Discuss the benefits of an increase in infrastructure spending on the UK economy

Edexcel A-Level Economics Paper 1 June 2022 Extract

With reference to Extract B, discuss the benefits of an increase in infrastructure spending on the UK economy. Use an aggregate demand and aggregate supply diagram to support your answer. (15 marks)

Paragraph 1

One benefit of an increase in infrastructure spending on the UK economy is a decrease in the inflation rate. As the government spend more money on infrastructure projects like HS2, this will lead to much better transport links when complete. The government has so far spent around £40 billion on HS2 and Extract B also mentions many smaller examples like reopening Bow Street Station in Wales. Overall, as transport links improve, businesses can improve their labour productivity as workers can produce more output per hour, especially when work involves travel and client visits. This effect can be illustrated with an increase in long-run aggregate supply which shows that the productive potential has increased in the economy. Ceteris paribus (assuming the same level of demand in the economy), there are more goods and services being produced, hence a fall in the price level from p1 to p2, as shown below.

Evaluation

However, increasing spending is likely to be damaging to the UK economy overall as an increase in spending will worsen the budget deficit. This is the difference between government spending and tax revenue in a given year. Higher budget deficits each year accumulate as national debt, which is dangerous. High levels of debt carry a huge opportunity cost as the government must pay back more principal debt but also interest. For example, the UK government paid close to £100m in interest alone, which could have been spent on public services had debt and interest been lower. 

Paragraph 2

Another benefit of an increase in infrastructure spending is an increase in economic growth. The extracts mention plans for the government to increase spending on new capital projects by around £20 billion of additional spending per year. As the government starts new projects this immediately increases aggregate demand (AD) since government spending (G) is a component of AD. This spending also leads to an increase in the demand for labour such as construction workers and admin workers. This will further lead to an increase in consumer confidence and an increase in disposable incomes which usually lead to an increase in consumer spending and therefore a further increase in aggregate demand, as shown below from AD1 to AD3. This is known as the multiplier effect. The diagram also shows an increase in economic growth (real gdp) from y1 to y3.

Evaluation

However, one disadvantage with supply-side policies like this is a huge time lag. This means that there will be a lengthy period between when, in this case, infrastructure spending is increased, to the time when the productive potential actually increases. For example, spending on projects like HS2 in the UK have incurred costs of over £40 billion, but has already taken over ten years and is incomplete.

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