To what extent does investment in infrastructure impact on economic growth? How are countries’ responses to their infrastructure needs affected by institutional and economic factors, and how can infrastructural inadequacies be overcome? This paper, published in the Journal of Development Economics, presents a structural model of infrastructure and output growth that takes account of key factors in the relationship.
Infrastructure affects productivity and output, but growth can also shape supply and demand for infrastructure services. When determining how infrastructure development comes about and how it affects the wider economy, it is essential to estimate this two-way relationship simultaneously. It is also necessary to assess the importance of other variables in the relationship. The structural growth model developed in this paper helps to discern the mutual effects of infrastructure and the rest of the economy on one another. It focuses on asset formation in the power and telecom sectors, and applies the model to 75 countries. The model indicates that the contribution of infrastructure services to growth is substantial and exceeds the cost of provision.
The model specifies the ways in which country characteristics and policies enter the interaction between infrastructure and growth, and lead to different outcomes. It also distinguishes between economies in a mature, stable situation (a “steady state”) and convergence towards that point. Applying the model reveals that:
- The impact of infrastructure on growth is significant, outweighing the cost of providing infrastructure services.
- Countries that invest do so especially in infrastructure sectors. Conversely, factors that prevent high rates of investment particularly hinder infrastructure investment.
- Private ownership of infrastructure assets and government credibility (such as honouring contracts) are important for infrastructure growth, but matter less for the ratio of assets to income in a steady state.
- The ability to co-ordinate policies within a country – centralisation – also seems to help infrastructure growth.
- Ethnic and income diversity have negative effects on the ratio of assets to income in a stable situation, although these diminish as democracy increases.
- Population density and urbanisation tend to increase the returns to infrastructure investment and speed up adjustment to imbalances.
While infrastructure investment can boost growth, realising its potential depends on institutional and economic characteristics that affect the ratio of assets to gross domestic product. The model suggests a number of policy implications:
- In the long run, governments can invest effectively in infrastructure by themselves, but they have more trouble dealing with infrastructure imbalances in the short and medium terms.
- Institutional capabilities that lend credibility and effectiveness to government policy play an important role in the development process through infrastructure growth.
- Credibility also raises productivity levels and per capita income.
- Countries can gain a great deal from improving investment and performance in infrastructure sectors.
- But achieving better outcomes requires institutional and organisational reforms that go beyond designing and funding infrastructure projects.
- It would be beneficial to conduct further research incorporating other infrastructure sectors, the issue of infrastructure quality and more detailed information on institutional capacity and organisational arrangements.
