# **_Inadequate state of physical infrastructure_**

Second, the inadequate state of physical infrastructure, another key component of Custo Brasil, constrains connectivity while hindering the increase of economies of scale, which is a crucial feature needed to reap the benefits of trade integration and to boost productivity growth. In principle, increasing the efficiency in overall public infrastructure is expected to raise productivity directly through higher infrastructure capital (measured as capital intensity) which makes private capital more productive. Recent analysis conducted by IMF (2015) - for a panel of 17 advanced economies during the 1985-2013 period - provided evidence that an increase in public investment equivalent to 1 percent of GDP is associated to an increase of labor productivity of 0.5 percent over the medium term, although primary through higher physical capital intensity. The impacts are higher the more efficient is the public spending system. In Brazil, the average rates of investment in overall infrastructure have been decreasing in the past decades, falling from an average of 5.42 percent over GDP in the 1970s and 1980s to an average of 2.15 percent in 2011-16 (Frischtak and Mourao, 2017). This sinking investment trend, explained by a reduction in public investment that was not counterbalanced by private sector investment,<sup>31</sup> brought negative impacts in terms of infrastructure adequacy: Brazil scores lower than its main export competitors on qualitative indicators of infrastructure adequacy, both in terms of overall infrastructure and transport infrastructure (Figures 21 and 22). Moreover, the strong preference for road transport over other modes combined with low percentage of paved roads<sup>32</sup> increases logistics costs. There is also evidence that inadequacy of transport infrastructure is associated with market segmentation in Brazil: evidence presented by Garcia-Escribano, Goes and Karpowicz (2015) shows a positive correlation between slower price convergence across major metropolitan areas and longer commuting times between cities in Brazil. All these factors together contribute to hamper domestic market integration, which then prevents increasing economies of scale, a crucial feature to reap the benefits of trade openness.

<!-- Start of picture text --> Figure 21. Quality of overall infrastructure, rank Figure 22. Quality of road infrastructure,<br>(2016-17) rank (2016-17)<br>1 = best; 144 = worst 1 = best; 144 = worst<br>140 122 123 140 121 123<br>120 120 108<br>95<br>100 87 100<br>80 64 65 80<br>59 54<br>60 60 41<br>35 34<br>40 23 40 26<br>13 14<br>20 20<br>0 0<br><!-- End of picture text --> 31 In addition, public infrastructure spending efficiency in Brazil, and Latin America in general, has been hampered by several factors, as listed by Fay et al. (2017), such as: weak planning, project appraisal and preparation capacity; overly rigid or myopic budgeting; difficulties with budget execution; inefficient procurement system; unclear project sustainability (caused by an imbalance between capital and current spending); uncompetitive construction industry. 32 Almost 60 percent of cargo in Brazil flows through highways of which only 14 percent is paved.

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