Infrastructure Investment and Economic Growth

 Growth in real GDP per worker and five types of infrastructure per worker

 

There is a new paper from three World Bank researchers on the relationship between infrastructure and economic growth, a difficult topic they tackle with some sophisticated econometric techniques using data from the World Bank and the Penn tables. Disentangling the economic effects of infrastructure from the effects of other macroeconomic factors requires long time periods and a method to extract estimates from the data.  The researchers use a pooled mean group estimator to compare differences between countries in growth of real GDP per worker and investment in five types of infrastructure per worker between 1992 and 2017.

 

Because other factors like population growth, education levels, openness to trade and type of exports have significant effects on economic growth, any measured effect of infrastructure investment will be small by comparison. This research estimated the strength of the relationship between real GDP per worker and infrastructure investment by the size of the infrastructure coefficients, shown in the table below. While the coefficient values are indeed small they also show clearly that higher investment in each of the five types of infrastructure leads to higher real GDP per worker, as shown in the figures below.  

 

This is an important result. Their model credibly finds larger effects for infrastructure investment on economic output than previous studies, and found the effects of infrastructure were higher in the three decades after 1991 than the two before. There are separate estimates for a group of low- and middle-income countries and another group of high-income countries. Infrastructure has more effect in the group of developing countries compared to industrialised countries.

 

The paper starts by reviewing previous research on the impacts of infrastructure investment on economic growth and development. Some studies showed a strong positive relationship between infrastructure development and economic growth, others found a mildly positive relationship or no relationship. The author’s note “Many factors are responsible for these varying results, such as differences in methods, differing approaches to measuring infrastructure development, the varying development stages of countries included in the sample, varying time periods, and geographical factors such as high or low population density.” 

 

Their study evaluates the contributions to growth in a panel of 87 countries over the period 1992 to 2017 of three main categories of infrastructure: transport, electricity, and telecommunications. The main estimate uses a pooled mean group estimator to estimate their effect on growth, and finds larger effects for infrastructure investment on economic output than found by previous studies. They also find the effects of infrastructure are higher in the three decades after 1991 than the two before. 

 

Although other studies have shown a strong positive relationship between infrastructure and economic growth in less developed countries lacking adequate infrastructure, whether this finding holds for industrialised economies remains an open question because other research has not found a significant effect. Is there a threshold level of economic development (measured in terms of per capita GDP or human development indicator) below which the relationship between the infrastructure and economic growth is stronger, and is the relationship is weak or absent above the threshold? 

 

The paper has separate estimates for 48 low- and middle-income countries and 39 high-income economies. Infrastructure has larger effects in the group developing economies compared to industrialised economies. Theinfrastructure coefficients that measure the effect are smaller in the developed country sample than the developing country sample, in Table 11. Railways essentially have a zero effect on both groups, unlike their effect in the earlier period 1970-91.  Compared to 1970-91 developing country coefficients for roads, electricity and mobile phones and particularly telephones are all higher.

Their Figures plot the relationship between real GDP per worker and the different infrastructure indicators in the 87-country panel from 1992 to 2017, with higher infrastructure per worker associated with higher real GDP per worker. This relationship is notably strong for electricity generation capacity (r = 0.77) and the telecommunications variables (r = 0.52 and r = 0.67 for mobile and fixed line telephones, respectively).

Figures 1 - 5. Real GDP per worker and various infrastructure variables, 1992-2017 country means

Timilsina,Govinda R.; Stern,David S.; Das,Debasish Kumar. How Much Does Physical Infrastructure Contribute to Economic Growth An Empirical Analysis. Policy Research working paper, WPS 9888 Washington, D.C.: World Bank Group. 

 

https://documents.worldbank.org/en/publication/documents-reports/documentdetail/553061639760111979/how-much-does-physical-infrastructure-contribute-to-economic-growth-an-empirical-analysis

More Data on Australian Contractors

 Grattan Institute Transport Infrastructure Report

 

 

The Grattan Institute, a Melbourne based think tank for public policy, released an important report into procurement of Australian transport infrastructure projects. Their Megabucks for Megaprojects report has four chapters and makes 12 recommendations. The chapters contain a lot of carefully compiled and useful information, while the recommendations are all worthy and, despite their careful phrasing, make a strong case for greater client involvement in the design, documentation and management of large public sector projects. 

 

Chapter 3 of the report is ‘Competition is fundamental’, addressing the issue of the dominance of tier one contractors. The chapter collects data on projects and contractors that is not readily available, with the sources and methodology detailed in the appendices. Their key point is the increase in size of projects since 2014, as shown in Figure 3.3 below.

For the last few years the quarterly value of work done on these large transport projects has been over $5 billion. In 2020 Australian governments spent a record $120 billion on road and rail transport projects. 

The argument is that it is increasingly difficult for mid-tier contractors to win work on these very large projects, of the 11 projects above $3 billion 8 were ‘contracts involving multiple tier one firms’. These firms are ‘few and well-known’ in Australia and their Figure 3.10 shows how few, and how they consolidated their position through M&A over the last couple of decades. 

The two sources of potential competition for the three tier one contractors are domestic rivals that might scale up sufficiently or new international entrants to the Australian market. In chapter 4 the report argues strongly for breaking up large contracts to allow greater participation from domestic firms, Recommendation 10 is: State governments should develop and use a systematic approach to determining an optimal bundling of work packages for large projects, including when to disaggregate bundles that include both complex and straightforward activities. While not a new idea it is still important because public clients do not generally do this, and often do not have the resources required to manage multiple contracts. 

 

That leaves international entrants, which the report argues have been playing an important role since 2005: ‘International entrants add to local competition, and it’s very helpful to governments if there are a variety of market players willing and able to take on work. In particular, when tier one firms form a joint venture to bid on a large contract, the only source of genuine competition may be from international firms’. Their Figure 3.5 shows the distribution of contracts between new international entrants and firms that were already here in 2006. Of those firms, Bouygues won 4 contracts, Lang O’Rourke and Acciona 5 each. 

There are barriers to entry when bidding for these contracts, on top of the high bid costs. These are the lack of transparency in the weighting given to selection criteria and the emphasis on local experience. The report’s Recommendation 8: In selecting a successful bidder, governments should not weight local experience any more heavily than is justified to provide infrastructure at the lowest long-term cost. Governments should publish weightings of the criteria used to select the winning bid for a contract. The Grattan Institute is strongly opposed to ‘market-led proposals’ from contractors, and strongly in favour of open tendering. The state with the highest transparency rating is NSW, also the state with the most contracts with new international entrants. 

The report collects data on 51 projects over $1 billion in Australia since 2006. Their dataset of transport infrastructure projects includes 177 contracts worth more than $180 billion (in December 2020 dollars). That data makes this an important contribution to the debate about construction industry policy in Australia, to the limited extent that there is such a debate. A couple of decades ago this data would have been published by the Commonwealth, by the Department of Industry or similar organization, and incorporated into the procurement guides being developed by the Australian Procurement and Construction Council and related State agencies. The report concludes “these guidelines leave a great deal of room for subjectivity in the choice of contract type. Although some of the state guidelines and decision-support documents are quite detailed, none go so far as to prescribe a rigorous and systematic methodology for procurement strategy selection.”

 

This raises the awkward question of who the report is addressing. The fundamental problem is the politicization of the project selection process not the cost of delivery, Australian construction is not expensive by international standards. The recommendations address the problem obliquely by highlighting improvements in procedures and processes, all of which have merit, but not considering alternatives such as the role an independent authority could play or national coordination of procurement and other regulatory systems. In this it was something of a missed opportunity

 

 State and Federal budgets have billions in unallocated funds for projects at all levels (community sports grants, local and regional infrastructure) and for major projects the Commonwealth has Snowy Hydro, the NAIF, the Murray-Darling Basin Plan etc etc. These projects, large and small, shovel money out the door with little or no accountability and there is no evidence that politicians are interested in change at this time.  

New Anticorruption Website

Practical help for public officials and politicians planning anticorruption reforms

CurbingCorruption is a new website that provides concrete anticorruption advice tailored to specific sectors such as construction, education, health, fisheries, etc. For those concerned about this issue it will, I think, be an important resource.

It has been set up by Mark Pyman, and developed by him with assistance from other anticorruption specialists. Pyman was the Programme Director for Transparency International tackling corruption in the military and Defence Ministries worldwide 2004-2015, and in Afghanistan he was one of three international Anti-Corruption Commissioners 2015-2017. He believes that much more progress against corruption is possible, as the mission statement explains:

Our vision is that corruption can be addressed and reduced better than people realise. Even in the toughest corruption environments, where progress may only be possible in tiny steps, there are many improvement measures that can help, and which can form the basis of a much larger improvement when circumstances change.

We believe that there are two key components to doing this. First, enabling public officials and politicians to develop counter-corruption initiatives. At present, only a very small proportion of people in these positions have knowledge or experience of ways to tackle corruption. Public officials, because they operate the machinery of government, are in perhaps the best position to enable sustainable reforms and to collaborate with politicians, civil society, corporate stakeholders and others.

Second, building up knowledge, insights and experience at sector level. At present, most anti-corruption knowledge is at the national, cross-government level, which is broad and complex. At sector level, whether public service delivery sectors like health or economic sectors like telecommunications, there is both more knowledge and more ownership from those working in the sector. This increases the chances of success whether for small initiatives, such as within a department, or large ones, such as across a whole agency or ministry.

The site collects a vast number of reports and studies, all referenced and usually linked, and the sector reports contain many examples of a wide range of initiatives from around the world. The construction sector report runs to 59 pages. The Introduction to the Construction, Public Works and Infrastructure page says:

The value of this sector is huge, with roughly half of all fixed capital investment by governments and Public-Private Partnerships being in the construction of public infrastructure. The volume is increasing every year. The value of losses through corruption is estimated at between 10 and 30% of this total, and others believe that a similar amount could be lost through mismanagement and inefficiency (Wells 2015, Matthews 2016). This means that by 2030, unless measures are introduced that effectively improve this situation, close to $6 trillion could be being lost annually through corruption, mismanagement and inefficiency. Losses on this scale cannot be tolerated in any sector, but losses in infrastructure investment have particular significance, because infrastructure underpins every aspect of economic growth and human development. ‘Engineering and construction’ is the sector with the most reported bribery and corruption in advanced economies globally – see the figure below from Price Waterhouse Coopers (2014).

 

The website is still a work-in-progress, but the idea is to use what’s already on the site as a foundation and to crowdsource additions and revisions by inviting users to contribute their own experiences, insights, and suggestions, and eventually for the website to be managed by collaborative groups of users, with different teams focused on different sectors.

This will, I hope, become a widely used resource in the fight against corruption and illegal practices. It shows there are alternatives to accepting corruption as inevitable and something to be accommodated, and highlights the role of local action as well as institutional measures.

Previous relevant posts:

Australian Royal Commissions here

Canadian Charbonneau Commission here