Boarnet - 1998

JOURNAL OF REGIONAL SCIENCE, VOL. 38, NO. 3, 1998, pp.
381–400
SPILLOVERS AND THE LOCATIONAL EFFECTS OF PUBLIC

INFRASTRUCTURE*
Marlon G. Boarnet
Department of Urban and Regional Planning and Institute of Transportation Studies,
University of California, Irvine, Irvine, CA 92697-7075, U.S.A.
Email: mgboarne@uci.edu
ABSTRACT. This paper examines the possibility of negative output spillovers from
public infrastructure. A model of productive public capital shows that when input factors
are mobile, public infrastructure investments in one location can draw production away
from other locations. In a linear production-function framework, this effect would be
manifested as a negative output spillover from public capital. Using data for California
counties from 1969 through 1988, such negative spillover effects are shown to exist in the
case of street-and-highway capital. The data show that changes in county output are
positively associated with changes in street-and-highway capital within the same county,
but output changes are negatively associated with changes in street-and-highway capital
in other counties.
1. INTRODUCTION
The effect of public capital on the private-sector economy has been the
subject of a large body of recent research. The question, argued vigorously by
both policy analysts and econometricians, is whether public infrastructure
enhances the returns to private factors of production. Yet for all the attention
given to this topic, one important aspect of public capital has been somewhat
overlooked. Public capital is provided at a particular place, and if such capital
is productive, it enhances the comparative advantage of that location relative to
other places. Thus one possible effect of public capital is to draw production into
a relatively infrastructure-rich location, in part at the expense of more infra-
structure-poor locations. That notion, formalized into a hypothesized negative
spillover effect of public infrastructure, is the focus of this paper.
The recent round of production function studies of public capital began with
the metropolitan area studies of Eberts (1986), Deno (1988), and Duffy-Deno
*Eugene Jae Kim and Inha Yoon provided excellent research assistance. I have also benefitted
from discussions with Randall Crane, Amihai Glazer, and Douglas Holtz-Eakin, and from the
comments of three anonymous referees. I am grateful for financial support from the U.S. and
California Departments of Transportation, through a grant administered by the University of
California Transportation Center.
Received January 1996; revised January 1997 and May 1997; accepted May 1997.
© Blackwell Publishers 1998.

Blackwell Publishers, 350 Main Street, Malden, MA 02148, USA and 108 Cowley Road, Oxford, OX4 1JF, UK.
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382 JOURNAL OF REGIONAL SCIENCE, VOL. 38, NO. 3, 1998
and Eberts (1991); however, attention soon gravitated toward Aschauer’s (1989)
analysis of national time-series data. His estimates suggested not only that
public capital was productive, but that, at the margin, public infrastructure
investment would yield higher returns than private-sector capital investment
(Aschauer 1989). Criticism that Aschauer’s and other similar time-series results
were due to spurious correlations led to increased use of state-level panel data
(Jorgenson, 1991; Tatom, 1991). Most of the state studies, when corrected for
unique state effects, showed no association between public capital stocks and
private-sector output or productivity (Evans and Karras, 1994; Garcia-Mila,
McGuire, and Porter, 1996; Holtz-Eakin, 1994; Kelejian and Robinson, 1994).
Most of the recent literature on public capital has focused on whether or
not infrastructure has productive effects and has given relatively little attention
to how productive public capital might shift economic activity from one location
to another. This contrasts with other economic development literatures that
have prominently debated whether economic gains in one location are offset by
losses elsewhere. For example, Bartik’s book on local economic development
devotes an entire chapter to the question of whether such policies are merely a
zero-sum game when viewed from a national perspective (Bartik, 1991, Chap-
ter 8).
This paper examines the locational impacts of public capital by modeling
and testing for a hypothesized negative output spillover from public capital.
Negative output spillovers can result when mobile factors of production migrate
to locations with the best infrastructure stocks. In such cases, the infrastruc-
ture-rich locations gain output at the expense of the places from which factors
of production migrated. The goal of this paper is to test for the existence of
negative output spillovers from street-and-highway capital, using data for
California counties for the years 1969 through 1988. Before the empirical test
is presented, a simple model helps clarify the key ideas.
2. THE MODEL
This section sketches a model of public capital in two cities, A and B. Each
city has one firm and both firms produce identical products with identical
technology. The output of each firm is sold on the world market at price p. The
supply of labor and capital are perfectly inelastic in the short run in each city,
although both factors of production can migrate between cities in the long run.
In order to focus on the productive effects of infrastructure, public capital will
be assumed to be provided at no cost in each city.1
Output in each city is produced according to
Q = α(G)f(L,K)
1
A formal model of tax finance is not needed to demonstrate the possibility of negative output
spillovers. For that reason, a financing mechanism for public capital is not examined in this paper.

BOARNET: SPILLOVERS & PUBLIC INFRASTRUCTURE 383
where:
Q = output;
G = public capital stock in the city;
L = labor inputs employed by the firm;
K = private capital stock inputs;
α ′ (G) > 0;
fL > 0; fLL < 0; and
fK > 0; fKK < 0.
Initially, let LA = LB, KA = KB, and GA = GB, where subscripts denote the city.
Firms in both cities have factor demands that are defined by the marginal
revenue product curves for labor and capital. The choice of G is external to the
firm, such that ∂Q/∂L = α(G)fL(L,K) and, similarly, ∂Q/∂K = α(G)fK(L,K). The
supply and demand for each input factor are equilibrated when the factor
price is equal to the marginal revenue product for that factor, as shown here
for City A:
(1) wA = pα(GA)fL(LA,KA)
rA = pα(GA)fK(LA,KA)
where w and r are the price of labor and private capital, respectively.
Assume that City A increases its endowment of public capital. From Equa-
tion (1), the price of labor and private capital, wA and rA, increase. In the short
run, with fixed factors, the benefits of the increased public capital investment
in City A accrue to workers and the owners of private capital in that city in the
form of higher factor prices. In the long run, the factor-price differential induces
labor and capital migration from City B to City A.
As both labor and capital move from City B to City A, the impact on the
marginal products of labor and capital, and thus on wages and capital prices,
depends on the sign of the second partial derivatives fLK and fKL. Consider first
the case where fLK = fKL = 0. After factor migration is complete, the marginal
revenue product of both labor and capital increase in City B.2 Because wA = wB
and rA = rB in long-run equilibrium, the marginal revenue product of labor and
capital is also higher after factor migration in City A. Output in the two cities,
after factor migration, is
QA = α(GA + ∆G)f(LA + ∆L,KA + ∆K)
QB = α(GB)f(LB – ∆L,KB – ∆K)

Given that, the increase in public capital in City A has the following effects:
2
Denote the increase in public infrastructure in City A as ∆G and the amount of labor and
capital that migrated from City B to City A as ∆L and ∆K, respectively. The marginal revenue product
of labor in City B is pα(G)fL(L – ∆L,K – ∆K), which is higher than the original marginal revenue
product of labor if fLK = 0. A similar argument holds for the marginal revenue product of capital.

1. The marginal revenue product of labor and capital increases in both cities.
2. Wages and capital prices increase in both cities.
3. Some labor and capital inputs migrate from City B to City A.
4. Output increases in City A and decreases in City B.
5. Given the fact that the marginal physical products of labor and capital also
increase in both A and B, and that the sum of labor and capital in both cities
is unchanged, total output in City A plus City B increases.
The basic results given above are unchanged when both fLK < 0 and fKL < 0.
A more interesting and possibly more realistic case is when both fLK > 0 and
fKL > 0. In this case, after some labor and capital move from City B to City A, the
marginal revenue product of labor (MRPL) might either increase or decrease in
City B, depending on the relative magnitudes of fLL and fLK. If the effect of fLL is
larger than the effect of fLK, MRPL in City B is larger after the out-migration of
factors. Similar logic applies to the marginal revenue product of capital (MRPK)
in City B. In this case, the qualitative results are the same as above. Most
importantly, factor prices rise in both cities, some factors and thus some produc-
tion shifts from City B to City A, and total output in A plus B is larger than
before the public capital investment in City A. If the effect of fLK and fKL
dominates, in equilibrium it is possible for all labor and capital to move from
City B to City A in response to the infrastructure investment in City A. Even in
that case, the qualitative flavor of the results derived above still holds. Wages
and capital prices increase; labor, capital, and production shift from City B to
City A; and total output is larger than before City A’s additional public capital
investment.
3. THEORETICAL EXTENSIONS
The above model demonstrates the basic logic of negative output spillovers.
Mobile factors of production migrate to places with the best infrastructure
stocks, and that migration results in output gains in places with well developed
public capital stocks and output losses elsewhere.3 The purpose of this paper is
to test for the negative output spillovers predicted above, and, for that reason,
the theoretical apparatus will not be developed much further. However, some
comments on possible extensions to the model are appropriate where such
extensions will be useful for guiding and interpreting the empirical work
presented later.
3
There are some similarities between this result and the large literature on tax competition
among local jurisdictions (e.g., Wilson, 1986; Zodrow and Mieszkowski, 1986). In property-tax-
competition models, a reduction in one jurisdiction’s property tax rate can draw mobile factors of
production into the low-tax city from other jurisdictions. In the model above, an increase in public
infrastructure that does not require local funding draws mobile factors from other locations.

Imperfectly Mobile Factors of Production

Suppose that the supply of labor in each city is fixed both in the short run
and long run at LA = LB = L .4 As before, the investment in G in City A raises the
returns to labor and private capital in that city. Let ∆K be the amount of private
capital that must move from City B to City A to equalize capital rents in the two
cities. Given that fkk<0, the marginal revenue product of private capital is higher
in the long run in City B after some private capital has moved to City A. Capital
rental rate equalization ensures that the marginal revenue product of capital
also increases in City A in the long run. The long-run marginal revenue products
of labor are
MRPLA = pα(G A + ∆G) f L ( L , K A + ∆K )
MRPLB = pα (GB ) f L ( L , K B − ∆K )
As before, the change in the marginal revenue product of labor depends on

the sign of fLK. If fLK = 0, the marginal revenue product of labor in City B is
unchanged, whereas the marginal revenue product of labor in City A is higher
after the investment of ∆G in that city. In that case, the public capital investment
in City A raises wages in City A, leaves wages unchanged in City B, induces some
migration of private capital from City B to City A, increases output in City A
while decreasing output in City B, and raises the total (summed) output
produced in City A and City B.
If fLK < 0, the marginal revenue product of labor rises in City B as capital
moves from City B to City A, and the marginal revenue product of labor falls in
City A. Yet, with immobile labor, output produced still rises in City A and falls
in City B. In the more plausible case of fLK > 0, the marginal revenue product of
labor in City B falls as capital moves from City B to City A, and the marginal
revenue product of labor in City A rises with the in-migration of private capital
to that city. Again, output rises in City A and falls in City B.
Note that, if fLK ≥ 0, the benefits of the public capital investment accrue to
the fixed factor (labor) in City A in the form of higher factor prices, but wages
do not rise in City B. Also note that, in the two-factor model sketched above, the
prediction that output will rise where public capital investments are made and
fall elsewhere persists as long as at least one factor is mobile.
Point Infrastructure and Network Infrastructure

The discussion so far has assumed that the benefits of public infrastructure
are strictly local. Yet many public goods produce benefits outside the funding
jurisdiction, suggesting the possibility of positive benefit spillovers. The distinc-
tion between local benefits and spillover benefits can be clarified by defining
4
This is a simplification of the more realistic case where capital can move with lower cost than
labor. The exposition below is intended to illustrate the implications of imperfect factor mobility by
considering a polar case.

capital with strictly local benefits as “point infrastructure” and capital with
spillover benefits as “network infrastructure.”5 Munnell (1992) hypothesized
that positive spillovers could explain why studies of United States time-series
data typically found larger output elasticities for public capital than the elas-
ticities estimated with data from U.S. states. Holtz-Eakin and Schwartz (1995)
tested Munnell’s hypothesis for the case of highway capital, and found no
evidence of positive output spillovers across states.6
The empirical test below focuses on street-and-highway capital for Califor-
nia counties. The advantages of using street-and-highway data are twofold.
First, data for street-and-highway spending are available for several years,
allowing the construction of reliable street-and-highway capital stock variables;
and second, using street-and-highway data allows a ready comparison with the
work of Holtz-Eakin and Schwartz (1995).
The primary disadvantage of using street-and-highway capital is that the
negative spillover effects predicted by the model in Section 2 might be masked
by positive spillover benefits. Roads have characteristics of both point and
network infrastructure. In the context of the county data used below, streets and
highways are point infrastructure to the extent that they produce benefits
within the county. Streets and highways are network infrastructure to the extent
that they facilitate travel between different counties. Looking for the negative
output spillovers predicted in Section 2 is thus complicated by the possibility of
countervailing positive output spillovers. This requires that the empirical work
disentangle the positive and negative spillover effects of street-and-highway
capital. One technique for doing that is described in the empirical work that
follows.
4. AN EMPIRICAL TEST
Description of the Test

If public capital enhances the returns to mobile factors of production, total
output in a jurisdiction can depend positively on the stock of public capital in
that locality and negatively on the stock of public capital in other localities. To
test for this, a county production function is modified to include both a measure
of the county’s own stock of streets and highways and a measure of the stock of
5
I thank an anonymous referee for suggesting this terminology. One motivation for this
terminology is the fact that network externalities are a possible reason why infrastructure invest-
ments in one locale can have spillover benefits in other jurisdictions.
6
Note that Holtz-Eakin and Schwartz (1995) tested for positive output spillovers which are
theoretically due to public capital benefits which extend outside the jurisdiction. In Section 2, the
benefits of public capital are strictly within the jurisdiction, and the negative output spillovers are
due to factor migration. Interestingly, while Holtz-Eakin and Schwartz (1995) were concerned with
testing for positive output spillovers, the spillover parameter was significantly negative in seven of
twelve regressions in their paper. Excluding the specifications that did not control for unobserved
heterogeneity among states, the spillover parameter was significantly negative in four out of nine
regressions in Holtz-Eakin and Schwartz (1995).

streets and highways in other counties in the same state. Thus the production
function for a county is as shown below.
(2) Q = f(L, K, H, Ho)
where:
Q = county output;
L = labor inputs in the county;
K = private sector capital stock inputs in the county;
H = street-and-highway capital stock in the county; and
Ho = street-and-highway capital stock in other counties in the dataset.
The production function in Equation (2) includes the term Ho, the street-
and-highway capital in other counties. A key part of the empirical test is to define
“other counties” in a sensible way. Where should the empirical test look for the
negative spillovers that are predicted by the theory in Section 2? To answer that
question, two insights are important.
First, the negative output spillovers are driven by factor migration. Thus
street-and-highway capital in one county ought to have the strongest spillover
effect in those places that are the county’s closest competitors for mobile capital
and labor. In short, negative spillovers ought to be strongest across places that
are close substitutes as locations for production.7
Second, rather than attempt to identify a single close economic competitor
for each county, a more fruitful strategy is to adopt sensible rules of thumb that
classify how counties might compete for mobile factors and thus for production.
Borrowing terminology from the spatial econometric literature, counties are
defined as close or distant neighbors based on criteria that are designed to
measure how easily factors, and thus production, can migrate between counties.
Several different definitions of neighboring counties are used. Those neigh-
bor definitions are based on geographic contiguity, similarities in per capita
income and population density, and similarities in industrial composition. Each
type of neighbor definition is discussed in more detail in Section 5. First, consider
the econometric specification used in this analysis.
7
Given that the negative spillovers in Section 2 are driven by factor migration, one could study
how labor and private capital move in response to differences in public capital stocks. Yet the
production function approach implemented below has several advantages. First, using a production
function allows a comparison to the already large literature on production-function studies of public
capital. Second, the negative output spillovers predicted in Section II require only that at least one
factor be mobile. Studying factor migration requires that the empirical work account for the
possibility that the particular factors being studied are imperfectly mobile, which would complicate
the analysis. Third, a study of factor migration would require data on more variables than are
available here, especially given the role of local amenities in attracting labor (Gottlieb, 1995; Roback,
1982).

Model Specification
The regression model is based on a log-linear Cobb-Douglas aggregate
production function for counties, shown below.
(3) log(Qc) = αo + α1log(Lc) + α2log(Kc)
Nc
∑w H ) + ε
+ α 3 log( H c ) + α 4 log(
n= 1
n n c
where:
Q = output;
L = employment inputs;
K = private-sector capital stock;
H = street-and-highway capital stock;
and c subscripts index counties; and “log” denotes natural logarithm.
Nc is the number of “neighbor” counties whose street-and-highway capital
stock affects output in county c. Thus the term ΣwnHn is a weighted sum of
street-and-highway capital stock in all counties where such infrastructure is
judged to be important for output in county c.8
The simplest, and most obvious, definition of neighbor relationships is based
on sharing a common border. Such a measure can be implemented by setting
wi, j equal to one if counties i and j share a border, and setting wi, j equal to zero
otherwise. The term ΣwnHn can be represented in matrix notation by the product
WH, where W is a matrix with elements wi, j, and H is a column vector of county
street-and-highway capital stocks. Other neighbor relationships can be imple-
mented by changing the definition of the W matrix.
Previous production function research has established the importance of
controlling both for the effect of time and for unique effects associated with the
geographic areas (Evans and Karras, 1994; Garcia-Mila, McGuire, and Porter,
1996; Holtz-Eakin, 1994; Kelejian and Robinson, 1994). With that in mind
Equation (3) can be rewritten as
8
The specification in Equation (3) is similar to that used by Holtz-Eakin and Schwartz (1995)
to examine cross-state spillovers from highway capital. The primary difference is that the term
ΣwnHn restricts attention to first round, or immediate, neighbors. Holtz-Eakin and Schwartz defined
neighbors such that highway capital in one state affects immediate neighbors in a first-round effect,
and then affects the neighbors of those immediate neighbors in a second-round effect, and so on.
Either the term ΣwnHn or the Holtz-Eakin and Schwartz specification which captures higher-order
effects is consistent with the theory developed in Section 2. Attention here is restricted to first-round
neighbor effects because that allows a specification that is linear in the parameters, as opposed to
the non-linear model in Holtz-Eakin and Schwartz (1995). One should also note that restricting
attention to immediate neighbors is a more conservative test of spillovers, since any higher-order
neighbor effects are not measured.

(4) log(Qc, t) = α1log(Lc, t) + α2log(Kc, t)

N
∑w H
+ α 3 log( H c,t ) + α 4 log(
n=1
n c, t ) + γ t + f c + ε c, t
where:
c indexes counties and t indexes years;
Q, L, K, and H are as defined before;
wn defines neighbor relationships;
N is the number of counties, which is equal to 58;
γ is a vector of year-specific intercepts;
f is a vector of unique, time invariant, county effects; and
ε is an i.i.d. disturbance.
As Holtz-Eakin and Schwartz (1995) note, using either deviations from
means or first differences to estimate Equation (4) identifies the parameters
based on year-to-year fluctuations. This could obscure the long-run relationship
between output and public capital (Munnell, 1992). For that reason, Holtz-Eakin
and Schwartz (1995) suggest transforming Equation (4) into what they call “long
differences.”
Subtracting the equation for the initial year from the equation for any other
year, T, gives
(5) log(QT) – log(Q0) = α1[log(LT) – log(L0)] + α2[log(KT) – log(K0)]
+ α3[log(HT) – log(H0)] + α4[log(WHT) – log(WH0)] + γT – γ0 + εT – ε0

where W is a (58x58) matrix of the wn, and the c subscripts have been suppressed.
If T is sufficiently far from the initial year, this captures the long-run
relationship between the variables. Following Holtz-Eakin and Schwartz (1995),
long differences are formed for all t ≥ 6 (i.e., for all years 1974 through 1988,
with 1969 being the initial year). The resulting long differences are pooled, such
that there are 870 total observations.
Holtz-Eakin and Schwartz (1995) further note that pooling the long differ-
ences induces serial correlation. Using the information on the covariance struc-
ture of the error term given in Holtz-Eakin and Schwartz (1995, p. 463),
generalized least-squares estimates for pooled versions of Equation (5) were
obtained for several different W matrices. The results are discussed below.
5. RESULTS
Data and Preliminary Results

Data on gross county product, employment, private capital stocks, and
street-and-highway capital are available from 1969 to 1988. Gross county
product is derived by apportioning state product to counties based on total
county personal income, as is consistent with the methodology used by the

Southern California Association of Governments to estimate county product

within their region.9 Private capital stock is constructed by apportioning Mun-
nell’s estimates of California private capital to counties.10 The apportioning
methodology is the same as that used in Munnell (1990), which in turn follows
Da Silva Costa, Elson, and Martin (1987). Street-and-highway capital stock is
constructed using a perpetual inventory method based on annual street-and-
highway expenditures, in each county, starting in 1957. Employment in each
county is available from the Census Bureau’s County Business Patterns for each
year. See Boarnet (1995, Appendix A) for a detailed description of the data
sources and the methods used to construct the county product, private capital,
and street-and-highway capital variables.
Table 1 gives descriptive statistics of the logs and long differences of logs of
all variables. The means and the range of the data are expected when compared
with similar data for states reported in Holtz-Eakin and Schwartz (1995).11 Note
that, from the summary statistics for the long differences, the public input
(street-and-highway capital stock) grew more slowly than the private inputs
during the study period. Yet long differences also indicate that the value of
state highway capital stocks grew at a faster rate than total street-and-high-
way capital stocks. Also note (again from the statistics for the long differ-
ences) that there is good cross-county variation in the growth of all the
variables in the regression specification.
Column A of Table 2 presents the results of estimating Equation (5) with
the geographic contiguity W matrix defined above. The coefficients on labor and
private capital are significantly positive (at better than the 1 percent level) in
column A. The magnitude of the private capital variable is consistent with
previous production-function research that used state data, although the coef-
ficient on labor is toward the low end of the range of elasticities obtained from
state studies. (See, e.g., Garcia-Mila and McGuire, 1992; Garcia-Mila, McGuire,
and Porter, 1996; Holtz-Eakin, 1994; and Holtz-Eakin and Schwartz, 1995.) The
coefficient on own-county street-and-highway capital is also significantly posi-
tive at the 1 percent level. The coefficient on neighbors’ street-and-highway
capital is insignificant in column A of Table 2.12
9
Given the limited data that are available on output for counties, this was the best feasible
approach. Yet cross-county commuting can cause some differences between county output and county
personal income. This might be one reason why the output elasticity of labor reported in Table 2 is
lower than what is usually found in other production-function studies.
10
I thank Douglas Holtz-Eakin and Alicia Munnell for providing the state private capital data.
11
The only exceptions to this are the large values for the maximum long difference of county
output and employment. These are due to the growth of three counties that started from a small
base in 1969. All long differences greater than 1.5 for county output and employment are due to
Alpine, Mono, and Nevada counties. Their 1969 populations were 500, 5,200, and 26,500, respectively.
12
Holtz-Eakin and Schwartz (1995) suggested two extensions of the concept of geographic
contiguity. Both extensions were implemented and the results do not differ from those in column A.
For details, see Boarnet (1996).

TABLE 1: Descriptive Statistics

Standard
Variable Mean Deviation Minimum Maximum
Levels
Q: County Output 7.28 1.85 1.77 11.98
L: Employment 10.04 1.94 5.38 15.10
K: Private Capital 6.99 1.74 2.32 11.63
H: Street-and-Highway Capital 5.83 1.16 3.56 9.54
SH: State Highway Capital 3.59 1.14 0.99 8.20
WH 7.69 0.89 6.18 9.93
WpdenH 5.90 0.68 4.62 7.63
WincH 6.31 0.58 5.35 7.62
WFIREH 6.24 0.56 4.56 7.97
WmanuH 6.54 0.58 5.40 9.45
WnetSH 4.00 1.00 2.13 7.81
Long Differences
Q: County Output 0.52 0.31 –0.12 1.62
L: Employment 0.58 0.49 –0.62 3.69
K: Private Capital 0.54 0.32 –0.74 1.54
H: Street-and-Highway Capital 0.23 0.15 –0.16 0.66
SH: State Highway Capital 0.73 0.49 –0.07 2.56
WH 0.22 0.11 –0.03 0.60
WpdenH 0.21 0.09 –0.02 0.48
WincH 0.23 0.07 0.07 0.52
WFIREH 0.26 0.07 0.08 0.52
WmanuH 0.25 0.08 0.03 0.53
WnetSH 0.71 0.46 0.02 2.06
Note: Output, private capital, and street-and-highway capital are in logs of millions of dollars.
Employment is in logs. Long differences cover 1974 through 1988 and are computed as the difference
from the natural log of the 1969 value. W is the geographic contiguity neighbor matrix used in column
A of Table 2. WnetSH is calculated with only state-highway capital, as in column F of Table 2.
The results in column A of Table 2 suggest either that street-and-highway

capital does not produce the negative spillovers predicted by the model in Section
2, or that negative spillovers are roughly balanced by the positive (or network)
spillovers from road infrastructure. Additional tests were performed to distin-
guish between these two explanations. The strategy for the tests was to change
the definition of neighboring counties, and thus the W matrix, so that positive
and negative spillovers, if they exist, can be measured separately.
The first alternative definition of the W matrix measures how counties
compete for economic activity, and thus for mobile factors of production. Neigh-
boring counties, in this definition, are counties that are close substitutes as
locations for production. Those counties need not be geographically contiguous.
For example, Los Angeles and San Francisco counties may be close competitors
for economic activity, and could be defined as such through an appropriate W
matrix. Yet because Los Angeles and San Francisco counties are separated by
several intervening counties and a distance of almost 400 miles, a W matrix

TABLE 2: Regression Results; Dependent Variable = log(county output)

Independent Variable Column A: Column B: Column C: Column D: Column E: Column F:
contiguous population per capita proportion proportion highway
neighbors density income FIRE manufacturing network
neighbors neighbors employment employment weighted
neighbors neighbors contiguous
neighbors
L 0.365 0.369 0.365 0.362 0.365 0.374

employment (0.021) (0.021) (0.020) (0.020) (0.021) (0.021)
K 0.217 0.224 0.213 0.217 0.216 0.211

private capital stock (0.021) (0.021) (0.020) (0.020) (0.021) (0.021)
H 0.236 0.268 0.300 0.246 0.236

own county’s street (0.052) (0.052) (0.052) (0.052) (0.051)
and highway capital
W*H –0.016 –0.307 –0.806 –0.216 0.125

neighbor counties’ street (0.078) (0.098) (0.140) (0.127) (0.121)
and highway capital
SH 0.065
own county’s state (0.016)
highway capital
W*SH 0.047
neighbor counties’ (0.026)
state highway capital
N 870 870 870 870 870 870

2
R 0.67 0.67 0.69 0.67 0.67 0.67
All independent variables are in logs. All regressions are in long differences specification from
Equation (5). Standard errors are in parentheses. Coefficients on year dummy variables not shown.
Only state-highway capital is used for SH and W*SH in column F, as explained in Section 5 of the
text.
based on similarity and not geography might capture little information about
how the highway network connects those two counties. The implication is that
a neighbor matrix based on competition for mobile factors might measure
negative spillovers typical of point infrastructure, but little of the positive
network benefits of the street and road network.
The second alternative W matrix is based explicitly on the connectivity of
the highway network. Such a matrix should capture positive network spillovers
of highway capital better than the geographic contiguity matrix, which incorpo-
rated no information on how the road network connects adjacent counties. The
specific form of the alternative W matrices, and the empirical tests, are described
in more detail below.

Results from Alternative Neighbor Matrices

Four W matrices were constructed to measure characteristics which proxy
for how counties compete for mobile factors of production. Each W matrix was
constructed so that the weights, wi, j, are larger for counties that are more similar.
The general formula for the weights in these “county similarity” W matrices is13
1 / Xi − X j
wi, j =
Si
Si = ∑1/ X
j
i − Xj
The four characteristics which are used in place of X in the above formula
are:
Wpden Xi = population density, in persons per acre, in county i in 1980;
Winc Xi = per capita income in county i in 1980;
WFIRE Xi = proportion of 1980 employment in county i that is in finance,
insurance, and real estate; and
Wmanu Xi = proportion of 1980 employment in county i that is in manu-
facturing.14
Wpden and Winc are potentially good proxies for how counties compete for
mobile labor and production that can locate in places with similar urban
characters. Wmanu and WFIRE measure similarities in industrial composition
which Garcia-Mila and McGuire (1993) found were important for state growth
patterns. Specifically, Garcia-Mila and McGuire (1993) found that state growth
patterns were influenced by employment shares in manufacturing, FIRE, trans-
portation and public utilities, and services. Of those four categories, Garcia-Mila
and McGuire (1993) suggested that the effect of manufacturing and FIRE
employment is likely due to interactions between firms in those industries and
other sectors of the economy. Because those interactions might also proxy for
characteristics that facilitate factor mobility or economic competition across
counties, the W matrices for industrial composition are based on employment
shares in the manufacturing and FIRE sectors.
In addition to the four matrices that test for negative spillovers, a matrix
based on highway network connectivity was also implemented to examine how
state highways produce positive spillover benefits. Importantly, cross-county
network spillovers are likely due almost entirely to state highways; most local
13
See Case, Hines, and Rosen (1993) for a similar treatment. Note that the term Si normalizes
wi, j such that the sum of the weights for any county, i, equals 1.
14
For each of the Wpden, Winc, WFIRE, and Wmanu matrices, 1980 data are used because that year
is approximately in the midpoint of the data that are used to estimate the regressions. Population
density and per capita income are from the 1980 census. Proportion of employment in the manufac-
turing and FIRE sectors is constructed from County Business Patterns data.

streets are somewhat unimportant for cross-county travel. The state highway
system includes all interstate, federal, and state highways, so the network W
matrix, Wnet, is based only on the state highway network. Specifically, Wnet is
constructed so that any two contiguous counties are stronger neighbors if they
are connected by more state highways, as shown below15
N i, j
wi, j =
∑N
j
i, j
where Ni, j = the number of state highways that cross the border of counties i
and j if i and j share a common border. Otherwise Ni, j equals zero.
Because positive network spillovers are assumed to be associated predomi-
nantly with state highways, the variable H is modified in this instance to include
only state highway capital. State highway capital was defined using the same
perpetual inventory technique that was used for street-and-highway capital,
such that state highway capital is a subset of the street-and-highway capital
variable used in columns A through E of Table 2.
Columns B through F of Table 2 show the results of using each of the five
alternative W matrices defined above. In all five columns, the coefficients on
labor and private capital are essentially the same as in column A. Similarly, the
coefficient on own-county street-and-highway capital is unchanged in columns
A through E.
In column B of Table 2, which uses the neighbor matrix based on differences
in population density across counties (Wpden), the coefficient on neighbors’
street-and-highway capital is significantly negative at the 1-percent level. This
suggests negative output spillovers across counties of similar population density.
In column C, using the neighbor matrix based on differences in per capita income
(Winc), the coefficient on neighbors’ street-and-highway capital is again signifi-
cantly negative at the 1-percent level. In column D, which uses WFIRE, the
coefficient on neighbors’ street-and-highway capital is significantly negative
using a 5-percent one-tailed test. The same coefficient is positive but insignifi-
cant in column E, which uses Wmanu.
Lastly, the results in column F, which uses only state highway capital stock,
give a smaller, but significantly positive, coefficient for own-county highway
capital. The coefficient for neighbors’ state highway capital is significantly
positive using a 5-percent one-tailed test. This suggests that state highways
produce positive network spillovers across contiguous counties once the neigh-
bor definition is modified to incorporate information about the connectivity
provided by the state highway network. That could be one reason why the
geographic contiguity W matrix in column A gave no evidence of negative
spillovers.
15
There have been few changes to the state highway network during the time period of this
study, so current highway maps were used for Wnet.

Overall, the results provide evidence of the negative output spillovers

predicted in Section 2. Of the four W matrices specifically designed to measure
negative spillovers (in columns B through E of Table 2), three give evidence of
such spillovers. Furthermore, the differences in the significance of the WH term
in columns A through E are largely due to differences in the magnitude of the
coefficient, suggesting that the strength of the spillovers varies depending on
how neighbor counties are defined.
One last question is why there is no evidence of negative spillovers across
counties with similar shares of manufacturing employment. Per capita income
and proportion of employment in FIRE are both positively correlated with
county population density, whereas manufacturing share is not. (For 1980, the
bivariate correlation coefficients are 0.22 for county population density and per
capita income, 0.54 for population density and proportion of employment in
FIRE, and –0.06 for population density and proportion employment in manu-
facturing.) In other words, the neighbor matrices in columns B through D (Wpden ,
Winc , and WFIRE) all measure cross-county similarities which are tied to urbani-
zation, whereas Wmanu is a much poorer measure of similarities in urban
character. The evidence here suggests that negative spillovers from public
capital are strongest across similarly urbanized counties, and that similarly
urbanized counties are close competitors for mobile factors of production.
Robustness of the Empirical Tests

Three additional tests were used to check the robustness of the results in
Table 2. First, it is possible that the significant WH terms proxy for unobserved
similarities across counties. To control for that, each regression in Table 2 was
reestimated with a first-order spatially autoregressive error term, ε = ρWε + u,
where u is an i.i.d. disturbance. For each regression in Table 2, the W matrix in
the error term was the same as the W matrix in WH. This controls for the
possibility that the significant WH terms are simply capturing interactions
across neighbor counties that are not actually due to the street-and-highway
capital stock, but are instead driven by other (unobserved) variables. In no
instance did this specification change the sign or significance pattern of the
results in Table 2.
Two tests were performed to examine whether the results in Table 2 show
the effect of street-and-highway capital on county output, rather than the
reverse causal link. First, using the vector autoregression techniques described
in Holtz-Eakin, Newey, and Rosen (1986), changes in street-and-highway capital
stocks were regressed on lagged changes of both street-and-highway capital and
county output. The null hypothesis that the coefficients on output equalled zero
could not be rejected in regressions with two, three, four, or five lags, suggesting
that the primary channel of causality does not flow from county output to
highway capital stocks.

Second, the ratio of state highway miles divided by total road miles in each
county was used as an instrument for log(H) in columns A through E of Table
2.16 The motivation for this is that the split between state and local roads in a
county is largely determined by geography, pre-existing development, and past
highway-building decisions, and thus is likely exogenous to short-term changes
in output.17 Some support for this idea can be found in the fact that the ratio of
state divided by total road miles is smaller in densely settled counties with little
land available for highways.18
To control for possible endogeneity, log(H) was regressed on the ratio of state
highway miles divided by total road miles. The results were used to get a
predicted value of log(H) for each county for the years 1969 and 1974 through
1987. Long differences of the predicted value of log(H) were then used in the
regression shown in Equation (5). In only one case does using the predicted value
of log(H) give results which substantively differ, either in sign or statistical
significance, from those reported in Table 2. The coefficient on WFIREH, that was
statistically significant in Table 2, is not significant when the predicted value of
log(H) is used in the regression. Results for all three tests discussed above are
available upon request from the author.
6. DISCUSSION
The coefficient estimates in Table 2 suggest that street-and-highway capital
is associated with higher output within the same county and with lower output
in counties with similar population density, income, or employment shares in
the FIRE sector. These results are from a specification that uses differences in
the variables and county fixed effects. Furthermore, the results are unchanged
when a spatially correlated error structure is used, and there is only one change
when a predicted value for log(H) is used in the regression. Overall, the evidence
supports the idea that street-and-highway capital influences output in Califor-
nia counties, and that such infrastructure creates negative output spillovers
across counties of similar urban character.
For a 1 percent increase in each county’s street-and-highway capital stock,
the net percentage change in output in any county (and thus the net percentage
16
The data on state highway and total road miles are from the California Statistical Abstract.
17
The choice of an instrument for log(H) was constrained by the fact that the specification in
Equation (4) requires time-varying independent variables. Any time invariant characteristic of
counties, such as geography, is subsumed into the fixed effect. The ratio of state highway miles divided
by total road miles, while presumably being influenced by geography and past development, also
varies over time for this sample. The sample is almost equally divided between counties for which
the ratio increased and counties for which the ratio decreased from 1969 to 1987. The average change
in the ratio from 1969 to 1987 is a 12 percent increase.
18
In 1987, the ratio of state to total road miles ranged from 0.038 in San Francisco County to
0.218 in rural Amador County.

change in statewide output) is the sum of the coefficients on H and WH in Table

2 [i.e., the sum of α3 and α4 in Equation (4)].19
Taking all insignificant coefficients as being equal to zero, the net output
effect of a 1 percent increase in street-and-highway capital, implied by Table 2,
ranges from 0.24 (using either the contiguity matrix in column A or Wmanu in
column E) to –0.506 (using Winc in column C). The net effects in columns B and
D (Wpden and WFIRE, respectively) are close to zero. The net output effect for
state-highway capital in column F is 0.11, but this cannot be compared directly
to the results in columns A through E because local street capital are excluded
from the regression in column F.
Choosing a “best” estimate from the above results is complicated. The results
in Table 2 suggest that street-and-highway capital have both positive and
negative spillovers. For example, the Winc matrix in column C of Table 2 is
designed to capture negative spillovers, and thus presumably does not capture
the network benefits from street-and-highway capital. Similarly, Wnet is not
designed to capture the negative spillover effects. Thus the true net effect of
street-and-highway investment likely lies somewhere between the positive net
effects from columns A and E and the negative net effects from columns B and
C. A more precise statement is not possible.
Many previous studies have suggested that public capital is not as produc-
tive as private capital at the margin (e.g., Evans and Karras, 1994; Garcia-Mila,
McGuire and Porter, 1996; Holtz-Eakin, 1994). This suggests that the net effects
implied by columns A and E are unreasonably large. It is also implausible that
investment in productive public capital would, on net, reduce output. (For a
discussion of this point in the context of economic development, see Bartik,
1991.) Thus the large negative net effect in column C also lacks believability.
Overall, it is not too unreasonable to conclude that the net effects of street-and-
highway capital investment are close to the small net effects in columns B and
D. That finding is consistent with previous state level studies which concluded
19
This is derived as follows. The own-county output elasticity of public capital, ∂log(Qi)/∂log(Hi),
is the coefficient α3 in Equation (4). Also from Equation (4), changes in street-and-highway capital
in county j affect output in county i by
∂ log(Qi ) α 4 wi, j
= 58
∂H j ∑ wi, j H j
j =1
Given that, the elasticity of output in county i with respect to street-and-highway capital in county
j is
∂Qi H j ∂ log(Qi ) α 4 wi, j H j
= Hj = 58
∂H j Qi ∂H j ∑ wi, j H j
j =1
If all counties in the state get a 1-percent increase in street-and-highway capital, the effect on output
in county i is α3 (the own-county effect), plus the sum of the neighbor effects in all counties, which
is α4(Σwi, jHj)/(Σwi, jHj) = α4.

that infrastructure investment is not productive at the margin (e.g., Evans and
Karras, 1994; Garcia-Mila, McGuire, and Porter, 1996; Holtz-Eakin, 1994; Kele-
jian and Robinson, 1994). This research suggests that infrastructure investment
is productive for counties, but public capital also produces negative output
spillovers that can reduce the size of any output effect when measured at the
state level.
Given that, two issues are important. First, this research suggests that,
although much effort has been devoted to arguing whether state or national
infrastructure stocks are too large or too small, the more important effects are
local. Based on this study, street-and-highway capital is associated with in-
creased output within a county, positive network spillovers, and negative output
spillovers. Understanding the pattern of those sub-state gains and losses can be
at least as important as knowing the magnitude of the statewide effect from
infrastructure investment.
Second, with imperfect factor mobility, a pattern of local output gains and
losses from infrastructure can have distributional effects. The gains to infra-
structure investment should, in general, accrue to the fixed factor. Beyond that,
information on production technology and factor mobility are necessary to infer
how local public capital projects affect factor prices outside of the project area.
Because of the distributional implications, examining how factor prices are
affected by infrastructure spillovers is an especially important topic for future
research.
In terms of policy implications, the following conclusions are possible. First,
although street-and-highway capital might be productive within a county, the
existence of negative output spillovers raises the possibility that infrastructure
investment might yield only small output gains over a larger region or state.
Lacking more detailed information on how the spillover effects from public
capital balance out, the assessment from state-level studies that infrastructure
is unlikely to provide large private-sector productivity gains is probably still the
most prudent guide for policy.
Second, because highway projects are often funded with large state and
federal subsidies, the results in this paper suggest the possibility that local
projects might draw economic activity away from areas that are helping to
subsidize the project. The 90 percent federal subsidy rates that are typical for
interstate highway projects reflect an implicit assumption of strong, positive,
network spillovers. The coefficient estimates in Table 2 suggest that negative
spillovers might be larger in magnitude. Given that the interstate highway
network is essentially complete, modern highway projects might do more to
facilitate travel within a county than between counties. If that is true, lowering
subsidy rates might be appropriate for many highway projects.
Overall, this study suggests that both research and policy should more
carefully consider the local gains and losses created by public capital projects.
For projects that enhance the returns to private factors of production, theory
suggests a redistribution of economic activity from locations with poor infra-

structure stocks to those with more well-developed stocks. The empirical evi-
dence presented here supports that hypothesis. Future research should examine
the locational effects of public capital projects in more detail.
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JOURNAL OF REGIONAL SCIENCE, VOL. 38, NO. 3, 1998, pp.

SPILLOVERS AND THE LOCATIONAL EFFECTS OF PUBLIC

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

QA = α(GA + ∆G)f(LA + ∆L,KA + ∆K)

QB = α(GB)f(LB – ∆L,KB – ∆K)

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

Imperfectly Mobile Factors of Production

MRPLA = pα(G A + ∆G) f L ( L , K A + ∆K )

As before, the change in the marginal revenue product of labor depends on

Point Infrastructure and Network Infrastructure

© Blackwell Publishers 1998.

Description of the Test

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

(4) log(Qc, t) = α1log(Lc, t) + α2log(Kc, t)

+ α3[log(HT) – log(H0)] + α4[log(WHT) – log(WH0)] + γT – γ0 + εT – ε0

Data and Preliminary Results

© Blackwell Publishers 1998.

Southern California Association of Governments to estimate county product

© Blackwell Publishers 1998.

TABLE 1: Descriptive Statistics

The results in column A of Table 2 suggest either that street-and-highway

© Blackwell Publishers 1998.

TABLE 2: Regression Results; Dependent Variable = log(county output)

L 0.365 0.369 0.365 0.362 0.365 0.374

K 0.217 0.224 0.213 0.217 0.216 0.211

H 0.236 0.268 0.300 0.246 0.236

W*H –0.016 –0.307 –0.806 –0.216 0.125

N 870 870 870 870 870 870

© Blackwell Publishers 1998.

Results from Alternative Neighbor Matrices

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

Overall, the results provide evidence of the negative output spillovers

Robustness of the Empirical Tests

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

change in statewide output) is the sum of the coefficients on H and WH in Table

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

© Blackwell Publishers 1998.

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