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We thank Santiago Acosta-Ormaechea, Andy Berg, Emmanouil Kitsios, Prakash Loungani, Chris Papageorgiou, Dawit Tessema, Felipe Zanna and participants at an IMF seminar for useful comments and suggestions. All remaining errors are ours. We acknowledge also the financial support from U.K.’s Department for International Development (DFID) under the project “Macroeconomic Research in Low-Income Countries,” with project ID number 60925.
To our knowledge, Hall and Jones (1999) were the first to define the concept of “social infrastructure”.
We leave out the Great Recession period due to its peculiarities.
There is one exception that is discussed later.
To be specific, it occurs only for human capital accumulated via schooling, which we seek to model here. For example, it would not be the case for the accumulation of human capital through on-the-job training. It is worth clarifying that this delayed effect of accumulated human capital on output is distinct from time-to-build arguments. Time-to-build delays in public capital would imply that investments in roads and schools would become part of their productive stocks with some delay. Typically models with time-to-build lags for economic capital (see, e.g., Leeper et al, 2010) are calibrated at a quarterly frequency and look at much shorter delays relative to human capital acquired via schooling. If we modeled time-to-build lags for roads and schools, such delays would affect both types of investments symmetrically. In contrast, as our objective is to bring out a key difference between roads and schools more sharply: once a road is completed, it can be immediately used in a productive manner, while having built a school does not automatically translate into more human capital available to the economy; it will take several more years to train students who will become productive workers in the future. As such, we abstract from time-to-build considerations.
Some contributions have emphasized that, especially in developing economies, investment spending can be inefficient and typically a significant fraction does not translate into public capital (see, e.g., Pritchett, 2000 and Dabla-Norris et al., 2012). While some papers (see, e.g., Buffie et al., 2012) incorporate public investment inefficiencies in the model, here we abstract from this additional feature because such considerations would apply symmetrically to both social and economic investment and our goal is to emphasize their distinguishing features.
For a critique of studies using infrastructure stock arrived at using perpetual inventory method which find low or insignificant returns, unlike those based on physical measures, see Straub (2008).
Recall, the effect of schools on output through increased effectiveness of labor (via e) happens slowly over time or with a gradual delay, which is in contrast to the effect of economic infrastructure on output. The computation of the return to schools takes this delay into account. In particular, we calculate the stream of additional output (net of depreciation) resulting from an initial one unit increase in investment in schools in the initial equilibrium. The stream is discounted to the initial period using the domestic market interest rate (rd). The return to schools is then simply rd times this present value.
While a number of tools are available to solve such dynamic models with perfect foresight, our numerical simulations are generated using a set of programs written in Matlab and Dynare (see http://www.cepremap.cnrs.fr/dynare).
To be specific, as the economy grows at rate g, a permanent increase of 1% of initial GDP in normalized terms implies that the expenditure also grows over time at the same rate.
Since we consider the case in which the government finances deficits only via international borrowing, the increase is in public external debt.
If the model featured an income/output-based tax instead of a consumption-based tax, the differences would be larger because output differences are much larger across the two scenarios than consumption differences. Putting it differently, relative to income-based taxation, consumption-based taxation reduces the disadvantage of investment in schools in terms of debt sustainability implications.
Djibouti ramped up public investment from about 12-14% of GDP to as much as 30% of GDP over 2013-2015 (see IMF, 2016a). See IMF (2016b) for the analysis of the Maldives’ currently undergoing investment of 35%-38% of GDP to upgrade its tourism infrastructure over a period of 4 year from 2016 onwards. Andreolli and Abdychev (2016) analyze debt sustainability implication of Lesotho’s construction of an hydropower plant with total investment of about 31% of GDP over a period of 7 years. In the context of big-push scenarios, Ghazanchyan et al. (2016) study how improving the efficiencies of capital spending and of tax revenue collection affect growth and debt sustainability in Cambodia, Sri Lanka, and Vietnam.