3. Institutional infrastructure corresponds to what new institutional economics5 calls the ‘institutional environment’. It includes internal and external norms (or formal and informal institutions) that shape economic behaviour and decision-making processes. These norms are governed by what Buchanan and Tullock (1962) would call the constitutional framework (choice of rules governing economic and social interactions), as well as unstated conventions and various forms of implicit behaviour, the ‘choice within rules’. Examples are the legal system, the economic constitution, banking and finance regula- tion, the bureaucracy, along with informal institutions such as trust, culture, business networks, and acceptance of social norms.
Jochimsen’s definition of infrastructure and his emphasis on institutional aspects recognize that the key foundations of a market economy are the markets themselves, institutions and policies that support and enhance markets and market-based behaviour, skills and enterprise, not just physical structures.
An infrastructure project can create a new market or alter the structure of a market, expand competition in other markets, widen market-oriented conduct and innovation and contribute to the reform of policies and government insti- tutions and practices that alter the investment climate in the country (Stern and Lankes, 1998). While in principle such impacts could be incorporated into cost–benefit analysis,6 in practice cost–benefit analysis seems unlikely to capture all of the effects of institutional change resulting from infrastructure investment.
demand in the capital goods-producing sector raises the price of capital goods, thereby lowering the quantity of these goods demanded by the private sector.
Finally, the increased government demand in the economy creates a general scarcity of current resources, inflationary pressures, a rise in nominal and real interest rates, and a further contraction of capital spending.
But the crowding out argument is based on the assumption of an unchanged rate of return to private capital in the face of higher public capital accumula- tion. If public capital devoted to infrastructure purposes is in fact complemen- tary rather than competitive to private capital in the production of goods and services, then a rise in the public capital stock makes private capital more productive. New motorways and trunk routes allow faster transportation of goods from factory to markets. Power stations lower the cost of running machinery. As a result, higher levels of public investment might filter into higher profit rates for the private businesses, more than offsetting the adverse consequences. Aschauer found that while an increase in public investment initially crowded out private investment, in the medium term it improved productivity levels in the private sector (both labour and multi-factor produc- tivity) to such an extent that it had a net positive effect on private investment.
Aschauer’s findings stimulated a bevy of research and discussion on the topic in the early 1990s that, to a large degree, was responsible for the ‘redis- covery’ of infrastructure as a major public policy issue (Hieronymi, 1993, p. 76). Some studies supported Aschauer’s findings and estimated supra- normal returns for public infrastructure. In particular, the World Bank in 1994 found evidence which overall confirmed that the role of infrastructure in growth is substantial, and frequently greater than that of investment in other forms of capital. Their summary and assessment of 14 studies on this question covering within-country and cross-country data suggested significant likely benefits from investment in public infrastructure.
Others, however, were less sure and argued that the statistical basis for these estimates is weak. A number of papers published by the European Investment Bank found that there was sufficient contrary evidence to counsel against simply attributing large indirect benefits to public investment. It was argued that the empirical results are not robust to changes in model specifica- tion, and that there is actually some evidence to suggest that excessive public investment can hinder growth – presumably because of the distortions due to higher taxes, or the crowding out of private investment (Gruber, 1994; Girard et al., 1994; Hurst, 1994).
Aschauer has revisited the topic on several occasions (Aschauer, 1995, 2001) and defends his original estimates. In 2001, he pointed to empirical support, for a range of countries, that investment in public infrastructure has positive spillover effects on an economy’s productivity and thus on economic growth. For example:
the results of the empirical analysis: substantiate the notion that the relationship between public capital and economic growth is nonlinear; provide reasonable esti- mates of a positive impact of public capital on economic growth; uncover positive growth effects from both core (highways, water and sewers) and other (primarily schools and hospitals) public capital, with particularly high impacts of urban infra- structure such as water and sewer capital. (Aschauer, 2001)
His early work indicated that cross-country differences in productivity growth can be explained in part by differences in levels of infrastructure spending (Aschauer, 1989). More recent studies confirm a statistically significant posi- tive relationship between productivity and infrastructure and suggest that infrastructure may be a key determinant of comparative advantage between countries (Yeaple and Golub, 2002). Also, Milbourne et al. (2001) found a positive effect on economic growth from public investment, with particular evidence of gains from investment in transportation, communication and education.
A further feature of the recent evidence is the finding that it is not only economic infrastructure investment that is valuable. Again it is Aschauer (2001) who provides most support for this view.
Previous studies of the relationship between public capital and the economy have tended to find support for the notion that ‘core’ public capital – typically comprised of highways, water and sewer systems – is more important than ‘other’ public capital.
When he estimated output and employment growth where allowance is made for the separate impacts of core and other public capital, the results indicated that the output and employment growth effects were positive for both core and other public capital, as was evident from the earlier quotation.
These studies are predominantly at a national or multi-country level. When the effects of infrastructure investment are considered at a less aggregated level, it may be more difficult to establish that rates of return on infrastructure are appreciably larger than those on other investments. That, at least, is the conclusion of Flyvbjerg et al. (2003) who warn of ‘overselling’ projects in terms of regional and economic growth effects (pp. 65–72).
Consider, for example, transport. Transport infrastructure is used by both businesses and private individuals, and it can be seen as an input into the production of a transport service, which in turn is used as an input into a final product or service demanded by consumers, such as a visit to a friend or the availability of a certain commodity in the local shops. Investment in transport facilities should produce a reduction in the cost of the input, either through decreased outlays for undertaking a trip or decreased time spent on a trip, which may also translate into reduced outlays, or both. In effect, the invest- ment reduces the ‘price’ and this lowering of the price of infrastructure services will have two consequences in the short term. First, it will increase
the demand for that service by both private individuals and businesses, and second, it will add to the level of profits made by businesses generally, as a result of cheaper transport costs reducing overall production costs for firms in the area. For this impact to be significant, transport costs need to be an impor- tant element in total production costs, and the change in transport costs as a result of the road has to be large (Parkinson, 1981).
In the longer run, transport investment can generate a relocation of indus- try and economic activity. This occurs when a firm decides to relocate because of a change in accessibility brought about by road investment. As in the short run, the change in transport costs has to be significant to matter. However, the evidence would indicate that transport costs are a relatively small component of the final cost of goods and services. Parkinson (1981) found transport costs to be typically only 5–10 per cent of total production costs, although they do vary from one industry to another and from firm to firm.8The upshot is that even large-scale investments, that give rise to large savings in expenditure, time and inconvenience, may have a small impact on company profitability (Flyvbjerg et al., 2003).
That is not to say that investment in public infrastructure is unproductive – no one would advocate a country without roads, for example. Part of the diffi- culty is that investment in infrastructure is not a continuous process but tends to be ‘lumpy’ and discontinuous. Once an economy reaches a certain stage of development it needs a good road system. Major investment may then take place in building motorways and trunk routes. Until the system is nearly completed its full benefits are not available to the economy or society.
However, once completed, the capacity may be adequate for many years to come. The result is that at certain stages in economic development infrastruc- ture may be a constraint on growth, but once the constraint is dealt with, further investment does little to expand productive capacity. Measuring the overall economic effects of infrastructure investment may be a very difficult task (FitzGerald, 2003).
It may also be the case that high returns apply to some forms of infrastruc- ture but they do not carry across the board to all types of infrastructure. Aschauer in his early studies identified streets, highways, airports, mass transit systems, water and sewerage, as well as power and electricity, all of which can be viewed as inputs into production with the capacity to reduce exchange and transactions costs. Later, he found evidence of high returns from social infrastructure, but these effects may be more difficult to identify at a local or regional level when there is significant mobility of the work force. At a regional level, the impacts on development may be greater the more the investment is geographically concentrated, creating a cluster of firms in related industries all drawing on simi- lar regional infrastructure and resources. Nevertheless, economic impacts are not the only consideration, for infrastructure has significant socioeconomic and
organizational characteristics. Some infrastructure services are considered to be a citizen’s right, and government is expected to ensure a minimum avail- ability to everybody (for example, health care) to some degree, irrespective of their capacity to pay. This leads us to the public characteristics of infrastruc- ture.