Public Investment as an Engine of Growth

IMF Working Papers, August 11, 2014

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On average, evidence shows only a weak positive association between investment spending and growth and only in the same year; lagged impacts are not significant.
There is little evidence of long term positive impacts from public capital drives.
Some individual countries may be exceptions (for example Ethiopia in recent years, where high public investment has coincided with high GDP growth), but it is probably too early to draw definitive conclusions.
The largely instantaneous positive association suggests either reverse causality (capital spending tends to be cut in slumps and increased in booms) or Keynesian demand effects (spending boosts output in the short run).
The evidence argues against strong long term productivity effects from public investment when assessed by spending flows, because productivity effects are triggered by completed investments, which take several years.
Historical experience shows that many public capital drives have been followed by slumps rather than sustained booms.

Reverse causality: governments increase capital spending in booms and cut it in slumps, producing an instantaneous correlation with GDP growth.
Keynesian demand effects: short-run output increases from spending that do not necessarily translate into long-run productivity gains.
Completion and utilization lag: long-term productivity benefits depend on completed investments and their effective use, not on the timing of spending alone.

Case studies indicate public investment drives tend to be financed eventually by borrowing.
Common problems documented in past drives include: poor analytics at project selection, incentive problems, and investment decisions distorted by interest-group influences.
These implementation failures help explain the lack of persistent growth effects in many countries.

For current public investment drives to succeed, governments should avoid repeating past behaviors that undermined outcomes.
Key policy actions suggested by the evidence:
- Take analytical issues seriously at the project-selection stage.
- Safeguard the decision process against interests that distort public investment decisions.
- Focus on ensuring investments are completed, effectively operated, and maintained so that potential long-term productivity effects can materialize.
- Pay attention to financing sustainability, given the tendency for drives to be financed by borrowing.

Capital spending; Expenditure; Infrastructure; National accounts; Private investment; Public investment spending.
Keywords listed include: Africa, Big Push, boom variable, Capital spending, economic growth, Infrastructure, investment boom, investment boom variable, investment drive, investment ratio, on-the-shelf government investment, Private investment, production function, Public Capital, public investment, Public investment spending, WP.

Source: Andrew M. Warner, "Public Investment as an Engine of Growth", IMF Working Papers 2014, Issue 148.