# **1. Introduction**

Public investment is often considered a powerful policy lever to foster economic growth. This is particularly the case in emerging market and developing economies (EMDEs), which face significant investment gaps to meet their sustainable development objectives in an environment where private investment has been in a broad-based and prolonged slump (World Bank 2024).<sup>5</sup> Public investment facilitates production; promotes the flows of capital, labor, goods and services; and provides the infrastructure needed to improve human capital and productivity. Given the nonexcludable and non-rival nature of public goods and services, and substantial costs involved in the development and maintenance of public infrastructure, it often cannot be supplied effectively by the private sector.

That said, public infrastructure projects are generally costly and can lead to high budget deficits and unsustainable levels of public debt, particularly when the planning and execution of investment projects is weak (Adarov and Panizza 2024; Afonso and Alves 2023; Berg et al. 2012). Government spending may suffer from inefficiency, especially in countries with governance issues, corruption, and weak fiscal monitoring and accountability mechanisms, and in the worst cases, may yield infrastructure that is unproductive and costly to maintain (Chakraborty and DablaNorris 2011; Dabla-Norris et al. 2012; Pritchett 2000). In countries with weak institutions, public investment may also crowd out private investment, particularly when scaling up is sizeable and fast-paced (Aschauer 1989a; Cavallo and Daude 2011). Thus, the net macroeconomic effects of public investment can also be small or even negative.

In fact, the empirical estimates of public investment multipliers reported to date differ significantly. The estimates are sensitive to the sample of countries and timeline investigated, estimation methodology, incorporation of non-linear effects, and fiscal shock identification strategies (see Section 2 for discussion). Empirical work examining public investment multipliers in EMDEs is especially scarce. The main challenge in performing such research also rests in the difficulty of identifying changes in public spending that are uncorrelated with contemporaneous macroeconomic shocks, and that can thus be deemed as exogenous.

In light of these caveats, in this paper we aim to contribute to this literature in a number of ways. First, we use the data on public investment for a broad sample of 129 EMDEs over a long span of time (1980-2019). The large sample is helpful to better understand implications of public investment in EMDEs as a whole, as well as explore heterogeneity across country groups. Second, we bring together many of the methodological improvements in recent empirical research focusing on the role of initial conditions in determining the macroeconomic effects of public investment. These include: (i) prevailing business cycle conditions at the time of the shock; (ii) fiscal space; (iii) public investment efficiency; and (iv) the initial public capital stock level. While these themes have been touched upon in some earlier studies, no paper has yet brought them all together and

> 5 Public investment in the context of the paper refers to general government gross fixed capital formation.

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