# **1. Introduction**

Inadequate infrastructure, especially public infrastructure, is often viewed as a key impediment to economic growth and development in low‐ and middle‐income countries. While increasing infrastructure investment has been a part of national development strategies for decades, its perceived importance has gained prominence with the rapid development of China and its infrastructure‐led growth strategy; as well increased infrastructure‐specific finance through new bilateral lending, the Asian Infrastructure Bank, and the Belt and Road Initiative.

Despite the importance of public infrastructure investment, there is wide disagreement about the size and significance of its effect on growth in developing countries (Calderon and Serven 2014). On one hand, the needs are clearly great – close to 700 million people do not have access to safe drinking water and 1.2 billion are without electricity – and so one should expect a sizable impact.<sup>2</sup> Several papers have estimated large returns to infrastructure investment ‐‐ most frequently cited, Aschauer (1989). But as infrastructure investment is endogenous – for example, growth for other reasons might generate public revenues which allows the construction of infrastructure ‐ many of those empirical studies lack causal validity and estimated impacts are implausibly large. Many other papers have found insignificant or negative impacts (Bom and Ligthart 2014), possibly because public investment in developing countries often fails to generate productive capital due to corruption and the presence of “white elephants” (Pritchett 2000).

Perhaps less appreciated is that there is a great deal of confusion in the empirical and policy discussion about the dynamics and mechanisms through which public infrastructure investment would affect growth. For example, empirical studies (and policy reports) are often vague about whether it is the level of infrastructure that affects growth, or whether infrastructure investment (and hence changes in infrastructure levels) affects growth. Likewise, empirical studies often have difficulty estimating _when_ the boost to growth might occur (whether the size of the effect will increase or decrease over time) and what country‐level factors determine the impact on growth (as different studies are for particular countries or reflect a cross‐country average). All these aspects are crucial for evaluating the effectiveness of a country’s public investment‐led growth plans.

This paper makes contributions in two areas to try to address these gaps. First, we develop a model of the effect of public investment on long‐term growth – called the Long‐Term Growth Model Public Capital Extension (LTGM‐PC) – that is simple enough to be solved in an Excel spreadsheet without macros (which is provided as a companion to this paper on the website www.worldbank.org/LTGM).<sup>3</sup> Unlike coefficients estimated in most empirical studies, the LTGM‐PC allows for the effect of extra public investment to vary across countries and over time within the same country. In the model, the effect of an increase in public investment (or the quality of that investment) and the full dynamic growth path depend on country‐specific factors such as the scarcity of public capital (relative to GDP) and some crowding in of private investment. The model also allows for the fact that the public capital stock might be of low‐quality construction, which is a practical concern in many developing countries.

More technically, our model builds on the celebrated Solow‐Swan growth model and another World Bank Excel‐based tool known as the Long‐Term Growth Model (LTGM) (Loayza and Pennings 2018, and

> 2 <u>http://www.worldbank.org/en/news/feature/2016/04/16/spending‐more‐and‐better‐essential‐to‐tackling‐the‐infrastructure‐gap</u>

> 3 The relevant data and parameters for all countries are already pre‐loaded into the LTGM‐PC spreadsheet.

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