Links between infra & growth

It's hard to argue that infrastructure is now the binding constraint

On July 9, T N Ninan wrote in Business Standard, where he anxiously looked at the inconsistency between high infrastructure investment and low traffic growth. There is merit in these concerns and brings 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.

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. The 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 include 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, these companies 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 these regions to production sites or markets all over the world. By this story, investment in infrastructure creates 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 by creating conditions in which private investment can create employment growth. Gross domestic product growth and prosperity are made by private investment, which creates jobs. Infrastructure investment is impactful when it is followed by private investment.

Some of the best minds of the 1990s and 2000s devoted themselves to establish the institutional frameworks through which the infrastructure could be improved. We admire the contributions of the people who ended state control in telecom, established the National Highways Authority of India, Delhi Metro, Cochin airport, multiple competing terminals at Jawaharlal Nehru Port Trust, etc. In the early years, an institutional apparatus was established and then significant capital was put into these mechanisms.
 

Illustration Ajay Mohanty

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.

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 the 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.

None of this reasoning interferes with fully private infrastructure projects. If a private person believes that a good return on equity can be earned, they should always have the ability to take the risk and build an asset. As long as a private person feels he/she can make money building an asset, he/she should always be welcome to do so.

But this reasoning hinders the case for public spending. There is a big hurdle while spending public money — the marginal cost of public funds —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. The state-led initiatives that add infrastructure in India have a whiff of the Chinese problem, where increasingly inefficient state-led investments induced a declining incremental capital-output ratio of the economy.

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, policy risk, faults of public systems, such as the tax system, and the lack of rule of law followed by 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 fears associated with the agencies and regulators.

Alongside this, we must wonder why employment is low, but the wage remains high in many pockets of the population. Perhaps the welfare programmes are distorting labour supply. An array of non-economic factors hamper women’s labour supply. If women’s labour supply could surge, it would help reduce wages and foster more investment and jobs.

The writer is a researcher at XKDR Forum