World Economic Outlook/IMF

In the current global environment of sub-par growth, there is a strong case for increasing public investment in countries where conditions are right, finds a new study by the IMF. The study, which is published in the IMF's October 2014 World Economic Outlook report, examines the macroeconomic effects of public investment in a large number of countries. The findings suggest that in countries with infrastructure needs, now is a good time for an infrastructure push. "Now is really a good time for an infrastructure push, because you have low borrowing costs and weak demand in advanced economies and you have infrastructure bottlenecks in developing economies that really need to be addressed. An obvious question though is, can countries afford to do this? Won't it just raise public indebtedness? And what we find quite interestingly in the chapter is that the boost these countries get from doing increased infrastructure investment offsets the rise in debt, so the debt to GDP ratio doesn't increase. In other words public infrastructure investment can pay for itself if it's done correctly," said Abdul Abiad, of the Research Department, at the IMF. Many advanced economies are stuck in a low growth and high unemployment environment, and borrowing costs are low. Increased public infrastructure investment is one of the few remaining policy levers to support growth. In many emerging market and developing economies, infrastructure bottlenecks are putting a brake on how quickly these economies can grow. Infrastructure: where do we stand? Infrastructure is the backbone of everyday life, underpinning economic activity. There is no activity that does not rely on infrastructure in some form. Conversely, inadequacies in infrastructure are quickly felt— power outages, insufficient water supply, and decrepit roads adversely affect people's quality of life and present significant barriers to the operation of firms. The stock of public capital, a proxy for infrastructure, has declined significantly as a share of output over the past three decades across the world. In emerging market and developing economies, gaps in the quantity of infrastructure per capita are glaring. For example, power generation capacity per person in emerging market economies is only one-fifth of the level in advanced economies; and in low-income countries it is about one-eighth the level in emerging market economies. In some advanced economies the quality of the existing infrastructure stock is deteriorating because of aging and insufficient maintenance. "The reason we are looking at this now is that there are a couple of problems that need to be addressed in the global economy. One is that in advanced economies, demand is weak and as a result, growth is too low and unemployment is too high. In developing economies the problem is supply, they have "bottlenecks" in their infrastructure -- inadequate roads and ports and power outages that act as a brake on how quickly these economies can grow, according to Abiad." The road to take: The study finds that increased public infrastructure investment raises output in the short term by boosting demand and in the long term by raising the economy's productive capacity. In a sample of advanced economies, an increase of 1 percentage point of GDP in investment spending raises the level of output by about 0.4 percent in the same year and by 1.5 percent four years after the increase (Figure 1, panel 1). "Our study, which is Chapter 3 of the World Economic Outlook finds that public infrastructure investment can help on both fronts. It can raise output in the short run by boosting demand and it can also help in the long run by boosting supply or productive capacity, Abiad said." In addition, the boost to GDP a country gets from increasing public infrastructure investment offsets the rise in debt, so that the public-debt-to-GDP ratio does not rise (Figure 1, panel 2). In other words, public infrastructure investment could pay for itself if done correctly. Effects of infrastructure investment are shaped by a number of factors. However, the report cautions against just increasing infrastructure investment on any project. The gains from infrastructure investment will depend on the following conditions: - The degree of economic slack. The short-term boost to output is substantially larger when public investment is undertaken during periods of economic slack and monetary policy accommodation, with the latter limiting the increase in interest rates in response to the rise in investment.