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2.2. **Internal Balance:** A high government deficit in the previous year is expected to decrease govemment expenditures in the following year and, therefore, the government's ability to make infrastructure investments in the current period. Similarly, maintenance is likely to be postponed in the context of high government deficits (Easterly, Rodriguez and Schmidt-Hebbel, 1994). Accordingly, the higher the government deficit in the previous period (the greater the internal imbalance), the lower the level of infrastructure expenditures expected. However, several opposing forces may be at work as well. First, the uncertain investment climate caused by deficit induced inflation implies that the government may choose to increase infrastructure investment to compensate for or stimulate private investment. Further, the existence of high deficits in the past may signal the inability or unwillingness of governments to undertake the hard decisions necessary to bring the budget into balance and, accordingly, their unwillingness to lower infrastructure service provision. Overall then, the relationship between the intemal balance and current infrastructure expenditures is uncertain.

The measure of internal imbalance used, BBGDPL, is the budget balance as a percentage of GDP (with a negative value implying a deficit), lagged one year. Nominal values in domestic currency of both the budget balance and GDP are the basis of the computation. The data source for the component variables is the World Bank's _World Tables_ 1993. Analysis is undertaken to explore the sensitivity of results to an altemative measure of intemal imbalance, the domestic inflation rate, INFL4, given the link between intemal balance and domestic inflation. This variable captures the ability of the govemment to sustain a deficit without serious inflationary consequences. INFL4 is calculated as log differences of the Consumer Price Index, when it exists, and the log differences of the Wholesale Price Index otherwise. The data source for INFL4 is WDR91SD.

2.3. **External Balance:** _A priori,_ the relationship between the extemal balance and infrastructure expenditures is unclear. On the one hand, countries with large imbalances in their current account in the previous period are likely to adopt or have imposed on them stabilization policies which include reining in govemment expenditures. That is, all government expenditures, including expenditures on infrastructure, are likely to decrease when the external balance is negative. In addition, the maintenance of a positive trade balance implies that policies are being pursued which maintain intemational competitiveness. A force in the opposite direction concerns the fact that the correction of structural current account imbalances may entail increased infrastructure investments. That is, govemments facing imbalances need to increase their capacity to export and this may necessitate shifting a larger proportion of government expenditures to infrastructure expenditures on ports or other infrastructure investments supporting export growth. Overall, the impact of the external balance on infrastructure expenditures is uncertain.

Several altemative indicators of the extemal balance are considered. The first is the trade balance as a proportion of GDP, lagged one year, TBWTGDPL. The trade balance for a given year is calculated as the value of exports minus imports, all divided by GDP (all measured in current local currency). The data source for the value of exports minus imports