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Beyond Keynesianism in the Year of the Dragon

Justin Yifu Lin's picture

Millions of Chinese have just celebrated the beginning of the year of the Dragon - a year which according to Chinese tradition is auspicious for ambitious undertakings. These may be required as the global economy faces severe headwinds. According to the January edition of Global Economic Prospects (GEP) report the world economy is expected to grow at 2.5 percent and 3.1 percent in 2012 and 2013, significantly below the 3.6 percent projected for both years in last July’s GEP. But even achieving these much weaker outturns is highly uncertain. The downturn in Europe and weaker growth in several large developing countries, such as Brazil and India, could potentially reinforce one another, resulting in an even weaker outcome. But without growth it will be more difficult to reduce the high debt of some advanced economies to sustainable levels and create much needed jobs world-wide.

In these uncertain times, a global infrastructure initiative could help the global economy regain momentum as I argue in my recent Working Paper. Such an initiative would benefit both developed and developing countries. Governments of advanced economies could support growth in their own countries through infrastructure investments by taking additional steps to attract private sector investments in bottle-neck releasing infrastructure investments that are ultimately self-financing. These investments – if well chosen - while improving future competiveness would create much needed jobs directly in the construction and manufacturing sector that have suffered from particularly high unemployment rates in several countries,  and indirectly in service sector as well.

B
ut opportunities for bottleneck-releasing infrastructure investments in advanced economies tend to be limited, since their infrastructure is on average well developed. In developing countries, to the contrary, lack of infrastructure impinges on the daily lives of millions of people, who have no access to electricity, safe drinking water, basic sanitation or all-weather roads. It also renders firms less competitive, affecting productivity, transaction costs, and output quality adversely. Many businesses are never started, since the required infrastructure services are not available. Going forward the demand for infrastructure is likely to increase even further, as population grows, urbanization rates become higher and countries grow richer.

But infrastructure is not only a by-product of growth. It can also be an important driver of economic development. As I argue in my on New Structural Economics, economic development in any country is a process of continuous technological innovation, industrial upgrading and diversification, and structural transformation. Countries start with more than 85 percent of the population making a living through agriculture when income levels are low. At this agrarian stage, farmers produce mostly for their own consumption and the need for infrastructure services is limited. When the production moves to manufacturing, economies of scale become larger, and producers will mostly produce for other people and no longer for themselves. As market range expands, good infrastructure will enable entrepreneurs to get their goods and services to market in a secure and timely manner and facilitate the movement of workers to the most suitable jobs. Empirical cross-country studies tend to confirm that infrastructure investment has a large effect on growth in developing countries.

Infrastructure investments in developing countries would not only raise their growth, they would also increase demand for capital goods from capital good-exporting countries, most of which are advanced economies, thereby, raising their exports and creating jobs. A US$1 increase in investment in developing countries is associated with a US$0.50 increase in imports. In 2009, about 70 percent of traded capital goods from low-income countries were sourced from high-income countries. A US$1 increase in investment in developing countries is therefore likely to be associated with a US$0.35 increase in exports from high-income countries. These are not small amounts. A global infrastructure initiative could thus generate a virtuous, self-reinforcing cycle of global growth by boosting growth in developing countries and developed countries alike.

History shows that a bold infrastructure initiative can be truly transformative. In 1919, when the young lieutenant colonel, Dwight D. Eisenhower, drove from Washington, D.C., to Oakland, California, with the Motor Transport Corps Convoy, it took him 56 days to cover the 3,250 miles, covering an average of 58 miles during daily 10-hour rides. Upon his return, he reported that bridges were destroyed by the convoy, trucks became stuck during rain, and some roads simply could not accommodate quick and easy travel. When Eisenhower promoted the Federal-Aid Highway Act of 1956 he envisioned that “its impact on the American economy—the jobs that it would produce in manufacturing and construction, the rural areas it would open up—was beyond calculation”. Opportunities to transform economies through infrastructure investments still abound in developing countries today—to the benefit of advanced economies.
 

A bold global infrastructure initiative would be especially helpful for solving the dilemma besetting the Eurozone countries. Without structural reforms to enhance the competitiveness of the debt crisis-hit countries, any stabilization measure is just buying time and problems will recur sooner or later. Moreover, fiscal adjustments are often contractionary and may further reduce demand, jobs, growth, and government revenues at least temporarily, with dire social and policy consequences. Many structural reforms on the other hand, while key to boosting growth in the medium term, might only gain traction once demand increases. A concerted push for a global infrastructure initiative could increase demand, build confidence and contribute to a sustained global recovery from the current crises. It is a global win-win.  

Comments

Submitted by Nachiket Mor on
Dear Dr. Lin, As a former banker from India there is no question in my mind that infrastructure is important but I wonder if, given scarce resources, there isn't a need to think much more carefully about how one decides which specific piece of infrastructure has the highest returns and how it must be financed. In the city of Mumbai for example development of roads and bridges including the famous (and relatively new) one over the sea (the Worli Sea Link) has been prioritised even though much of the traffic in the city is through public transportation and walking. And, for a variety of reasons the richest city in India continues to depend on Central Government largesse to finance much of this infrastructure development because its leaders refuse to levy and collect an adequate amount of property tax from its citizens and as a direct consequence do not really have to consult them when they make these decisions. The story unfortunately is not very different even at the level of the smallest unit of government in India -- the gram panchayat -- there is an even stronger reluctance to levy and collect even the existing set of taxes from its citizens. Given this reality, where central or state government funding (as opposed to from local sources) is the principal source of resources for infrastructural projects, there is, to my mind, enormous scope for misallocation of resources - with the government, for example, "struggling" to find the $2 billion or so annually to ensure universal financial access or the $5 billion to provide broad-band connectivity and the panchayat level, while simultaneously having "found" over $10 billion for a large loan waiver programme for larger farmers. I feel that a sense that all type of infrastructure is good, combined with soft budget constraints and the availability of resources from multilateral institutions for these large centrally financed / state government financed infrastructure projects, weakens the pressure for reform on the ground and while in the near-term citizens feel that they are getting a free ride by getting infrastructure which they are not paying for, in the longer-run I feel that these low return investments exert a moderating influence on growth impulses and exacerbate inflationary pressures and cost the citizens far more. Therefore, while agreeing with you that infrastructure has the potential for large impact, I would be eager to learn from you how you feel one should select the most important projects and how one should use the means of financing as a tool to both pay for them as well as to ensure that the highest return investments are being prioritised. Sincerely, Nachiket Mor

Dear Mr. Mor, Thank you very much for your excellent comment. I completely agree with you that identifying the right, bottleneck-releasing projects is key to making any infrastructure initiative a success. Unfortunately, identifying projects with high economic returns can be a very challenging, complex and time-consuming task. As you mention in your comment, in India, but also in many other developing countries, revenue and expenditure assignments related to infrastructure spending have been pushed to lower levels of government. This requires a comprehensive alignment of fiscal responsibility and accountability, but also coordination in terms of project selection, which is often not straight forward. Regional coordination in infrastructure projects could sometimes significantly help in reducing infrastructure costs but is often difficult to implement. Infrastructure projects can also lead to significant positive as well as negative externalities (e.g. environmental damage) which need to be figured in. As a result, identifying the right projects often requires significant an array of institutional, legal, social, environment, financial, regulatory, and engineering studies. These studies tend to be costly, particularly for complex projects. Often both governments and the private sector are reluctant to allocate substantial resources upfront to support project preparation activities. Some new initiatives are underway to address these shortcomings. In November 2010, the World Bank Group launched the Infrastructure Finance Center of Excellence, which aims at leveraging Singapore’s expertise in urban development and financing and the World Bank’s global development knowledge and operational experience to attract more private capital for public infrastructure projects throughout Asia. The center provides tailored technical assistance to governments on project identification, preparation, and marketing and assists client government in securing project preparation funds via third party facilities. In addition, in the context of G20 meetings, the Multilateral Development Banks have developed an Action Plan which proposes concrete actions to improve project preparation, develop regional projects and help countries to improve spending efficiencies. Sincerely, Justin Lin