Development ‘secret’

Feb 27, 2013 Editorial

We continue with our discussion of the three elements of the “American System” of development, which were followed (with variations, of course) by every other country that successfully became “developed”. These elements were: infant industry tariffs, internal infrastructural improvements, and a sound system of national finance. Noting that China, which is on course to supplant the US as the #1 economy in the world, we elaborated on ‘infant industry’ tariffs in “China’s Growth Secret”.
Today, we look at ‘internal infrastructural improvements’. The early proponents of the American System demanded that the national and state governments design, finance and construct canals, bridges, ports, railroads, toll roads, and a wide variety of communication and transportation facilities that would allow businesses to operate more efficiently and profitably. In some cases these projects were paid for directly (tolls, for example) and in other cases they were paid for tax revenues generated by higher levels of economic activity.
It is easy to make a case for state involvement in infrastructure investment. The costs of infrastructure can be very high, while even if the benefits are much higher they are likely to be diffused throughout the economy, making it hard for any individual company to justify absorbing the costs of investment. In this case the state should fund infrastructure investment and pay for it through the higher taxes generated by greater economic activity.
Since its accession to office in 1992, the PPP government has concentrated on infrastructural investment. In fact, since then the state has consistently been the largest investment source in Guyana through its capital projects. But from the experience of the successful economies such as Germany and Japan etc, the question is not whether the state should build infrastructure, but rather how much it should build. In fact this is one of the greatest sources of confusion in the whole development debate. Nowadays, most infrastructure “bulls” implicitly assume that infrastructure spending is always good and the optimal amount of infrastructure is more or less the same for every country.
But this is completely wrong. Infrastructure investment is like any other investment, in that it is only economically justified if the total economic value created by the investment exceeds the total economic cost associated with that investment. If a country spends more on infrastructure than the resulting increase in productivity, more infrastructure makes it poorer, not richer.
But the big problem is in the value created by the investment. One can think of the value of infrastructure primarily as a function of the value of labour saved. In countries with very low levels of productivity, each hour of labour saved is less valuable than each hour saved in countries with high levels of productivity. For this reason less productive countries should have much lower capital stock per capita than more productive countries.
Other ‘infrastructure’ matter too – not just the physical variety. If a country has low levels of social capital – if it is hard to set up a business, if less efficient businesses with government connections can successfully compete with more efficient businesses without government connections, if the legal and political structure creates problems in corporate governance (the “agency” problem, especially), if the legal framework is weak, if property rights are not respected, if intellectual property can easily be lost – then much infrastructure spending is likely to be wasted.
In fact it turns that it may be far more efficient to focus on improving, say, the legal framework than to build more airports, even though (and perhaps because) building airports generates more growth (and wealth for the politically connected) today. Weak social capital becomes a constraint on the ability to extract value from infrastructure, and this constraint is very high in poor countries with weak institutional frameworks.
However, when Governments take an overwhelming lead in investments, even veering into the private sector arena as in Guyana today, large-scale government ambitions allied to strong political motivation and funded by cheap and easy access to credit can lead very easily to the wrong kinds of investment programmes.

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