How Much Does Physical Infrastructure Contribute to Economic Growth? An Empirical Analysis

Public Disclosure Authorized

Public Disclosure Authorized

Policy Research Working Paper

9888

How Much Does Physical Infrastructure

Contribute to Economic Growth?

An Empirical Analysis

Govinda Timilsina

David I. Stern

Debasish K. Das

Development Economics

Development Research Group

December 2021

Policy Research Working Paper 9888

Abstract

Existing literature on the relationship between infrastructure and economic growth is inconclusive. This study evaluates the contributions to economic growth of three main categories of infrastructure-transport, electricity, and telecommunications-using data from 87 countries over 1992-2017. Compared with existing studies, this study uses more recent data, includes new types of infrastructure such as mobile phones, and provides separate estimates for developing and developed countries. The

pooled mean group estimator, which tests for the weak exogeneity of the infrastructure variables, is employed. The key finding of the study is that an increase in infrastructure, especially electricity generation capacity and telecommu- nications, has significant positive effects on gross domestic product. Infrastructure has a larger effect in more recent years (1992-2017) than in earlier years (1970-1991), and the effects of infrastructure are higher in developing economies than in industrialized economies.

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How Much Does Physical Infrastructure Contribute to Economic Growth?

An Empirical Analysis1

Govinda Timilsina, David I. Stern, and Debasish K. Das2

JEL Codes: O18, O47

1. The authors would like to thank Gal Hochman, Pravakar Sahoo, and Fan Zhang for their valuable comments and suggestions. The views and interpretations are of authors and should not be attributed to the World Bank Group and the organizations they are affiliated with. We acknowledge World Bank's Research Support Grant (RSB) for financial support.
2. Govinda Timilsina ([e-mail]) is a senior economist at the Development Research Group, World Bank, Washington, DC; David Stern ([e-mail]) is a professor in the Arndt-Corden Department of Economics in the Crawford School of Public Policy at the Australian National University, Canberra, Australia. Debasish Das ([e-mail]) is an assistant professor, Department of Economics, Khulna University, Bangladesh and a Ph.D. candidate at the Arndt-Corden Department of Economics.

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1. Introduction

Policy makers, particularly in developing countries, often face a critical question: how much they should invest in physical infrastructure from their scarce financial resources, both resources generated domestically and provided by foreign sources such as bilateral and multilateral donors and direct foreign investment. This question is also important for international development institutions such as the World Bank Group and regional development banks that wish to maximize their impact on economic development and social welfare in recipient economies.

Timilsina et al. (2020) review a large body of literature and conclude that no consensus exists on the impacts of infrastructure investment on economic growth. Some existing studies show a strong positive relationship between infrastructure development and economic growth, whereas others find a mildly positive relationship or no relationship. Many factors are responsible for these varying results, such as differences in methods, differing approaches to measuring infrastructure development, the varying development stages of countries included in the sample, varying time periods, and geographical factors such as high or low population density (Timilsina et al. 2020; Elburz et al. 20173).

To further illuminate the role of infrastructure in economic growth and development, this study uses a dynamic panel data model to evaluate the contributions of three main categories of infrastructure: transport, electricity, and telecommunications, to growth in a panel of 87 countries over the period 1992 to 2017. Our main estimate uses the pooled mean group estimator (Pesaran et al., 1999) to estimate the effects of these and other inputs on growth.

The best previous research on this topic (see Burke et al., 2018), such as Caldéron et al. (2015), is based on data that ends in 2000 and does not include new types of infrastructure such as mobile phones and internet connections. Our study makes four main contributions. First, we expand the types of infrastructure considered to include these new categories, specifically mobile phones. Second, we update the analysis to include the most recent available data (2017). Third, we provide separate estimates for developed and developing countries. Finally, we estimate short- and long-run elasticities of GDP with respect to infrastructure.

Identifying the effect of infrastructure on economic growth and development is challenging because it is likely to be built in the expectation that there will be demand for it, creating a reverse causality challenge (Cook, 2011). There are also likely to be lags of varying

3 Elburz et al. (2017) conducted a meta-analysis of 42 empirical studies published between 1995 and 2014 highlighting the sensitivity of results to various factors.

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lengths before the full extent of economic benefits is received from infrastructure. Identifying the effects of specific types of infrastructure will also be challenging because provision of electricity, transport, and telecommunications infrastructures are likely to be positively correlated. For example, World Bank (2018) finds that the impact of improved access to electricity in rural areas is positively related to road access. One way to address this issue, that has been used in some previous research (e.g. Calderon et al., 2015) is to use a dynamic model, which allows us to test the effect of past changes in infrastructure on growth, while testing for the weak exogeneity of infrastructure inputs.

Although several studies show a strong positive relationship between infrastructure and economic growth in less developed countries deprived of adequate infrastructure (Calderón and Servén, 2010; Kodongo and Ojah, 2016; Chakamera and Alagidede, 2018), whether this finding holds for industrialized economies remains an open question. Is there a threshold level of economic development (measured in terms of per capita GDP or human development indicator) below which the relationship between the infrastructure and economic growth is stronger, whereas the relationship is weak or absent above the threshold? An investigation of this relationship by separating the countries into different groups by income, using the World Bank classification of countries into high-income,middle-income, and low-income countries, can help answer this question. Therefore, we also provide separate estimates for a group of low- and middle-income countries and a panel of high-income economies.

Our study finds larger effects of infrastructure on economic output than found by the previous best studies. We also find that the effects of infrastructure are a higher after 1991 than before that date. The infrastructure has larger effects in developing economies as compared to those in industrialized economies.

The paper is organized as follows. Section 2 presents a review of previous research on the relationship between infrastructure and economic growth. The next two sections introduce the data and econometric methods used. Section 5 presents and interprets the results. Section 6 draws key conclusions and policy insights.

2. Previous Research

Several early studies (e.g., Aschauer, 1989; Munnell, 1990; Duffy-Deno and Randall 1991; Garcia-Milla 1992; Rives and Micheal 1995; Wylie, 1996; Morrison and Schwartz, 1996.) investigate the role of public infrastructure in economic growth. For example, using state-level data in the United States, Munnell (1990) finds that public capital has a significant,