The International Monetary Fund (IMF) has made a strong pitch for higher public investment in infrastructure to counter the weakness in global economic recovery.
Its recently released World Economi Outlook (WEO) features a study which examines the macroeconomic effects of public investment in a large number of countries.
Due to weaker than expected global activity in the first half of 2014, the IMF has revised downward the growth forecast for the world economy to 3.3% for this year, 0.4 of a percentage point lower than in the April 2014 WEO. The global growth projection for 2015 was lowered to 3.8%.
In a speech made at Georgetown University last month, Christine Lagarde, managing director, IMF, said that public investment in infrastructure, together with growth-friendly fiscal policies and structural reforms, can “accelerate growth, increase employment and achieve a new momentum” instead of muddling along to a “new mediocre”.
She warned that a weak global recovery, if not addressed squarely, could lead to “low growth for a long time”, as people cut back on investment and consumption today in fear of tomorrow’s lower growth potential. Other clouds on the horizon include asynchronous monetary policy normalisation; migration of new market and liquidity risk to the less-regulated, non-bank sector; and a build-up of financial sector excesses in advanced economies.
According to the WEO study, in advanced economies an increase in infrastructure investment could provide a much-needed fillip to demand, and is one of the few remaining policy levers available to support growth, given already accommodative monetary policy.
“The crisis has inflicted a heavy toll on both growth and investment, which remain well below their long-term trends,” said Lagarde.
“As of last year, we have estimated that for the G-20 countries, GDP is 8% lower than it could otherwise have been. The shortfall in investment is even higher – nearly 20% below trend.”
The study notes that the stock of public capital, which reflects to a large extent the availability of infrastructure, has declined significantly as a share of output over the past three decades across advanced, emerging market and developing economies.
In advanced economies, this reflects primarily a trend decline in public investment from about 4% of GDP in the 1980s to 3% of GDP at present.
This has led to deficiencies in the quality of existing infrastructure stock in these countries. For example, the American Society of Civil Engineers noted in 2013 that 32% of major roads in the US are now in poor or mediocre condition, and the US Federal Highway Administration estimates that between $124bn and $146bn annually in capital investment will be needed for substantial improvement in conditions and performance.
However, emerging economies still have only a fraction of the public capital available in advanced economies, due to lower efficiency of public investment. Power generation capacity per person in emerging market economies is one-fifth the level in advanced economies, and in low-income countries it is only one-eighth the level in emerging markets. The discrepancy in road kilometres per person is similarly large.
Key considerations
The WEO study bases its recommendation of higher public investment in infrastructure on two key factors. One, real interest rates are expected to remain lower than pre-crisis levels for the foreseeable future; and two, higher public investment raises output, both in the short term because of demand effects and in the long term as a result of supply effects, as the productive capacity of the economy increases with a higher infrastructure capital stock.
In a sample of advanced economies, an increase of one percentage point of GDP in investment spending raises the level of output by about 0.4% in the same year and by 1.5% four years after the increase. In addition, the boost to GDP a country gets from increasing public infrastructure investment offsets the rise in debt, so that the public debt-to-GDP ratio does not rise. Thus, if done correctly, public infrastructure investment pays for itself.
The study also presents evidence from advanced economies that suggests that an increase in public investment that is debtfinanced can have larger output effects than one that is budget neutral (by raising taxes or cutting other spending), with both options delivering similar declines in the public-debt-to-GDP ratio. But it also cautions that this should not be interpreted as a blanket recommendation for debt-financed public investment, as adverse market reactions – which might occurin some countries with already-high debt-to-GDP ratios or where returns on infrastructure investment are uncertain – could raise financing costs and further increase debt pressure.
For those emerging market and developing economies where infrastructure bottlenecks are constraining growth, the gains from alleviating these bottlenecks could be large; but increasing public investment may lead to limited output gains, if efficiency in the investment process is not improved. Thus, a key priority in many economies, particularly in those with relatively inefficient public investment, should be to raise the quality of infrastructure investment by improving the public investment process.
This could involve, among other reforms, better project appraisal and selection that identifies and targets infrastructure bottlenecks, including centralised independent reviews, rigorous costbenefit analysis, risk costing, zero-based budgeting principles and improved project execution.
The report also quotes an April 2014 Fiscal Monitor article which found that only half of the increase in government investment in emergingmarket and developing economies from 1980-2012 translated into productive capital. The same article noted that reducing all inefficiencies in public investment by 2030 would provide the same boost to the capital stock as increasing government investment by five percentage points of GDP in emerging market economies, or by 14 percentage points of GDP in low-income countries.
To conclude, while the scope for investment differs across countries, epending on infrastructure gaps and fiscal space, ensuring efficient infrastructure spending is crucial for all countries.
The IMF chief cited the Global Commission on the Economy and Climate’s finding that integrating lower emission standards into infrastructure investment would cost only a tiny fraction (about 4.5%) of total projected spending. Efficient investment can be good for growth, good for jobs and good for the environment.