Infrastructure investment and growth

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1 Infrastructure investment and growth Luis Servén The World Bank IMF, November 2010

2 Background How important is infrastructure for economic growth? Old question even in Adam Smith s Wealth of Nations Empirically revived after Aschauer (1989) who found huge rates of return on public capital in the U.S. For policy-making, the key link is that between infrastructure spending and growth. What do we know about it empirically? 2

3 Background Two distinct logical steps involved: (1) From spending to infrastructure services the cost of acquiring (and operating) infrastructure assets (2) From infrastructure assets to growth the productivity of infrastructure assets (or their services) The bulk of empirical macro research has focused on (2). But for optimal spending / provision decisions we need to know more about (1) too. 3

4 Infrastructure and growth Start with (2): from assets to output / growth Two common empirical approaches: Growth regressions augmented with infrastructure measures Infrastructure as another input in aggregate production function (or its dual, the cost function) On balance, majority of studies especially recent ones on developing economies find significant positive effects Some methodological caveats with many studies reverse causality, heterogeneity, non-stationarity... A key issue is the measurement of infrastructure assets Physical indicators (e.g., road km) Monetary indicators (investment flows or their cumulative totals) 4

5 Infrastructure and growth Measures of infrastructure spending can be very poor proxies for the quantity / quality of assets Poor project selection; procurement; corruption (Tanzi-Davoodi 1997; Pritchett 2000; Keefer-Knack 2007) more on this later Empirical studies, by reported finding (Straub 2007) Negative None Positive 5

6 Growth in real GDP per capita (%) Infrastructure Stock and Economic Growth 7 6 BWA TWN CHN KOR MLT 5 HKG THA MYS CYP OMN SGP 4 LKA ROM IRL ARE JPN HUN PRT ESP IDNIND GHA TUN GRC LUX PAK 3 EGY DOMPAN AUT BEL BRABLR CZE FIN ISL MAR RUS NOR POL TTO ITA ISR FRA LVA TUR CHL AUS DNK DEU GBR CAN USA SVN SYR 2 NLD COL SWE ETH MRT IRN CRI BHR CHE BGD BGR BFA BEN CMR COG DZA ECU MEX SAU EST NPL TZA PHLPRY ZAF SVK MWI NZL CIVGTM SLV URY 1 PERARG LBY RWA UGA GMB HND YEM BOL GAB JAM LTU BDI SDN NGA GNB KAZ VEN TCD KEN ZMB TGO HTI GIN 0 ZWE JOR HRV CAF SEN NER SLE -1AGO NIC0 KGZ MDG -1 YSR QAT UKR -2 ZAR IRQ y = x R 2 = Aggregate Index of Infrastructure Stocks, IK1 (in logs) 6

7 Growth in real GDP per capita (%) Infrastructure Quality and Economic Growth 7 BWA6 TWN CHN KOR MLT 5 HKG OMN CYP MYS THA SGP 4 ROM LKA JPN IRLARE HUN PRT TUN PAK PAN IND IDN GRC ESP GHA 3 NOR LUX LVA MAR EGY RUS POL DOMTTO ISL FIN TUR USA SYR SWE SVN ISR ITAFRA AUT CZE BEL BRA BLR CHL CAN DNK GBR DEU NLD COL SAU TZA PHL ZAFPRY NZL SVK NPL MWI MRT MEX 2 AUS ECU ETHEST IRN CRI BHR CHE LBY SLV URY GTM DZA COG PER YEM HND RWA CMR CIV BGD BGR BFA GMB GAB VENUGA BEN ARG 1 JAM NGA SDN BOL TGO TCD ZWE ZMB LTU GNB KAZ KEN BDI HTI GIN0 HRV JOR NIC SEN SLEKGZ CAF -1AGO NER MDG-1 YSR QAT UKR -2 ZAR IRQ y = x R 2 = Aggregate Index of Infrastructure Quality, IQ (in logs) 7

8 Infrastructure and growth Example of growth approach: Calderón-Servén 2009 Empirical growth framework with physical measures of infrastructure Synthetic index of telecom, transport and power assets plus (noisy!) measures of quality of assets Large panel dataset Results: Infrastructure quantity and quality have robust growth effect and economically significant. Not much evidence of heterogeneity (in log-log terms) Across developing regions Landlocked vs other countries Related to infrastructure endowment (i.e., non-linearities) Hence the marginal contribution of infrastructure development to growth is higher wherever quantity / quality are lower. 8

9 Changes in growth per capita (%) Figure 2 Growth changes across regions due to infrastructure development ( vs averages) World Western Europe East Asia South Asia Middle East & North Africa Sub-Saharan Africa Infrastructure Stocks Infrastructure Quality Infrastructure capital -- Brookings

10 Infrastructure and growth How does the growth contribution of infrastructure development vary across countries? Closer look Calderón, Moral and Servén (2010): Cobb-Douglas production function approach -- physical and human capital; infrastructure Focus on the contribution of infrastructure to labor productivity (GDP per worker) synthetic infrastructure index (as before) 88 industrial and developing countries, (> 3,500 obs) Allow for heterogeneity of infrastructure contribution both generic and along specific dimensions Empirical framework allows intercepts, error variances and short-run dynamics to differ freely across countries. Imposes (testable) cross-country homogeneity of long-run coefficients. 10

11 Infrastructure and growth Main results Infrastructure elasticity in range.07 to.10 and robust. Elasticities of other inputs (physical and human capital) in line with literature (around 0.35, 0.10 respectively) No evidence of (general) cross-country parameter heterogeneity Accords with cross-country stability of factor shares (Gollin 2002) But country-specific estimates are noisy (especially in LICs), so tests may have low power. Test for specific forms of heterogeneity By income level: infrastructure elasticity could differ in rich and poor countries By level of infrastructure endowment: nonlinear effects of infrastructure (network effects?) By population size: economies of scale / congestion effects. By quality of policy framework: high / low distortions Only this test comes close to 10% significance 11

12 Long-run coefficient Long-run coefficient SLV SLV RWA TGO KEN NGA MDG BEN LSO BFA NPL SEN GHA ETH MWI GMB MLI UGA MOZ TZA PAK TUN TTO NIC SGP ROM CMR COL JPN PER BRA CHN EGY JOR CIV IND IDN DZA CHL BOL CPV GTMDOM ARGGRC CAN AUS DNK FRA GIN SYR THA URY KOR NZL ESP MEX MYS MAR MUS PRT ZWE PHL TUR ZAF ISL SWE ISR PRY CHE PAN BLX FIN GBR NLD USA ITA LKA IRL HND ECU NOR IRN VENCRI JAM GAB AUT PAK TUN TTO NIC RWA SGP TGO CMR COL ROM JPN PER KEN BRA BEN CHN EGY JOR IDN KOR LSO NGA DZA BFA MDG CIV IND THA URY ESP GTM CPV BOL ARG CHL GRC NZL DOM MEXMYS DNK FRA CAN GIN MUS PRT NPL SEN PHL ZWE SYR MAR ZAFISR CHE BLXAUSISL PANPRY TUR USA SWE GHA GBR NLD FIN ETHMLI GMB ITA UGA MWI LKA IRL MOZ HND ECU NOR IRN VEN CRI GAB JAM AUT TZA NER Logarithm of GDP per worker NER Infrastructure index per worker Output elasticity of infrastructure vs. per capita GDP Output elasticity of infrastructure vs. Infrastructure stock SLV SLV ISL CPV TTO TUN PAK SGP NIC TGO RWA ROM CMR COL JPN PER JOR KEN BRA KOR LSOURY NZL ESPEGY NGA DNK BEN GRCHL DZA DOM BOL ARG BLX BFA GTM CIV CAN FRA IDN ISR MDGMYS MUS CHE PRT MEX GIN SWE SEN SYR THA ZWEAUS NPL MARZAF PAN FIN PRY TUR NLD PHL USA GHA GBR GMB IRL MLI ITA NOR MWI LKA UGA ETH HND ECUMOZ IRN CRI VEN GAB JAM AUT IND CHN PAK TUN TTO NIC SGP COL ROMTGO RWA JPN PER CMR KENBRA CHN CHL BEN JOR IDN THA KOR EGY INDLSO NGA URY NZL MYS ARG DZA BFA CAN GRC NPL BOL CPV FRA AUS DOMDNK GIN ISR GTM BLX ISL MDG PHLMUS MAR PRT ESP ZWE ZAF MEX SWE CHE PRY PAN TURUSA SEN SYR FIN GMB ITA ETH GHA GBR NLD LKA MWI MLI IRL ECU MOZ NOR UGA HND IRN VENCRI AUT JAM GAB CIV TZA TZA NER Logarithm of population Output elasticity of infrastructure vs. population NER Price of investment 12 Output elasticity of infrastructure vs. distortion index

13 Infrastructure and growth Further homogeneity tests Break sample into high / low along the relevant dimension and test for equality of mean infrastructure elasticity. Per Capita Income (A) Per Capita Income (B) Infrastructure Endowment Total Population Distortions High Low p-value Overall, no strong evidence that the elasticity varies across countries. The implication is that the marginal product of infrastructure declines as the infrastructure / output ratio rises. 13

14 From spending to assets All this is only about the benefit side of infrastructure what about the cost? Cost-benefit comparison is needed to assess the extent of under-provision of infrastructure and whether it is greater than that of other inputs (e.g., human capital) Limited evidence on this (e.g., Canning and Pedroni 2008: no generalized infrastructure shortage across countries / sectors) Calderón and Servén (2010): big growth impact of infrastructure catch-up in Africa but massive cost involved: 10% to 15% of GDP for (half) catching-up, even ignoring O&M. Loayza (2010): big growth impact in Egypt but only if much of the cost is financed by spending cuts elsewhere 14

15 Sub-Saharan Africa: cost of infrastructure catch-up 15

16 From spending to assets Is spending a good proxy for infrastructure development? Spending is often very inefficient: bad projects, waste Weak link between spending and assets / services (Pritchett 2000): it is mediated by government technical capacity, fiscal institutions, budgetary practices, governance... Big scope for corruption and political clientelism Tanzi and Davoodi 1997; Keefer-Knack 2007: weak governance and corruption raise measured public investment in reality, much is rent extraction rather than asset acquisition. Incentives for investment over O&M: bigger room for corruption, political favors and photo-ops so build new roads rather than maintain old ones. 16

17 From spending to assets Better understanding of costs of asset acquisition, and their determinants, is needed for policy decisions. Without it, a big push to infrastructure may lead to massive waste But this requires much more complete and detailed data on infrastructure spending and performance Often we cannot even establish the facts especially on O&M, but in many countries also on sector-wise investment spending Bad data also hampers accountability / transparency Poor data arguably is one of the biggest obstacles to better diagnostic of the problems and design of solutions 17

18 From spending to assets New database under construction investment by infrastructure sector in developing countries Builds on earlier data collection for Latin America (Calderón and Servén 2004, 2010) Disaggregation into power, water/sanitation, roads, rail, telecom when feasible Disaggregation into public and private investment Time coverage from 1980 Preview of work in progress.

19 Cumulative investment (% of GDP) ('85-) Infrastructure investment and governance (cumulative investment, percent of 1985 GDP) EGY EGY TUR JOR TUR JOR BOL BOL IDN PHL CHL IND IDN PHL IND CHL PER MEX ARG COL BRA COL PER MEX BRA ARG Bureaucracy (Ave. of the 1980s) Corruption (Ave. of the 1980s) Infrastructure investment vs quality of bureaucracy Infrastructure investment vs control of corruption Weaker governance is associated with higher investment / GDP ratios (like in Tanzi-Davoodi 1997 and Keefer-Knack 2007)

20 From spending to assets How big is the cost impact of governance? Look at the average unit cost of infrastructure assets c K t 0 T Note that c should be expected to vary across infrastructure sectors. Construct sector-specific c with K respectively given by road km power generation capacity (Gw) telephone lines T I t K 0

21 From spending to assets Across countries, c may vary with per capita GDP (wages, RER) and other factors Add also climatic / geographic / demographic controls in regressions Some data limitations: No information on O&M spending No information on asset quality (except % roads paved) Small country sample (only 17 countries for the moment ) No retrospective info on fiscal / budgetary institutions, so look instead at the correlation of unit cost with broader governance-related variables: (Control of) corruption [higher is better] Quality of bureaucracy [project selection, procurement ]

22 -2-1 Unit costs for roads ('85-) Unit costs for ml ('85-) Unit cost of infrastructure assets and control of corruption (controlling for GDP per capita) IDN PHL BOL CHL Power PHL BOL ARG JOR CHL COL EGY PER TUR PAK BRA THA VNM IND ZAF IDN EGY MEX PER JOR ARG BRA COL IND MNG Phone lines MEX Corruption (Ave. of the 1980s) TUR Corruption (Ave. of the 1980s) CHL IDN EGY JOR Roads PHL TUR ARG IND BOL MEX PER COL BRA MNG Corruption (Ave. of the 1980s)

23 IDN Power Unit costs for EGC ('85-) -2-1 Unit costs for roads ('85-) Unit costs for ml ('85-) Unit cost of infrastructure assets and quality of bureaucracy (controlling for GDP per capita) PHL BOL CHL BOL PHL PER ARG VNM TUR JOR CHL EGY PAK BRA COL THA IND ZAF IDN PER MEX MNG ARG JOR EGY BRA COL IND Phone lines MEX Bureaucracy (Ave. of the 1980s) TUR Bureaucracy (Ave. of the 1980s) CHL IDN EGY JOR Roads PHL ARG TUR IND BOL PER MEX COL BRA MNG Bureaucracy (Ave. of the 1980s)

24 From spending to assets Weaker governance is associated with higher asset costs in all sectors examined. Corruption and low bureaucratic quality drive a wedge between investment spending and actual infrastructure development. Regression estimates suggest that the magnitude of the wedge is considerable 1 sd improvement in corruption raises by 25% the volume of assets acquired with a given amount of investment 1 sd improvement in bureaucratic quality raises it by 18%

25 Conclusions Extensive research on the growth benefits of infrastructure Overall, solid evidence that infrastructure quantity and quality help growth Also evidence of a positive impact on equity hence scope for a double poverty-reducing effect Effects are bigger where infrastructure endowments are lower so potentially a big payoff from infrastructure catchup for LICs But much less attention has been paid to the costs More analysis of returns vs costs of infrastructure assets is needed with more focus on specific sectors in specific countries Poor data on spending (especially O&M) is one of the biggest obstacles to better understanding of costs 25

26 Conclusions Poor governance drives a wedge between infrastructure spending and actual infrastructure development Low government capacity, weak fiscal governance and corruption inflate asset costs, discourage O&M, and reduce the efficiency of spending This has big effects on the cost of infrastructure development Raising the efficiency of spending is a key priority Research needs to identify institutional mechanisms and incentives that favor sound spending decisions Developing stronger project selection and evaluation capacity Assessing if / how different budgetary institutions, checks and balances can help Otherwise, more spending may yield a lot of waste and not much more infrastructure development. 26

27 End

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