity	of	output	to	varia-
tions	in	inputs.		The	larger	its	elasticity,	
the	greater	the	contribution	a	factor	of	
production	makes	to	output.		The	elas-
ticity	for	physical	labor	is	the	winner,	at	
0.42.	Holding	other	factors	constant,	a	
ten-percent	increase	in	the	share	of	the	
population	in	the	workforce	increases	
per-capita	output	by	4.2	percent.
	 The	qualitative	dimension	of	labor	
is	nearly	as	important.		A	ten-percent	
increase	in	the	share	of	the	population	
with	a	bachelor’s	degree	raises	output	
by	 3.7	 percent,	 presumably	 because	
better-educated	 workers	 are	 better-
skilled	and	more	productive.		
	 Less	important	is	the	contribution	
made	by	physical	capital:	increasing	it	
by	ten	percent	expands	output	2.6	per-
cent.		A	similar	boost	to	public	capital,	
or	 infrastructure,	 adds	 only	 half	 as	
much,	1.3	percent,	to	output.
	 Connecticut’s	high	rank	in	GDP	
per	 capita	 traces	 to	 the	 high	 quality	
and	quantity	of	its	factor	inputs.		The	
share	of	the	population	employed	and	
the	quantity	of	public	capital	available	
to	workers	are	both	above-average,	by	
about	3%	and	5%,	respectively.		But	
it	is	in	its	stock	of	human	and	private	
capital	 where	 the	 state	 really	 shines.	 	
At	nearly	34%,	we’re	fourth	from	the	
top	in	the	percent	of	the	population	
holding	a	bachelor’s	degree	or	higher,	
compared	 with	 a	 50-state	 average	 of	
26%.		And	private	capital	per	worker,	
estimated	 by	 allocating	 the	 nation’s	
capital	stock	across	states	by	industry,	
stands	some	29%	above	average.
	 Given	these	resources,	the	model	
predicts	that	Connecticut	would	rank	
seventh	among	states	with	a	per-capita	
GDP	 of	 $43,000.	 	That	 we	 actually	
come	 in	 $10,000	 higher	 than	 pre-
dicted,	 at	 $53,000,	 may	 be	 due	 to	
the	 higher	 efficiency	 of	 Connecticut	
inputs,	or	to	other	factors	not	captured	
in	this	simple	model.
BUyINg BETTER hUMAN CApITAl
	 Human	 capital	 appears	 to	 offer	
a	 larger	 return	 on	 investment	 than	
does	physical	infrastructure.		But	can	
we	be	sure	that	increased	government	
spending	 will	 actually	 translate	 into	
improvements	 in	 educational	 attain-
ment?		After	all,	academic	success	can	
potentially	depend	on	a	host	of	other	
demographic	factors.
	 A	separate	regression	(p.	5,	right	
table)	 tests	 the	 strength	 of	 the	 con-
nection	between	current	spending	on	
education	and	educational	attainment.	 	
Assuming	that	the	workforce	mirrors	
the	general	population,	with	a	median	
age	 of	 40	 nationwide,	 the	 “typical”	
worker	with	a	B.A.	started	grade	school	
in	1971	and	finished	college	in	1988.	 	
Regressing	 educational	 attainment	 in	
2006	 against	 real	 per-student	 educa-
tional	expenditure	during	those	earlier	
years,	 after	 controlling	 for	 important	
demographic	influences,	shows	a	sig-
nificant	 link	 between	 spending	 and	
achievement.
	 Spending	 an	 additional	 $1,000	
per	student	in	1982-84	dollars	annu-
ally	during	grade	school	(worth	$2,100	
at	 today’s	 prices)	 raised	 the	 popula-
tion’s	share	of	bachelor’s	degrees	by	1.7	
points.		A	similar	increase	in	post-sec-
ondary	spending	boosted	educational	
attainment	by	1.3	points.		Considering	
that	 increased	 college	 spending	 needs	
to	be	sustained	for	just	four	years,	as	
opposed	to	13	years	for	grade	school,	
higher-education	spending	appears	to	
be	the	better	bargain.
	 Spending	on	education	at	all	levels	
in	Connecticut	during	the	’70s	and	’80s	
exceeded	the	50-state	average	by	more	
than	15%.		For	higher	education,	how-
ever,	that	lofty	perch	reflected	healthy	
outlays	 by	 private	 colleges.	 Ranked	
by	 government’s	 spending	 on	 public	
colleges	and	universities,	Connecticut	
landed	just	one	spot	above	the	bottom	
quintile	in	the	early	1980s.
	 As	the	accompanying	scatterplots	
show,	 Connecticut	 has	 maintained	 a	
lead	 in	 funding	 elementary	 and	 sec-
ondary	education	in	recent	years,	and	
has	 made	 significant	 improvements	
since	1990	in	its	commitment	to	pub-
lic	higher	education.		Both	charts	com-
pare	the	relative	position	of	each	state	
in	1990	(horizontal),	to	2004	(verti-
cal),	with	per-student	spending	in	both	
6  THE CONNECTICUT ECONOMY  SPRING 2009
PER-STUDENT GOvERNMENT 
SPENDING FOR GRADE SCHOOL
SOURCE: The Connecticut Economy, based on U.S. Depart-
ment of Education data.
Indexed spending 1990
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PER-STUDENT GOvERNMENT 
SPENDING FOR COLLEGES 
UNIvERSITIES
Indexed spending 1990
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CT
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CT
SOURCE: The Connecticut Economy, based on U.S. Depart-
ment of Education data.SPRING 2009  THE CONNECTICUT ECONOMY  7 
years	 indexed	 to	 100.	 	 Connecticut	
spent	 more	 at	 the	 grade	 school	 level	
than	the	50-state	average	in	both	years:	
by	47%	in	1990,	and	by	a	less	generous	
26%	in	2004.		A	similar	comparison	for	
college	spending	shows	a	more	marked	
change:	Connecticut	went	from	spend-
ing	12%	less	than	average	in	1990,	to	
19%	more	than	average	in	2004.		Only	
one	other	state,	Pennsylvania,	managed	
a	more	dramatic	shift	in	priorities.
	 By	other	measures,	the	state’s	sup-
port	for	public	higher	education	appears	
less	steadfast.		Like	many	states	in	the	
northeast,	Connecticut	has	a	long	tra-
dition	 of	 sending	 many	 of	 its	 col-
lege	students	to	private	institutions	of	
higher	learning,	a	practice	in	evidence	
across	a	range	of	educational	statistics.	 	
Our	state	spending	on	higher	educa-
tion	 per	 high	 school	 graduate—an	
index	of	institutional	commitment	to	
publicly-funded	 higher	 education—is	
still	only	40th	in	the	nation.	We’re	in	
the	middle	of	the	pack	when	it	comes	
to	education’s	share	(K-college)	of	total	
government	spending,	and	spending	as	
a	percent	of	GDP	places	Connecticut	
fourth	from	the	bottom.		
DON’T fORgET ThE SMAll STUff
	 The	returns	to	investments	in	pub-
lic	 capital,	 though	 smaller	 than	 for	
education	 spending	 directly,	 are	 also	
positive.		Part	of	the	public	education	
budget	is,	in	fact,	earmarked	for	capi-
tal	 outlays	 on	 buildings,	 classrooms	
and	 equipment.	 	 And	 the	 spending	
patterns	seen	for	current	expenditures	
on	education,	as	discussed	above,	are	
largely	repeated	in	the	case	of	capital	
spending.	
	 Thanks	 to	 UConn	 2000	 and	
related	 capital	 investment	 projects,	
Connecticut	has	jumped	from	spend-
ing	barely	one-quarter	of	the	average	
state	 allotment	 for	 capital	 improve-
ments	in	1990	to	a	sum	that	exceeded	
the	50-state	average	by	11%	in	2004.	 	
Only	 New	 Hampshire	 did	 more	 to	
boost	investment	in	higher	education	
public	capital	over	this	period.
	 The	 Nutmeg	 State	 has,	 however,	
failed	to	maintain	a	consistently	high	
level	of	support	for	capital	investments	
at	the	elementary	and	secondary	level.	 	
In	1990,	per-pupil	capital	spending	in	
Connecticut	 exceeded	 the	 average	 by	
17%,	 ranking	 us	 13th	 among	 states.	 	
By	 2004,	 we	 had	 slipped	 to	 28th,	
spending	some	7%	less	than	average.
	 In	 fact,	 the	 state’s	 track	 record	
of	 investment	 in	 all	 forms	 of	 public	
infrastructure—roads,	 bridges,	 build-
ings,	 and	 the	 like—has	 been	 mixed.	 	
Granted,	we	do	rank	an	estimated	10th	
among	 states	 in	 the	 stock	 of	 public	
infrastructure	per	worker	in	fiscal	year	
(FY)	2006.		But	Connecticut	was	one	
of	a	handful	of	states	that	allowed	its	
public	 infrastructure	 stock	 to	 shrink	
during	 the	 1990s	 (see	 graph).	 This	
estimate	is	based	on	capital	spending	
data	from	the	U.S.	Census	Bureau	that	
stretch	back	to	1991,	and	assumes	that	
investment	 that	 year	 was	 sufficient	
to	 offset	 wear	 and	 tear	 on	 the	 then-
existing	 stock.	 Summing	 the	 stream	
of	spending	in	subsequent	years,	after	
adjusting	for	rising	prices	and	depre-
ciation,	produces	a	working	estimate	of	
the	real	capital	stock	in	2006	and	the	
intervening	period.	
	 UConn	 2000	 notwithstanding,	
Connecticut	has	made	relatively	little	
overall	improvement	to	its	infrastruc-
ture	 in	 recent	 years.	 	 Between	 FY	
1992	 and	 2006,	 Connecticut	 added	
less	than	two	percent	to	its	total	real	
stock	of	public	capital,	compared	with	
a	50-state	average	of	12%.	Only	Rhode	
Island	 posted	 a	 more	 meager	 gain.	 	
And	like	our	tiny	neighbor	to	the	east,	
Connecticut	 brings	 home	 middling	
grades	 at	 best	 on	 state	 infrastructure	
report	cards.	(See	Arthur	Wright’s	dis-
cussion	 of	 the	 rankings	 by	 the	 Pew	
Center	on	the	States	on	page	8,	and	also	
CFED’s	 latest	 Development	 Report	
Card	for	the	States	at	www.cfed.org.)
lEMONS fROM lEMONADE
	 With	 the	 economy	 currently	 in	
recession,	 businesses	 are	 paring	 their	
workforces	and	reducing	their	invest-
ments	 in	 plants	 and	 equipment.	 As	
the	production	function	model	of	the	
economy	makes	clear,	the	consequence	
of	these	cuts	will	be	a	shrinking	econ-
omy.	 	 But	 such	 challenges	 can	 also	
double	as	opportunities.
	 The	model	also	shows	the	method	
in	what	some	regard	as	the	madness	of	
President	Obama’s	ambitious	recovery	
plan:	government	spending	on	human	
and	 public	 capital	 can	 both	 offset	
some	 of	 the	 short-run	 reductions	 in	
private	consumption	and	investment,	
and	pave	the	way	for	a	more	produc-
tive	economy,	once	business	conditions	
improve.	 	 Investments	 in	 education,	
roads,	 bridges,	 and	 public	 buildings	
have	long	been	the	province	of	govern-
ment,	and	the	federal	government	in	
particular	is	in	the	best	position	of	any	
major	economic	actor	at	the	moment	
to	ramp	up	its	spending.
	 Connecticut	can	become	a	prime	
beneficiary	 of	 the	 stimulus	 plan’s	
focus	on	education	and	infrastructure.	 	
Though	 we	 currently	 enjoy	 ample	
stocks	of	human	and	public	physical	
capital,	the	state’s	efforts	at	augmenting	
these	resources	have	been	spotty.		State	
and	local	budget	cuts	will	make	that	
job	no	easier.		An	infusion	of	federal	
aid	may	help	to	build	the	state’s	future	
productive	capacity,	or	at	least	mitigate	
the	worst	effects	of	the	belt	tightening	
that	will	accompany	leaner	State	and	
municipal	budgets.
CONNECTICUT LAGS IN 
ExPANDING PUBLIC CAPITAL
SOURCE: The Connecticut Economy, based on the U.S.  
Census of Governments.
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RI

Keynes Rules: Human and Public Capital Spending to the Rescue

http://cteconomy.uconn.edu/articles/SL_S2009.pdf

Keynes Rules: Human and Public Capital Spending to the Rescue

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