Abstract
Selected Issues
Infrastructure Investment in New Zealand: Gaps and Multiplier Effects1
There has been an increased emphasis by the government on spending on infrastructure. However, it is not clear from a long-term perspective if all of New Zealand infrastructure needs will be met.
The infrastructure investment gap to 2040 for New Zealand is quantified in the Global Infrastructure Outlook by Oxford Economics and the G-20. The report estimates New Zealand’s average infrastructure investment gap is around 0.3 percent of GDP per year.
Closing the infrastructure investment gap is analyzed using ANZIMF (Australia-New Zealand Integrated Monetary and Fiscal model). It is a version of IMF’s GIMF (Global Integrated Monetary and Fiscal model), a micro-founded, overlapping generations dynamic stochastic general equilibrium (DSGE) model, with a role for infrastructure investment.
There can be further gains for the New Zealand economy from closing the infrastructure gap. Infrastructure investment has been demonstrated to be productivity-enhancing, with positive economy-wide spillovers. The long-term real GDP gain can range from 0.65 to 0.8 percent relative to New Zealand’s outlook in the World Economic Outlook.
The range of outcomes is a result of different forms of financing the additional public infrastructure spending. The least productive financing is personal income tax (crowds out consumption and distorts labor supply) followed by goods and services tax (only crowds out consumption), with deficit financing (which, however, crowds out some private investment) as the most productive.
The government can use the closure of the gap to satisfy other fiscal policy objectives:
The government could close the gap earlier. If the gap was closed by 2027, there would be higher short-term gains in real GDP, with the same long-term gains. This would be subject to the ability to quickly scale up the amount of infrastructure investment.
The government could take the opportunity to further regional development. By providing more funding to regions in need of development than implied by their current shares in GDP, the regions could gain up to an additional 20 percent, translating to 5 percent for New Zealand as a whole.
The government could aim for higher quality infrastructure investment. An illustrative example is presented where New Zealand has Singapore-level quality scores. This could be realized at least in part by a greater use of New Zealand’s public-private partnership (PPP) framework.
A. Introduction
1. There has been an increased emphasis by the government on infrastructure spending. However, it is not necessarily clear from a long-term perspective if all of New Zealand’s infrastructure needs will be met. This paper reports on the current and projected infrastructure investment gap for New Zealand, using the analysis of Oxford Economics, for the Global Infrastructure Hub. Moreover, given the magnitude of the gap, this paper demonstrates that there can be further gains in terms of growth in the near- and medium-term that can be achieved by fully closing said gap, using the IMF’s ANZIMF (Australia-New Zealand Integrated Monetary and Fiscal model). These gains can be augmented by focusing on additional fiscal policy choices, such as the time horizon to close the gap, regional development, or the quality of the infrastructure delivered.
2. The extent of the infrastructure investment gap is an important question, because it represents foregone gains in productivity that would allow for higher growth. There is an extensive literature that has demonstrated this theoretically (Aschauer, 1989), empirically (Bom and Ligthart, 2014) and through model simulation and consideration of fiscal policy (Abiad and others, 2016). Much of the literature generally concludes that infrastructure of sufficient quality and quantity can improve the quality of the workforce, the provision of capital, and firms’ access to domestic and foreign markets. Interconnectivity is particularly important in a geographically distant country like New Zealand, with concentrated but dispersed population nodes, and without any neighboring, land-connected countries with which to trade. Governments can play an important role in closing the gap, or in encouraging the private sector to do so.
B. A Baseline for the Infrastructure Investment Gap
3. The Global Infrastructure Hub is the primary source in this paper for the baseline infrastructure investment gap. It is a G-20 initiative, that has published a Global Infrastructure Outlook authored by Oxford Economics.2 It forecasts current trends and needs for infrastructure investment until 2040 (a 25-year period, starting in 2016), deriving the infrastructure investment gap from calculating needed spending less spending based on current trends for seven sectors – roads, rail, airports, ports, electricity, telecoms and water – for 50 countries, comprising over 85 percent of global GDP. These seven sectors are considered core infrastructure, which is only a subset of the standard definition of government investment in fixed capital in the national expenditure accounts, as it excludes structures (such as hospitals, police stations, prisons, and schools) and capital equipment (for example, ambulances and police cars, and military equipment).
4. Current trends and needs for the future are determined from extensive calculations. Current trends for infrastructure investment extrapolate spending trends to 2040 through a thorough analysis of the data for each country, combined with regression analysis for each of three groups of countries (low and lower middle income, high middle income, and high income). Infrastructure needs are computed for each of the seven sectors so that a country will match the 75th percentile of current trends infrastructure stock per capita in their income group, adjusted for quality considerations. Box 1 gives a more detailed explanation of the methodology.
The Six Step Methodology of the Global Infrastructure Outlook
1. Compute the seven infrastructure stocks on a per capita basis for 2015 for all the countries in an income group (such as the high-income group, to which belongs New Zealand.
2. Estimate single-equation models for each of the seven sectors using panel estimation, with a set of explanatory variables usually drawn from a subset of GDP per capita, the manufacturing and agricultural shares of GDP, population density, and the urban share of population, plus country-specific fixed factors.
3. Given the forecasts of the explanatory variables, forecast infrastructure stocks per capita to 2040. These are then converted using perpetual inventory equations of the form Kt = Kt-1(1 – δ) + It to calculate the current trend investment for each of the seven sectors.
4. Using the single-equation models, estimate what the value of the stocks should have been in 2015 given explanatory variables, to compute the expected infrastructure stock per capita.
5. Using the infrastructure quality measures for each country (from the World Economic Forum’s Global Competitiveness Report 2014–15), derived a quality-adjusted expected infrastructure stock per capita.
6. Compare the quality-adjusted expected infrastructure stock per capita across countries in a country grouping, to determine the 75th percentile, from which comes for each country, in combination with the perpetual inventory equation, its investment needs.
Infrastructure investment gap = investment needs – current trends in investment
5. The global infrastructure investment gap is estimated at 2015 US$94 trillion between 2016 and 2040. 3 This is a gap of 19 percent against the current trend investment in infrastructure extrapolated to 2040, an average of 2015 US$3.7 trillion per year. It implies that global infrastructure investment spending as a share of GDP should be 3.5 percent now, versus 3.0 percent actual. All the infrastructure sectors have higher needs than current trends, roads being the greatest (Figure 1).
Global Infrastructure Needs versus Trends and Historical Averages
(Percent of global GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.Global Infrastructure Needs versus Trends and Historical Averages
(Percent of global GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.Global Infrastructure Needs versus Trends and Historical Averages
(Percent of global GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.6. New Zealand has a small gap, but not relative to many other advanced economies. According to the Global Infrastructure Outlook, New Zealand’s overall gap from 2016 to 2040 is roughly 9.5 percent of GDP, implying cumulative infrastructure investment needs of 2015 US$190 billion, versus the current cumulative trend spending of 2015 US$171 billion. This translates into an infrastructure investment spending gap of almost 0.3 percent of GDP per year until 2040, smaller than Australia and the United States, but larger than other key advanced economies and China (Figure 2).
Infrastructure Needs versus Comparators
(Percent of GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.Infrastructure Needs versus Comparators
(Percent of GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.Infrastructure Needs versus Comparators
(Percent of GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.7. New Zealand’s infrastructure investment gaps for the seven sectors differ from the global picture (Figure 3). There has been extensive investment in roads, and current trends continue to indicate this to be the case, matching the investment needs. Stronger needs exist in the rail and electricity sector, since New Zealand historically has had weak rail linkages (because of difficult terrain on each island with small inland populations). There is also a recognized need to upgrade and expand the power grid.
Infrastructure Components
(Percent of GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.Infrastructure Components
(Percent of GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.Infrastructure Components
(Percent of GDP per year)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: Global Infrastructure Outlook, Oxford Economics.8. An aggregate infrastructure investment gap as a share of GDP is constructed from 2018 to 2040 (Figure 4). It uses the forecasts for GDP from the IMF’s World Economic Outlook, April 2018 (WEO) and infrastructure investment from the Global Infrastructure Outlook. The increased spending in the FY2016/17 fiscal outcomes and FY2017/18 fiscal budgets are roughly consistent with closing the gap in 2016 and 2017, so the gap used here is zero in 2016 and 2017. The gap from 2018 forward for New Zealand differs slightly from that of the Global Infrastructure Outlook as nominal GDP growth is more variable in the WEO until 2023, and then slightly higher thereafter. The two most important gaps are in rail (over 0.1 percent of GDP year) and electricity (almost 0.1 percent of GDP per year).
Infrastructure Investment
(Percent of GDP)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Sources: Global Infrastructure Outlook, Oxford Economics; and IMF staff calculations.Infrastructure Investment
(Percent of GDP)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Sources: Global Infrastructure Outlook, Oxford Economics; and IMF staff calculations.Infrastructure Investment
(Percent of GDP)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Sources: Global Infrastructure Outlook, Oxford Economics; and IMF staff calculations.9. However, the measurement of the gap by this methodology should be treated with care, especially since it may not account for risks specific to New Zealand. This sectoral analysis has its limitations, being based strongly on an econometric methodology. The actual measured gaps would also be affected by project-specific analysis of the benefits and costs necessary to confidently determine the prospective gains from further infrastructure investment. Overall, risks are such that the baseline measure of the infrastructure gaps is a most likely a low estimate. They also relate to the current split between the three major urban areas – Auckland and its satellites, Hamilton and Tauranga; Wellington and its suburbs; and Christchurch – and the rest of country, often referred to as “the regions,” with particular ones in need of development as they have less and lower-quality infrastructure, fewer employment opportunities, and/or greater inequality and poverty. There are three of these risks, which are interrelated and therefore reinforce one another:
Water-related infrastructure (for the “three waters,” potable, waste and storm) has often reached the end of its useful life. This is particularly true in the regions, and may not be accurately reflected in the service-life data from the advanced economies used to construct the depreciation rates for water infrastructure. Local governments are most likely falling behind on their maintenance needs, currently underspending capital budgets by up to 30 percent (Controller and Auditor-General, 2017).
The estimates of population growth for the baseline gap is based on historic norms. However, net migration has been at record highs for a sustained period of time, since 2014. Repeatedly, expectations that net migration would begin to decline to historic norms have been dashed, and the upside risk that net migration may not return to its historical average soon is still very much in play.
The placement of infrastructure is based on current patterns of urbanization. Most infrastructure needs are assumed to be in the three major urban areas, following historic trends, requiring mostly new infrastructure. However, a possible solution is to encourage more population growth in the regions in need of development. These regions’ infrastructure needs would be greater, as they are more isolated, have less existing infrastructure to serve as a kernel for new construction, and have more infrastructure in need of improvement, in comparison to adding or rebuilding neighborhoods in the major urban areas.
C. Benefits from Closing the Infrastructure Investment Gap
10. There are benefits to closing the gap for New Zealand. These benefits can be quantified with the help of ANZIMF, which a version of the IMF’s GIMF (see Box 2 for further details).
ANZIMF – The Australia-New Zealand Integrated Monetary and Fiscal Model
ANZIMF is an annual, multi-region, micro-founded general equilibrium model of the global economy. It is based on the IMF’s Global Integrated Monetary and Fiscal model (GIMF), with supporting documentation that is broadly applicable to ANZIMF (Kumhof and others, 2010, and Anderson and others, 2013). Structurally, each country/regional block is close to identical, but with potentially different key steady-state ratios and behavioral parameters. This exercise focuses on New Zealand, and the fiscal block.
Consumption dynamics are driven by saving households and liquidity-constrained (LIQ) households. Saving households face a consumption-leisure choice, based on the overlapping generations (OLG) model of Blanchard (1985), Weil (1989) and Yaari (1962) where households treat government bonds as wealth since there is a chance that the associated tax liabilities will fall due beyond their expected lifetimes, making the model non-Ricardian and endogenizing the long-term determination of the real global interest rate to equilibrate global savings and investment. The real exchange rate serves to adjust each country’s saving position (its current account and associated stock of net foreign assets) relative to the global pool. LIQ households cannot save, consuming all their income each period, amplifying the model’s non-Ricardian properties in the short term.
Private investment relies on the Bernanke-Gertler-Gilchrist (1999) financial accelerator. Investment cumulates to the private capital stock for tradable and nontradable firms, which is chosen by firms to maximize their profits. The capital-to-GDP ratio is inversely related to the cost of capital, which is a function of depreciation, the real corporate interest rate, the corporate income tax rate, and relative prices, and an endogenously determined corporate risk premia.
Government absorption consists of exogenously determined spending on consumption goods and infrastructure investment. Both affect the level of aggregate demand. Spending on infrastructure cumulates into an infrastructure capital stock (subject to constant but low rate of depreciation of 5.3 percent). A permanent increase in the infrastructure capital stock permanently raises the economy-wide level of productivity. The calibrated output elasticity with respect to core infrastructure capital is 0.170 (Bom and Ligthart, 2014).
Trade is tracked bilaterally between all regions. There are flows for goods, services, and commodities, and they react to demand, supply and pricing (i.e. the terms of trade and bilateral real exchange rates) conditions. Commodities trade, and its related demand and supply equations, are based on food products, as New Zealand has strong exports for dairy products, meat, and kiwi fruit.
The nominal side of the economy depends on implicit Phillips’ curves and monetary policy. The core price is the consumer price index, CPI, while relative prices mimic the structure of the national expenditure accounts. There is also wage inflation, which is implicitly a key driver for CPI inflation. In the short term, the nominal side of the economy is linked to the real side through monetary policy, which is conducted under a CPI inflation targeting regime, where with an interest rate function returns expected inflation to target over several years.
Fiscal policy is driven by a sufficiently detailed government sector that can reproduce simplified fiscal accounts for each country. Fiscal policy aims to maintain a debt target (expressed in flow space as a deficit target) using at least one of seven policy instruments. On the spending side, these are government consumption, spending on infrastructure spending, general lumpsum transfers to all households (such as pensions, aged care provisions, unemployment insurance) and lumpsum transfers targeted to LIQ households (such as welfare, certain pensions). On the revenue side, there are taxes on consumption (the goods and services tax, GST), personal income (PIT) and corporate income (CIT).
The government does not have to be the sole supplier of infrastructure investment. Nontradable firms can be in public-private partnerships (PPPs), by diverting some of their investment into the infrastructure capital stock, which will still register in the national expenditure accounts as private business investment. Firms can either be repaid for their expenses in the future by the government or through a revenue stream. The revenue stream option does not appear explicitly in the model, since it is merely a circular reshuffling of a user fee from households to firms, which would then return to households, as owners of the firms. The government can also provide equity investment injections into the private sector, which will then be converted by firms over some pre-determined time horizon into private business investment, that will contribute to the infrastructure capital stock rather than the private business capital stock.
11. Any additional infrastructure spending requires financing. There are two feasible financing choices for the government – increasing the deficit, or using funds from general revenues. Financing through spending cuts (which would most likely be reduced government employment) would be a harder-to-implement, time-consuming process, whereas raising debt and revenues can be done relatively rapidly in the New Zealand political system, which has only a one-house legislature, (often) with a majority government in power.
In the case of deficit financing, the government would borrow to finance their expenditures, through its standard mechanisms, and would increase the level of debt permanently.
In the case of funding from general revenues, the most logical approach would be to increase one or both of the personal income tax (PIT) and the goods and services tax (GST).
12. There are limitations to using model simulations to capture the economic outcomes from closing an exogenously specified infrastructure investment gap. First, most importantly, there is uncertainty as to quantification of the pass-through of infrastructure investment and stock to productivity growth. Second, the caveats associated with ANZIMF are limitations of this analysis, such as the under-responsiveness of trade flows (common to many DSGE models). Third, the methodological concerns for constructing the gap itself can produce misleading results if the gap is quantified incorrectly.4 Finally, because closing the gap will stimulate the economy, it will also increase GDP which would affect somewhat the demand for infrastructure, changing the investment needs, and hence the infrastructure investment gap – a feedback effect that is ignored here, but may not be significant given New Zealand’s small gap.
13. Current infrastructure spending by the New Zealand government is still consistent with the forecast of the gap used here. The Global Infrastructure Outlook dataset was built contemporaneously with the FY2015/16 budget paths, and tried to capture the trends current at that time, which may have even exceeded the capital allowances stated in the budget. The budgets in FY2016/17 and FY2017/18 increased spending on infrastructure to close the gap for the most part for those two years, and possibly out to FY2020/21, primarily by accounting for stronger-than-expected growth in GDP and population. Therefore, the gap in the short term may be somewhat over-estimated, although other factors also point to some degree of underestimation, as outlined at the end of the previous section.
14. Figure 5 illustrates the effects of closing the New Zealand gap. It assumes participation by both the national government and local governments (who derive some financing, but not all, from the national level). The figure shows the first 10 years (using lines) followed by snapshots for the end-point at 2040, and the long-term steady-state result from maintaining the new higher level of the infrastructure capital stock (using vertical bars). There are three variants for financing the closure of the gap: deficit financing by government (blue line and bars); government financing using PIT only (red line and bars); and government financing using both PIT and GST (green line and bars).
Closing the Baseline Infrastructure Investment Gap by 2040
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculations.Closing the Baseline Infrastructure Investment Gap by 2040
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculations.Closing the Baseline Infrastructure Investment Gap by 2040
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculations.15. In the long term, real GDP would be as much as 0.8 percent higher than otherwise, for a long-term multiplier of around 2.7. The small gain reflects that New Zealand’s gap is small. With higher productivity, there is a slight long-term depreciation in the real effective exchange rate, allowing for stronger exports. Even though imports cost more, consumption is still between 0.3 to 0.6 percent higher in the long term. A higher infrastructure level means a permanent increase in the level of productivity, passing to the level of labor demand and therefore to wages and labor income, as well as demand for capital and private business investment. Firms would have more income, and would be a source of further wealth to households (their owners) further stimulating consumption. However, there are variations among the three types of financing.
16. Deficit financing would provide the greatest gains. In the short term, deficit financing would be most advantageous, although the government would face a permanent 5.5 percent increase in the government debt to GDP ratio, which would slightly crowd out private business investment, offsetting some of the productivity gain from the additional infrastructure investment. However, the cumulative deficits required out to 2040 are closer to 6.6 percent of GDP, meaning that the additional growth from infrastructure investment reduces the government debt to GDP ratio in the long term by 1.1 percentage points. Deficit financing also increases demand for private saving flows, some of which come from abroad, leading to a worsening of the current account deficit. In the short term, this drives an additional appreciation of the real effective exchange rate, until the economy-wide productivity gains are large enough to lead to a long-term depreciation, relative to the baseline of WEO-consistent forecasts.
17. Financing with PIT and/or GST would be less beneficial and reduce GDP gains. Such taxation would be a drag on consumption, especially during the initial phases of closing the gap, as liquidity-constrained households would adjust their spending downwards immediately. Using PIT financing alone would reduce the gains accruing to the economy the most, as higher PIT not only reduces consumer buying power, it taxes a factor of production directly, and reduces labor productivity, counteracting some of the gains from additional infrastructure investment. Overall, there is less demand for foreign financing – what remains is driven by borrowing for consumption, offset by weaker investment. Therefore, there is less of a short-term appreciation of the real effective exchange rate.
D. Closing the Gap as a Tool for Fiscal Policy
18. Closure of the infrastructure investment gap can be used as tool to further fiscal policy goals. As the government closes its gap, it could alter its focus in one (or more) of three ways for additional benefits: 1) increase the amount of investment in order to reach the desired infrastructure capital stock earlier, allowing New Zealand to maximize its gains sooner; 2) increasing emphasis on spending in regions in greater need of development; and 3) improving the quality of the infrastructure delivered, which could include public-private partnerships (PPPs).
Focus on Closing the Gap Sooner
19. The government could alter the length of time taken to close the gap. Instead of closing the gap over 25 years, the government could choose to help kick-start short-term growth by closing the gap in 10 years, using deficit financing (Figure 6). Although long-term benefits would remain unchanged, doing more than closing the gap would presumably accrue few extra benefits. The government would have to increase their debt load more quickly, and this may pose a risk to credit ratings, and could impose additional sovereign risk premia, although those risks are not quantified here. As moving from under 0.3 percent of GDP to over 0.5 percent of GDP for infrastructure cannot be done easily (because of procurement processes, and selection processes involving cost-benefit analyses), it is assumed to be phased in over four years.
Infrastructure Investment Gaps
(Percent of GDP)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Sources: Global Infrastructure Outlook, Oxford Economics, and IMF staff calculations.Infrastructure Investment Gaps
(Percent of GDP)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Sources: Global Infrastructure Outlook, Oxford Economics, and IMF staff calculations.Infrastructure Investment Gaps
(Percent of GDP)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Sources: Global Infrastructure Outlook, Oxford Economics, and IMF staff calculations.20. Figure 7 compares the benchmark scenario (blue line and bars) against the 10-year scenario with deficit financing (red line and bars). The long-term real GDP gains around the same as in the benchmark scenario, at 0.8 percentage points. But by shortening the time horizon, economic gains are moved forward, and there is much more fiscal stimulus in the short term. Real GDP increases much more rapidly in the short term, adding twice as much to growth over the first 10 years relative the benchmark scenario. Consumption also increases more strongly. However, if the government does it solely through deficit financing, there is greater crowding out of private business investment in the first several years, also leading to crowding out of labor demand and income, and therefore consumption. There is increased demand for foreign financing through the current account, leading to a stronger short-term real effective exchange rate appreciation, although the permanent productivity effects still lead to a long-term depreciation of the real effective exchange rate. Overall, changing the speed at which the gap closes can provide short-term benefits to growth, and fiscal policy can provide a more prominent role in short-term demand management, but with productive spending ensuring long-term gains.
Closing the Gap Earlier
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculationsClosing the Gap Earlier
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculationsClosing the Gap Earlier
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculations21. In practice, changing the horizon for fiscal policy implementation requires careful planning and consideration. It may not be possible to reduce some projects to a shorter horizon and if the economy is already in an expansionary phase, it may be difficult to attract the resources required to carry out the investment. As of 2018, New Zealand has little spare capacity in its labor and capital markets, and might not be able to absorb the needs of a faster expansion of infrastructure investment.
Focus on Furthering Regional Development
22. The government can augment its regional development goals when closing the infrastructure gap. The results so far rest on the assumption that benefits in New Zealand are homogenous, when there may be regional differentiation. By increasing infrastructure investment in regions in need of further development, New Zealand opens up the possibility of greater benefits, not only in terms of the level of real GDP, but also to meet other (social) goals, such as alleviating inequality and poverty.
23. The infrastructure gaps in the Global Infrastructure Outlook do not depend on their physical location within New Zealand. Many of the gaps are dependent on location of the population, so placing new infrastructure in the regions can encourage populations to settle elsewhere, in addition to closing the gaps in the regions. Successful redirection of the population would most likely depend on other policies outside of the provision of infrastructure, but that lies outside the scope of this paper, and it is assumed for the discussion that follows that the proper policies are in place.
24. In New Zealand, regions in need of further development generally coincide with poorer regions. These regions are defined in this paper as a subset of New Zealand’s 16 local government areas – Northland, Waikato, Bay of Plenty, East Coast (Gisborne), Hawke’s Bay, Manawatu-Whanganui, Tasman/Nelson, West Coast, and Southland, which have been the increased focus of regional development efforts in recent years (MBIE, 2017) and often have had low household income growth (Figure 8).
Average Annual Household Income Growth, 2007–2017
(Annual Percent Growth)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: MBIE (2017).Average Annual Household Income Growth, 2007–2017
(Annual Percent Growth)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: MBIE (2017).Average Annual Household Income Growth, 2007–2017
(Annual Percent Growth)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Source: MBIE (2017).25. Regions in need of further development might have a higher output elasticity of public capital than the rest New Zealand, allowing for greater GDP gains than under the benchmark scenario. This is supported by the available literature (Box 3). As an illustrative example, an output elasticity of 0.221 is used. In the benchmark scenario used so far, with a New-Zealand-wide elasticity of 0.170 (as found in Bom and Ligthart, 2014), it is assumed that infrastructure investment is distributed by the regions’ share of total GDP. Given that these regions account for 26.0 percent of total GDP on average from 2012 to 2016, the implied elasticity for the rest of New Zealand is 0.152. On a per capita basis, there has been underinvestment in the regions in need of development, thereby redistributing the stock of infrastructure over time to the rest of New Zealand. Five additional cases are considered:
Weight the distribution of infrastructure based on the average population from 2012 to 2016, so that these regions receive 32.6 percent of the total investment, implying a New Zealand-wide output elasticity of public capital of 0.175. Using population as a basis is more likely to maintain the current ratio of infrastructure between these regions and the rest of New Zealand.
Repeat the population-weighted distribution of infrastructure investment, but with an additional efficiency assumption, using Italy as an analogous case (from Percoco, 2004, outlined in Box 3), that overall efficiency is 5 percent lower in these regions.
Repeat both scenarios, but augment the population weight for the regions in need of development by 25 percent so that these regions receive 40.8 percent of infrastructure investment, lifting the output elasticity to 0.180.
An illustrative scenario where the infrastructure gap is solely closed through investment in these regions, to demonstrate the upper bounds of the possible gains, but ignoring the obvious point that the rest of New Zealand does indeed face some infrastructure gaps that need to be addressed.
Choosing the Output Elasticity for the Regions in Need of Development
A revised output elasticity with respect to core infrastructure capital is chosen based on available empirical studies. Recent literature focuses on the United States, Italy and Spain. That of Italy and Spain often look at the regions based on their income disparities, and is more applicable to the New Zealand case. It suggests that regions in need of development can benefit more from increased infrastructure investment.
Literature on Italy focuses on the split between the more industrialized, urbanized North, versus the poorer, more rural South. Bonaglia and others (2000) find that much more of TFP growth in the South than in the North is attributable to public investment. Furthermore, by using a production function approach over 1970 to 1994, they find an output elasticity for the South of about 0.495, versus between 0.1 to 0.2 for the regions of the North. This finding is supported by Marrocu and Paci (2008), using a later sample from 1996 to 2003 under a different production function, with elasticities for core infrastructure of 0.185 for the South, 0.095 for the North, and 0.119 for all of Italy. Percoco (2004) considers the role of efficiency in regional public infrastructure investment, both technical (physical transformation of inputs) and allocative (choosing between factors of production). The frontier for technical efficiency, at 100, is of interest for this paper, and all of Italy falls short by 21 percent, while the South does even worse, by 25 percent.
The literature for Spain focuses more on the individual regions, and has a fuller consideration of the elasticities from infrastructure investment within the region (“inside investment”), and spillovers from investment elsewhere (“outside investment”). Marvão Pereira and Roca-Sagales (2007), using SVARs for Spain and its regions based on data from 1970 to 1995 find an elasticity of 0.523 for core infrastructure. The regions in need of development comprise less than 40 percent of GDP and have elasticities that are 20 to 30 percent higher when combining effects of inside and outside investment. Marquez and others (2011), using an SVAR approach from 1972 to 2000, agree with this finding, but draw a distinction between short- and long-term responses of GDP, finding that private investment benefits from extra public investment in the long term. However, in the short term, there is a tendency for public investment to serve as a substitute for private in these regions, while they act as complements in wealthier regions like Cataluña, reducing the short-term effectiveness for regional development. Finally, Puente (2017), using a production function approach over 1980 to 2015, generally supports the finding that the regions have higher returns to public investment, and have led to better GDP growth per capita. Output elasticities of public capital seem to be about 20 to 30 percent higher for these regions.
For New Zealand, Cochrane and others (2010) concludes that an increase in regional infrastructure spending increases population growth, real income and land values, but is itself endogenous and spatially correlated. While the individual regions are used in their estimation of a four-equation model under 3-stage least squares, there are no estimations for individual regions presented. But the methodology better captures interregional spillovers and demonstrates the positive impact on productivity for New Zealand, which had been in doubt for New Zealand as presented in Kamps (2006) for OECD countries.
Based on this information, the regions in need of development should have an output elasticity somewhere in the range of 20 to 50 percent higher than the rest of New Zealand. Often the elasticities in level terms are notably higher than the modern literature, summarized in Bom and Ligthart (2014), with its output elasticity with respect to core infrastructure of 0.17. For this application, the illustrative output elasticity chosen is 30 percent higher, at 0.221. The effective output elasticity for New Zealand will be a weighted average between that of the regions in need of development and the rest of New Zealand (imputed as a value of 0.152 from the baseline calibration of 0.17 and the GDP share of the rest of New Zealand), where the chosen weights are explained below when presenting each illustrative scenario.
26. Devoting more resources to regional development will augment the outcome. It will make more of a difference for those regions in need of further development, but not so much at the aggregate level. Table 1 shows the long-term outcomes on real GDP for the five scenarios. There are small gains for New Zealand, usually less than 0.1 percent of GDP in the long term. However, this is only from a shift of spending from the rest of New Zealand of 6.6 percentage points of spending when using the population share, or almost 8.3 percentage points using the augmented share. Most of the gain should accrue to the regions in need of development – their spillovers to the major urban areas are slight; instead the regions are usually subject to spillovers from the major urban areas (taking Marquez and others, 2011, as an indication). If the benchmark gains are attributed to these regions based on their GDP share, then they receive 0.21 percentage points of the increase in GDP. This will increase to 0.25 percentage points under the scenario based on the augmented population weights.
Closing the Infrastructure Investment Gap for Regional Development
(Deviations from WEO-consistent forecasts)
“Lower” means that technical efficiency is 5 percent lower in the regions in need of development relative to the rest of the country.
Closing the Infrastructure Investment Gap for Regional Development
(Deviations from WEO-consistent forecasts)
| Aggregate Output Elasticity | Aggregate Real GDP Full Effect | Aggregate Real GDP Lower 1/ | Regional Real GDP Full Effect | |
|---|---|---|---|---|
| Benchmark | 0.170 | 0.80 | … | 0.21 |
| Population Share | 0.175 | 0.82 | 0.81 | 0.23 |
| Population Share | 0.180 | 0.84 | 0.83 | 0.25 |
| Plus 25 Percent Illustrative | 0.221 | 0.98 | … | … |
| “Regions Only” |
“Lower” means that technical efficiency is 5 percent lower in the regions in need of development relative to the rest of the country.
Closing the Infrastructure Investment Gap for Regional Development
(Deviations from WEO-consistent forecasts)
| Aggregate Output Elasticity | Aggregate Real GDP Full Effect | Aggregate Real GDP Lower 1/ | Regional Real GDP Full Effect | |
|---|---|---|---|---|
| Benchmark | 0.170 | 0.80 | … | 0.21 |
| Population Share | 0.175 | 0.82 | 0.81 | 0.23 |
| Population Share | 0.180 | 0.84 | 0.83 | 0.25 |
| Plus 25 Percent Illustrative | 0.221 | 0.98 | … | … |
| “Regions Only” |
“Lower” means that technical efficiency is 5 percent lower in the regions in need of development relative to the rest of the country.
Focus on Improving the Quality of Infrastructure Investment
27. Another way in which the return to infrastructure investment can be augmented is by improving the quality of the infrastructure. While New Zealand generally produces high quality infrastructure for the funds it spends, it is not the leader among the high-income group; rather it is Singapore, as seen by the quality scores presented in Table 2 from The Global Competitiveness Report (World Economic Forum, 2017). In this case, “quality” can be thought of as some combination of more efficient use of funds and better technology, which is a similar but less technical definition than those for allocative and technical efficiency discussed in the previous section.
Infrastructure Quality Scores
(Range of 1 to 7; 7 is best)
Infrastructure Quality Scores
(Range of 1 to 7; 7 is best)
| New Zealand | Singapore | |
|---|---|---|
| Energy | 6.5 | 6.9 |
| Airports | 5.6 | 6.9 |
| Ports | 5.5 | 6.7 |
| Rail | 3.5 | 5.9 |
| Roads | 4.7 | 6.3 |
Infrastructure Quality Scores
(Range of 1 to 7; 7 is best)
| New Zealand | Singapore | |
|---|---|---|
| Energy | 6.5 | 6.9 |
| Airports | 5.6 | 6.9 |
| Ports | 5.5 | 6.7 |
| Rail | 3.5 | 5.9 |
| Roads | 4.7 | 6.3 |
28. Applying a “conversion factor” would bring the quality of New Zealand infrastructure to the same level as Singapore, based on their quality scores. The conversion factor is the weighted sum of the ratio of Singapore quality score to that of New Zealand equivalent for each of the five sectors (energy, airports, ports, rail, and roads), where the weights are based on the average share of each sector in New Zealand’s infrastructure capital stock. It is assumed that the conversion factor is also valid for the water and telecommunications sectors. The aggregate conversion factor of 1.23 is then applied to the benchmark rate of pass-through of new infrastructure capital into New Zealand’s productivity.
29. Figure 9 presents the outcomes for New Zealand if its new infrastructure had the same quality as in Singapore. The blue line and bars are the benchmark scenario, while the scenario with improved quality is the red line and bars. The infrastructure investment gap is unchanged, as is the spending is required to close it. For ease of comparison, only the case of deficit financing is considered. However, the differences between the two scenarios are very similar under the variants for financing the gap using PIT or PIT and GST.
Matching Infrastructure Quality in Terms of Real GDP
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Sources: Global Infrastructure Outlook, Oxford Economics; and IMF staff calculations.Matching Infrastructure Quality in Terms of Real GDP
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Sources: Global Infrastructure Outlook, Oxford Economics; and IMF staff calculations.Matching Infrastructure Quality in Terms of Real GDP
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2018, 203; 10.5089/9781484365823.002.A001
Note: The bar marked “SS” is the steady-state value.Sources: Global Infrastructure Outlook, Oxford Economics; and IMF staff calculations.30. The scenario demonstrates that New Zealand could experience further gains by improving their quality scores. If the quality of the newly-built infrastructure was at levels achieved in Singapore, real GDP would be almost 0.2 percentage points above the gains in the benchmark scenario, so that closing the infrastructure gap would results in a 1.0 percent gain in the long term. Most of the effects on the economy are the qualitatively the same as the benchmark scenario, but quantitatively amplified. However, improved quality does not directly incur additional government spending, thereby avoiding any additional government debt.
31. The government could help realize these gains by relying more on PPPs. New Zealand already has a PPP framework in place. Its goal is not to move funding needs off the government books; rather, the main expected benefits are greater efficiency gains from using private sector expertise and knowledge when building new infrastructure (Treasury, 2015). Risks are supposed to be mitigated and allocated between the public and private sectors through the agreements put in place to govern the process, as suggested in the literature (Corbacho and Schwartz, 2008).
E. Conclusions
32. Summary. There has been high quality work done to quantify the infrastructure gap for New Zealand by Oxford Economics on behalf of the Global Infrastructure Hub, drawing on international experiences and local data sources, but recognizing the risk that the infrastructure gap may be even larger than that stated in this work. This paper provides further analysis about the effects on New Zealand’s economy of closing the infrastructure gap. Closing the gap has quantifiable benefits, not just because it is a short-term stimulus to aggregate demand, but because of longer-lived effects on productivity, benefiting all sectors of the economy.
33. The form of financing for the additional spending matters. While there are economic gains in all cases, the magnitude of those gains depends on whether the spending relies on deficit or tax financing. In the long term, because of the small amounts required to finance the expenditure, financing by deficits are preferable to tax financing. However, deficit financing has its risks. If the infrastructure needs were much greater, the level of debt incurred would be costlier in the long term, and could outweigh the productivity gains in the economy by crowding out too much investment, and possibly lead to an additional sovereign risk premium on New Zealand’s borrowing from abroad.
34. Closure of the gap can be used to further fiscal policy objectives. By changing or augmenting its focus, the government could provide even more benefits. Three examples on which the government could focus are:
Shortening the time horizon over which it works to close the infrastructure investment gap to achieve the same level of infrastructure stock in the long term. Consequently, the government could provide additional short-term stimulus to the economy.
Furthering regional development. Evidence from other countries suggest that regions in need of development have a higher output elasticity with respect to infrastructure capital. Therefore, New Zealand could increase their returns to infrastructure investment by ensuring that closing the infrastructure gap does not just build on patterns that favor the major urban areas, but pushes more to its regions in need of further development. However, the success of such a strategy would depend on other policies to encourage the utilization of that infrastructure where it is installed, primarily by encouraging the relocation of firms and households.
Improving the quality of infrastructure investment. An illustrative example is presented where New Zealand has Singapore-level quality scores. This could be at least partially achieved by using the existing PPP framework.
35. There are prospective gains from closing New Zealand’s infrastructure gap. New Zealand has improved its infrastructure spending in the past several years. Nonetheless, there is scope to expand it further, to reduce its (admittedly small, but probably understated) infrastructure gap to match other advanced economies, and possibly help with regional development concerns.
References
Abiad, A., D. Furceri, and P. Topalova, 2016, “The Macroeconomic Effects of Public Investment: Evidence from Advanced Economies,” Journal of Macroeconomics 50: 224–240.
Anderson, D., B. Hunt, M. Kortelainen, M. Kumhof, D. Laxton, D. Muir, S. Mursula, and S. Snudden, 2013, “Getting to Know GIMF: The Simulation Properties of the Global Integrated Monetary and Fiscal Model,” International Monetary Fund, IMF Working Paper 13/55.
Aschauer, D., 1989, “Is Public Expenditure Productive?” Journal of Monetary Economics 23(2): 177–200.
Bernanke, B., M. Gertler and S. Gilchrist, 1999, “The Financial Accelerator in a Quantitative Business Cycle Framework,” in J. Taylor and M. Woodford, eds., Handbook of Macroeconomics, Volume 1c, Amsterdam: Elsevier.
Blanchard, O., 1985, “Debts, Deficits and Finite Horizons,” Journal of Political Economy 93(2): 223–47.
Bom, P., and J. Ligthart, 2014, “What Have We Learned from Three Decades of Research on the Productivity of Public Capital?” Journal of Economic Surveys 28(5): 889–916.
Bonaglia, F., E. La Ferrara, and M. Marcellino, 2000, “Public Capital and Economic Performance: Evidence from Italy,” Giornale degli Economisti e Annali di Economia 59(2): 221–44.
Cochrane, W., A. Grimes, P. McCann and J. Poot, 2010, “The Spatial Impact of Local Infrastructural Investment in New Zealand,” Motu Economic and Public Policy Research Working Paper No. 10–12.
Controller and Auditor-General, 2017, Local Government: Results of the 2015/16 Audits, Wellington, New Zealand: Controller and Auditor-General, retrieved at https://www.oag.govt.nz/2017/local-govt/docs/local-govt.pdf.
Corbacho A., and G. Schwartz, 2008, “PPPs and Fiscal Risks: Should Governments Worry?” in G. Schwartz, A. Corbacho and K. Funke (eds.), Public-Private Partnerships: Addressing Infrastructure Challenges and Managing Fiscal Risks, New York: Palgrave Macmillan.
International Monetary Fund, 2018, World Economic Outlook, April 2018, Washington, D.C.: International Monetary Fund.
Kamps, C., 2006, “New Estimates of Government Net Capital Stocks for 22 OECD Countries, 1960–2001,” IMF Staff Papers 53(1): 120–150.
Kumhof, M., D. Laxton, D. Muir, and S. Mursula, 2010, “The Global Integrated Monetary and Fiscal Model (GIMF) – Theoretical Structure” International Monetary Fund, IMF Working Paper 10/34.
Marrocu, E. and R. Paci, 2008, “The Effects of Public Capital on the Productivity of the Italian Regions,” Applied Economics 2008: 1–14.
Marquez, M., J. Ramajo, and G. Hewings, 2011, “Public Capital and Regional Economic Growth: a SVAR Approach for the Spanish Regions,” Investigaciones Regionales 21: 199–223.
Marvão Pereira, A., and O. Roca-Sagales, 2007, “Public Infrastructure and Regional Asymmetries in Spain,” Revue d’Économie Régionale et Urbaine 2007(3): 503–519.
Ministry of Business, Innovation and Employment (MBIE), 2017, “Briefing for the Incoming Minister for Regional Development,” Wellington, New Zealand: Government of New Zealand, retrieved at http://www.beehive.govt.nz/sites/default/files/2017-12/Regional%20Economic%20Development.pdf.
Oxford Economics and Global Infrastructure Hub, 2017, Global Infrastructure Outlook: Infrastructure Investment Needs, 50 Countries, 8 Sectors to 2040, July, 2017, Sydney: Global Infrastructure Hub.
Percoco, M., 2004, “Infrastructure and Economic Efficiency in Italian Regions,” Networks and Spatial Economics 4: 361–378.
Puente, S., 2017, “Regional Convergence in Spain: 1980–2015,” Banco de España, Economic Bulletin 3/2017: 1–6.
Treasury, 2015, Public Private Partnership Programme – The New Zealand PPP Model and Policy: Setting the Scene; A Guide for Public Sector Entities, Wellington, New Zealand: Treasury, retrieved at https://treasury.govt.nz/sites/default/files/2015–10/ppp-public-model-and-policy-sep15.pdf.
Weil, P., 1987, “Permanent Budget Deficits and Inflation,” Journal of Monetary Economics 20(2): 393–410.
World Economic Forum, 2015, The Global Competitiveness Report, 2014–2015, Geneva: Global Competitiveness and Benchmarking Network.
World Economic Forum, 2017, The Global Competitiveness Report, 2017–2018, Geneva: Global Competitiveness and Benchmarking Network.
Yaari, M., 1965, “Uncertain Lifetime, Life Insurance, and the Theory of the Consumer,” Review of Economic Studies 32(2): 137–50.
Prepared by Dirk Muir (APD). The chapter benefited from valuable comments by the Treasury of New Zealand and participants at a joint Treasury and Reserve Bank of New Zealand seminar.
The report is the flagship publication for the Global Infrastructure Hub based in Sydney, Australia, and published on-line at https://www.gihub.org/. The report’s author, Oxford Economics, is a private, global economics consulting firm, focusing on macroeconomic forecasts. Oxford Economics and the Global Infrastructure Hub, Global Infrastructure Outlook: Infrastructure Investment Needs, 50 Countries, 8 Sectors to 2040, can be found at https://outlook.gihub.org/ (for the both database and the report).
Values in level terms are in constant 2015 U.S. dollars, abbreviated as 2015 US$.
These can found in the Global Infrastructure Outlook, pp. 179–180. The most interesting concern, conceptually, is that technological innovations over the forecast could fundamentally change the role and provision of infrastructure.
