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Good and bad economics: Economics of infrastructure investment
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Helen Hughes an Australian economist once said there were only two types of economics: good economics and bad economics. Bad economics is given various tags such as practical economics, home grown economics, pragmatic economics and self-reliant economics to deviate from sound principles of economics. The laws of economics, most of the time, are like physical laws that cannot be contravened even though at times countervailing actions could be taken to reduce their impact.
Discussions on contemporary national economic issues are often flawed by prejudices, ideological commitments, political biases and hidden motives. Data and statistics are manipulated, massaged or misinterpreted to justify preconceived positions and support bad economic policies. There are misconceptions in many areas in economic policies such as external debt and debt sustainability, deficit financing, infrastructure development, food security import substitution strategies and other inward looking economic policies.
Fundamental premise
Above all these particular issues is the fundamental premise that pervades economics: the scarcity of resources and the need for their optimum use. If there is no recognition that resources are scarce and that they must be used in a rational manner to obtain optimum results, then economics goes out of the window. Public policy must be based on this fundamental premise that resources are scarce and must be used carefully. The need to use scarce resources in the most optimum manner applies especially and most forcefully to public investments.
Economics of infrastructure development
There is considerable confusion in the economics of infrastructure investment. The fundamental principles of economics must be applied to understand and evaluate the economics of infrastructure development as such investment is of paramount importance for sustainable economic development.
Infrastructure development is vital for rapid economic development. Poor infrastructure has been a serious constraint for economic development. The energy crisis in the mid nineties that affected industrial production adversely to such an extent that economic growth was negative is a clear illustration of the importance of infrastructure. The development of highways, ports, bridges, public transport, railways, telecommunications, fisheries harbours and irrigation are important for an economy’s rapid development. These constitute essential economic infrastructure whose development is vital as the efficiency of investment is determined by the state of infrastructure.
Impressive infrastructure development
There has been an impressive development of infrastructure particularly in enhancing energy capacity, development of roads, irrigation and fisheries infrastructure. However the economics of infrastructure development, especially the methods of financing, priorities and returns to investment require serious evaluation. A new focus on future investment in infrastructure development that evaluates the costs and benefits of such investment is needed.
Financing infrastructure
While the importance of infrastructure development is undeniable and recent development of infrastructure commendable, the means of financing large investments in infrastructure have important economic repercussions. Economic infrastructure investments are large and their economic returns take a long period of time. In many cases it is even difficult to determine precise benefits of infrastructure investment. Therefore the manner of financing infrastructure investment is significant.
However beneficial investments in infrastructure are, if they lead to large fiscal deficits, these would lead to inflationary pressures. Further, with large expenditures in infrastructure that in most cases have significant import content, such investments increase import expenditure and strain the trade balance and balance of payments. Foreign financing of such infrastructure at high interest rates and shorter maturities result in high foreign debt servicing costs.
Therefore the prioritization and phasing out of infrastructure investment are necessary. Owing to the large borrowing for infrastructure it is necessary to ensure that costly infrastructure projects lead to higher export earnings or reduce import expenditure. Investment in energy would no doubt increase the production capacity and help export industries. In the case of roads and bridges, some highways would be economically more beneficial than others. Similarly, the development of ports and other transport infrastructure has a range of cost: benefit ratios. Therefore prioritization of infrastructure on the basis of costs and benefits is important. Import costs, export earnings and the impact of financing on the public finances and debt servicing costs should be considerations in infrastructure investment.
All infrastructure investments in recent years are not economically justified. Massive foreign funding for infrastructure projects that don’t result in increased tradable goods is a burden on the public finances and a strain on the balance of payments. The large investment in mega projects and sports stadiums and other costly unproductive infrastructure have low returns while increasing the foreign debt serving costs.
Foreign debt driven infrastructure development with long gestation periods and low returns can lead to a foreign debt trap. Infrastructure projects that either save or earn foreign exchange at realistic real exchange rates are the least burdensome. Infrastructure development such as for power and energy, ports, roads, bridges, water supply, agriculture, fisheries and irrigation could enhance production.
Summing up
One of the noteworthy achievements of the government has been the improvement of the country’s economic infrastructure especially in the last five years. On the other hand, there are concerns that some economic infrastructure developments may not be cost effective. The prioritisation of infrastructure on the basis of costs and benefits is important. Import costs, export earnings and the impact of financing on the public finances and debt servicing costs should be considerations in infrastructure investment.
The methods of financing including large foreign financing of infrastructure projects could have adverse effects on long term economic stability. Foreign funded large infrastructure projects should have potential for increasing foreign exchange earnings or reducing import expenditure or else it would be a burden on the balance of payments.
However important infrastructure development is for the country, expenditure on infrastructure investment should consider the costs and benefits of such investment and how they are financed. One current misconception is that all infrastructure investments are beneficial to the country’s economic and social development. Several large infrastructure projects can only be described as White Elephants, Others will bring in only small benefits.
While vast amounts of money have been spent on costly economic infrastructure, education and health have been starved of funds. This could constrain future economic and social development.