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IMFSurvey Magazine: Interview

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How to Step Up Financing for African Infrastructure

Highway construction in Kenya. New sources of funding for infrastructure in Africa can bring their own problems (photo: Zhao Yingquan/Xinhua/Corbis)

INVESTMENT IN AFRICA

How to Step Up Financing for African Infrastructure

IMF Survey online

February 22, 2012

  • Weak infrastructure negatively impacts growth, quality of life
  • Private investment, foreign borrowing can spur infrastructure development
  • Countries must manage challenges of private investment, foreign borrowing

Africa can step up investment in its infrastructure by augmenting traditional sources of financing with foreign borrowing and private investment, but risks need to be managed, suggests a top economist at the International Monetary Fund.

Weak infrastructure is an obstacle to raising growth and reducing poverty in many countries in Africa as well as in other regions.

In an interview with IMF Survey online, Andrew Berg of the IMF's Research Department cautions that tapping alternative sources of financing is not a cure-all for meeting Africa’s infrastructure needs.

IMF Survey online: What are the challenges facing infrastructure development in Africa?

Berg: If you go to the continent, you can see that there is a tremendous infrastructure deficit. It affects all levels of society and all aspects. It affects health, education and growth. The biggest gap is probably in energy. Thanks in large part to the work of Vivian Foster and her colleagues at the World Bank, we have a pretty sharp picture. Thirty or forty years ago, Africa’s electrical energy output per person was comparable or even more than in East Asia and South Asian countries like Bangladesh and other similar countries.

However, since then, the development of energy infrastructure has been relatively flat or stagnant in Africa, while those countries in East Asia and South Asia now produce roughly three times the energy per capita that Africa does.

There is a lot of talk about how bad corruption and red tape are; and about how they hold back businesses, growth, and prosperity. That is true. But, if you ask businesses to rank their problems, more often than not they would rank inadequate infrastructure and inadequate energy as being more important than corruption, red tape, and poor governance combined.

IMF Survey online: What is the impact of inadequate infrastructure?

Berg: You can see the costs of this in all sorts of ways: companies in Africa often have to have their own generators because they cannot get power. That power can easily cost four times what it would cost a company in most countries in the world to produce; so that puts the countries in Africa at a big disadvantage.

But it is not always about profits and growth. We observe in Malawi that one of the most important determinants of whether AIDS treatment programs worked well was whether people were close to a decent road. Not a great road, but a decent road in rural areas, so that they could get to the clinics or the drugs could be delivered. That made a lot of difference to the effectiveness of the AIDS treatment.

So along all sorts of dimensions, infrastructure is a big problem. Despite the success we have seen in Africa in the last ten or fifteen years, it is, of course, holding the continent back.

IMF Survey online: How have these projects been financed in the past and why have they not been more successful?

Berg: The main way infrastructure spending is financed at the moment is out of domestic resources of the country. Governments raise taxes. But there are not a lot of resources to go around; countries are poor so it is hard to raise taxes; tax systems are often not very efficient.

And there are many competing demands. We are talking about the need for infrastructure development, but we could be talking about how incredibly important it is to spend on AIDS, health, education, or any number of things. And then you could talk to someone else about how because of the inefficient tax systems, we have to make sure not to kill off these growing private sectors with too much taxation. At every direction you look, it is not easy to find the resources.

IMF Survey online: What other sources are available to finance public investment in infrastructure?

Berg: Aid is the obvious one. Many countries get quite a lot of aid as a share of their own income and that does finance a fair amount of infrastructure spending. Generally, in the 1990s and 2000s, much of the focus was on delivering social services, health, and education. It was associated with a certain focus on human development.

I think, at least among many observers and perhaps many policymakers in Africa, there has been a sense in recent years that the pendulum has swung too far and needed to swing back toward infrastructure. So we can hope and expect that more aid will be able to be devoted toward infrastructure in future—that is one source.

Another source is public-private partnerships or, in other words, private investment in public infrastructure. For example, you could have a project where a private company would build and manage a road and the rate of return would come from tolls on the road, or it could be done for a port or for a power supply.

Those types of investments have been growing. However, they are not the miracle cure. For example, in many places it is hard to collect enough money from electricity to pay the costs. People are poor. There may be a tradition of nonpayment. There are many complications that make it hard for a company to make money doing electric generation—that is the second source.

A third source, now available to countries, is more commercial lending. Countries can borrow money on world capital markets. They can issue a bond where they are going to promise to pay back $100 million in 10 years with interest, and in return they get the money now and they can use that for what they want.

IMF Survey online: What are the costs and benefits of foreign borrowing for infrastructure development?

Berg: Let us say you want to build a big electrical power plant. If you use your tax revenues or domestic revenues to do that, it is not just a financial issue. When you want to import the generators for that power plant, you do not have any extra dollars.

The country has to find the dollars to import those generators so that they have to put resources to work exporting, or they have to take some of their crops and export. In the end, the dollars that they are using to buy those generators are dollars that they cannot use for others things such as importing consumer goods or medicine. They have to keep these scarce resources into building the power plant.

If they get a loan from abroad, they get dollars from abroad that they can use to import the generators, and they can continue to keep importing medicines, radios, food, or whatever they need with those dollars. So they do not have to squeeze so much on the other things to build that road. It really helps to avoid having to cut consumption or cut other important activities to build this power plant, which is what you want to do if you are already poor. That is the good thing about the loans.

The danger is that you have to repay them. And you have to repay them whether the power plant works out or not. So it raises the stakes. If the power plant does not work out, you are going to have to find the resources to repay the loan.

One thing which is not always obvious is that even really good projects can create a problem for repaying the loan. Suppose this power plant I am talking about will allow all sorts of businesses to start. Maybe the tariffs will not cover the costs of the power plant; but there are going to be lots of new businesses doing all sorts of new things, creating wealth and exporting. It is a great project and the country will be much better off. But the loan is the government's to repay so the government has to, somehow, collect either tariffs on the electricity, or taxes on these new businesses to repay the loan.

We find that, in many cases, the tax rates in countries are so low that even if a project pays back more than the cost of the project itself, most of the benefit goes to people outside the government. Thus, the government may have a hard time collecting that. So they may have to raise tax rates to repay the loan and that is really hard to do.

IMF Survey online: Is this what you mean when you say that more investment does not necessarily lead to growth?

Berg: I was actually worried about an even more optimistic situation in which the investment does lead to growth, but the government still has to somehow translate that growth into the ability to repay the loan.

But beyond that, the history of big increases in public investment does give one pause. It is disappointingly challenging to find those success stories of cases where booms in public investment led to sustained booms in growth.

There are many reasons why public investment spending may not translate into growth. It is hard to prioritize and build the right projects and it is hard to maintain them. You can build a beautiful plant but if you do not keep it running, it does not help. This can become a situation in which you spend a lot of money, use a lot of resources, borrow money, and in the end, may not have the productive useful capital that you thought you had.