Infrastructure and economic growth: Of multiplier and network effects

The need for infrastructure creation in India is now being widely debated and analysed. It would be prudent to try and better understand how infrastructure creation contributes to the economic well-being of a nation. Some of the fundamental questions that come to mind are: How much does infrastructure creation matter for an economy? What “multiplier effect” does infrastructure have?

Given the massive scale of infrastructure projects and, consequently, the public and private investment in such projects, it is worthwhile reiterating the economic, financial and social benefits of infrastructure creation. A better idea about the benefits that accrue from assets helps in making optimal decisions.

The link between infrastructure and economic growth has long been recognised. In a recent paper, titled “Growth and Infrastructure Investment in India: Achievements, Challenges and Opportunities”, Aswini Kumar Mishra, Kunapareddy Narendra, and Bibhu Prasad Kar have yet again established that a solid link between infrastructure and economic growth exists.

They find that not only do infrastructure investments have a “huge impact on national and local development, but also exhibits a very high rate of return, even compared to other investments, perhaps due to its spill-over or externality effects”. Two key takeaways from the paper are the “statistically significant” positive impact on growth that infrastructure investments have and the positive correlation among the various infrastructure sectors.

The second point implies that, for example, better transportation infrastructure helps the economy not just by contributing to growth directly, but also through assisting storage infrastructure in delivering better returns and eliminating wastage of goods. Warehousing infrastructure can add more value in an environment where the transportation linkages to the warehouses improve, and vice versa.

The ability to create great economic value from land at a significant distance from the centre of consumption depends on not just creating warehouse or light manufacturing infrastructure or growing crops on the land, but also on the ability to create facilities to transport goods so produced in the area to the consumption point. This ability to generate value through the “network effect” of infrastructure to create positive linkages between various assets is a crucial component to maximise the economic, financial and social value creation.

In the paper “IFC Economics Notes 1, The Impact of Infrastructure on Growth in Developing Countries”, Antonio Estache and Gregoire Garsous have some additional interesting takeaways. They maintain that the poorer a country, the more infrastructure matters to economic growth; but not surprisingly, they also conclude that the weaker the institutions (legal and administrative frameworks) in a country, the lower the growth payoff from infrastructure investments.

For an economy such as India, in which there is socio-economic movement as a significant part of the population continues to rise out of poverty to form the new middle class, the study points out the ability of investments to create infrastructure that the new middle-class entrants can utilise to improve their lives. Credible institutions, credible policies and an effective conflict-resolution mechanism matter more than ever in this context.

For the country to truly create the infrastructure that contributes to economic growth, strong institutions will be essential. In essence, “hard” infrastructure such as airports, seaports, railroads, telecom towers, power transmission networks and renewable energy can be created at a rapid pace with the optimal economic dynamics only when the so-called “soft” infrastructure of a robust regulatory regime is in place and fully functional.

While the direct impact of high-quality infrastructure is one that gets attention, the indirect advantages and “network effects” of infrastructure assets do not get as much attention, perhaps because they are harder to quantify. That said, finding the “correct” pace of infrastructure creation while working under the various constraints of regulations, financing and availability of skills is crucial.

While it is true that rapid infrastructure asset creation is needed, it is equally true that the necessary financing facilities must match the pace of such asset creation. It is essential that new assets are created with robust financing structures that can sustain over long periods of time. The recent issues in the infrastructure sector suggest that though avoiding low-quality assets is important, but it is equally important to avoid good assets funded using poor “capital structures”. Infrastructure assets do add significant economic value if countries can find the right balance between infrastructure creation and ensuring sustainability of financing.

(Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm.)