The media is widely reporting the discovery of a labyrinth of air-conditioned tunnels under the Gadhafi complex. By the time Saddam Hussein was removed from power, he had built close to 80 palaces in Iraq, with his initials carved into their walls, columns and ceilings. This is of course not unique to the region. Ceausescu’s House of the Republic remains the world’s second largest building, with over 1000 rooms and nearly 500 crystal chandeliers.
These extravagant structures highlight why infrastructure investments are often not growth enhancing in the absence of good governance. Without transparency and accountability, questionable spending goes unpunished.
Our Economic Development Prospect (EDP) report underscores this problem, especially in the oil-exporting developing countries such as Libya, Syria, and Yemen. Empirical results confirm a positive and significant relationship between expansion in public investment and income growth in economies with good rule of law (above the median), but this relationship breaks down in economies with poor governance.
When governance is good, public investments crowd in private investment by providing the energy, roads, logistics and communications links necessary for firms to function productively.
With poor governance, public investment is more likely to crowd out private investment by using resources that would otherwise be used by the private sector. For example, if heavy government investment raises the costs of resources to the private sector. This is most likely when governments are borrowing heavily and public spending pushes up interest rates.
In addition, with poor governance, public investment may not stimulate growth because it is spent on unproductive assets that are desirable only to special interest groups—assets such as a labyrinth of tunnels or dozens of palaces. Without accountability, public investment may also lead to excessive and unproductive rent-seeking behavior, as agents vie for lucrative contracts.
All in all, the results confirm that public investment cannot fill in for private investment, especially when governance is weak. The reverse is also true. Private investment is reluctant to go to countries with poor rule of law because property rights are not well established and resource costs are uncertain.
To revive investment above and beyond pre-Arab-Spring levels, a move to transparency and accountability is urgent. Indeed, investment surged in many economies undergoing economic transitions that made early moves to improve governance. And countries with better indexes of rule of law attract significantly more foreign investment by multinationals.
Governance is about giving people voice, but it is also necessary to prevent a dire misallocation of resources.
For the Lead Economist of the Middle East & North Africa Region's recent blog on the Report and subject, please go here.