"Dwelling on years of research and a wealth of evidence, this new book is a masterful combination of theory, facts, and intuition. It provides a clear, rigorous, and unified perspective on the role of infrastructure in growth and development. That investing in infrastructure may be not only about promoting markets and reducing production costs, but also about achieving health and education outcomes, empowering women, and fostering innovation, is a message that development practitioners and multilateral institutions would do well to heed."--Otaviano Canuto, vice president, World Bank

Pierre-Richard Agénor is the Hallsworth Professor of International Macroeconomics and Development Economics at the University of Manchester and codirector of the Centre for Growth and Business Cycle Research. He is the coauthor of Development Macroeconomics (Princeton) and author of The Economics of Adjustment and Growth, among other books.

PUBLIC CAPITAL, GROWTH AND WELFARE

ANALYTICAL FOUNDATIONS FOR PUBLIC POLICY By PIERRE-RICHARD AGÉNOR

PRINCETON UNIVERSITY PRESS

Copyright © 2013 Princeton University Press
All right reserved.
ISBN: 978-0-691-15580-7

Contents

Introduction and Overview..........................................11 | Basic Channels.................................................112 | Public Capital and Education...................................493 | Public Capital and Health......................................724 | Public Capital and Innovation..................................1115 | Public Capital and Women's Time Allocation.....................1326 | Public Capital and Poverty Traps...............................1747 | Research Perspectives..........................................192Lessons for Public Policy..........................................219References.........................................................225Index..............................................................247

Chapter One

Basic Channels

Macroeconomists typically emphasize three basic channels through which public capital may affect growth: a direct productivity and cost effect on private production inputs, a complementarity effect on private investment, and a crowding-out effect on private spending through the financial system.

This chapter begins by reviewing the evidence on all three effects. It then presents a basic OLG framework, with full capital depreciation, that accounts for the productivity effect. The equilibrium and the balanced growth path (along which key macroeconomic variables grow at a constant rate) are then derived, and the growth effects of public investment are examined, under alternative assumptions about the importance of the existing public physical assets for the production of new capital. The cost effect of public capital is also discussed, with respect to labor inputs. Optimal fiscal policy is analyzed next. The chapter concludes by discussing various extensions, including indirect taxation, the complementarity effect of public capital on private investment, public capital in the utility function, partial depreciation, and maintenance expenditure.

1| Background

1.1| Productivity and Cost of Private Inputs

The direct productivity and cost effects of infrastructure is the argument that is most commonly referenced to account for a growth effect of public capital. If, as is normally the case, production factors are gross complements, a higher stock of public capital would tend to raise the productivity of other inputs, such as labor and the stock of private capital, thereby reducing unit production costs. Given decreasing returns, the magnitude of this effect would depend, of course, on the initial stock of public capital. In mature economies, marginal productivity effects are likely to be limited; but in low-income countries, where stocks of infrastructure assets are relatively low to begin with, they could be substantial.

Sub-Saharan Africa is a case in point. In most countries of the region, particularly the lower-income ones, infrastructure remains a major constraint on economic activity, depressing firm productivity perhaps by as much 40 percent (Escribano et al. (2008)). For one set of countries power is the most constraining factor by far; a majority of firms cites it as a major business obstacle. Africa's power infrastructure delivers only a fraction of the services found elsewhere in the developing world (Eberhard et al. (2008)). The 48 countries of sub-Saharan Africa (with a combined population of about 800 million) generate roughly the same amount of power as Spain (with a population of about 45 million). For a second set, inefficient functioning of ports is equally significant. Deficiencies in transport and in information and communication technologies (ICTs) are less prevalent but substantial in some cases.

Africa's road density is sparse when viewed against the size of the continent and the distribution of its population. In rural areas over 20 percent of the population lives in dispersed settlements, where typical population densities are less than 15 people per square kilometer. Only one-third of the population living in rural areas are within two kilometers of an all season road, compared with two-thirds in other developing regions. In cities, population density is relatively low by global standards and does not benefit from large economies of agglomeration in the provision of infrastructure services. As a result, the costs of providing a basic infrastructure package can easily be twice as much as in other, more densely populated cities in the developing world (Foster and Briceño-Garmendia (2010)). Lack of railways in the region is a key constraint to trade expansion, especially for agriculture and extractive industries.

Estimates by the African Development Bank suggest that in sub-Saharan Africa transport and energy costs, at 16 and 35 percent of total costs, respectively, represent by far the largest share of firms' indirect costs. A large fraction of these costs is the result of the poor quality of basic infrastructure. For instance, because of inadequate transport facilities and unreliable supply of electricity, firms often incur additional expenses in the form of more expensive transportation means and onerous energy backup systems. Poor quality of electricity provision has a particularly large impact on the poorest countries (Escribano et al. (2010)). In many countries of the region, lack of irrigation also represents a major constraint on agricultural productivity (see Food and Agriculture Organization (2008)). With the availability of fresh water becoming increasingly vulnerable to climate change, in coming years the continent may face severe losses in annual grain production, as well as drastic reductions in energy capacity production.

The productivity and cost effects of public infrastructure may be magnified in the presence of externalities associated with the use of some production factors, such as, for instance, learning-by-doing effects resulting from a high degree of complementarity between physical capital and skilled labor. In addition, independent of its direct effect on the marginal product of factor inputs in the production process (as discussed earlier), public infrastructure may also have an indirect, additional impact on labor productivity. The idea, as suggested for instance by P. Ferreira (1999), is that with better access to roads and other means of public transportation (such as railways), workers can get to their job more easily, therefore spending less time commuting from home or moving across different work locations. This would tend to reduce traffic-related stress, which can be detrimental to concentration on the job. With greater access to electricity and telecommunications, workers can perform a number of tasks more rapidly (such as checking price quotations), as well as additional tasks away from the office (such as checking electronic messages from home). In poor countries, improved access to mobile phones has led to the development of new data services, such as mobile-phone-based agricultural advice, health care, and money transfer, which may all provide significant benefits in terms of productivity. By providing easier access to information, broadband networks may have a large impact on productivity as well. In turn, higher productivity would tend to enhance growth. Czernich et al. (2011), for instance, in a study of OECD countries during the period 1996–2007, found that a...