increased growth. As stressed in Stern (1991) management and organization are also key elements of growth in countries where capital is scarce. By improving the quality of project proposals, appraisals and budgeting, public investment management raises the returns on public capital by ensuring maintenance of existing assets and reducing waste. This link between capital investment and growth cannot be taken for granted, especially in the context of poor governance and rudimentary public investment systems. Second, when primary fiscal surpluses are allowed to substitute for private savings, this places fiscal policy in general, and policy decisions regarding the balance between capital and recurrent expenditures in particular, at the center of the discussion about the determinants of growth.<sup>25</sup>

# **III.1 Public Investment Management Capacity**

**To measure the degree to which the ratio of optimal public capital-to-GDP, x**<sup>**+**</sup> **, responds to changes in the factors identified in the endogenous growth model outlined above** , this section begins by carrying out a sensitivity analysis of a public capital accumulation equation, embedded in the general equilibrium model to capture insights on the effect of several key factors and parameters. The public capital accumulation equation is specified as follows (see Section II above and Marrero, 2008):

where x<sup>+</sup> is the optimal ratio of public capital to GDP, β is the discount factor of the representative household, ψ is the share of output devoted to public services, δ g is the depreciation rate of public capital, γ is the economic growth rate and 1/ σ is the inter-temporal elasticity of substitution. Note that the total effect of all the factors on the ratio of public capital to GDP is the sum of the direct and indirect effects, with the strength of the indirect effects largely dependent on the depreciation rate of public capital and on household preferences between present and future consumption.

**There are two main findings from a sensitivity analysis aimed at measuring the weight of factors related to the quality of public investment management on growth.** A higher depreciation rate for public capital ( δ g), due for instance to uneven maintenance of public capital, reduces the quality-adjusted public capital-to-GDP ratio, with negative effects on growth. Similarly, setting the elasticity of inter-temporal substitution at unity, to reflect the stronger preference in developing countries to consume now rather than in the future, magnifies the ‘congestion’ effect. These two factors have a bearing on the level of public investment, given the country’s institutional setting, on the impact of public investments on private capital accumulation, and, as a result, on a country’s long-term growth trajectory.

**The importance of a country’s institutional setting is highlighted in the Public Investment Management  (PIMa) index (see Figure 1).** The PIMa index is drawn from the diagnostic framework by Rajaram et al. (2010) and its application in detailed country case studies. It establishes the relationship between countries (horizontal axis) and their ranking across the PIMa

> 25Egen and Skinner (1992) develop a fiscal policy and output growth model that, using data from 1970 to 1985 for 107 countries and correcting for any endogeneity in government policy, finds that a balance budget increases government spending and taxation reduces output growth.

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