Rich Country or Poor Country, Invest in Infrastructure

BY GONZALO HUERTAS

Introduction

If you were in a bar in Bangladesh, speaking with your colleagues about the tough state of the global economy, there’s a high possibility that the lights would go out at some point during the conversation. If this debate occurred during a taxi drive in Brazil, you might overhear the driver sighing as he hit another pothole. Were the same conversation happening over the phone in India, you wouldn’t be too surprised if you suddenly lost your network connection.

Despite rapid GDP growth in recent years, these countries suffer from major infrastructure deficits. For the larger set of countries that have long struggled to achieve rapid economic growth, poor infrastructure is even more problematic. While leading emerging markets may suffer from an eroded highway, many smaller economies may not have a highway at all. The problem feeds on itself: the lack of infrastructure impedes economic growth, and the lack of economic growth slows infrastructure development.

One of the grave concerns left by the financial crisis of the 2000s has been the sustained lower level of potential output for many nations across the world.[1] This issue has raised serious doubts regarding perspectives for economic development in the future.[2] The question remains: how can we pursue faster, more resilient growth when economies are weighed down by structural deficiencies across the board? While infrastructure investment may not be the most revolutionary solution, it is an absolutely essential one.

The Challenges So Far

What do we know about the deficiencies of global growth? Recent literature has drawn attention to two worrying phenomena.

One is the so-called productivity paradox. In short, the rate of productivity growth has been decelerating over the past decades in advanced economies. Productivity is the major driver of long-term economic prosperity, and developed nations generally set the benchmark for the rest of the world’s technological frontier.[3] Ninety-four percent of economists in the Wall Street Journal’s May 2015 survey agreed that weak capital spending had either a “large” or “modest” impact on the disappointing level of productivity performance following the financial crisis.[4]

A second challenge to global growth is secular stagnation, a world in which a large amount of money is saved and becomes available as loanable funds. However, little of the money is actually invested. The lack of investment weighs down on demand and shows up in sluggish growth figures.[5]

The productivity paradox and secular stagnation highlight two urgent needs. First, we need to put our resources to work by promoting forms of investment that boost economic activity in the long run. Second, we must develop policies that raise the efficiency associated with combining labor, capital, and productivity. The resources to invest are available, but we are missing the political will and technical expertise to invest in the right projects.

Infrastructure as a Growth Kickstarter

For the people of the agrarian province of Savannakhet, Laos’s most populous district, daily circumstances in the early 2000s were extraordinarily hard. Families lived in subsistence conditions in remote, isolated areas. One in every five households was living under the poverty line, and access to health care and other social services were hampered by the absence of paved roads and public transportation.[6]

However, Savannakhet would soon find itself amidst an infrastructure revolution. Assisted by the Asian Development Bank, Laos and its neighboring countries embarked on a 1,400 km land route project that directly connected the ports of Mawlamyine, Myanmar to the Danang deep-sea port in Vietnam (passing through Laos and Thailand) by constructing and improving roads, bridges, tunnels, and electricity grids.[7]

The corridor became fully operational in 2006 and had astounding implications for the families of Savannakhet. Provincial GDP grew at a rate of over 10 percent from 2006 to 2011. The number of people living in poverty fell by over a third in the same period, declining at a rate almost twice that of the rest of the country. As cross-border trade doubled, modern housing, markets, guesthouses, and shops emerged all along the corridor.[8]

Infrastructure investment can generate short-term benefits by boosting aggregate demand, but its most significant impact lies in its long-term effects.[9] Businesses have access to larger markets; rural citizens have expanded access to public goods and services like schools and hospitals.

Investing in physical infrastructure—electricity, gas, telecommunications, transportation, water supply, and sewerage—makes economic sense.[10] Yet it’s an area where national governments have underperformed time and again.

A Social Debt That’s Long Overdue

It’s difficult to feel moved by concepts like public capital or infrastructure investment because there’s no clear emotional component to steel bridges and copper wires. However, the infrastructure shortfalls faced by most countries today represent a serious constraint on economic and social development.

One in three children born in rural Mongolia today will have no access to improved water sources such as a household connection, public standpipe, or protected well on the premises of their homes.[11] Fifteen percent of Turkey’s entire electricity production is lost due to faults in transmission and distribution.[12] Brazil’s ports rank far behind the rest of those in Latin America and close to the “extremely underdeveloped” category.[13] Finally, contrary to popular belief, even Germany has covered only half of its local rail system’s needs (€260 million) over the past decade.[14]

From a global perspective, these deficiencies shouldn’t be surprising. Public investment in the past thirty years has declined steadily in advanced, emerging, and developing economies alike[15] and has only recently begun to pick up emerging and developing countries.[16] But if infrastructure leads to such clear social and economic benefits, why have nations across the globe consistently underinvested in it?

The reason is a mix of political and financial constraints. Infrastructure projects are a long-term enterprise, but policy makers face incentives to prioritize programs that generate immediately visible benefits. This is especially problematic for maintenance spending, which holds no glory for politicians wishing to show off big projects to their constituents. Infrastructure investments also require significant cash investments at the outset. Cash-strapped governments and firms with limited access to capital face difficulty in financing the large initial costs of infrastructure projects. For the public sector, raising the necessary resources usually implies either raising taxes or taking out debt, both of which may be unpopular and link the financial constraints to the political ones.

 How to Lead an Infrastructure Push

Infrastructure deficiencies are a social debt that’s long overdue. Overcoming these deficits will require a long-term commitment from national and local authorities to coordinate an infrastructure push that sets the investment process in motion.

South Australia’s Strategic Infrastructure Plan sets a good example for government coordination. Aware of the challenges posed by urban population growth and a diversifying economy, local officials joined forces with the national government and the private sector to identify physical capital priorities and lay out clear, long-term investment objectives. One of the plan’s flagship projects, the $564 million Northern Expressway, which was designed and constructed through joint ventures and funded by a dual effort between national authorities and the local government, was opened three months ahead of schedule. It went on to become a best practice case study for the Australian government.[17]

Another positive example for successful coordination, especially for financially constrained developing countries, is Argentina’s recent Vaca Muerta agreement, signed in January 2017. Faced with the world’s second-largest non-conventional gas reserves, much of which have gone untapped, national authorities devised a multi-stakeholder accord. Firms committed to a long-term investment plan, local governments agreed not to increase applicable taxes, worker unions included productivity clauses in their collective bargaining agreements, and the federal government provided the investment in highways and railroads necessary to run the entire operation. The Argentine government is currently moving forward with site operations as it aims to reduce its dependence on foreign energy imports.[18]

Regional infrastructure projects can sometimes be more cost effective and efficient than national efforts. By pooling resources with neighbors, countries can better exploit economies of scale. In Latin America, the Itaipú-Asunción-Yacyreta Transmission Line Project, which was developed jointly between the governments of Paraguay and Brazil, addresses the region’s electricity transmission losses. The project also attracted funding from the Mercosur Structural Convergence Fund, a financial support mechanism that seeks to reduce structural asymmetries between its partners.[19]

National and regional efforts comprise the core of any serious infrastructure push, but multilateral approaches are also effective. International financial institutions, while traditionally supportive of new projects, have been less willing to provide assistance for public capital maintenance. However, avoiding capital deterioration can be more cost-effective than starting new projects from scratch.[20] Multilateral development banks also have an important role to play in assisting developing countries with early-stage risk assessment and project development support.

Getting Specific: The Right Kind of Infrastructure Spending for the Right Kind of Country

Not all infrastructure investment is created equal.

We must carefully consider the differences between infrastructure investments in developing and developed countries. In the former, pushing for investment in new projects that expand capacity makes sense precisely because developing nations suffer from undersupply. For industrialized nations, however, a considerable amount of public and private capital may already exist (for example, extensive interstate highway systems, modern international airports, and extensive electric grids). Developed countries may therefore find it more cost effective to focus on maintenance spending. Consider, as a case in point, the erosion of paved highways in the United States: research from Michigan State University suggests that for every dollar spent on preventive pavement maintenance, taxpayers save four to ten dollars on rehabilitation costs down the line.[21]

A second important distinction is differences across countries’ fiscal space.  Nations with high public debt-to-GDP ratios (a mixed bag that includes Japan, Italy, and Portugal, but also Greece, Lebanon, and Jamaica) may be hesitant to go on a spending spree which could worsen their existing debt levels. They may also be unable to access cheap capital to fund such projects.

The International Monetary Fund (IMF) sought to address this concern in the October 2014 edition of their World Economic Outlook. Given economic slack and monetary accommodation, the positive effects of spending on aggregate demand could reduce public debt-to-GDP levels, the report finds.[22] In all fairness, that same report also advises caution for those cases where returns are uncertain and the efficiency of investment is particularly low. Still, additional contributions to the literature have sought to ease debt concerns by pointing to the current global scenario of persistently low real interest rates. For countries with large current account surpluses—such as Germany—domestic infrastructure might be a profitable alternative to investing in foreign assets.[23]

Finally, there are some important regional differences regarding infrastructure priorities through 2020. The International Development Finance Club has compiled a list of estimated funding needs, which showcases important geographic differences in priorities.  In Asia, requirements are highest in the energy sector and would consume almost half of the total necessary infrastructure funding— about 3.4 percent of annual regional GDP.  In Latin America, priority lies in telecommunications with over 40 percent of total infrastructure spending needs. In Europe and Central Asia, low highway quality makes road transportation the key subsector for future development focus.[24],[25]

Conclusion: The Time Is Now

Rarely have conditions been more optimal for a big push in infrastructure spending. Borrowing costs are low, economic activity is weak, and developing nations are lacking many kinds of basic social and productive services.

In its 2014 World Economic Outlook, the IMF devoted an entire chapter to the importance of public spending in infrastructure, emphasizing that its successful implementation raises economic activity in both the short and long term. Among its concluding remarks, the report called for an increase in infrastructure investment by those countries with clearly identified needs and the capacity to efficiently mobilize the necessary resources.[26]

It is easy to see that mistakes have been made in the search for prosperity. It is also easy to surrender to disappointment or frustration in the pursuit of greater economic returns. But now is not the time to stop trying. When 18th-century economists shrugged at the idea of further economic growth, citing the fixed amount of arable land as an insurmountable limitation, they failed to foresee that human willpower and innovation would overcome it. Three centuries later the debate is back, and we already know what the next step should be.

Acknowledgements

I am thankful to Professor Henry Lee for his helpful suggestions while writing this article. I would also like to acknowledge Cecilia Garibotti and Rodrigo García Ayala, who provided critical feedback.

Gonzalo Huertas is currently pursuing his master’s in public administration in international development at the John F. Kennedy School of Government at Harvard University, and is the President of the Harvard Kennedy School Argentine Society. Before coming to Harvard he worked as an international economics advisor at the National Cabinet of Ministers of Argentina.