The FINANCIAL -- Development banks should step up their engagement in infrastructure, argue EBRD economists.
Fiscal stimulus through infrastructure
Government infrastructure spending has one of the highest fiscal multipliers among all types of fiscal stimulus measures – that is, an extra dollar of infrastructure spending translated into higher increase in the overall value added for the economy compared with most other fiscal measures. The high multiplier reflects both direct and indirect effects of infrastructure provision, according to EBRD.
Directly, construction projects tend to be labour intensive, meaning that much of the expenditure goes directly back into the economy through wages. Indirectly, better infrastructure boosts productivity of firms that use it, resulting in faster economic growth.
This makes increased infrastructure investment an attractive policy option amidst increased fears of "secular stagnation" in advanced economies - a sustained post-crisis period of weak economic growth due to insufficient demand - and slower growth in emerging markets.
At the same time, the extent to which infrastructure fiscal stimulus can be effective varies from country to country. It depends on the potential for new infrastructure to benefit the wider economy, closely linked to a country’s institutional capacity. It also depends on the availability of fiscal space to finance infrastructure.
Potential to benefit from infrastructure
The potential for new infrastructure to benefit an economy depends on a number of factors:
The current stock of infrastructure (and expected future path of infrastructure investment) - economic returns to infrastructure tend to be higher when the existing stock is lower;
Institutional capacity – the ability to design, select, procure and implement infrastructure projects effectively. It reflects both technical capacity and general quality of economic institutions. Numerous "white elephant" projects can impose high fiscal burden without yielding growth benefits;
Appropriate balance between spending on new infrastructure and maintenance spending: maintenance spending often gets overlooked in favour of large new projects that make headlines while returns to maintenance spending can be equally high (or higher).
None of the EBRD countries of operations (and developing and emerging market countries more generally) are currently perceived to have very high quality infrastructure, as reflected in the World Economic Forum (WEF) index. Thus the high existing stock of infrastructure is unlikely to be among the key factors limiting returns to infrastructure provision in these countries while institutional capacity often appears to be a binding constraint.
Chart 1 plots countries in terms of their infrastructure transition indicators and indicators of governance related to the degree of development of each country’s economic institutions. In addition, countries that rank in the bottom quarter of WEF’s worldwide rating of the efficiency of government spending are marked as dark triangles. Based on this representation, countries can be broadly divided into three groups: those with high institutional capacity (having higher governance indicators and higher average infrastructure transition scores, in the top right corner of the chart); those with medium institutional capacity and those with limited institutional capacity (located in the left bottom corner of the chart where both perceived quality of governance and infrastructure transition scores are low).
Chart 1.Institutional capacity
WEF data on efficiency of government spending are not available for Belarus, Kosovo, Tajikistan, Turkmenistan and Uzbekistan.
Fiscal space for infrastructure spending
Infrastructure spending in many ways represents an investment with a long payback period: as new infrastructure benefits firms throughout the economy, it can boost growth by an amount sufficient to offset the increase in debt needed to finance the infrastructure in the first place. In this way, debt-financed infrastructure spending need not increase the debt-to-GDP ratio in the long run.
If that is the case, it may be appropriate for governments to pursue a golden-rule type fiscal policy, balancing or near-balancing revenues and current expenditures (expenditures on social transfers, wages, goods and services and interest payments, thus excluding investment).
A significant number of countries in the region balance or nearly balance their current expenditures and revenues, while at the same time having relatively modest levels of capital spending (below 5 per cent of GDP on average, see Chart 2).
Chart 2. Fiscal space for infrastructure
Countries marked with red circles have public debt-to-GDP ratios in excess of 80 per cent; countries marked with yellow triangles have public debt-to-GDP ratios of 60 to 80 per cent (Montenegro’s public debt, estimated at 58 per cent of GDP, may exceed 60 per cent shortly). Public investment average for the period 2010-14, with preliminary estimates for 2014.
Several countries, however, have high levels of public debt and thus may find it more difficult to increase infrastructure spending by issuing more debt, not least because additional debt issuance may carry high cost and crowd out private investment.
Overall, the analysis suggests a number of countries where current capital spending is modest, current fiscal balance is positive (or deficit is small) and public debt-to-GDP level is moderate. These countries (located in the top left part of the chart) are deemed to have appropriate fiscal space for increased infrastructure financing.
To ease fiscal space constraints where such constraints are binding or may become binding, governments can further leverage user fees and charges as a source of financing. They can also seek greater private sector participation in provision of infrastructure. Both are at the core of the EBRD’s approach to infrastructure. At the same time, concessions and public-private partnerships do not necessarily reduce the burden on public finance if government’s contingent liabilities (such as demand risk guarantees) are ultimately called. In some of these countries national or EU level rules may restrict fiscal deficits; or exchange arte arrangements may put de facto limits. In these cases the use of grants can be considered.
Overall, the public sector tends to account for a major share of infrastructure provision, from around 15 per cent (Austria) to around 60 per cent (Sweden) in the EU-15 economies and 22 per cent (Cyprus) to 76 per cent (Poland) in the new EU member states, according to estimates published by the European Investment Bank.
Case for more infrastructure spending in the region
Table 1 summarizes scope for scaling up infrastructure spending in countries where the EBRD invests based on fiscal space and the current institutional capacity to deliver infrastructure efficiently.
Countries in the bottom right corner are deemed to both have the institutional capacity and fiscal space to scale up infrastructure spending.
At the same time, a number of countries in the top left corner appear to have neither. Countries in other red cells are constrained either by their current delivery capacity or by their lack of fiscal space.
In countries with sufficient institutional capacity but limited fiscal space use of grants and concessional finance could be considered.
In countries with low-to-medium institutional capacity to deliver infrastructure, the priority is to increase technical capacity to design and implement projects through targeted technical assistance alongside efforts to scale up spending on infrastructure. In the longer term, the priority is to strengthen the core economic institutions that help to reduce waste in infrastructure provision.
Here, the development banks can play an important role by stepping up their engagement in infrastructure provision -- where the project management capacity is weak, with strong technical support; and where fiscal space is limited, with the use of blended finance or grants.