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SPECIAL ISSUE

THE FEDERAL RESERVE BANK
OF CHICAGO

DECEMBER 2002
NUMBER 184b

Chicago Fed Letter
Midwest infrastructure: Assessing the contribution of basic
infrastructure to economic growth
by Richard Mattoon, senior economist

A recent Chicago Fed conference on the basic infrastructure of the Midwest highlighted
the need for policymakers to better understand which infrastructure investments provide
the greatest economic return. In addition, they need to understand how to price and
manage these infrastructure assets to ensure that investments are efficient and productive.

Readers can access an expanded version of this article,
to be published only on the
Internet, by following the
Research Publications link
to Chicago Fed Letter, 2002,
December (Midwest Infrastructure Issue) from the
Bank’s homepage,
<www.chicagofed.org>.

On September 25, 2002, participants
from government, academia, and business gathered at the Federal Reserve
Bank of Chicago to discuss the role of
infrastructure in the growth of the economy. The conference, cosponsored by
the National Association of State Budget
Officers (NASBO), was designed to assess the condition of the region’s infrastructure and to discuss approaches to
valuing, maintaining, and investing in
these assets. This was the fourth conference in the Chicago Fed’s Midwest
Infrastructure Program.

In his welcoming remarks, Michael H.
Moskow, president and chief executive
officer of the Chicago Fed, noted that
infrastructure systems, such as roads,
water systems, energy, and telecommunications, are key to the economic
health of any region. However, many
analysts believe we are under-investing
in these critical assets. Moskow challenged the conference participants to
explore methods for pricing and managing our infrastructure assets to ensure that infrastructure investments
are efficient and productive.
Scott Pattison, executive director of
the conference cosponsor, NASBO,
noted in his opening address that the
conference was particularly timely given the extraordinarily difficult budget

challenges currently facing the states.
With operating budgets being strained,
there is a concern that investments in
infrastructure may suffer. Pattison said
that in this context, it is particularly
important that policymakers understand the contribution of infrastructure to their state’s economy.
What is the condition of the basic
infrastructure of the region?

Rick Mattoon, a senior economist at the
Chicago Fed, provided an overview of
the condition of the basic infrastructure
assets of the five states (Illinois, Indiana,
Iowa, Michigan, and Wisconsin) that
comprise the Seventh Federal Reserve
District. While the condition of roads,
water systems, and buildings in the region is not substantially different from
that of the rest of the nation, various
measures do suggest that the condition
of the Midwest’s infrastructure assets
could be improved upon. For example,
Illinois, Iowa, and Wisconsin all reported slightly over 35% of their road
pavement as being in either poor or
mediocre condition. The national average is 27%. Indiana and Michigan
fared only slightly better, reporting
scores of 24% and 34%, respectively.
One source of relatively good news
comes in the form of District capital
management practices. A 2001 study

by Governing magazine found that District
states are making progress on establishing
the systems that will help track the condition of their infrastructure and are taking
steps to catch up on their maintenance.
District scores ranged from a high of A–
in Michigan to a low of B– in Indiana.
Infrastructure and development

The conference participants next considered the relationship between infrastructure and economic development.
Geoffrey Hewings, director of the
Regional Economics Applications Laboratory at the University of Illinois, presented evidence of the changing role
(and growing importance) of transportation infrastructure in the Midwest
economy. Hewings emphasized that with
the fragmentation of production, the
various parts of the region have become
increasingly interrelated. This changing
relationship between producers and
suppliers has made transportation infrastructure a critical component in
competitiveness. For example, in the
Chicago area, the average firm is more
dependent on external suppliers and
external markets than in the 1970s
and 1980s. This has left firms more dependent on inter-regional trade. The
efficiency with which this inter-regional
trade is conducted is largely dependent
on an efficient transportation network.
In this context, Hewings stressed that
transportation infrastructure should be
seen as an input to efficient production
on par with other inputs like raw materials, labor, and capital.
Hewings also warned about the effect
that bottlenecks in transportation could
have on economic development. Using
the example of constraining the Chicago
railroad transportation system at its 2005
capacity, Hewings estimates such a bottleneck would cost the Chicago region
almost $2 billion in lost output and nearly 18,000 jobs by 2020.
Chicago’s railroad freight infrastructure was the topic of the presentation
by Karyn Romano, transportation director with the Metropolitan Planning
Council. The council was the lead agency in a coalition of groups that produced
a 2001 study called “Critical cargo,”
which suggested a regional strategy

for enhancing the freight transit system.
Romano began by emphasizing Chicago’s
dominant role as a freight hub. The
freight system contributes $8 billion to
the region’s economy and is responsible
for 117,000 jobs. Chicago is the third
largest intermodal shipping hub in the
world with over half of U.S. container
traffic passing through the region.
Romano reported that freight volumes
are expected to rise significantly through
2020; however, the system needs significant improvements to ensure Chicago’s
premier position. The current system is
burdened by congestion and engineering problems such as an excessive number of railroad grade crossings. The
system is also inefficient in terms of transferring rail freight. Freight transfer often requires the use of trucks; a more
efficient system would transfer goods
from one train to another.
Romano noted that the study makes
three recommendations for improving
the region’s rail infrastructure. First, there
is a need to organize public and private
support for a package of capital improvements, including establishing a freight
corridor, building grade separations, and
upgrading intermodal connector routes.
Second, the report recommends aggressively pursuing federal funding. Finally,
it recommends creating a regional
public/private freight entity to help
manage the region’s freight system.

between roads and productivity by allowing road-building activities to respond
to overall economic conditions. He also
tried to relate the dependence of individual industries on roads to increases
in productivity in their industry. Presumably, industries with lots of vehicles use
roads more intensively and should receive a significant benefit from road
investment. Finally, Fernald’s model allows for roads to be subject to congestion. His study found that the rate of
return for roads was significantly higher before 1973 (when the interstate highway system was being built) than in the
period that followed. Fernald suggested that while building a first interstate
highway system would be highly productive, building a second system would
obviously be more duplicative and less
productive. Fernald also found that
vehicle-intensive industries benefited
disproportionately from the interstate
highway system but that the data did
not support the view that roads offer
an abnormal return on the margin.
Fernald concluded by suggesting that
the macroeconomic literature has not
made the work of policymakers much
easier. They still must answer the question of where infrastructure projects
make the most sense and which projects
reflect the best investment.

The last panel of the morning discussed
the productivity of infrastructure investments. Senior economist John Fernald
of the Chicago Fed presented his research on the returns to investments in
highways. The correlation between the
value of road stock and changes in labor
productivity since World War II has interested macroeconomists as a research
question. The challenge has been to
establish the causality of this relationship. Does public capital increase productivity or does increased productivity
encourage investment in public capital?
It is also possible that this is a spurious
correlation or reflects a set of common
factors affecting both measures.

Randy Eberts, executive director of the
Upjohn Institute, offered his views on the
value of the transportation system to the
region’s economy. He suggested that the
key question in assessing the value of infrastructure is not whether transportation
systems are important to the economy but
rather whether additional investments
in transportation systems contribute to
economic growth. Part of the challenge of
answering this question is that economic
development is a complex process, affecting income and product generated
within a region. Increases in these factors
can in turn lead to gains in jobs, income,
quality of life, environmental preservation, and even sustainable development.
Transportation infrastructure can support these outcomes by improving access to employment or production and
improving connectivity between cities.

In conducting his research, Fernald
attempted to measure the relationship

Eberts suggested two tools for assessing
the contribution of transportation

How productive are investments?

infrastructure to these economic development goals—benefit–cost analysis and
macro-production function estimates.
Making these assessments requires understanding the complex relationship
between infrastructure system facility
characteristics (such as lane miles, grade
and pavement conditions), facility outputs (access, traffic flow, speed, and reliability) and outcomes (productivity,
income/output generation, job creation,
and business location).

assets. For example, regional airport capacity needs to be expanded. Interstates
and tollways need greater capacity and
rebuilding. New infrastructure is needed
to deal with suburban and exurban (development that is neither fully suburban
nor rural) congestion. In addition, existing mass transit needs rehabilitation and
expansion. Other infrastructure needs
are improvements to freight systems,
renewing older urban infrastructure,
ensuring a reliable energy supply, and

Congestion is limiting the productivity of many of Chicago’s
infrastructure assets.
Eberts reviewed the literature estimating
the returns to investments in highways.
Generally speaking, studies suggest that
the U.S. is currently not under-investing in transportation infrastructure. The
one-time super returns to highway
projects have been replaced by normal
returns that are typically less than returns
to private capital. However, Eberts cautioned that individual regions might be
over- or under-investing in transportation, depending on the needs of their
economy. While highways are clearly necessary to stimulate growth, they cannot
do so without other factors being present.
Infrastructure and Chicago

Keynote speaker Dave Schulz, director
of Northwestern University’s Infrastructure Technology Institute, described the
role infrastructure has played in the history of the Chicago area and its continuing importance to the city’s economy.
Schulz suggested that Chicago and much
of the Midwest economy has been built
on big infrastructure. However, the city
and the region seem to be losing that
advantage and the area is facing significant infrastructure challenges. Schulz
noted that infrastructure is what made
Chicago a dominant location in the country. This infrastructure included work
on ports and rivers, pollution control,
potable water, rail construction, public
transportation, airports, and highways.
Today, the region faces significant infrastructure problems. Congestion is
limiting the productivity of many of these

sorting out telecommunications. Schulz
suggested that a particular opportunity for the region would be a high-speed
rail network linking midwestern cities.
He suggested that this could help integrate the region’s economy, while maintaining Chicago’s dominance as the hub
of the Midwest.
To accomplish these projects and overcome a seeming lack of will to build infrastructure, Schulz suggested several
strategies. Among these were: educating
people about the importance of infrastructure; restoring public confidence
in the infrastructure industry; taking
measures to mitigate negative impacts
from projects; and building interdisciplinary project teams to design and build
infrastructure. Most of all, Schulz emphasized the need to make “visionary”
plans that integrate all phases of the infrastructure life cycle from planning
and design, to construction, to operations and maintenance, to monitoring
and evaluation. Schulz concluded his
push for reinvigorating Chicago’s infrastructure by quoting Teddy Roosevelt,
who said “make the dirt fly!”
Infrastructure asset management

The next conference topic touched on
best practices for infrastructure asset
management. Roemer Alfelor from the
Office of Asset Management of the Federal Highway Administration described
work underway to provide guidance
to states on how to best manage their
transportation assets. Alfelor provided

a definition of asset management as a
“strategic approach to optimal allocation of resources for the management,
operation, and preservation of transportation infrastructure.” A good asset management system creates a feedback loop
that links six key elements, ranging from
data collection and inventory through
performance monitoring, and developing alternatives to program development, implementation, and monitoring.
Asset management is becoming easier
as new tools and analytic techniques are
becoming available that improve the
quality of information necessary for
decision support.
Alfelor reported that state departments
of transportation are beginning to adopt
asset management programs, particularly since the public is demanding greater
accountability for maintaining the roads.
Michigan is among the lead states in
adopting asset management. Alfelor also
stated that the importance of asset management has risen as our highway infrastructure has aged and states have taken
on a larger role in highway maintenance.
He concluded by noting that it is the
role of the Office of Asset Management
to provide technical assistance and leadership in encouraging states to use asset
management principles.
James Fountain, assistant research director for the Government Accounting
Standards Board (GASB), then discussed
the impact of GASB Standard 34 on
Michael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research; Douglas
Evanoff, Vice President, financial studies; Charles
Evans, Vice President, macroeconomic policy research;
Daniel Sullivan, Vice President, microeconomic policy
research; William Testa, Vice President, regional
programs and Economics Editor; Helen O’D. Koshy,
Editor; Kathryn Moran, Associate Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago. The views expressed are the
authors’ and are not necessarily those of the
Federal Reserve Bank of Chicago or the Federal
Reserve System. Articles may be reprinted if the
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the reporting of capital assets by state
and local governments. GASB 34 focuses on government performance by requiring state and local governments to
report the value of capital assets. This
makes it easier to assess whether capital
assets are being properly maintained.
Fountain noted that there are several
reasons to report capital assets. First, it
helps users determine whether the current-year revenues cover the cost of current year services. Second, it allows an
assessment of the service efforts and costs
of programs. Third, it allows a better
assessment of the deterioration or improvement in a government’s financial
position. Finally, it allows an assessment
of the service potential of long-lived
physical assets.
GASB allows some flexibility in how governments account for their capital assets.
A government can base its infrastructure
reporting on the historical cost of the
infrastructure (or if records are inadequate, the estimated historical cost) or
it can use the modified approach that
relies on condition assessments of infrastructure at least every three years. Currently, many governments are opting for
the modified approach, but Fountain
noted that this approach is no less rigorous. He concluded by defining a performance-based asset management
system as “a holistic and systematic approach to asset development and preservation that promotes maximum service
performance at minimum life-cycle costs.”

Regional governance for infrastructure

Cameron Gordon, executive director
of the Advisory Council of Intergovernmental Relations, next turned to the
topic of optimal regional governance
for making infrastructure investments.
Gordon noted that understanding the
value of infrastructure is a tricky process. Often the benefits go beyond the
obvious physical value of the structure
to indirect benefits, such as changes in
organization and management. For
example, when the railroads were built,
organizational and management changes introduced time zones and standardized schedules, which were benefits
above and beyond the rails themselves.
Gordon said that four organizational
factors should be kept in mind when
managing regional infrastructure. These
are scale (size of operations), scope
(range of activities), structure (internal
patterns of authority and communication), and strategy (long-range objectives). The goal is to combine these
four factors to produce infrastructure
synergies that decrease unit costs for
scale, scope, and structure.
Gordon next discussed the complexity
of defining appropriate infrastructure
regions in the context of the American
federalist system. Without formal guidelines, regional infrastructure arrangements have ranged from coalitions, to
compacts, to multistate commissions, to
regional authorities. Examples include

the Appalachian Regional Commission
and the Midwest Regional Rail Initiative. The success of regional infrastructure governing structures is hard to
assess, but systems can be designed to
create measures for new regional infrastructure management systems. Gordon
provided a template with a checklist for
planning regional infrastructure systems.
Using the template requires analyzing
a project’s dimensions by characteristics
like service area, infrastructure service
provided, physical assets, jurisdictions
involved, and management and fiscal
capacity. Each of these characteristics
needs to be assessed against the criteria
of scale, scope, structure, and strategic
objectives to properly assess its contribution to the region. With a rising need
for regional infrastructure, establishing
effective governance structures will be
critical to planning, building, and managing regional projects.
Conclusion

The presentations at the conference
clearly demonstrated that it is critical
for policymakers to understand the economic value of infrastructure. This goes
beyond accounting for the condition of
infrastructure to an understanding of the
specific value of individual infrastructure
projects to economic growth. For policymakers to make informed choices
about scarce resources, more work needs
to be done to assess the marginal value
of specific infrastructure projects.


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