Infrastructure-based development

Infrastructure-based economic development also called infrastructure-driven development combines key policy characteristics inherited from the Rooseveltian progessivist tradition and Neo-Keynesian economics in the United States, France's Gaullist and Neo-Colbertist centralized economic planning, Scandinavian social democracy as well as Singaporean and Chinese state capitalism : it holds that a substantial proportion of a nation’s resources must be systematically directed towards long term assets such as transportation, energy and social infrastructure (schools, universities, hospitals…) in the name of long term economic efficiency (stimulating growth in economically lagging regions and fostering technological innovation) and social equity (providing free education and affordable healthcare).[1][2] While the benefits of infrastructure-based development can be debated, the analysis of US economic history shows that at least under some scenarios infrastructure-based investment contributes to economic growth, both nationally and locally, and can be profitable, as measured by a high rate of return. The benefits of infrastructure investment are shown both for old-style economies (ports, highways, railroads) as well as for the new age (airports, telecommunications, internet...).

According to a study by D.A. Aschauer,[3] there is a positive and statistically significant correlation between investment in infrastructure and economic performance. Furthermore, the infrastructure investment not only increases the quality of life, but, based on the time series evidence for the post-World War II period in the United States, infrastructure also has positive impact on both labor and multifactor productivity. The multifactor productivity can be defined as the variable in the output function not directly caused by the inputs, private and public capital. Thus, the impact of infrastructure investment on multifactor productivity is important because the higher multifactor productivity implies higher economic output and hence higher growth.

In addition to Aschauer’s work, Munnell’s paper[4] supports the point that infrastructure investment improves productivity. Munell demonstrates that the decrease in multifactor productivity growth during the 1970s and 1980s relative to the 1950s and 1960s is due to the decrease of public capital stock rather than the decline in technological progress. By showing that public capital plays an important role in private sector production, Munnell helps Aschauer establish that infrastructure investment was a key factor to “the robust performance of the economy in the ‘golden age’ of the 1950s and 1960s.”[3]

To prove his point, Aschauer builds a model, using the data for the time period from 1953 to 1988, to simulate the effect of higher public investment on the aggregate economy. His simulation shows that, on net, the increased investment in core infrastructure might have greatly improved the performance of the economy.

Aschauer uses the production function $Y= F(K,G,N,Z)=ZK^{\alpha}G^{\beta}N^{1-\alpha-\beta}$, where:

• Y = level of output
• K = private fixed capital
• G = level of government productive services
• N = population or labor force
• Z = index of technological progress
• α and β are constants determined by available technology.

He estimates the production function relation using the average data from 1965 to 1983 for the 50 states. This enables Aschauer to conclude that the level of per capita output is positively and significantly related to core infrastructure investments, in other words an increase in the core infrastructure investments leads to an increase in the level of per capita output.[3]

However, infrastructure has positive impact not just on the national level. By implementing the cross-sectional study of communities in one state, Janet Rives and Michael Heaney confirm “the links identified in national level studies between infrastructure and economic development”[5] are also present locally. Because infrastructure enters the production function and increases the value of urban land by attracting more firms and house construction, the core infrastructure also has a positive effect on economic development locally.

According to an overview of multiple studies by Louis Cain,[6] the infrastructure investments have also been profitable. For example, Fogel estimated the private rate of return on the Union Pacific Railroad at 11.6%, whereas the social rate that accounts for social benefits, such as improved firm efficiencies and government subsidies, was estimated at 29.9%.[6] In another study, Heckelman and Wallis estimated that the first 500 miles of railroad in a given state led to major increases in property values between 1850 and 1910.[6] They calculated the revenue gain from the land appreciation to be $33,000-$200,000 per mile, while construction costs were $20,000-$40,000 per mile. Hence, on average the revenue from construction of a new railroad outweighed the costs. While initial construction returns were high, the profitability diminished after the first 500 miles.

Even though the revenue streams on infrastructure construction investment fall due to diminishing returns, Edward Gramlich indicates that the rate of return on new construction projects was estimated at 15%. Furthermore, the rate of return on maintenance of current highways was estimated at 35%. It means that even without further new construction, the investment in the maintenance of the core infrastructure is very profitable.[6]

Roller and Waverman,[7] utilizing data for 21 OECD countries, including US, over a 20-year period, from 1970 to 1990, examined the relationship between telecommunications infrastructure investments and economic performance. They used a supply-demand micro-model for telecommunications investments jointly with the macro production equation, accounting for country-specific fixed effects as well as simultaneity. They conclude that there is a causal relationship between telecommunications infrastructure investment and aggregate output.

Shane Greenstein and Pablo T. Spiller examined the effects of telecommunication infrastructure on economic performance in the United States. They conclude that infrastructure investment accounts for a significant fraction of the growth in consumer surplus and business revenue in telecommunications services, both of which indicate the growth in economic performance.[7]

Some European and Asian economists suggest that “infrastructure-savvy economies” [1] such as Norway, Singapore and China have partially rejected the underlying Neoclassical “financial orthodoxy” that characterizes the ‘Washington Consensus’ and initiated instead a pragmatist development path of their own[8] based on sustained, large-scale, government-funded investments in strategic infrastructure projects: “Successful countries such as Singapore, Indonesia and South Korea still remember the harsh adjustment mechanisms imposed abruptly upon them by the IMF and World Bank during the 1997-1998 ‘Asian Crisis’ […] What they have achieved in the past 10 years is all the more remarkable: they have quietly abandoned the “Washington consensus” by investing massively in infrastructure projects […] this pragmatic approach proved to be very successful.”[9]

Research conducted by the World Pensions Council (WPC) suggests that while China invested roughly 9% of its GDP in infrastructure in the 1990s and 2000s, most Western and non-Asian emerging economies invested only 2% to 4% of their GDP in infrastructure assets. This considerable investment gap allowed the Chinese economy to grow at near optimal conditions while many South American, South Asian and African economies suffered from various development bottlenecks: poor transportation networks, aging power grids, mediocre schools....[1]

In the West, the notion of pension fund investment in infrastructure has emerged primarily in Australia and Canada in the 1990s notably in Ontario and Quebec and has attracted the interest of policy makers in sophisticated jurisdictions such as California, New York, the Netherlands and the UK.

In the wake of the Great Recession that started after 2007, liberal and Neo-Keynesian economists in the United States have developed renewed arguments in favor of “Rooseveltian” economic policies removed from the ‘Neoclassical’ orthodoxy of the past 30 years- notably a degree of federal stimulus spending across public infrastructures and social services that would “benefit the nation as a whole and put America back on the path to long term growth”.[10]

References

1. ^ a b c M. Nicolas Firzli & Vincent Bazi (Q4 2011). "Infrastructure Investments in an Age of Austerity : The Pension and Sovereign Funds Perspective". Revue Analyse Financière, volume 41, pp. 34-37. Retrieved 30 July 2011.
2. ^ T. Rephann & A. Isserman (March 1994). "New Highways as Economic Development Tools". West Virginia University Regional Research Institute, Paper 9313. Retrieved 9 Nov 2012.
3. ^ a b c Aschauer, David Alan (1990). “Why is infrastructure important?” Federal Reserve Bank of Boston, New England Economic Review, January/February, pp. 21-48.
4. ^ Munnell, Alicia (1990). "Why has Productivity Growth Declined? Productivity and Public Investment.", Federal Reserve Bank of Boston, New England Economic Review, January/February, pp. 3-20.
5. ^ Rives and Heaney (1995). "Infrastructure and Local Economic Development" Journal of Monetary Economics, vol. 25, no. 1, pp. 58-73.
6. ^ a b c d Cain, Louis (1997). “Historical perspective on infrastructure and US economic development” Regional Science and Urban Economics, vol. 27, pp. 117-138.
7. ^ a b Röller and Waverman (2001). “Telecommunications Infrastructure and Economic Development: A Simultaneous Approach” The American Economic Review, vol. 91, no. 4, pp. 909-923.
8. ^
9. ^ M. Nicolas J. Firzli World Pensions Council (WPC) Director of Research quoted by Andrew Mortimer (May 14, 2012). "Country Risk: Asia Trading Places with the West". Euromoney Country Risk (.). Retrieved 5 Nov 2012.
10. ^ Felicia Wong (Q1 2013). "Fighting the ‘Great Recession’: Why America Needs Rooseveltian Resolve". Revue Analyse Financière World Pensions Council RAF/WPC Special Report on US Economy (N° 46): 18–19. Retrieved 26 Jan 2013.