Does infrastructure now generate growth?
Business Standard, 11 July 2022
On 8 July, T. N. Ninan wrote in the Business Standard, where he anxiously looked at the inconsistency between high infrastructure investment and low traffic growth. There is merit in those concerns. There is a related question: What is the role of infrastructure investment in achieving high growth? In the early 1990s, a causal chain could be plausibly argued, where more infrastructure would generate more growth. Today, the bottlenecks seem to be elsewhere.
The argument in favour of a causal impact of infrastructure upon growth
India's tryst with globalisation began in the early 1990s. We shed our suspicious approach to the outside world, and removed barriers to globalisation. This was of central importance in unleashing the growth episode of 1991-2011. Decades of orthodoxy around the themes of autarky, hostility to the West, self-reliance and export pessimism were proven wrong by the performance of the economy when trade and capital controls were removed.
Most global production takes place in `global value chains'. Global companies (which includes Indian multinationals) place production at cost-efficient centres. Parts and sub-assemblies are moved around the world, as production takes place step by step at efficient locations. India's edge -- low wages-- means that there are many good production sites, deep in the hinterland. This requires good infrastructure, to move goods to ports/airports in India, and then to production sites with low wages.
This story contains a causal claim:
- Build connectivity to remote locations,
- and the firms will come,
- they will transport parts and sub-assemblies there,
- hire low-wage labour that will do a few precise tasks,
- and then ship out sub-assemblies or finished goods from there, to production sites or markets all over the world.
By this story, investments in infrastructure create conditions for private investment and then sustained employment.
Infrastructure investment, in and of itself, does not generate jobs or growth in steady state. It is a means to an end, it creates conditions in which private investment can create employment growth. GDP growth and prosperity are made by private investment which creates jobs. Infrastructure investment is impactful when it is followed through by private investment.
The great Indian infrastructure build-out
Some of the best minds of the 1990s and 2000s devoted themselves to establishing the institutional frameworks through which the infrastructure could be improved. We admire the contributions of the people who ended state control of telecom, established NHAI, Delhi Metro, the Cochin airport, the multiple competing terminals at JNPT, etc. In the early years, institutional apparatus was established, and then significant capital was put into these mechanisms.
The results are all around us. Bombay and Delhi have decent airports and some metro lines. There was a remarkable surge in highway commissioning in the last six years. The prices of plane tickets crashed and the middle class is flying. Decent bandwidth is now ubiquitous: the IT and ITES industries have long forgotten the connectivity constraint.
Has the causal claim held up?
A vast infrastructure industry continues to chug along, building new assets. But it is time to step back and re-examine the core proposition. Is friction in movement -- of atoms and electrons -- the binding constraint which is holding back the Indian economy? The key troublesome fact is the loss of momentum in private investment which began in 2011. If we believed that the infrastructure build-out was going to have a causal impact upon private investment, then the outcomes on private investment should have been different.
A reduced cost of transportation always helps, but then so do many other things. Sectoral perspectives generate proposals for more spending on education, health, skills, etc. Economic thinking requires identifying and addressing the binding constraint. It seems right, to think that in the 1990s, pro-globalisation policies created a new set of possibilities for private investment in global value chains, and that the frictions of transportation were then the binding constraint. The simple graphs of infrastructure going up and private investment growth going down, from 2011 onwards, suggest that this is not the case today.
Implications for infrastructure investment
None of this reasoning interferes with fully private infrastructure projects. If a private person believes that a good ROE can be earned, they should always have the ability to take the risk and build an asset. As long as a private person feels she can make money building an asset, she should always be welcome to do so.
But this reasoning hinders the case for public spending. There is a big hurdle when spending public money -- the Marginal Cost of Public Funds (MCPF) -- where each Rs.1 spent by the government imposes a cost of perhaps Rs.3 upon the economy. For any public spending proposal, we should be certain that the overall gains to society will be very large, over three times the taxpayer money that is spent. It is now hard to make this case for public infrastructure spending. State-led initiatives that add infrastructure in India have a whiff of the Chinese problem, where increasingly inefficient state-led investments induced a declining ICOR of the economy.
What are the binding constraints to private investment and employment growth?
Why did private investment growth subside in the post-2011 period? We need to identify and address the binding constraints. Vijay Kelkar and I wrote a book on this.
Our sense is that the private sector has been deterred by an interventionist state, by policy risk, by faults of public systems such as the tax system, and by the lack of rule of law at coercive state agencies such as regulators. The cost of moving raw materials to a remote location in India, and then taking a sub-assembly out, is no longer the bottleneck. The problems lie in the tax system, the capital controls, the legal risk, the sudden policy changes, and the fear inspired by the agencies and regulators. The rule of law is the most important infrastructure of all.
Alongside this, we must wonder why employment is low but the wage remains high in many pockets of the population. Perhaps the welfare programs are distorting labour supply. An array of non-economic factors hamper women's labour supply. If women's labour supply could surge, this would help reduce wages, and foster more investment and jobs.
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