Assessing the effect of public capital on growth: An extension of the World Bank Long-Term Growth Model

Abstract

To analyze the effect of an increase in the quantity or quality of public investment on growth, this paper extends the World Bank’s Long-Term Growth Model (LTGM), by separating the total capital stock into public and private portions, with the former adjusted for its quality. The paper presents the LTGM public capital extension and accompanying freely downloadable Excel-based tool. It also constructs a new infrastructure efficiency index, by combining quality indicators for power, roads, and water as a cardinal measure of the quality of public capital in each country. In the model, public investment generates a larger boost to growth if existing stocks of public capital are low, or if public capital is particularly important in the production function. Through the lens of the model and utilizing newly-collated cross-country data, the paper presents three stylized facts and some related policy implications. First, the measured public capital stock is roughly constant as a share of gross domestic product (GDP) across income groups, which implies that the returns to new public investment, and its effect on growth, are roughly constant across development levels. Second, developing countries are relatively short of private capital, which means that private investment provides the largest boost to growth in low-income countries. Third, low-income countries have the lowest quality of public capital and the lowest efficient public capital stock as a share of GDP. Although this does not affect the returns to public investment, it means that improving the efficiency of public investment has a sizable effect on growth in low-income countries. Quantitatively, a permanent 1 ppt GDP increase in public investment boosts growth by around 0.1–0.2 ppts over the following few years (depending on the parameters), with the effect declining over time.

Infrastructure and economic growth: Evidence from the United States

“…Also, using the dynamic panel model, Boopen (2006) found that transport capital contributed significantly to the economic growth of Sub-Saharan African countries and Small Island Developing States. Employing the World Bank's Long-Term Growth Model (LTGM), Devadas and Pennings (2019) analyzed the effects of an increase in the quantity or quality of public investment on growth. They found that a permanent 1% GDP increase in public investment increases growth by around 0.1 to 0.2 percentage points.…”

A Framework to Assess Debt Sustainability and Fiscal Risks under the Belt and Road Initiative

“…The theoretical approach, based on Devadas and Pennings (2018), uses a constant elasticity production function to derive the marginal productivity of BRI investments. This model assumes that the impact of additional investment on growth declines as the public capital stock rises.…”

“…The literature also presents two very different approaches to estimate the impact: one is theory based and the second empirical. This paper presents both approaches: First, it applies the marginal productivity of efficiency-adjusted public investment to estimate the impact of investment on growth in the medium term, following Devadas and Pennings (2018). Second, the paper estimates the impact on growth of physical infrastructure, controlling for a broad set of variables, following Calderon (2009).…”

“…is the ratio, expressed in logs, of adjusted investment and GDP. It is constructed using the efficiency index as in Devadas and Pennings (2018). The term µ captures unobserved country characteristics.…”

“…Empirical estimates of the growth impact of infrastructure investment vary significantly among studies.25 This is equivalent to Equation 3 inDevadas and Pennings (2018).26 The effect of public investment on growth is most sensitive to the elasticity of output to public capital, , which is calibrated based on meta-analysis studies -- andNunez-Serrano and Velazquez (2016), and a recent paper byCalderon et al (2015).27 This is equivalent to Equation 16A inDevadas and Pennings (2018).…”