Elementary, my dear Watson!
Mahmoud A Ayub* makes the argument for investment in infrastructure
Sherlock Holmes once told a visibly shocked Dr Watson that he could not care less whether the earth went around the sun or vice versa, for it had no relevance to the pursuits of his daily life. How wrong he was!
Sherlock Holmes' statement finds its parallel in the misplaced zeal of policy makers in many developing countries to slash public investment in infrastructure in times of fiscal constraints.
Of course countries need to undergo fiscal retrenchment when budgets need balancing. And it goes without saying that low priority "white elephants" should be the first projects to be delayed or dropped. However, the extent to which public infrastructure spending should bear the brunt of adjustment is questionable. There is substantial evidence that in developing countries such as Egypt infrastructure investment -- for new projects as well as for oft-overlooked maintenance procedures -- suffers a disproportionate decrease in times of fiscal austerity. International financial institutions have to bear at least part of the blame in encouraging the slashing of critical infrastructure investment in times of fiscal crisis.
This myopic targeting of infrastructure spending is primarily a consequence of the use of the current budget deficit to GDP ratio as the single benchmark to assess fiscal performance. Economists and policy makers should, instead, evaluate fiscal adjustment in terms of the economically more relevant yardstick of the inter-temporal budget constraint. This constraint tells us that the present value of all the future government revenues must be sufficient to cover the existing stock of debt plus the present value of all future government spending. For this calculation, the present value of revenue and expenditure is evaluated at the interest rate the government pays on its marginal borrowing. Any project with a higher return than that interest rate should be undertaken.
Many infrastructure maintenance and construction projects have such high rates of return that they easily satisfy this condition. For example, even using a discount rate of 10 per cent, the new Cairo Third Terminal Project and the Sharm El- Sheikh Airport Project have economic rates of return of 15 per cent and 22 per cent respectively.
The above discussion has two important implications for Egypt. First, while the reduction of the country's external debt from 130 per cent of GDP in the late 1980s to about 33 per cent of GDP at present is commendable, the continuation of this excessively conservative external borrowing strategy will not lead to the growth rate of six to seven per cent needed for the labour market to absorb roughly 600,000 new job seekers annually, let alone begin to deal with current levels of unemployment. Avoiding external public borrowing for projects with high rates of return carries a real -- and, if the evidence from Latin American countries is any guide, sizeable -- penalty in the form of foregone economic growth. Second, in an external environment where investment funds are not plentiful, it becomes critically important for Egypt to reduce delays in the implementation of projects already approved and funded. Bureaucratic delays in Egypt imply that even after a project has been approved by external funding sources, it still takes a year, sometimes even two years, for disbursements to begin from these projects. Again, the cost of these bureaucratic delays is enormous for the country.
Another argument made for cutting public infrastructure spending is that the private sector would take over some aspects of infrastructure provision. Private provision of infrastructure is indeed promising, and Egypt has had some success in this area, especially in power and airport financing. However, private provision is still at an incipient stage in most developing countries. For the most part, infrastructure is provided publicly almost everywhere, and this has been true in the past for today's developed countries. Egypt's case demonstrates that a combination of negative external factors (such as regional instability), problems of cost recovery and contractual agreements, as well as the relatively unfavourable domestic investment climate, stifles available private funds.
Even when private infrastructure provision is viable, it is important to manage the transition to private ownership carefully. To slash high-yielding public infrastructure spending and expect the private sector to fill the gap overnight is a leap into the dark. Contrary to popular perception, there is little evidence in developing countries that the declining trend in the public infrastructure was compensated by increased involvement by the private sector in infrastructure provision. Even in countries such as in Latin America where private investment in infrastructure has been more forthcoming, its fluctuation from year to year makes it impossible to rely solely on private investment.
Evidence indicates that private investment in infrastructure becomes most viable when it complements public investment, where an enabling institutional and regulatory framework to facilitate private participation exists. In their book Beyond Stabilisation, Easterly and Serven conclude, based on the Latin American countries' experience of the last two decades, that some high-return publicly- funded projects should never have been cut in response to budgetary woes. The authors also argue that opening up infrastructure industries to private sector participation has had mixed results, so far failing to resolve Latin America's infrastructure problems. They calculate the long-term GDP growth cost of reduced infrastructure investment during the 1990s to have been from one to 33 percentage points. Much of the supposedly favourable effect of the investment cuts on high public sector balance was offset by higher future deficits resulting from lower output growth. In the words of the authors, "Latin American countries have figuratively shot themselves in the foot."
In short, fiscal austerity focussed on the compression of growth-enhancing public expenditures in the hope that the private sector will fill the gap is not a safe way to place public finances on a sound footing. The unmet needs for infrastructure services are massive. According to one World Bank estimate, the combined annual infrastructure needs for middle income countries such as Egypt amount to some $365 billion, over five per cent of their GDP. Roughly half of this is for maintenance and upgrading of existing infrastructure capital. These magnitudes are far beyond the financing capacities of the private or public sector alone.
So far the focus has been on the growth- enhancing aspects of infrastructure investment. At least as important is the role of investment financing in poverty reduction, social development and the achievement of the Millennium Development Goals (MDGs).
Evidence from World Bank studies indicates that lack of piped water reduces school attendance by two to 17 per cent in Africa, varying from country to country. Doubling rural families' share in access to tap and well water would increase enrollment by 20 per cent in rural India. Water and sanitation in schools increases girls' attendance by 15 per cent in Bangladesh. Better water and sewerage is associated with reduced absenteeism and improved test scores for children in Tanzania and Nigeria. Electrification of schools in Colombia and Honduras led to increased educational attainment. Evidence from Morocco demonstrates that girls' attendance more than doubles with the presence of a paved road in the community. It also leads to better teacher retention. Finally, in Jamaica 73 per cent of women reported mobility as a critical factor in accessing pre-natal care.
Of course access to infrastructure, while necessary, is not sufficient. Issues of quality of service, affordability, efficiency, regulatory and institutional development and transparency are also very important. However, there is little doubt that to achieve sustainable poverty reduction and meet the MDGs, multi- sectoral interventions, backed by strong public investment in infrastructure, would be critical.
* The writer is director of the World Bank for Egypt, Yemen and Djibouti, and is based in Cairo.
