57748 W O R K IN G PAP E R N O .49 Current Debates on Infrastructure Policy Antonio Estache Marianne Fay WORKING PAPER NO. 49 Current Debates on Infrastructure Policy Antonio Estache Marianne Fay © 2009 The International Bank for Reconstruction and Development / The World Bank On behalf of the Commission on Growth and Development 1818 H Street NW Washington, DC 20433 Telephone: 2024731000 Internet: www.worldbank.org www.growthcommission.org Email: info@worldbank.org contactinfo@growthcommission.org All rights reserved 1 2 3 4 5 11 10 09 08 This working paper is a product of the Commission on Growth and Development, which is sponsored by the following organizations: Australian Agency for International Development (AusAID) Dutch Ministry of Foreign Affairs Swedish International Development Cooperation Agency (SIDA) U.K. Department of International Development (DFID) The William and Flora Hewlett Foundation The World Bank Group The findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the sponsoring organizations or the governments they represent. The sponsoring organizations do not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the sponsoring organizations concerning the legal status of any territory or the endorsement or acceptance of such boundaries. All queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 2025222422; email: pubrights@worldbank.org. Cover design: Naylor Design About the Series The Commission on Growth and Development led by Nobel Laureate Mike Spence was established in April 2006 as a response to two insights. First, poverty cannot be reduced in isolation from economic growth--an observation that has been overlooked in the thinking and strategies of many practitioners. Second, there is growing awareness that knowledge about economic growth is much less definitive than commonly thought. Consequently, the Commission's mandate is to "take stock of the state of theoretical and empirical knowledge on economic growth with a view to drawing implications for policy for the current and next generation of policy makers." To help explore the state of knowledge, the Commission invited leading academics and policy makers from developing and industrialized countries to explore and discuss economic issues it thought relevant for growth and development, including controversial ideas. Thematic papers assessed knowledge and highlighted ongoing debates in areas such as monetary and fiscal policies, climate change, and equity and growth. Additionally, 25 country case studies were commissioned to explore the dynamics of growth and change in the context of specific countries. Working papers in this series were presented and reviewed at Commission workshops, which were held in 2007­08 in Washington, D.C., New York City, and New Haven, Connecticut. Each paper benefited from comments by workshop participants, including academics, policy makers, development practitioners, representatives of bilateral and multilateral institutions, and Commission members. The working papers, and all thematic papers and case studies written as contributions to the work of the Commission, were made possible by support from the Australian Agency for International Development (AusAID), the Dutch Ministry of Foreign Affairs, the Swedish International Development Cooperation Agency (SIDA), the U.K. Department of International Development (DFID), the William and Flora Hewlett Foundation, and the World Bank Group. The working paper series was produced under the general guidance of Mike Spence and Danny Leipziger, Chair and Vice Chair of the Commission, and the Commission's Secretariat, which is based in the Poverty Reduction and Economic Management Network of the World Bank. Papers in this series represent the independent view of the authors. Current Debates on Infrastructure Policy iii Acknowledgments This paper was prepared for the Growth Commission (http://www.growthcommission.org/) Workshop on Global Trends and Challenges held on September 28­29, 2007 at Yale University. The authors are grateful to Eduardo Engel, Guillermo Perry, Stéphane Straub, and workshop participants for comments received. iv Antonio Estache and Marianne Fay Abstract This paper provides an overview of the major current debates on infrastructure policy. It reviews the evidence on the macroeconomic significance of the sector in terms of growth and poverty alleviation. It also discusses the major institutional debates, including the relative comparative advantage of the public and the private sector in the various stages of infrastructure service delivery as well as the main options for changes in the role of government (i.e. regulation and decentralization). Current Debates on Infrastructure Policy v Contents About the Series ............................................................................................................. iii Acknowledgments ..........................................................................................................iv Abstract .............................................................................................................................v Introduction ......................................................................................................................9 The State of the Infrastructure Sectors ........................................................................11 How Much Do We Know on the InfrastructureGrowth Nexus?...........................14 How Much Infrastructure Is Needed? ........................................................................19 Where Should Infrastructure Investments Be Made?...............................................24 Are the Infrastructure Needs of the Poor Being Met? ..............................................28 How Large a Role for the Private Sector?...................................................................31 How Is the Role of the State in Infrastructure Evolving?.........................................37 Concluding Comments .................................................................................................43 References ....................................................................................................................... 45 Current Debates on Infrastructure Policy vii Current Debates on Infrastructure Policy Antonio Estache Marianne Fay 1 Introduction The recent history of infrastructure policy making perfectly illustrates the negative consequences of politicians and academics' attraction to fads. The problem with fads is an up phase is necessarily followed by a down phase, regardless of the importance of the issue. This happened to infrastructure. It never stopped being important, although to different degrees in different countries and at different stages of development. However, its standing in the agenda of researchers and policy makers has cycled through highs and lows in the last 20 years. This has resulted in an unfortunate slowdown in much needed investments and maintenance in the sector. Consider the evolution over the last 25 years of the perception among politicians and academics of the public sector responsibility for electricity, telecoms, transport, and water and sanitation. During the 1980s, with a few high profile exceptions in the AngloSaxon world, these sectors were clearly seen as a public sector responsibility and governments were looking inward for means to improve their quality and volume. But during the 1990s, these concerns largely disappeared from governments' agenda. Instead, received wisdom was that the private sector was going to take over these services, leaving only a residual role for governments (deregulation and restructuring, and the regulation of remaining residual monopolies). The time had come for the private sector to 1 Antonio Estache is teaching at the Universite Libre de Bruxelles (ULB). Prior to that, he spent 25 years (1982­2007) at the World Bank working on the reform and regulation of network industries (electricity, telecoms, transport, and water and sanitation), on public sector reform (budgetary processes, civil service reform, expenditure monitoring, and tax reform), on decentralization, and on macroeconomic modeling. Marianne Fay is the codirector of the World Development Report 2010 on climate change. She has held positions in different regions of the World Bank (Eastern Europe and Central Asia, Latin America and the Caribbean, Africa) working on infrastructure, urbanization, and more recently, adaptation to climate change. Her research has mostly focused on the role of infrastructure and urbanization in development, with a particular interest in issues related to urban poverty. She is the author of a number of articles and books on these topics. Ms Fay has recently been appointed as the new Chief Economist for the Sustainable Development Network of the World Bank--a position she will take after finishing the World Development Report, in the summer of 2009. Current Debates on Infrastructure Policy 9 show what it could do after a frustrating long experience with an underperforming public sector. The vision did not play out as expected. Almost 20 years after privatization began to be touted as the solution to infrastructure woes, the role of the large scale private sector in the delivery of infrastructure services in energy, water, or transport is far from being as widespread as many had hoped for, at least in developing countries. This is why many governments have stopped betting on an acceleration of private investment in the sector for the years to come. Local micro or smallscale private providers have jumped in to compensate for the failures of the model envisaged by the promoters of largescale privatizations as well as for the failures of the remaining public monopolies. But given the fact that scale economies are defining characteristics of most infrastructure services, this could mean higher than needed costs for residential users. The costs of the failure to get the vision to materialize are not minor. There is a strong and widespread sense among policy makers that some of the differences in growth rates between East Asia and other parts of the world can be attributed to the failure to invest sufficiently in infrastructure. Users' frustration with the switch from tax financing of these services to user financing only worsened the unhappiness with the new vision. The related rejection of the privatization experience has now become an effective political campaign items for politicians around the world. Today, many governments are struggling to compensate for the collective failures to improve infrastructure in the 1990s. Most developing countries need to compensate for the inherited investment gaps in largescale network expansions or on major maintenance of the existing networks. The public sector is once again seen as the major player in financing many of these expansion needs and for developing countries. And because of the high costs and limited capacity to pay of many of the users, the donor community is expected to be a central actor in the scalingup of the public investment efforts, at least in the poorer countries. The emerging new vision is no longer a dichotomous choice between public and private on the full spectrum of dimensions associated with infrastructure service delivery. Instead, pragmatism dominates. The public sector is expected to retain an important financing role while the private sector can help in meeting the very significant needs associated with infrastructure construction, operation, and/or to some extent financing in sectors such as telecoms, energy generation, and transport services. This evolution is actually observed around the world, in developed as well as in developing countries. The paper is organized as follows. Section 2 offers an overview of the current state of the sector while section 3 summarizes the intensive academic debate on the interactions between growth and infrastructure. Sections 4 and 5 look at the thorny question of how much infrastructure is needed to sustain growth levels consistent with poverty reduction objectives, and the efficiency 10 Antonio Estache and Marianne Fay equity tradeoffs that may be associated with the decision of where these investments should be made. This is followed in section 6 with a discussion of the povertyrelated dimensions of the infrastructure access problems. Sections 7 and 8 debate the relative role of the private and public sector in infrastructure, focusing on the main institutional changes observed in the last 10­15 years and on their implications for the effectiveness of service delivery. Section 9 concludes. The State of the Infrastructure Sectors Many of the issues to be discussed in this paper are anchored into a basic problem: the insufficient stocks of infrastructure and hence the insufficient flows of associated services. To give a sense of this gap, table 1 provides a quantitative snapshot of the sector based on the latest data available on the service coverage provided to populations in each sector for country groupings reflecting their income levels. The main observations that can be made are obvious: (i) access remains shockingly low in poor countries, despite the donor funded efforts of the last decades and, (ii) we are remarkably ignorant of how well or badly the sector is doing. The Big Picture2 First, the levels of access to infrastructure services are, as expected, strongly correlated with a country's average income. Uppermiddle income countries have the highest access rates (in the developing world) and are very close to meeting the infrastructure needs of all but 10 percent of their population. The lowestincome countries are very far from meeting those needs, in particular in terms of electricity. Table 1: Access to Utilities Services, by Sector Percentage of Percentage of Percentage of population with Number of fixed & population with population Country access to mobile telephone access to with access to Income networked subscribers per improved water sanitation level electricity (2000) 1,000 people (2005) sources (2005) (2005) Low 31 114 75 61 Lower- 82 511 82 77 middle Upper- 87 901 94 91 middle Developing 58 523 83 80 Source: World Development Indicators 2007. 2 For a fuller discussion of the evidence on access, quality and prices in infrastructure, see Estache and Goicoechea (2005). Current Debates on Infrastructure Policy 11 Second, progress in achieving full coverage varies significantly across sectors. It has been reasonably good in water and in telecoms (driven, in the case of telecoms, by the technological revolution that has lowered costs and made service possible even in relatively lowdensity areas). Sanitation continues to be a problem but it is attracting increasing attention as a result of growing interest in environmental problems. Somewhat surprisingly, the biggest problem is the energy sector. The absence of a widely available meaningful indicator for transport precludes it from being included in this comparison. If one considers table 1 as a baseline from which progress from reform could be measured, the challenge is not a modest one. While the international community has been increasingly concerned with the importance of infrastructure needed to generate the investment that will generate growth--as illustrated by the results of investment climate surveys--this table suggest that it would be a major mistake to ignore household need. Indeed, the political sustainability of infrastructure reforms depends on household needs being taken into account as the experience of Latin America demonstrates (see Fay and Morrison 2007 for a discussion). The challenge is not a minor one for the international donor community, but it is one that is increasingly being recognized. Commitments to improve access rates to water and to some extent to telecommunications have been formalized through the MDGs. The commitments to electrification have been added as part of the Johannesburg Declaration but much less progress is being made on that front. No similar collective commitment exists for the transport sector. Overall, progress in being made, but implementation is slow so that in many countries, the goals are not being met.3 The Big Holes in the Big Picture Somewhat surprisingly, table 1 summarizes most of the information available to policy makers. The remaining data available on these sectors tends to focus on technical dimensions. Some is policy relevant (e.g. power generation capacity) but much is too specific to technical issues. As compared to the information available on health or education for instance, the information gap the infrastructure sector faces is huge and shows no sign of narrowing.4 On transport for instance, very little information is available on what could serve as a reasonable baseline to assess the economic or social performance of the sector. We know for instance that road density in the poorest developing countries is about a third what it is in the richest developing countries and about 3 For a discussion of the countries and sectors for which the MDGs are unlikely to be met, see World Bank (2005a). 4 Living Standard Measurement Surveys (LSMS), Demographic and Health Surveys (DHS), and household consumption surveys do not really provide the required data to address the issue well. First, the sector is generally not well covered in these surveys. Second, there are significant differences in the quality of the data available for urban and rural areas. 12 Antonio Estache and Marianne Fay a sixth what it is in developed countries. However, this data does not capture the quality or even dimension of the infrastructure and gives the same weight to a onelane rural road, and a 12lane ringroad. The heterogeneity in what the stock data measures may well be the worst for roads. Similarly, on energy, most of the information available on access rates is based on extrapolations from a small sample of representative countries. The last time survey was conducted by the International Energy Agency on behalf of the international community was in 2000. Household surveys provide additional information but there are major compatibility issues. Anyone interested in information on prices or quality in the sector will have to work with heroic assumptions to try to generate some credible comparable crosscountry datasets. The data situation on access to water is somewhat better to the extent that the UN anchored Joint Monitoring Program has managed to generate some degree of continuity and consistency in the monitoring of progress--although their data sets also rely on some controversial assumptions and extrapolations. Only for the telecoms sector can a reasonably good picture can be generated, thanks in large part to the efforts of the International Telecommunications Union. Unsurprisingly, this is the sector that has attracted the most interest among academics. Research goes where data is, not necessarily where problems are! The problems with the monitoring of access rates may surprise many. Even more surprising is the failure to monitor progress in the affordability and quality of these services--dimensions that should be part of the baseline needed to track progress, particularly as regards poverty. This information is unavailable in most developing countries. Most of the related information published is anecdotal, and crosscountries comparisons are often not meaningful, because definitions for quality standards and service pricing practices vary significantly across countries. An ideal baseline would also include information on the cost of the sector. This is particularly important in view of the size of the projects and of the associated financial transactions. Comparable cost data in infrastructure are largely unknown in this sector in developing countries. As such the frequently heard policy message urging policy makers to improve cost recovery because it costs too much to the taxpayers is seldom based on an accurate estimate of the costrecovery tariff or its affordability to poor households. Moreover, the cost to taxpayers is seldom known. Recent work on quasifiscal deficits represents a rather heroic attempt to come to grips with this issue (Ebinger 2006). As for data on public spending on infrastructure, they are largely nonexistent as very few countries estimate how much they spend on infrastructure (one exception is India) and the IMF's Government Financial Statistics do not collect this information. A worldwide database exists that compiles information on investments funded through projects that involve a privatepublic partnership, but this database has its limitations (see http://ppi.worldbank.org/). Current Debates on Infrastructure Policy 13 The Upshot... There is a long way to go still in meeting the infrastructure needs of the poorest countries of the world. The MDGs help by motivating efforts to address some of them or at least prompting the international community to monitor progress. This is not the case for energy and transport since they are not part of the core MDGs. As a result, the commitments to monitor progress are more subdued and certainly not consistent with the importance of these sectors to growth as discussed in the next section. On the other hand, the critical importance of both energy and transport to the climate change agenda might provide a welcome impetus to collect better information and monitor progress. The accountability of governments, operators, and donors requires a lot more information than is currently available. To get things done, measurement is needed. This starts with a good baseline and for now, this only exists in the telecoms sector. How Much Do We Know on the InfrastructureGrowth Nexus? Common sense suggests that modern economies cannot function without infrastructure and that infrastructure is a critical part of any economy's production function.5 But common sense is not equivalent to evidence when it comes to assessing differences in countries' or regions' growth paths. Even if infrastructure is necessary for modern economies to function, it may not be the case that more infrastructures cause more growth at all stages of development or at any for that matter. Maybe the binding constraints lie elsewhere--in poor incentives or missing markets for example. What follows reviews some of the reasons why considerable disagreement remains as to whether infrastructure accumulation can explain countries' differing growth path. A Slow Convergence of Views Infrastructure may affect growth through many channels (see Agénor and MorenoDodson 2006 for an overview). In addition to the conventional productivity effect, infrastructure is likely to affect investment adjustment costs, the durability of private capital, and both demand for and supply of health and education services. Many of these channels have been tested empirically. This is reflected in the wide variety of findings in the now abundant empirical literature on infrastructure and growth or productivity. Indeed exhaustive reviews of the 5 Absent or unreliable transport, electricity or telecom services imply additional costs for firms or prevent them from adopting new technologies. Better transportation increases the effective size of labor markets, and various micro studies suggest an impact on human capital of access to water and sanitation (via health) and electricity and transport (that facilitate access to schools and the ability to study) (Brenneman 2002). Finally, relative infrastructure endowments will affect a region's comparative advantage, hence its development (Estache and Fay 1997). 14 Antonio Estache and Marianne Fay literature (Romp and de Haan 2005; Straub and Vellutini 2006, Briceño et al 2004, Gramlich 1994) show that while some authors find negative or zero returns, others conclude that there is a high impact of infrastructure on growth. However, a more careful analysis of the literature shows increasing consensus around the notion that infrastructure generally matters for growth and production costs, although its impact seems higher at lower levels of income. Romp and de Haan (2005) note that of 32 of 39 studies of OECD countries found a positive effect of infrastructure on some combination of output, efficiency, productivity, private investment, and employment. (Of the rest, three had inconclusive results and four found a negligible or negative impact of infrastructure). They also reviewed 12 studies that include developing countries. Of these, 9 find a significant positive impact. The 3 that find no impact rely on public spending data, which--as discussed below--is a notoriously imprecise measure especially for crosscountry analysis. Other metaanalyses report a dominance of studies that show a generally significant impact of infrastructure particularly in developing countries. Cesar Calderon and Luis Serven report that 16 out of 17 studies of developing countries find a positive impact as do 21 of 29 studies of high income countries.6 Briceño et al. (2004) carry out a similar review of about 102 papers and reach similar conclusions. Nevertheless, there remains tremendous variety in the findings, particularly as to the magnitude of the effect, with studies reporting widely varying returns and elasticities. In other words, the literature supports the notion that infrastructure matters but it cannot serve to unequivocally argue in favor of more or less infrastructure investments. The variety of findings is, in fact, unsurprising. There is no reason to expect the effect of infrastructure to be constant (or systematically positive) either over time or across regions or countries. Furthermore, estimating the impact of infrastructure on growth is a complicated endeavor, and papers vary in how carefully they navigate the empirical and econometric pitfalls posed by network effects, endogeneity, heterogeneity, and very poor quality data. The More, the Merrier (Network Effects) Infrastructure services are mostly provided through networks, a fact that implies a nonslinear relation with output. Telecom exhibits "pure" network externalities whereby returns to users increase with the number of users.7 But roads, rail, and electricity are also networked services so that the impact of new investments on growth, output or firm costs will depend on the overall state and extent of the network (see Romp and de Haan 2005 for a discussion). In other words, the marginal and average productivity of investments are likely to differ 6 Personal communication relating to work in progress. 7 The same can probably be said of water and sanitation networks where the public health value of safe water and sanitation systems are likely to increase the more individuals are served, in a kind of herdimmunity effect. Current Debates on Infrastructure Policy 15 significantly and the hypothesis of a constant or linear elasticity of output with respect to infrastructure is clearly incorrect. A few authors have explicitly modeled the nonlinearity of infrastructure's impact on output, growth, or production costs. Thus, Roller and Waverman (2001) find that the impact of telecommunication infrastructure on output is substantially higher in countries where penetration approaches universal coverage. In the case of roads, Fernald (1999) looking at the United States found that returns to investments were very high up to the point when the basic interstate network was completed. He argues that the completion of that network provided a onetime boost in U.S. productivity. Threshold effects in infrastructure can be modeled in a variety of ways-- through a measure of completeness of coverage as discussed above, or more simply through some measure of income as in Canning and Bennathan (2000). Hurlin (2006) develops a threshold model whereby the level of available infrastructure is the threshold variable but the number and value of the thresholds are endogenously determined. Applying this to the multicountry panel data set of Canning and Bennathan (2000), he finds strong evidence of nonlinearity and concludes that the highest marginal productivity of investments is found when a network is sufficiently developed but not completely achieved. The effect of infrastructure may also vary over time as other changes in the economy influence firms' abilities to take advantage of it. Thus, in Chile, Albala Bertrand and Mamatzakis (2004) find that infrastructure's productive impact became much more pronounced after 1973, when the Chilean economy liberalized. In sum, appropriate modeling of infrastructure's effect on growth must include nonlinear effects. If network externalities are not properly captured, the payoffs to infrastructure investments will be under or overestimated. Variables likely to affect this include (i) the stage of development of the network, (ii) a number of institutional variables such as the degree of liberalization of the markets, and (iii) competition across subsectors that will affect the quality of the overall network. Does Infrastructure Drive Growth or Vice Versa? (Endogeneity) Many authors have highlighted the fact that causality may run both ways between income and infrastructure. Indeed, most infrastructure services are both consumption and intermediate goods and many studies have documented that electricity consumption and demand for telephones and cars increase along with disposable income (Chen, Kuo, and Chen 2007; Ingram and Liu 1999; Roller and Waverman 2001).8 Similarly, countries tend to increase their investments in 8 The extent of reverse causation may vary across types and measures of infrastructure. For example, road networks that are long lived and slow to change are perhaps less likely to respond to changes in income (particularly in countries that already have a large network and where changes to cope with congestions--such as more lanes, better traffic management, and ring roads--will not 16 Antonio Estache and Marianne Fay environmental amenities as they become wealthier. Even studies that rely on constructed TFP estimates (whereby the dependant variable, TFP growth, is by construction orthogonal to capital) still may suffer from reverse causation if growth then influences decisions to invest in infrastructure (see Straub and Vellutini 2006 for a discussion). It may also be the case that a common factor causes both higher income and higher infrastructure endowment. Most of the critique of Aschauer's 1989 work (which launched the infrastructure and growth debate with its findings of implausibly high rates of return) centers on a failure to appropriately correct for the possibility that an omitted variable is driving the results. Later papers (see Gramlich 1994 for an overview of this literature) corrected for this by introducing country (or region) fixed effects and found much lower rates of return. However, the fixedeffect approach precludes looking at the impact of other slowmoving variables, which is why a number of authors prefer not to use it (for example, Estache, Speciale, and Veredas 2006). An alternative approach is to try to isolate the impact of changes in infrastructure on longterm growth, typically by using first differences. This approach generates its own set of problems. Indeed, first differences ignore the longterm relationship that exists in the data if infrastructure and growth are co integrated (which Canning and Pedroni 2004 find to be the case). One exception is Calderon and Serven (2004), who also take pains to deal with the endogeneity of the explanatory variables through the use of generalized method of moments (GMM) techniques.9 They find that an increase of one standard deviation in the index of infrastructure stock they use would raise the median country's growth rate by 2.9 percentage points, whereas an analogous increase in their infrastructure quality index would raise the growth rate by 0.7 percentage points. They do point out, however, that such increases in infrastructure quantity and quality would be extremely costly and would take decades to implement. To give an example, the growth payoff for Argentina and Mexico of catching up to the level and quality of infrastructure of the Republic of Korea would be 2.4 percent and 2.6 percent respectively, but would require these countries to invest upwards of 7 percent per year for over 20 years (World Bank 2005b, 2007). It may well be then that--as discussed later in this section--the fiscal distortion associated with such an effort, and the tradeoffs it would entail with other needed investments, would substantially reduce the net growth effect. A number of studies also devise estimation methods that make clear which way the causality runs (see Romp and de Haan 2005 for a discussion). One paper that illustrates this approach is Fernald (1999), who uses industry level substantially affect aggregate measures such as kilometers of roads per capita). This is not the case with telephones or electricity generating capacity (which responds to energy demand whose income elasticity has been around 0.5 since 1990 according to International Energy Agency 2006). 9 Note that they look at the impact of the level of infrastructure (not its change) on subsequent growth. Current Debates on Infrastructure Policy 17 productivity growth in the United States to measure the impact of road investments. Another illustrative paper is Canning and Pedroni (2004), who find robust evidence that causality runs both ways but that in the vast majority of cases infrastructure does induce longrun growth effects. (However, they do find a great deal of variation across individual countries as discussed below.) Finally, a number of authors rely on simultaneous equations systems that look at the determinants of supply of (and/or demand for) infrastructure as well as its impact on output or growth. Roller and Waverman (2001) and Esfahani and Ramirez (2003) are good examples of careful attempts in this direction. Esfahani and Ramirez's paper is also one of the few that uses first differences, and models both income per capita growth and infrastructure accumulation. In sum, infrastructure causes growth and growth causes greater demand for (and usually supply of) infrastructure. While disentangling the two is complex, new econometric approaches increasingly allow us to isolate the direction of interest and thereby reduce the overestimation issues that plagued early estimates of infrastructure's impact on growth. Is Every Infrastructure Project Special? (Heterogeneity) In the case of noninfrastructure capital, private entrepreneurs arbitrage between different types of investments to maximize overall return. Not so with infrastructure: it is generally not faced with a real market test. As such, we cannot assume that the right capital is built at the right time or place and we should therefore expect differences in rates of return across different projects. In addition, public infrastructure spending may be affected by public sector spending inefficiency. As a result, while financial estimates of investment in private capital may be a good proxy of the increases in private physical capital and may serve as the basis for constructing a stock figure through a perpetual inventory method, this is much less likely with infrastructure. There is also a need to better understand how decisions are made to invest in infrastructure as this is likely to affect the rate of return or the efficiency of a particular investment. (It may also help identify ways of improving infrastructure expenditure efficiency.) Politically motivated projects are likely to exhibit low (or lower) rates of return as their objectives are to bring in the votes rather than to maximize growth. This is certainly not limited to developing countries as evidenced by the controversies around Alaska's "bridge to nowhere" in the United States.10 Similarly, a recent careful attempt to model how investment decisions are made in France concluded that "roads and railways are 10 Alaska's famous $280 million "bridge to nowhere" that was one of the 6,371 special projects included in the 2005 U.S. Transportation Equity Act (a sixyear $286 billion bill). See http://dir.salon.com/story/news/feature/2005/08/09/bridges/index_np.html for a discussion. 18 Antonio Estache and Marianne Fay not built to reduce traffic jams; they are built essentially to get politicians elected" (Cadot et al. 2006, p. 1151).11 While some degree of porkbarrel politics is likely to exist everywhere, its extent and impact may vary. De la Fuente and Vives (1995) found little trace of political influence in Spanish infrastructure decisions, while Cadot et al. (2006) find it in France. However, Cadot and his coauthors conclude that in France the resulting distortions are small, possibly because this is a relatively new phenomenon (linked to administrative reforms in the early 1980s) that has mostly affected investments that are small relative to the existing network. A further complication in the modeling--and one that argues against a constant expected rate of return--is the fact that there may be lags in infrastructure's impact on growth. Most infrastructure is longlived, and it could be that its full impact is slow in coming as firms adjust slowly to the new opportunities offered. Duggal et al. (2006) find the productivity impact of increased IT infrastructure and associated private capital to have an approximate 4 to 5 year lag in the United States. Overall, even if not pork, public infrastructure investment may well have a noneconomic objective such as the physical or social integration of a country, or follow public health or safety concerns. As such, the investment may not aim to maximize growth. At any rate, careful modeling of the relation between infrastructure and growth should include an analysis of the determinants of infrastructure investments to avoid overestimating the growth or productivity related investment needs. The Upshot... The literature on infrastructure and growth teaches us that infrastructure is important but that its importance varies. It varies across countries, and over time, as countries change and the binding constraints shift. It also varies within countries and sectors. Can it explain differences in growth rates between countries? It certainly contributes but this literature is unlikely to provide a single answer. So, where do we go from here? How Much Infrastructure Is Needed? The key infrastructure question for policy makers is often whether an optimal level of infrastructure can be identified. Such an optimum could then serve to derive the investment commitments needed, for which funding must be identified. More prosaically, the concern boils down to a simple question: can we estimate a country's infrastructure investment needs? Other papers on the political economy guiding infrastructure investment decisions include 11 Rauch 1995, Alesina, Baqir and Easterly (1999), and Robinson and Torvik (2005). Current Debates on Infrastructure Policy 19 A Very Brief Introduction to Investment Needs Assessments Recipes Given that neither the market nor the state is likely to automatically provide the optimal level of infrastructure, a key question for economists working on the topic is how to measure this optimal level of infrastructure. One strand of answers looks at the rate of return on infrastructure. Thus, studies that find the rate of return to infrastructure to be negative/zero/positive often use these to conclude that countries are investing too much/the right amount/not enough in infrastructure.12 For example Bougheas, Demetriades, and Mamuneas (2000) find an inverted U shape relation between infrastructure and the rate of economic growth, with most countries on the upward sloping part of the curve. This would imply they are underinvesting in infrastructure. Esfahani and Ramirez (2003) also conclude to a tendency towards underprovision. Canning and Bennathan (2000) find variation across countries but a general tendency for middleincome countries to exhibit shortages in electricity generating capacity and paved roads. However, while these papers are broadly indicative of whether countries are under or overinvesting in infrastructure, they cannot identify actual investment needs. One approach that has been extensively used (and misused) estimates how much investment may be needed to satisfy firm and consumer demand triggered by predicted GDP growth (Fay and Yepes 2003; Briceño et al 2004). The model assumes no optimality.13 The relationship between income level and infrastructure service demand is established on the basis of past observed behavior in a sample of countries and extrapolated to the future using predicted income growth. However, as Lall and Wang (2006) point out, if past demand was rationed, and therefore may not be good a predictor of unrationed demand. They therefore argue for an approach that incorporates fiscal constraints and supply side bottlenecks, and models the gap between current and optimal level of provisions. Whatever its limitations (and they are severe), the approach developed by Fay and Yepes forms the basis of many of the multicountry investment needs estimates that exist. The most recent estimates generated from an update of the original model are presented in table 2. They suggest that the needs are large, particularly within lowincome countries where the investment needs have been estimated at around 4 percent of GDP with an additional 4 percent required for maintenance. 12 Note that in empirical studies where both infrastructure and overall capital are included, infrastructure is essentially entered twice, in which case an elasticity estimate no different from zero should be interpreted as infrastructure having the same rate of return as private capital. 13 The model identifies potential demand given expected growth, not the level of infrastructure that would maximize growth or some other social goal. 20 Antonio Estache and Marianne Fay Table 2: Investment and Maintenance Expenditure Needs as % of GDP (average 2005­2015) Country group Investment Maintenance Total Low income 4.2 3.3 7.5 Lower-middle income 3.8 2.5 6.3 Upper-middle income 1.7 1.4 3.1 Total developing 3.2 2.3 6.5 Source: Courtesy of Tito Yepes, based on Fay and Yepes (2003). The inclusion of maintenance needs calculated as a fixed proportion of the accumulated capital stock is essential from a practical point of view. The importance of maintenance and the need to budget for it has long been known but it has only recently been documented in the academic literature: Rioja 2003 and Kalaitzidakis and Kalyvitis 2004 highlight the fact that countries tend to underspend on maintenance, a fact that substantially reduces the useful life of infrastructure assets, hence their rate of return. Maintenance expenditure standards are well known and result in very predictable annual expenditure outlays when averaged over an entire network. Appropriate, but by no means generous, standards are approximately 2 percent of the replacement cost of capital for electricity, roads, and rail; 3 percent for water and sanitation; and about 8 percent for mobile and fixed lines. The estimates provided in table 2 serve as a rough benchmark for different country types. But they assume standardized unit costs and ignore many country and regional specificities. When looking at a particular country, these macro estimates should be complemented with other approaches, to allow for some "triangulation."14 However, these will require the definition of a set of goals-- which may be motivated by economic, engineering, social, environmental, or public health concerns. Societies may also differ on the level of services that is deemed appropriate.15 Table 3 illustrates the various ways in which the goals may be set this using the example of Mexico, where this exercise was undertaken in the context of a public expenditure review focused on infrastructure. 14 The process of estimating investment needs is so fraught with assumptions, uncertain data, and so forth that it is only common sense to rely on various approaches to generate a series of estimates. To the extent that the estimates appear to converge there can be more confidence in the recommendations that emerge. 15 An interesting example is given by the case of the Eastern and Southern Europe now joining the European Union. These counties are required by the accession agreements to pursue a quality of water and sanitation services that was reached in the city of Brussels only in the last few years. However, given that these countries have an income per capita much below the EU average, such a high level of service quality represents a huge financial burden (the cost has been estimated at around 9 billion for Romania, equivalent to 16 percent of its 2004 GDP) and is therefore being subsidized by the EU. Questions remain however, as in other EU accession countries, about the affordability of the maintenance of these sophisticated systems. Current Debates on Infrastructure Policy 21 Table 3: Different Approaches to Estimating Expenditure Needs in Infrastructure--the Example of Mexico "Benchmarking" Set target Costing Example: Example: exercise Stock target: What would it cost to get What would it cost for Mexico to achieve Mexico's infrastructure (per capita; per universal service coverage in water and unit of GDP; per km2) to the level of the sanitation, electricity, and access to year- LAC leader; or to the level of the East round roads? Asia median? Flow target: How does Mexico's expenditures on infrastructure compare to peers? Model Econometric: Engineering-economic models: Growth: What level of infrastructure These are "set" targets inasmuch as the coverage is needed to achieve x target is a particular level of coverage and percent level of growth and reduce quality is defined through engineering- inequality by z percent. No such model economic models. is available yet. Power sector: A well-defined international Demand: What level of infrastructure methodology, applied by CFE in Mexico, is coverage will be demanded by firms used to estimate the investment needed to and consumers for given growth maintain the integrity of the network and projections? This is the approach satisfy predicted expansion in demand. followed in Fay and Yepes (2003). Water/sanitation: A financial model estimates investment needed to attain the coverage goals set in National Hydraulic Plan. Roads: A well-defined methodology is used to estimate rehabilitation and maintenance expenditures; it is combined with road sector expert opinion on definition of major corridors and investment needs for their completion. Source: World Bank (2005b). The goldplate version of countryspecific "investment needs" analysis relies on sectoral micro studies. The approaches and methodologies vary depending on the sectors. In the case of electricity, sophisticated economicengineering models can be used to estimate the investments required to maintain the integrity of a network facing demand expansion.16 These models allow sector specialists to provide various sets of estimates depending on whether basic reliability of a system is pursued, or whether the goal is high quality and reliability. In the transport sector, the approach is usually more ad hoc and relies on a combination of sector specialists' estimates and detailed studies (particularly on the needs for upgrades or expansions). In the case of water and sanitation, the connection cost of universal coverage is easy to estimate, based on standard prices. However, the cost of associated works is Mexico uses the Wien automatic system planning package (WASP IV), a widely used model that 16 analyzes generating system expansion options, primarily to determine the least costly expansion path that will adequately meet the demand for electric power, subject to userdefined constraints. Other similar models are SUPER/OLADE/BID and MPODE, which are used by Colombia and Ecuador, for example. 22 Antonio Estache and Marianne Fay much harder to establish and there is usually no simple way of estimating rehabilitation needs. But even sophisticated sectoral studies can turn into unrealistic wish lists. It is useful therefore to do some simple benchmarking. This can entail comparing a country to its peers (as defined, say, by income levels) or to a country that offers a promising example (say, a newly industrialized country such as Korea), and asking how much it would cost to achieve the service coverage or quality of the comparator country. The comparison can be on the basis of coverage or quality or of expenditure flows. There usually is a need to include additional provisions for social objectives as well as maintenance. Social objectives may be the ones defined in the Millennium Development Goals or universal coverage.17 For middleincome countries, this is usually a small proportion of the overall tab, at least for bare bone coverage that may not include grid connection. For lowincome countries, where both coverage and income are low, the costs can be very high. What if Budget Constraints Affect the Optimal Level of Infrastructure? The problem with the approaches described above is that the optimal level of infrastructure provision cannot be divorced from how it is financed, Also, there may be a tradeoff between increased infrastructure and increased taxes. Aschauer (2000) finds that the level of public capital in most U.S. states was below the growthmaximizing level in the 1970s and 1980s, although public expenditure was too high (leaving open the question of what is the optimal balance between the two).18 Kamps (2005), who applies the same model to EU countries, argues that that the distortion associated with taxation discourages private investment. How much then should countries spend on infrastructure given competing needs for public spending, fiscal constraints, and limited ability to charge users? One approach is to develop a general equilibrium model that explicitly incorporates public investment costs and solve it for infrastructure. Rioja (2001) does this for Brazil, Peru, and Mexico, and identifies an optimal (defined as growthmaximizing) level of infrastructure, health, and education spending. However, this study, like others of its kind (for example, Cavalcanti Ferreira and Gonçalves do Nascimento 2005 and Estache and Munoz 2007) relies on parameters of elasticity of growth with respect to infrastructure estimated in other studies--which may or not be accurate. Theoretically, Aschauer's 2000 model could be used to calculate the growth or welfaremaximizing level of infrastructure spending. However, it also requires 17 The one original Millennium Development Goal pertaining directly to infrastructure is to "halve by 2015 the proportion of people without sustainable access to safe drinking water and basic sanitation." Electrification has now been included. 18 Rioja (2001) develops a general equilibrium model that explicitly models public investment's resource cost and that he solves to show the optimal level of infrastructure for three countries: Brazil, Peru, and Mexico. Current Debates on Infrastructure Policy 23 an estimate of the elasticity of output with respect to public capital (which he sets to 0.3 for the United States). Kamps actually calculates this elasticity for EU countries, but then constrains it to be constant and equal across countries (in his case at 0.2). One option could then be to apply Aschauer or Kamps' methodology to estimate growthmaximizing stocks of infrastructure (this would require calculating country/infrastructure specific elasticities, something the preceding discussion showed to be nontrivial). The cost of reaching or maintaining the optimal stock level could then be estimated using either countryspecific or international prices for these stocks. So which way to go with this literature? Lall and Wang (2006) offer a promising way forward although their model has not yet been empirically estimated and requires a more complete modeling of infrastructure supply decisions. It also remains a partial equilibrium analysis. Similarly, the Aschauer (2000) or Kamps (2005) models may well offer the basis for an interesting alternative. However, good data on the cost of infrastructure provision is required to translate these models into investmentneed figures and put them in the perspective of the available fiscal space. The Upshot... Deciding how much should be spent on infrastructure is clearly not an easy exercise. But it needs to be done and can offer basic benchmarks. The literature offers some guidance although there is a long way to go before the various approaches will generate lower and upper bounds that converge towards a robust assessment of needs--and one that accounts for the fact that infrastructure competes with other sectors for scare resources. Where Should Infrastructure Investments Be Made? With the reemergence of economic geography, infrastructure needs are being examined with a spatial twist: the question is no longer simply "how much" but also "where." The answer to that second question is even more problematic than the first, for two reasons. First, the most promising research is for now mostly theoretical. Second, spatial development policies debates are often politically charged, with advocacy often prevailing over rationality (as witness the older urban bias debate). An Introduction to the Relevance of the New Geography Economic to Infrastructure The "where" question is being addressed in an emerging strand of literature that has little empirical evidence to draw on, at least for developing countries. The new economic geography literature (see Baldwin et al. 2003 for an overview) suggests that infrastructure will interact with physical characteristics to affect the comparative advantage of a region, hence its growth and a country's settlement 24 Antonio Estache and Marianne Fay patterns. Puga (2002) offers a nice overview of the arguments and the evidence, particularly as they pertain to transport, which we summarize below. Infrastructure, particularly transport, is seen by most policy makers as critical in efforts to help disadvantaged regions become more attractive to investors: improved connectivity is usually seen as a key to allowing peripheral regions to better integrate the domestic or international economy. The impact of improved transport on a backward region is ambiguous, however, as it may remove a natural trade barrier that was protecting local industries and thus contribute to further concentration of employment in the advanced region. This is particularly likely within a country where wage differences are unlikely to be significant. Indeed, in France improved transport links has led to the concentration, rather than to the dispersion, of employment (Combes and Lafourcade 2001). In Italy, Faini (1983) has argued that the reduction in transport costs between the north and the south led to the de industrialization of the south. However, deconcentration within metro areas from the core to the periphery does happen with transport improvements. For example, Henderson and Kuncoro (1996) show that many firms moved out of Jakarta to the peripheral areas of the Greater Jakarta metropolitan region in the mid 1980s. These moves were facilitated by the construction of tollring roads around the city, retaining some agglomeration benefits of the region, but reducing congestion costs (for example, land rents and transport costs), enabling firms to benefit from lower land and labor costs in the periphery. These benefits exceeded the increased costs of transport serving the same market. Similarly, in Brazil the deconcentration of industry from Greater Sao Paulo to lowerwage populated hinterland cities followed the transport corridors first through Sao Paulo state and then into Minas Gerais, the interior state with the main iron ore and other mineral reserves (Henderson et al. 2001). But even though the improved interregional transport network in Brazil had significant productivity impacts and greatly contributed to the prosperity of states and towns at the periphery of the traditional economic core, it did not lead to industrialization in more remote, lagging areas (Lall, Funderburg and Yepes 2003). Location theory suggests that the nature and structure of a transport project will affect its impact on the local economy. Thus improving local--as opposed to interregional--infrastructure is much less likely to harm the local economy. Similarly hubandspoke networks encourage the concentration of activity in the hubs as firms located there face lower transport costs than firms in spokes (Puga 2002). Interregional networks will of course bring benefits to peripheral regions. However, the gap in relative accessibility will widen between central and peripheral regions, even if the biggest absolute gains occur in the remote areas. This point is well illustrated in Europe for highspeed trains (Vickerman et al. Current Debates on Infrastructure Policy 25 1999 in Puga 2002). It is also what explains the lack of impact of the national highway network on Brazil's northeast region discussed earlier (Lall, Funderburg, and Yepes 2003). Transport infrastructure simply isn't a silver bullet for regional development. Nevertheless, the empirical work quoted above--and much anecdotal evidence--suggests that infrastructure investments are likely to be necessary if nonsufficient for regional growth. Access to allweather roads, reliable telephony (for example through cell phones), and electricity is a prerequisite to allow rural areas to produce highervalue processed goods. Regions cannot export if their transport network results in excessively high costs (Iimi 2007). However, will matter is the interaction between these investments and other factors that determine a region's comparative advantage and its ability to market it. Project selection may also follow a goal of balanced regional development. In that case the result may not be a (national) growthmaximizing investment (although it may well be welfare maximizing). Targeting investments towards poorer regions may therefore entail equity/efficiency tradeoffs. This is documented in Spain by various studies by de la Fuente (2002a, 2002b), who finds that substantial investments in the poorer regions did result in convergence in income but at the cost of overall national growth. Investing in Rural or in Urban Areas? In most countries, much of output and growth is generated in cities, and today about half the world population lives in cities. Moreover, poor people urbanize faster than the population as a whole.19 But are these stylized facts sufficient to argue that infrastructure should go mostly to cities? In most countries the story is much more subtle than urbanrural dichotomies allow. First, the contrast is typically more between leading and lagging regions. Rural population in leading regions, close to booming urban center with strong demand for their goods and the roads and buses to take their goods to market, will tend to be more prosperous (and have much better infrastructure access) than rural or urban dwellers in lagging regions. So this brings us back to the earlier debate on balanced regional development. Second, in some regions (Africa, South Asia) the population remains mostly rural and will remain so for some time. Indeed, while the poor urbanize faster than the rich, a majority of poor people will still live in rural areas long after most people in the developing world live in urban areas (Ravallion 2002).20 Ultimately, the choice of the priority is really a policy choice that economists can only serve to inform. In particular, economic work can help in identifying some of the equityefficiency tradeoffs as well as the channels through which See Ravallion (2002) and Cohen (2004) for a discussion of population trends. 19 This is not a new debate. Almost 30 years ago, Lipton (1977) and Mellor (1976) were concerned 20 with the opposite question: was the urban bias of the international community rational? 26 Antonio Estache and Marianne Fay investments may affect local prosperity and wellbeing. In particular, there is wide agreement that infrastructure in rural areas can improve agricultural productivity and reduce rural poverty.21 Similarly, there is substantial evidence to show that infrastructure can reduce urban poverty (Henderson 2002). General equilibrium modeling can help identify the distributional impact of infrastructure reform, notably their differing consequences for urban and rural populations. Reforms tend to unbundle the urban and rural responsibilities of operators, ending historical crosssubsidies and forcing choices for more targeted subsidies to system expansions. Boccanfuso et al. (2006) for instance, show that water reforms in Senegal have had a very different initial impact in the capital city, secondary cities, and rural areas. They also show that unless interregional crosssubsidies are an option, most common costrecovery financing policies will have different consequences for the poor in regions that have different provider types (that is, large public, large private, or small private). A particularly interesting analysis of the differing impact of infrastructure investments between rural and urban poor comes from Adam and Bevan (2004). They show that infrastructure investments in Uganda that support tradables have different impacts on the distribution of poverty between rural and urban areas as well as on the real exchange rate and other macroeconomic variables. When infrastructure investment favor tradables (for example, telecommunications or energy, which tend to enjoy a much stronger demand from manufacturing and services than transport), the real exchange appreciation is strongest. When it is biased toward nontradables (for example, rural and urban roads), there is hardly any change in the real exchange rate. The main difference between the two scenarios is a distributional one. Support to tradables helps all income classes; support to nontradables helps the urban poor and, somewhat counterintuitively, hurts the rural poor, if population migration is ignored. The rural poor gain from more access to food, but they lose from the lower income they receive from food production. This loss is greater the more the infrastructure aid is biased toward nontradable goods. The Upshot... Deciding where to invest is as hard as or harder than deciding how much to invest. Reduced transport and communication costs will favor additional trade, additional mobility, and possibly additional demand for skilled workers in many of the developing countries. But to get there, some tough decisions need to be made on the location of investments. The tradeoffs are much more complex than often recognized, although recent work such as Adam and Bevan (2004) can help us understand them. However, we have little understanding of the dynamic impact of infrastructure investments on rural or urban economies or their 21 See Reardon (2001); van de Walle and Nead (1995); Lanjouw (1999); Jacoby (2000); van de Walle (2002); Gibson and Rozelle (2002); Renkow, Hallstrom, and Karanja (2004); Lokshin and Yemtsov (2005). Current Debates on Infrastructure Policy 27 integration. Continued empirical work on the topic will help the new economic geography literature become increasingly relevant for policy making. Are the Infrastructure Needs of the Poor Being Met? Infrastructure policy failures are typically hardest on the poor. First, the failure to provide for universal access has of course hurt the poor most. Second is through the failure to come up with tariff designs consistent with the poor's cash flows and ability to pay. The MDGs have helped somewhat in putting the access problem on the agenda. The strong voices of discontent with the privatization experiences, in particular in Africa, Latin America, and to a lesser extent Eastern Europe, have highlighted the affordability problems. How Bad Is the Access Problem for the Poorest? Table 1, presented earlier and summarizing the average access rates per country groups, hides the extent of hardship endured by the poorest population.22 Table 4 (generated from Briceño and Klytchnikova 2006) is based on information collected from household surveys rather than from some extrapolation, as the countrywide average indicators tend to be in energy and water and sanitation. Household survey data have their own limitations but the snapshot they offer provide useful additional information from a policy perspective. In particular, they provide a much better sense of the uneven distribution of the access gaps across income groups at various stages of development. The table shows that gaps between the poorest and richest 20 percent are systematically strongest in poorer countries. How Bad Is the Affordability Problem? The access gap is only part of the problem. There is also an affordability issue. Infrastructure practitioners rely on rules of thumb to get a sense of the affordability problem in any sector. One such rule of thumb (developed by the World Health Organization) is that households should not need to spend more than 5 percent of their income on their water and sanitation needs--3.5 for water alone. In the case of electricity, there is no such formal "rule of thumb" but many also assume that 4­6 percent is a maximum to spend on energy. The general, informal rule suggests that poor households should not have to spend more than 15 percent of their income on infrastructure services. 22 In the Demographic and Health Survey data, the poorer and richer are defined based on an asset index used as a proxy of the welfare level. In the Living Standard Measurement Survey data, households are ranked by total per capita expenditure. 28 Antonio Estache and Marianne Fay Table 4: Access to Infrastructure Services by Richest and Poorest 20 Percent of the Population (% of population receiving services) Electricity Water Sanitation Telephone Country grouping according to Poorest Richest Poorest Richest Poorest Richest Poorest Richest Income level 20% 20% 20% 20% 20% 20% 20% 20% Low 9.7 68.7 41.1 78.5 27.2 68.8 3.2 24.5 Lower-middle 79.5 99.3 64.5 86.6 48.2 78.7 21.2 66.1 Upper-middle 81.4 99.5 76.7 95 73.4 96.4 32 73.1 Source: Briceño and Klytchnikova (2006). Note: Data are the most recent available for 2000­04. Armed with these rules of thumbs, it should be easy to get a sense of the extent of the affordability problem across the world; but it remains impossible, because there is no systematic formal monitoring of this crucial issue. There are however a number of recent books which have documented quite carefully the problem within Africa, Eastern Europe, and Latin America--within the limits allowed by significant data constraints.23 The main lesson to emerge from that research is that that even though the share of household expenditure devoted to infrastructure services, including utilities, is only slightly higher in SubSaharan Africa than in other regions, the fact that households are so much poorer in Africa than elsewhere makes it more difficult for the population to deal with current costs of service. This is especially the case among those who are not connected to existing networks, because they tend to pay more for their services than connected households. The cost advantage for connected households is due itself in part to existing subsidies (services are often billed at prices below full cost recovery levels), which are very badly targeted, again simply because access rates to modern services are so low among the poor. What Can Be Done To Deal with Access and Affordability Problems? Affordability and access issues were already well known when the reforms of the 1990s where implemented. But efficiency concerns prevailed over equity or affordability ones. Recent research does suggest that the reforms generally increased efficiency although not equally across sectors and across regions. However, these efficiency gains were not always been shared with users, particularly the poor. Some of the reasons the poor did not always benefit include the following: Tariff rebalancing and restructuring became more efficient but also often more regressive or at least less progressive. Increased bill collections de facto increased tariffs. Increased quality and reliability usually were accompanied by increased tariffs to recover higher service costs. 23 Estache, Foster, and Wodon (2002) on Latin America for the World Bank; Foster and Yepes (2006) for Latin America; Alam et al. (2005) for Eastern Europe; Estache and Wodon 2007 on Africa; Ugaz and WaddamsPrice (2003) and Nellis and Birdsall (2005) on the international experience Current Debates on Infrastructure Policy 29 Creamskimming by new operators eliminated crossregional subsidies, slowing investment programs in the poorest regions when governments could not compensate through increased subsidies. Failures to offer payment facilities made it more difficult for the poor to afford new connections. All this implies that poverty was not addressed carefully in the regulatory and other reform packages implemented during the 1990s. Sadly, addressing the needs of the poorest is not that complex. For access there are three basic types of instruments: (i) instruments requiring operators to provide access (a service obligation to avoid unilateral exclusion by the provider);24 (ii) instruments reducing connection costs (through crosssubsidies or direct subsidies built into the tariff design or through credit or discriminatory payment plans in favor of the poor); and (iii) instruments increasing the range of suppliers (to give users choice, including the option of reducing costs by choosing lowerquality service providers). For affordability, broadly speaking, all instruments work in at least one of three ways: (i) by reducing bills for poor households (through lifelines or means tested subsidies based on socioeconomic characteristics or the characteristics of the connection, financed through crosssubsidies or direct subsidies built into the tariff design); (ii) by reducing the cost of services (by avoiding granting a monopoly right when it is not necessary or by providing an incentive for operators to reduce costs and pass on the cost reductions to users); and (iii) by facilitating the payment of bills (by allowing discriminatory administrative arrangements in favor of the permanently or temporarily poor) (Estache et al. 2002). While these recipes may seem obvious, they are not uncontroversial. Subsidies, particularly crosssubsidies, continue to be seen as undesirable policy instruments in many circles and that bad reputation has tended to spill over in infrastructure for the last 20 years or so. Yet, in spite of their bad reputation, most practitioners will argue that (i) subsidies (direct or not) are needed in most countries and (ii) they are not always as ineffective or distortionary as have been argued.25 These results seem to hold for both temporary and chronic poverty.26 The anedoctal and econometric evidence confirms that subsidies are hard to avoid. According to Foster and Yepes (2006), in the poorest part of Latin America (Bolivia, Honduras, Nicaragua, or Paraguay) over 50 percent of the households would have to pay more than 5 percent of their income for water or electricity services if tariffs were set at cost recovery levels. In India and Africa, around 70 24. This issue is not addressed here; interested readers should see Chisari, Estache, and Waddams Price (2003); Clarke and Wallsten (2002); Cremer and others (2001); Gasmi and others (2002); and Laffont (2005). 25 For a recent overview of the literature on subsidies of relevance to infrastructure see Komives et al. (2005). 26. For a useful review of the debate and survey of the empirical evidence, see Ravallion (2003). 30 Antonio Estache and Marianne Fay percent of the households would have that problem and could be expected to face difficulties in paying full costrecovery tariffs. In these regions, tariffs would likely have to increase by a factor of 10 to reach costrecovery levels, making it unlikely that poor households could afford them. And in many countries, crosssubsidies are the only realistic option given fiscal stress and the limited ability to fund subsidies through general taxes. In most instances, the tariff design aimed at ensure that the usage (after a minimum vital level) is priced at full cost while the amortization of the investment benefits from a subsidy or a cross subsidy. When general redistribution is not working, redistribution within the sector can be effective. These instruments are clearly not safe bets since wellintended targeting mechanisms have also been regressive as a result of failures to target access, consumption, or both.27 But bad designs are not equivalent to bad instruments. The Upshot... The sheer number of poor without access in many parts of the world and their geographical dispersion are two of the main challenges infrastructure reformers must address. It is unlikely that the poor will be able to afford the cost of reasonable levels of safe consumption of infrastructure services without some fiscal support. When general redistribution is not working, redistribution within the sector can be effective. These instruments are clearly not safe bets since well intended targeting mechanisms have also been regressive as a result of failures to target access, consumption, or both. But bad designs are not equivalent to bad instruments. Moreover, considering that the users who are connected today most probably benefited from subsidies paid out of general tax revenue during the many years during which the utilities (typically public) were running a deficit, cross subsidies between users is likely to be fair from an intergenerational equity viewpoint. How Large a Role for the Private Sector? Privatization remains a controversial topic among policy makers. During most of the 1990s, following the lead of the Thatcher experience in the United Kingdom and President Menem in Argentina, getting the private sector to take charge of most infrastructure investment decisions was one of the most popular ideas among economic advisors. The approach seemed particularly attractive to the many governments faced with fiscal constraints or unable to cope with multiple demands on a shrinking budget, or to get public enterprises to costeffectively deliver quality services. 27 Estache, Foster, and Wodon (2002) show how common this is in Latin America. Current Debates on Infrastructure Policy 31 Table 5. Percentage of Countries with Significant Large-Scale Private Investment in Infrastructure (2004) Electricity Electricity Water and Fixed-line Income level generation distribution sanitation Railways telecoms Low 41 29 18 34 50 Lower-middle 48 37 50 26 62 Upper-middle 58 48 47 60 72 Developing 47 36 35 36 59 Source: Estache and Goicoechea 2005. Note: Data for railways are from 2002. How Strong is the Presence of the Private Sector in Infrastructure? A recent survey (Estache and Goicoechea 2005) documents the presence or absence of largescale private operators in infrastructure in developing countries. The information is summarized in table 5 and three facts emerge. The first is that telecom is most effective in attracting the private sector. The second is that the involvement of the private sector is greater in richer countries. The third is that, even in highincome countries, the presence of the private sector is much less widespread than sometimes thought. Only about a third of developing countries can count on private sector operators for the delivery of electricity, water, or railway services. The largest private sector presence is in the fixedline telecommunication sector, where about 60 percent of countries rely on private operators. The private sector is estimated to have only provided about 20­25 percent of the investment realized in developing countries on average over the past 15 years or so.28 In Africa it has contributed to less than 10 percent of the needs and most of this contribution has gone to a handful of countries (South Africa, Kenya, Côte d'Ivoire, Senegal, Tanzania, and Uganda). This is not to deny the presence of the smallerscale private sector. In fact, where the state and the large private sector have failed to deliver services, the smallscale, generally local, private sector has filled the gap. The evidence on their role and details of their costs is mostly anecdotal, however. In a recent survey, Kariuki and Schwartz (2005) identified 23 African countries where small scale providers are supplying different kinds of services. For about half of these countries, these smallscale providers account for a very large share of water services. Similar information is available for parts of Asia and Latin America. In many countries, small providers are taking the lead in serving lowincome households and dispersed populations in rural and periurban areas where largescale providers are unwilling to go. This number as been arrived at by researchers working independently at the Department for 28. International Development (DFID) and the World Bank (World Bank 2005a). Very roughly, it has been worked out as follows. The overall investment has been estimated using changes in physical capital stocks in countries valued at international prices while the private sector share is estimated based on total commitments made during the same period by the private sector according to the World Bank PPI database. This is likely to be an overestimate, because commitments are not necessarily disbursed (and because these transactions include public funds). 32 Antonio Estache and Marianne Fay Moreover, increasingly, largescale operators from OECD countries are being replaced by developingcountry investors who have emerged as a major source of investment finance for infrastructure projects with private participation. The increasing presence of China and India in Africa or Latin America continues to make the headlines in those parts of the world. Schur et al. (2006) argue that in 1998­2004 these investors accounted for more of this finance in transport across developing regions--and for more in South Asia and Sub Saharan Africa--than did investors from developed countries. They show that during 1998­2004, developingcountry investors contributed more than half the private investment in concessions (54 percent), slightly less than half in greenfield projects (44 percent), and a smaller share in divestitures (30 percent). The large majority (29 percent) came from local companies investing in projects in their own country ("developing local" investors); of the rest (13 percent), almost all came from investors from nearby countries. How Much Private Money is Actually Flowing to Developing Countries? There is no information on actual disbursements by private investors in infrastructure. There is however an international database on commitments developed and maintained by the World Bank (http://ppi.worldbank.org/) that includes investments associated with management, concession, greenfield, and divestiture contracts that have reached financial closure. According to this commitment data, between 1990 and 2005, private investors committed $961 billion through more than 3,200 projects. That is an average of $64 billion per year. Figure 1 shows that private participation in infrastructure projects in developing countries peaked in 1996. The Asian crisis launched a broadly declining trend for several years afterward. However, in 2004 and 2005 investment recovered. Throughout the period over 75 percent of the investment went to the telecoms and the energy sector. Most investment has gone to Latin America and East Asia, although in the last 2­3 years Eastern Europe has enjoyed the highest levels of commitment. In fact, Eastern Europe has driven most of the recovery on commitments to private infrastructure projects. Africa and South Asia continue to be only modest beneficiaries of these types of investments. To put things in perspective, in the 2000­05 period these investments amounted to 0.85 percent of GDP for lower and uppermiddle income countries and about 0.69 percent for the leastdeveloped countries. This is not minor, but considering the ranges of investment needs discussed earlier, PPI represents only 10 percent of those needs for the poorest countries and about 25 percent for the richer developing countries. In other words, if the 25 percent is viewed as a benchmark, improvements in the investment climate for infrastructure investors and operators could generate more than a doubling of the private investment currently seen in the poorest countries. Current Debates on Infrastructure Policy 33 Figure 1: Infrastructure Projects with Private Participation in Developing Countries by Sector, 1990­2005 350 300 250 No. of projects 200 150 100 50 0 1990 1995 2000 2001 2002 2003 2004 2005 Year Total Energy Transport Telecom Water Source: The World Bank and PPIAF, PPI project database. To sustain the growth rates needed to reduce poverty, it is essential however to ensure that private investment does not crowd out public investment, as often happens. During the 1990s in Latin America and Africa, many government (and donors) slowed down their investment in infrastructure on the assumption that the private sector would more than compensate. It turns out that the net effect on investment in the sector was negative. In all sectors, with the exception perhaps of the water sector, there has been a difference in efficiency between public and private operators.29 In general, private operators have been more efficient, which implies that the users and the taxpayers can potentially benefit more from the private operation of the services. However, the level of efficiency and the distribution of the gains achieved from these better efficiency levels have been driven by the quality of the regulatory environment. Experience on that front has not been very good, as discussed later in the paper. What Drives the Participation of the Private Sector? The participation of the private sector depends on many dimensions. Exchange rate risks, commercial/demand risks, regulatory risks, and political instability can all be very damaging. These risks are typically accounted for in estimates of the minimum rate of return that private operators want from a deal in a given country. Ignoring for now the strategic motivations that may lead an operator to enter a country, even if the returns on a specific transaction are not high, most AngloSaxon and Nordic analysts, and increasingly analysts anchored in other traditions to identify business models or options, believe that estimates of the 29 For a recent overview see Gassner et al. (2007). 34 Antonio Estache and Marianne Fay cost of capital associated with a transaction can be a good approximation of the expected minimum return.30 Several recent articles estimate the cost of capital for the various subsectors.31 These estimates suggest that the returns required starting a project in lower income countries have to be at least 2­3 percentage points higher than in richer developing countries and more than twice what is generally expected in developed countries in infrastructure activities.32 The average ex post rates of return for the large OECD operators who have led many of the privatizations of the last 15 years often have been below this cost of capital, particularly in Eastern Europe and in Latin America. These results explain fairly clearly why the largescale western private sector is increasing where the public sector is coming back strongly to operate utilities. Even when these private operators continue to operate, they rely significantly more on highcost debt rather than on equity to finance the investments. These numbers imply that, all nonfinancial conditions being equal, the average tariff necessary to generate the minimum required rate of return in the poorest developing countries has to be higher than elsewhere and is increasing, because it needs to cover a higher and increasing cost of capital. This is politically a very difficult position to hold, and fewer and fewer private operators are willing to do so, particularly in politically sensitive sectors such as water and passenger transport. What Have We Learned from the "Infrastructure Privatization" Experience So Far? The experience of the past 15 years has also shown that the international community does not yet know how to address risk effectively. East Asia may have been the most effective in revealing that foreign exchange risk matters to infrastructure financing.33 The first generation of publicprivate partnerships in East Asia was hit hard by the 1997 crisis. Almost 10 years later, these partnerships have not yet fully recovered, except in China. Experience in Eastern Europe and Africa has shown that there is still a long way to go to understand how institutional reforms work in this sector. It may be that reforms have to be introduced slowly. Better documentation is needed of just how counterproductive it can be trying to force brutal institutional changes without taking the time to build the institutional capacity consistent with the desired 30 There is less of a tradition to rely on this yardstick among Francophone operators--at least in their assessment of potential markets since for the stock market, they proceed like everybody else and report the cost (and the return) on equity, one of the components on the costs of capital. 31. See Estache and Pinglo (2005) for all developing countries and Sirtaine and others (2005) for Latin America. 32. Sirtaine and others (2005) provide a detailed analysis of the evolution of the cost of capital in Latin America and compare it to the rate of return that can be estimated from the balance sheet of the main infrastructure operators in the region. 33 Investors in Argentina would probably argue that the pesification of the economy implemented in January 2002 is the best evidence so far of what that risk means. Current Debates on Infrastructure Policy 35 reforms. The difficulties of implementing concession contracts (which are derived from an AngloSaxon legal tradition) in francophone Africa where lawyers were much more familiar with affermage contracts (more typical of the French legal tradition) illustrate the potential for problems. The importance of this risk in Africa has been less well studied than the intensity and the drivers of renegotiation in general and in Latin America in particular (see Guasch 2004 for an overview of the issues in Latin America). Latin America's recent experience has shown the need to study the social and political risks better, because they matter to the effectiveness of reforms and hence their sustainability. Reforming by decree without an effort to build up support is no longer an option. In this region, the poor have clearly voiced their view on what kind of infrastructure services they want.34 Very often this implies that policy makers have to understand how to better balance the concern for equity with the need for incentives to invest that has dominated the past 15 years of reforms. The experience also shows that it is worth looking more carefully into options that ensure government and operators are committed to increased accountability to users and taxpayers. This can be achieved by adopting regulatory models that allow transparent documentation of efficiency, equity, and fiscal considerations.35 The experience also shows that politics matter. Anecdotes from Asia, Eastern Europe, and Latin America show that politicians are unlikely to give up control of a sector that buys votes in democratic societies. Moreover, in societies in which corruption is rampant, they will not give up control of a sector involving large amounts of money and in which contract award processes often provide opportunities for unchecked transactions. The Upshot... The debate on the role of the public sector in infrastructure continues to be one of the hottest in the academic literature and in political circles. Ideology continues to taint the facts and their interpretation. This debate is possible simply because the facts reveal a very complex and sometime inconsistent picture. The privatization wave has delivered on some of its promises but not all of them. Efficiency generally improved but many argue that most of it should be credited to increased competition and in the case of telecoms to a simultaneous 34. The rejection of the infrastructure reforms of the 1990s, in particular the increased role of the private sector in the delivery of services, did not play a minor role in the wave of political change in Argentina, Bolivia, Brazil, Uruguay, or República Bolivariana de Venezuela. 35. Indeed, reforms often have fiscal costs, often generated as part of renegotiations that could have been anticipated if a consistent framework had been adopted more widely for documenting the sources of costs and incomes of the regulatory operators, and accounting for reasonable demand forecasts. A crucial fact is that the gap between the rate of return of the business and the costs of capital will be paid by taxpayers or users. It turns out that the taxpayer has been called upon much more often than is recognized. See Campos et al. (2003) on the actual fiscal cost of the sector after 10 years of reform in Latin America. 36 Antonio Estache and Marianne Fay technological revolution. Privatization has not delivered as much as expected in terms of investments and those without access to begin with are the most penalized by this failure. Looking ahead, investors, operators, and governments seem to be internalizing the main lessons of the 1990s and are increasingly effective at dealing with risk mitigation. Investors are working more in sectors which are safe bets (such as telecoms). They are also more effective at picking the cherries on the cakes. The number of largescale concessions covering all the operations of a sector is shrinking. Sectorwide responsibilities are increasingly being covered by management or lease contracts that require no private investment. Where investment is taking place, it is done through various types of greenfield projects for specific investments (for example, bulk facilities such as power plants and water treatment plants). On the financial design, many of these projects face increasing costs of capital. To lower this hurdle, many contracts now include offtake agreements increasing the share of risk taken on by the government upfront (rather than reassigning it through ex post renegotiations). This has opened the door to many new operators from developing countries, led by China and India. However, many local country or regionspecific actors are more familiar with the specificities of the local market and often more effective at dealing with local political sensitivities. Some challenges are likely to continue. Unless these firms are not depending on any imports or foreign financing, they are likely to be subject to foreign exchange risks similar to those faced by the first generation of private investors and operators in the sector. The market for governmentsponsored guarantees against these risks is unlikely to shrink any time soon. The real question is whether the international financial community, private and public, is willing to scale up their support to private operators working in an environment in which many risks are known but many more seen to spring up a regular basis. In the meantime, as long as the private sector does not take the lead or is unable to do so for a variety of economic and political reasons, it seems reasonable to expect that governments somehow will have to take on the responsibility for delivering the services. How Is the Role of the State in Infrastructure Evolving? There are three basic debates on the role of the state in infrastructure. The first is the debate on the extent to which the public sector should be the main provider of these services. The second is about how the government should deliver its regulatory responsibility in a sector that is characterized both by market failures and by an extreme sensitivity to political pressure. The final debate is about the optimal allocation across government levels for these two main responsibilities. Current Debates on Infrastructure Policy 37 What Share of the Services is the Public Sector Delivering? This is not as obvious a question as it seems. The answer requires an unbundling of infrastructure services and physical infrastructure. In most developing countries--as well as in many developed countries--the physical infrastructure is to a large extent public. Railway tracks, roads, ports, water pipes, most basic infrastructures associated with fixed telephony, electricity transmission, and distribution or transport of gas are owned and generally operated by the public sector. Many projects are an exception to that rule, but the basic fact is that states finance much of the physical infrastructure necessary to produce the basic infrastructure services. Table 6 reproduces the data from table 5 from the viewpoint of countries without a major private actor in infrastructure. In about two thirds of the developing countries, the state is the main actor in electricity distribution, water distribution, and railway services. In over 50 percent of the countries, the state also is the main actor in electricity generation. Only in fixed telecoms services are there more countries in which the private sector dominates. In terms of investment, it is useful in this context to revisit information in previous section from the public sector angle. About 80 percent of infrastructure investments in the last 15 years was public. This figure likely is a lower band, because many of the deals signed during the 1990s in water and transport were renegotiated, and many of those renegotiations resulted in a demand for investment and operational subsidies from the state (Campos et al. 2003). From a pragmatic viewpoint, the main problem is that depending on the country group, public sector investment is still 50 to 120 percent lower than what is claimed to be needed to support high growth rates. The lower the income level, the higher the investment gap. This existence of such a gap is in fact what initially prompted many governments to enact reform. Most countries did not think the state was doing a good job at delivering services. We know now that the private sector is unlikely to intervene at the scale needed for the poorest countries to get out of poverty and for middleincome countries to get the critical mass they need to make the last jump to highincome status. Table 6: Percentage of Countries WITHOUT Significant Large Scale Private Investment in Infrastructure (2004) Electricity Electricity Water and Fixed-line Income level generation distribution sanitation Railways telecoms Low 59 71 82 66 50 Lower-middle 52 63 50 74 38 Upper-middle 42 52 63 40 28 Developing 53 64 65 64 41 Source: Estache and Goicoechea 2005. Note: Data for railways are from 2002. 38 Antonio Estache and Marianne Fay This has two implications that need to be addressed by the international community. First, it is essential for donors to help scale up investment efforts-- just like it has to be done in health and education. Second, it is essential for countries to learn how to deliver public services better. The foreign private sector may take on the management or operation of many services and over time pass on the knowledge to those countries that need it the most. But in many countries, the scale of the problems is so large that management contracts or leases won't be possible. Structural reforms are needed in the way the public enterprises are run. Unfortunately, it looks like we collectively stopped learning anything about this in the last 20 years (GomezIbanez 2006). A lot of work is needed in this field and the debates on how to proceed are likely to be as ideological as the debates on privatization have been for quite some time now. The leading advice for now seems to be to systematically corporatize public operators in the sector and possibly to name private managers to run the operations.36 But this requires a nontrivial political commitment to avoid other forms of interference with the management of the public services. How Should the Government Regulate Its Public Services? Lack of self regulation by the state or by public enterprises was a major criticism of the way the infrastructure sector was operated until the 1990s. The recognition that conflicts of interest and excessive political interference could eventually hurt users led to promotion of the idea that regulators should be independent from the political powers. This implied the creation of autonomous regulatory agencies that would be run by an individual or a board of directors. The individual or board would be recruited for skills and for a specific term independent of the political cycles, and would enjoy independent revenue sources. To many, this was also a way of increasing the transparency of transactions in the sector and hence reducing corruption.37 The creation of this sort of agency also would be a signal to the markets that governments were willing to cut the regulatory risks. Recent evidence by Andres et al. (2007) suggests that regulators across sectors in Latin America that were established under law, funded by a regulatory fee, and given a fixedterm regulatory commission screened by legislators, more effectively aligned cost of capital and rate of return. Gasmi et al. (2002) find equivalent results in the case of the telecoms sector for a worldwide sample. 36 Corporatization has complex implications for project selection. There is a risk that public enterprises will favor financial criteria over economic criteria for project selection unless there is a clear prohibition. With the increased concerns for major externalities, this issue probably not is getting the attention it deserves in policy circles and has long been out of fashion in academic circles. 37 For recent surveys of infrastructure and corruption, see Kenny (2006, 2007). Current Debates on Infrastructure Policy 39 Table 7: Percentage of Countries with Independent Regulatory Agencies, by Sector, 2004 Water and Fixed-line Income level Electricity sanitation Railways telecommunications Low 38 13 2 69 Lower-middle 63 32 8 60 Upper-middle 63 28 19 71 Developing 51 22 8 66 Source: Estache and Goicoechea 2005. Note: Data for railways are from 2002. Table 7 provides a snapshot of the position of countries with respect to this dimension of the role of government. Clearly, the idea of independent regulation has been mainstreamed in the telecom sector and to some extent in the energy sector. It is much less popular in the water and transport sectors. Also, as with private sector participation in infrastructure, it is an approach more likely to be adopted by richer countries. This is somewhat to be expected since the poorest countries face a significantly larger constraint in terms of human capital. In many countries, there is a sense that the opportunity costs of earmarking the good people to specialized agencies may be too high. In addition to the capacity issues, two broad concerns are emerging in the countries that have adopted the idea of an independent regulator. The first is a widespread sense among specialists that economic regulation and regulatory processes need to be taken much more seriously. They are essential for reducing opportunities for corruption and ensuring fair distribution of the rents generated by the remaining public and private monopolies in the sector. Accounting rules, contracts, regulatory processes and consultations, tariff or investment review procedures and methodologies, and timetables tend to lack the transparency needed for the accountability of these independent actors. This is not a minor problem. For instance, Bertolini (2006) finds in a survey of regulators in 2005 that less than 30 percent of regulators currently publish contracts and licenses. But the experience suggests that the implementation of the idea is not obvious and may not be appropriate at all stages of development. Eberhard (2007) for instance shows why a poor independent regulator may be worse than no regulator in some circumstances. There are alternative models for the effective regulation of public and private operators that reduce the risks to the users, taxpayers, and operators. For instance, independent auditors recruited on a retainer basis and with the obligation of conducting regularly scheduled audits and to be available for extraordinary audits have long been considered. The regulation of various African railways concessions and some Eastern European water concessions offers a variation around this model. In all cases, external auditors are supported by local units within ministries or even as independent agencies. 40 Antonio Estache and Marianne Fay Debate on the need for an independent regulator seems to be progressing slowly toward more a pragmatic approach that recognizes local specificities. One size does not fit all and never did. Progress is being made but still has some way to go. Does Decentralization Help the Performance of the Sector? Decentralization is the third main topic in discussions of the changes needed in the public sector. Since the 1970s many countries, particularly developing countries, have seen major shifts of responsibilities for expenditure and financing decisions to subnational government levels. Responsibility for most urban services (urban buses and railways, water, and even some road constructions) is often municipal. In view of the fast urbanization of most countries of the world, the relative importance of these mandates is likely to increase. It is also resulting in tense discussions between the various government levels on the appropriate match between the allocation of responsibilities for expenditures and revenue across infrastructure services. This core policy agenda has generated a lot of interesting academic work on decentralization design but very little directly relevant to infrastructure. Bardhan and Mookherjee (2000, 2003) offer some of the most influential recent theoretical findings on infrastructure, highlighting the role of local corruption on the effectiveness of public service decentralization. They show that under fairly mild assumptions, decentralization, financed by user fees rather than local taxes or intergovernmental grants, generates more efficient outcomes, no matter how poorly local democracy works. The problem is when some of the assumptions are released to account for relatively common real life situations. First, if user fees are not used--and full cost recovery is only very partial for many services-- the superiority of decentralized over centralized service provision is no longer as clearcut. Second, when ability to pay is constrained and user charges cannot be used to finance antipoverty programs, the optimal degree of decentralization depends on the degree of corruption in local and central governments. Most of the academic work on infrastructure decentralization is however theoretical. For now, there are relatively reliable empirical tests (see Shah, Thompson, and Zhou 2004 for a general survey and Bardhan and Mookherjee (2006) for a study more focused on infrastructure). The literature provides a few robust insights. First, decentralization tends to increase total and subnational spending on infrastructure, and even more so in developing than in industrial countries (Estache and Sinha 1995; Fisman and Gatti 2002; Faguet 2004). This can have two explanations: (i) centralized regimes tend to ration demand for infrastructure services; (ii) decentralization, by reducing the scale of service delivery, increases the unit costs. Second, the interaction between infrastructure, corruption, and any form of decentralization is not a simple one. Fisman and Gatti (2002) conclude there is a negative correlation between corruption and decentralization but Faguet (2004) does not Current Debates on Infrastructure Policy 41 find a strong relation either way. Olken (2005) finds that good centralized audits outperform decentralization in reducing the effects of corruption, at least for road maintenance. Finally, fiscal decentralization significantly affects the level and frequency of private participation but administrative and political decentralization do not. Fiscal decentralization tends to increase private sector participation in infrastructure (Ghosh Banerjee 2006). The literature and the policy advice on participatory approaches to service delivery can also be seen as an extension of the work on decentralization and points to additional insights of direct relevance to the debate on the pros and cons of decentralization. Ghazala (2004) and Cornwall (2003) observe that projects claiming "full participation" and "empowerment" have turned out to be driven by particular interests or elites, leaving the least powerful without voice or much choice. The poverty reduction effectiveness of these programs needs to be measured more systematically as well. The one quantitative study of an infrastructure activity is by Olken (2005), who finds that increasing grassroots participation had little impact in reducing corruption associated with road expenditure in Indonesia. He shows that topdown monitoring may be a better solution, even in a highly corrupt environment. In other words, traditional regulatory instruments have been more effective than participatory instruments in Indonesia's road program. But beyond decentralization's impact on governance and responsiveness to local needs, there are concerns that it may be associated with a decrease in resources available for infrastructure. The concern stems from the fact that subnational governments tend to have substantially less access to private capital or international donors. Most face such severe credit constraints that their ability to finance infrastructure investments is limited in the absence of support from the central government. The central issue in setting up mechanisms to channel private savings to local bodies for the financing of infrastructure is the assurance to lenders that they will be repaid. But this is often not enough. Indeed, a major impediment to the development of subnational credit markets is the moral hazard of explicit or implicit guarantees of a federal government bailout of subnational debt. For this reason, the development of subnational credit markets requires, inter alia, a strict nobailout policy for subnational governments in trouble. This approach has been adopted in Mexico, where the capital risk weighting of bank loans to local governments is linked to local credit ratings. The natural question that emerges is the extent to which the expected payoffs of decentralization might not be offset in the case of infrastructure by the loss of economies of scale and the reduced access to sources of financing already generally difficult to obtain for sectors with highcost lumpy investments and slow cash flows very sensitive to politics. One obvious solution is to pool credit risks of subnational governments, which, however, involves recentralization of some of the dimensions of infrastructure service delivery. The fact that this market is not very advanced in developing countries--despite strong political 42 Antonio Estache and Marianne Fay pressures in many middleincome countries--indicates the wide range of viewpoints about the desirability and limits of infrastructure decentralization. The Upshot... The role of governments in infrastructure likely will be a source of ideological debates for the foreseeable future. We know that governments will continue to play a key role as providers and financiers of the sector, and that. Furthermore, governments will continue to have a regulatory role in a sector in which the residual monopolies are likely to be strong. However we also know that the implementation of the mandate to deliver is plagued with potential sources of political interferences. The corporatization of public enterprises does not have a great track record in developing countries with a few exceptions in Asia. In most other countries, politics have tended to creep back into the agenda of the public and private managers of service providers within 3­5 years of their corporatization. Similarly, regulators have a poor record of sustainable, fair, and efficient arbitration of the joint interests of users, taxpayers, and operators. Independent regulators have been reasonably effective in the most advanced countries in telecoms and energy. However, they have encountered many problems in water and transport. In most cases, when a crisis has hit the sector, politicians have taken over regulation. Finally, because decentralization is generally more a political decision with economic and administrative consequences, the decentralized management of infrastructure services has been the victim of political disagreements across government levels, which have hurt otherwise rational decisions. Overall, a review of the experience of the last 15 years is sobering. In spite of the long history of analysis of the potential roles of the state in infrastructure, most of the progress in learning how to get things done has come from the theoretical research. Policy makers have few yardsticks or rules of thumbs they can use to set up reforms to get the public to deliver on any of its assignments-- operation, financing, or management. Anecdotes and examples of best practice abound, but credible specific guidelines are scarce. Concluding Comments The heterogeneity of the infrastructure business is such that it is difficult to draw specific conclusions for any given subsector or country from a broadbrush overview such as this one. However, some general conclusions can be drawn. First, the basic debates have not changed much over the last 25 years or so and they center on two core questions: Current Debates on Infrastructure Policy 43 Who should be in charge of the sector: the government or the private sector; the central government or the subnational governments; independent regulators or politicians? Who should pay for the services: the users, the taxpayers, or in some case the donors? There are plenty of variations and refinements around these two questions, driven by the relative importance assigned to the concern for efficiency, equity, financial viability, and accountability. Although a lot of learning has taken place on how to address those questions, some of the basic answers are still lacking. One of the main reasons for this lack of clearcut answers is the lack of objective data on the sector. Data gaps have been highlighted throughout this overview, including on basic issues such as costs and tariffs or the share of public or private resources allocated to expand or maintain the sectors. In recent years, more subjective data has become available based on questionnaires covering a wide range of topics such as the investment climate, corruption perception indicators, or the sources of happiness for people. There have also been refinements of household consumption and expenditure surveys to generate comparable data on problems in the sector for residential users. But these multiple sources generate information rarely comparable across sources and continue to leave major gaps. Ultimately, these data gaps are what allow ideological debates to dominate substantive debates in this sector. 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The printing of all the Working Papers in this Series on recycled paper saved the following: Trees* Solid Waste Water Net Greenhouse Gases Total Energy 48 2,247 17,500 4,216 33 mil. *40 inches in height and 6­8 Pounds Gallons Pounds CO2 Equivalent BTUs inches in diameter The Commission on Growth and Development Working Paper Series 40. Making Difficult Choices: Vietnam in Transition, Martin Rama, based on conversations with H. E. Võ Vn Kit, with Professor ng Phong and oàn Hng Quang, November 2008 41. Policy Change and Economic Growth: A Case Study of South Africa, by David Faulkner and Christopher Loewald, November 2008 42. International Migration and Development, by Gordon H. Hanson, January 2009 43. Private Infrastructure in Developing Countries: Lessons from Recent Experience, by José A. Gómez-Ibáñez, January 2009 44. From Financieristic to Real Macroeconomics: Seeking Development Convergence in Emerging Ecomnomies, by Ricardo French-Davis, January 2009 45. Setting Up a Modern Macroeconomic-Policy Framework in Brazil, 1993­2004, by Rogério L. F. Werneck, January 2009 46. Real Exchange Rates, Saving, and Growth: Is There a Link?, by Peter J. Montiel and Luis Servén, January 2009 47. Avenues for Export Diversification: Issues for Low-Income Countries, by Paul Brenton, Richard Newfarmer, and Peter Walkenhorst, February 2009 48. Macroeconomic Policy: Does it Matter for Growth? The Role of Volatility, by Antonio Fatás and Ilian Mihov, February 2009 49. Current Debates on Infrastructure Policy, by Antonio Estache and Marianne Fay, April 2009 Forthcoming Papers in the Series: Explaining China's Development and Reforms, by Bert Hofman and Jingliang Wu (February 2009) Growth Challenges for Latin America: What Has Happened, Why, and How to Reform the Reforms, by Ricardo Ffrench-Davis (April 2009) Electronic copies of the working papers in this series are available online at www.growthcommission.org. They can also be requested by sending an e-mail to contactinfo@growthcommission.org. T his paper provides an overview of the major current debates on infrastruc- ture policy. It reviews the evidence on the macroeconomic significance of the sector in terms of growth and poverty alleviation. It also discusses the major Commission on Growth and Development institutional debates, including the relative comparative advantage of the public Montek Ahluwalia Edmar Bacha and the private sector in the various stages of infrastructure service delivery as Dr. Boediono well as the main options for changes in the role of government (that is, regulation Lord John Browne and decentralization). Kemal Dervis ¸ Alejandro Foxley Antonio Estache, Professor, Universite Libre de Bruxelles Goh Chok Tong Marianne Fay, Lead Economist, DECWD, World Bank Han Duck-soo Danuta Hübner Carin Jämtin Pedro-Pablo Kuczynski Danny Leipziger, Vice Chair Trevor Manuel Mahmoud Mohieldin Ngozi N. Okonjo-Iweala Robert Rubin Robert Solow Michael Spence, Chair Sir K. Dwight Venner Hiroshi Watanabe Ernesto Zedillo Zhou Xiaochuan The mandate of the Commission on Growth and Development is to gather the best understanding there is about the policies and strategies that underlie rapid economic growth and poverty reduction. The Commission's audience is the leaders of developing countries. The Commission is supported by the governments of Australia, Sweden, the Netherlands, and United Kingdom, The William and Flora Hewlett Foundation, and The World Bank Group. www.growthcommission.org contactinfo@growthcommission.org