The world’s underinvested in infrastructure and a new approach to building infrastructure should be developed.
That is the message of an IMF report published on 18 June.
The report, named Making Public Investment More Efficient, critically reviews global experience in delivering infrastructure in the last 30 years, an era that has been dominated by neo-orthodox economic ideas where the market and private enterprise are given priority.
The results are now in. Investment in infrastructure essential for long-term growth and social engagement has been inadequate.
“Against the background of a steady decline in public investment as a share of GDP in advanced economies, evidence of infrastructure bottlenecks in emerging and developing economies, and the sluggish global economic recovery, many have called for ramping up public investment to raise long-run economic growth,” the report says.
The IMF notes that public investment is recovering in some parts of the world but the overall trend is down.
“In advanced economies (AEs), average public investment has steadily decreased from a high of just under 5 per cent of GDP in the late 1960s to a historic low of just over 3 per cent of GDP in 2012,” it says. “In contrast, in emerging markets (EMs) and low-income developing countries (LIDCs), public investment rates peaked at over 8 per cent of GDP in the late 1970s/early 1980s, declined to around 4-5 per cent of GDP in the mid-2000s, but have since recovered to 6-7 per cent of GDP. Hence, public investment rates in AEs remain at historic lows, but have partially recovered in EMs and LIDCs over the last decade.”
The growth of the public capital stock has risen steadily on a per capita basis across countries but it has generally lagged behind economic output.
“Since 1960, the real value of the public capital stock has nearly tripled on a per capita basis across all countries,” it says. “However, the public capital stock has failed to keep pace with rising output in AEs throughout this period. After a significant recovery of public capital stocks in the 1980s and 1990s, EMs and LIDCs saw reductions in their public capital/output ratios over the past decades, which have only just begun to reverse in the past few years.”
The IMF says the traditional rationale for the public provision of infrastructure is based on the concepts of public goods and market failures. Markets will fail to provide the socially beneficial level of a public good because it is norival (it can be consumed by many at the same time without being exhausted, like a road) and non-excludable (it is not possible to prevent those who do not pay from using it, like defence).
Potential underprovision of infrastructure also arises where services exhibit
- network effects (eg subway systems)
- positive externalities (eg clean water)
- or natural monopoly characteristics (eg electricity transmission).
These characteristics give a private provider the ability and incentive to raise prices and/or restrict output below socially desirable levels and provide a rationale for public provision. Governments may also intervene to address social or equity considerations, such as providing universal access (eg basic education) or ensuring that vulnerable groups have access to services (eg transportation).
The IMF report says that technological innovations have better enabled the commercialisation of a number of infrastructure networks, which were previously mostly the preserve of the public sector. Market segments formerly characterised by monopoly provision have changed due to growth in the size of the market and competition introduced by new technologies as in electricity generation and telecommunications.
More sophisticated instruments have been developed to regulate tax, or subsidise activities which generate externalities directly (eg pollution taxes, noise ordinances, electronic tolling on roads, and airport landing fees), enabling service provision and infrastructure investment decisions to be left largely to the private sector within an overarching policy or regulatory framework (eg telecommunication, electricity, airports, ports).
In recent decades, concerns about the public sector’s efficiency in providing infrastructure have also encouraged greater private sector provision. Government intervention can generate inefficiencies due to the absence of market signals and commercial discipline. Thus, the case for government intervention due to market failure has to be balanced against risks of “government failure.”
“Therefore, even if market failure occurs, private sector provision may be justified if governments cannot operate efficiently—that is, when governments incur excessive costs relative to expected benefits,” the IMF reports. “Nonetheless, the public sector still dominates the provision of social infrastructure because of equity considerations (eg universal access, social mobility). Similarly, despite technological advances, governments also remain the main providers of large and complex infrastructure projects, such as national railways and urban transport networks, mainly due to market conditions (eg pure monopolies) and private sector difficulties in financing big infrastructure projects (eg large fixed costs).”
The arguments in favour of using private finance in public infrastructure have been challenged by experience.
“The sharp increase is of particular concern in LIDCs, where PPP (public-private partnership) frameworks remain weak, potentially exposing public finances to significant risks, and having significant implications for the efficiency of public investment spending,” the report says. “… not all investment projects can be effectively delivered using a PPP. The benefits of PPPs mainly arise from the government’s ability to allocate risks efficiently between public and private parties to ensure the right incentives and reduce overall project costs. To do so, the outputs and the quality of services must be predictable and measurable for the duration of the project.”
PPPs in the IT or health sectors can be difficult, as the technological change is simply too rapid in relation to the typical length of a PPP contract. PPPs also require strong legal, policy, appraisal, approval, and monitoring arrangements to negotiate contracts and ensure that private partners meet their obligations. Evidence of whether PPPs can provide infrastructure more efficiently than traditional public procurement is mixed. The benefits of PPPs vary significantly across projects and countries.
The IMF report says that PPPs have sometimes been used to circumvent budgetary constraints and delay the recording of the fiscal costs of providing infrastructure services. This has led some governments to proceed with low-quality and fiscally costly projects that would otherwise have been excluded from their public investment plans. In some cases, PPPs have also resulted in large fiscal costs due to poor contract designs, optimistic assumptions about revenues from user fees, and minimum income guarantees provided by the governments.
The IMF says that a new approach to delivering public projects essential for long-term growth is now needed. It calls for governments to develop public investment management assessment (PIMA) tools to help guide decision-making and for more sophisticated risk assessment to be applied to future PPPs.
An earlier report about the IMF infrastructure initiative can be found The IMF Infrastructure initiative.