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Is Bangladesh Getting Public Investment Right?

This article is quoted from World Bank South Asia, the article is written by Zahid Hussain on 14th of December 2009.

ZahidPublicInvestmentEconomic growth in Bangladesh began to decline since FY06 at roughly the same time that its public investment rate started falling. The decline in growth also appears to coincide with slowdown in growth of infrastructure capital in the hard infrastructure sectors; particularly energy, transport and communication. It is therefore tempting to think that the two may be correlated.
Indeed, economic theory suggests that the availability of economic and social infrastructures makes it conducive for the private sector to invest; higher public capital increases productivity and reduces production costs; and by increasing demand public investment gives rise to profit and sales expectations which in turn induce private investments. These are known as the crowding-in effects of public investment.
Crowding in, however, cannot be taken for granted. Public investment can also crowd out private investment if it is made in activities that compete with the private sector. In addition, the growth impact of increased public investment depends on how it is financed. If it is financed through higher public debt, which implies higher future taxation levels, private investments may get crowded out.
Thus, whether or not public investment contributes to growth is an empirical question. A recent publication by Dr. S. R. Osmani claims that “Bangladesh was able to sustain accelerated growth…by improving public investment that also had a stimulating effect on private investment.” This hypothesis is based on a comparison of public investment rate in Bangladesh during 1981-2005 with public investment rates in Sri Lanka, India and Pakistan.
The hypothesis is not robust to a more detailed scrutiny. I estimated the impact of public and private investment rates on GDP growth in Bangladesh by running some “naïve” regressions–naïve because no attempt is made to use fancy time series econometric tools to take care of likely statistical pitfalls. The idea is to simply see whether there is any prima facie relation. The following results are worth noting:
• Public investment does not seem to matter. A one percentage point increase in public investment to GDP ratio contributes 0.33 percentage point to GDP growth with a one year lag. However, this estimate is so imprecise that it is not statistically significant.
• Private investment does. A one percentage point increase in private investment to GDP ratio contributes 0.28 percentage point to GDP growth with a one year lag. This estimate is statistically highly significant.

While more sophisticated econometric modeling may come up with different answers, these results suggest the presence of neither crowding out nor crowding in effects of public investment. What to make of it? It is hard to believe that in an infrastructure starved country such as Bangladesh, public investment does not matter for growth. Recent surveys of the literature (Romp and de Haan 2007 and Straub 2008) on public investment-growth nexus find significant positive effects of public investment on growth. Surely the apparent absence of such effects in Bangladesh has to do with the lumping of good and bad investments in the aggregate public investment series. The relation between public investment and capital accumulation can break down in the presence of significant inefficiencies or waste.

The bottom line: The question is not whether public investment matter, the question is whether Bangladesh has been making the right kind of public investment in right amount at the right time? Chronic gas and power shortages, low quality public roads and bridges, severe congestion in cities (Dhaka in particular) and ports, inadequacy of infrastructure for expanding coverage of ICT services all suggest that the answer is a resounding no. The best way to ensure that the public investment program makes a significant contribution to growth is by getting its composition right through close attention to its rate of return and complementing with private investment. This in turn requires clear delineation of the roles of the public and private sectors as well as strengthening the institutional framework within which the public investment program is formulated and implemented.

This article is quoted from World Bank South Asia. The article is quoted from End Poverty in South Asia – a blog to promote dialog on development in South Asia.

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