POLICY RESEARCH WORKING PAPER 1964

# Summary findings

Mexico's growth rate began to plummet at roughly the same time that its public investment expenditures declined. That decline also appears to coincide with a slowdown in the growth of infrastructure capital in the electricity, transport, and communications sectors. Because of these parallel developments, many economists have attributed at least part of the blame for the decline in Mexico's growth after 1981 to the decline of public infrastructure investment. The empirical results presented in this report provide only limited support for this argument. They also suggest, in turn, that increases in public investment would not automatically translate into faster output and productivity growth.

One reason not to take for granted a positive relationship between more public investment and faster growth is public investment's crowding out effect on private investment. Although the time-series regression results for Mexico all point toward a crowding out coefficient of less than unity, the existence of a significant crowding out effect limits the growth impact of public investment by reducing its net effect on capital accumulation.

The time-series results also suggest that the economy's total factor productivity growth responds positively to increases in the ratio of public to private investment. In light of that result, increases in public investment should have a positive net impact on economic growth, despite significant crowding out effects. Chow breakpoint tests indicate, however, that the positive productivity effect appears to have weakened significantly in the past decade.

A third reason for questioning a stable relationship is that the impact of increased public investment is likely to depend on how it is financed. The cross-country regressions reported here indicate that a general increase in the public capital stock has a positive impact on growth only if financed through savings generated through lower public consumption expenditures, but not if financed through higher public debt, which implies higher current and future taxation levels. The scope for reducing public consumption expenditures in Mexico is very limited, however, since they are already at rock bottom levels. Therefore, the only way to assure that the public investment program makes a significant contribution to growth is by improving its "quality" through careful attention to its rate of return and complementarity with private capital.

In iMlexico the most important reforms to make public investment more productive came from policymakers' recognition of the need to distinguish more clearly between the roles of the public and private sectors. This led to the privatization of most public enterprises and a reorientation of public investment to a more narrowly focused set of activities. In addition, the government took important steps to strengthen the institutional framework within which the public investment program is determined.

- - This paper a product of the Mexico Country Department emerged froin research in preparation of the 1998 Country Economic Memorandum and is part of the department's larger effort to engage Mexico's policymakers in an economic policy dialogue. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Carmen Lazcano, room 14-135, telephone 202-473-7776, fax 202-522-2113, Internet address clazcanoCaworldbank.org. The authors may be contacted at ulachler@worldbank.org or daschauer@cpabacus.bates.edu. August 1998. (19 pages)

emerged froin research in preparation of the 1998 Country telephone 202-473-7776, fax 202-522-2113, Internet address _The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about developnment issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent._ Produced by the Policy Research Dissemination Center