Luis Servn

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Latin Americas infrastructure gap a
macroeconomic perspective

• Luis Servén
• The World Bank
• ECLAC
• January 2005

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Plan

• The changing policy framework
• The infrastructure gap
• The output cost
• The lessons

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The changing policy framework

• Until the 1970s, the public sector dominated
  infrastructure provision in both industrial and
  developing countries.
• Since the 1980s (earlier in Chile and the UK)
  Latin America led the worldwide drive towards
  opening up of infrastructure to private
  initiative in various forms and extents.
• The drive was propitiated by a hardening of
  fiscal discipline in response to financial
  instability and macroeconomic crises
• In most countries, the fiscal retrenchment led
  to a sharp contraction of public infrastructure
  investment (similarly to the post-Maastritch
  fiscal adjustment in the EU)

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The changing policy framework
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The changing policy framework
Latin Americas fiscal adjustment Contribution
of consumption and investment
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The changing policy framework
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The changing policy framework
Latin America Total investment in
Infrastructure (weighted average of 7 countries,
percent of GDP)
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The changing policy framework
Latin America Total investment in
Infrastructure (6 major countries, percent of GDP)
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The changing policy framework
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The changing policy framework

• The private sector response
• Private initiative surged in the 1990s -- but
  with diversity across industries (and countries)
• Strong response in telecommunications, much less
  in transport.
• Evidence of public-private complementarity, not
  only substitution countries maintaining higher
  public investment attracted more private
  investment (Chile, Bolivia, Colombia)
• The rise in private investment was not enough for
  asset accumulation to keep up with other world
  regions
• The investment fall contributed to widen Latin
  Americas infrastructure gap in terms of
  quantity and quality -- widened over the 1980s
  and 1990s

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The changing policy framework
Brazil the power sector
Investment
Capacity change
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The infrastructure gap
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The infrastructure gap
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The infrastructure gap
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The infrastructure gap
Perceived infrastructure quality (Medians by
region, 2000)
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The output cost

• Why do we care about infrastructure ?
• The availability and quality of infrastructure
  services is key for productivity and
  profitability
• Robust association between infrastructure
  availability and aggregate output / growth within
  and across countries
• Partly driven by reverse causality (growth
  encourages demand for infrastructure services)
• But there is broad agreement that infrastructure
  development has a strong causal effect of on
  economic development.
• Evidence that infrastructure development helps
  reduce income inequality makes it easier for
  the poor to access economic opportunities, jobs,
  health and education.

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Source Calderón and Servén (2004b)
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Source Calderón, Easterly and Servén (2003)
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Source Calderón and Servén (2004b)
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The output cost

• What is the contribution of infrastructure
  services to aggregate output and/or its growth
  rate ?
• Three main empirical approaches in the
  literature
• Empirical growth models
• Augmented production (or cost) function
• VARs
• Caveats
• -- technical problems often severe
  (identification / reverse causality, spurious
  regressions)
• -- all else equal the costs of getting there
  are not explored large tax rises or cuts in
  other expenditures that may have an output cost

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The output cost

• The long-run growth approach
• Adding infrastructure into a standard growth
  regression
• Infrastructure usually proxied by
  telecommunications indicators (e.g., Easterly
  2001, Loayza et al 2003)
• Calderón and Servén 2004b panel of 100
  countries, 40 years
• Consider both infrastructure quantity and
  quality
• Synthetic infrastructure indicator first
  principal component of power, roads, telecom
  accounts for 80 of their variance.
• Endogeneity identification via GMM-IV with (a)
  internal instruments (b) demographic variables
• Growth contribution of infrastructure quantity
  and quality is statistically and economically
  significant.

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The output cost
Additional growth in LAC countries due to
increased infrastructure development
Source Calderón and Servén 2004b
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The output cost

• The augmented production function approach
• Unlike VARs and growth regressions, it is a
  structural approach
• Y F (K, H, Z) K physical capital H human
  capital (often omitted) Z infrastructure
  capital (power, phone lines, roads)
• Productive services assumed proportional to
  asset stocks
• In actual data, Z often is already included in
  K The coefficient on Z captures the return
  differential on Z over K
• In addition to usual reverse causality problem,
  spurious correlation problem when using time
  series nonstationarity of Y, K, Z leads to huge
  infrastructure coefficient estimates (Aschauer
  1990)

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The output cost

• The augmented production function approach
• Calderón and Servén 2005 panel time-series
  estimation for 90 countries, 40 years.
• Spurious regression problem does not arise here
  (due to large N)
• Only one long-run relation found resolves
  identification problem
• Pooled and country-specific estimates permit
  assessing heterogeneity across countries /
  regions
• Synthetic index and disaggregated infrastructure
  assets
• Results broadly similar to Calderón, Easterly
  and Servén 2003 in spite of very different
  approach (GMM-IV to deal with identification
  first-differencing to deal with nonstationarity)

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The output cost
Estimated (log) infrastructure coefficients (DOLS
estimates, 1960-2001, synthetic index)
Source Calderón and Servén 2005
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The output cost

• Country-specific estimates
• Synthetic Infrastructure Index, GLS--PIC (1,1)

Source Calderón and Servén 2005
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The output cost

• The estimated return on infrastructure assets is
  significantly higher than that on other physical
  capital in the vast majority of countries.
• Infrastructure has significantly lower returns
  than other capital only in 3 out of 89 countries
  none in LAC
• Across LAC countries, some heterogeneity too
• The differential return on overall infrastructure
  is significantly higher than average in Peru,
  Mexico, Colombia
• Differences also across assets e.g., the
  differential return on power generation capacity
  is significantly lower than average in Paraguay,
  but higher in Brazil

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The output cost
Estimated (log) infrastructure
coefficients (DOLS estimates, 1960-2001)
Source Calderón and Servén 2005
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The output cost
The cost of the widening infrastructure gap EAP
vs LAC
Source Based on Calderón and Servén 2005
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The lessons

• (1) Fiscal adjustment, as commonly measured and
  enforced, tends to have an anti-investment bias
• One (not the only) major factor is the use of
  inappropriate fiscal rules targeting liquidity,
  the cash deficit and gross public debt rather
  than solvency and net worth, which are key to
  fiscal sustainability.
• Infrastructure projects have a negative short-run
  liquidity effect -- it takes time to build the
  assets and get the returns.
• The focus on fiscal liquidity discourages such
  projects even if they are consistent with good
  public economics i.e., they enhance solvency.

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The lessons

• (2) Infrastructure investment cuts represent an
  inefficient fiscal adjustment strategy
• The direct effect of the spending cut is to raise
  liquidity and public sector net worth
• But there is an opposing indirect effect less
  infrastructure means less output and lower fiscal
  revenues tomorrow
• The indirect effect offsets partly the direct
  effect and can even make fiscal adjustment
  self-defeating.

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Summary

• Latin Americas infrastructure gap widened in
  the 1980s and early 1990s, at a substantial cost
  in terms of output and productivity.
• A major factor in the process was the investment
  slowdown caused by a public investment decline
  not offset (except in telecom) by private sector
  participation.
• The public investment compression reflected a
  biased and inefficient fiscal adjustment,
  encouraged by rules targeting liquidity and debt
  rather than solvency and net worth.
• Ensuring adequate room for productive spending
  requires fiscal rules that reconcile solvency and
  growth.

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End
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The changing policy framework

• Fiscal discipline has led to a public investment
  fall not only in developing countries also in
  the EU
• The fiscal targets imposed in the Maastritch
  Treaty contributed to a decline in public
  investment across Europe
• Out of 9 countries exceeding the Maastritch
  deficit limit in 1992, 8 met it in 1997. Public
  investment had fallen in all 8 !
• Infrastructure investment fell along with the
  total

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The changing policy framework