By Paolo Mauro
May 4, 2017
The infrastructure needs of emerging market economies, like China or India, differ from those of advanced economies like the United States or Germany. Many emerging economies must substantially expand their energy and transportation networks, or build them from scratch, to accommodate rapid economic growth. Our research shows the more people make, the more they spend on transportation. With emerging economies’ middle classes booming and incomes rising, this has big implications for how policymakers choose to invest in infrastructure.
What rising incomes mean for infrastructure needs
Infrastructure investment must keep pace with rapid population growth, particularly in sub-Saharan Africa, India, and other parts of Southeast Asia, and with per capita income growth. In addition, consumption continues to shift toward transportation spending, a fact that is often underappreciated.
There is abundant economic research about how changes in income affect the types of goods and services people choose to buy.
In the 19th century, German economist Ernst Engel showed that while household expenditure on food rises with income and family size, the proportion of income spent on food falls—this is known as Engel’s Law.
Our evidence from household surveys for 20 advanced and emerging market economies reveals a strong and positive relationship between personal income and transportation spending. Whereas people making $200 a year devote only 1 percent of their income to transportation needs, those making $20,000 a year spend 18 percent on transportation.
Over the next 20 years the number of people earning between $6,000 and $20,000 worldwide will rise by a little more than a billion, and many of these will purchase their first car. The number of people earning more than $20,000 will increase by almost 800 million, and many of these will begin to fly for leisure.
Taking these factors into account, consumer spending on transportation is projected to quadruple by 2035 in India, China, and other parts of emerging Asia, as well as in sub-Saharan Africa. Merely building the paved roads and railroads needed to accommodate growing world demand for transportation could cost some $48 trillion over the next 20 years. Emerging market and developing economies will need the bulk of that investment.
Tapping the private sector
Altering government spending priorities or raising money through taxes could finance some infrastructure investment. But the only realistic way to meet the large and growing infrastructure gap in emerging markets is through the private sector, including the potentially vast resources held by pension funds and life insurance companies worldwide.
This may require changes to prudential requirements to allow these investors to hold internationally diversified portfolios of infrastructure projects. Moreover, public-private partnerships with multilateral and regional development banks would provide the seal of approval that these investors require to participate in such projects.
Attracting private investors would also require governments to maintain stable regulatory environments that are free from arbitrary political interference. At the same time, calls on government guarantees of public-private partnerships have occasionally imposed budgetary costs equivalent to one or more percentage points of GDP in many countries, including Colombia, Indonesia, and Portugal. To reduce these risks, governments will need to monitor and disclose fiscal obligations stemming from projects involving private participation. Several countries, including Chile, now do so regularly.
It’s not just about more spending, it’s about effective spending.
The success of any infrastructure project is dependent on transparency and an independent media that can accurately monitor and report on projects. This allows citizens to pressure policymakers to pursue the public interest.
The publication of tenders and key contract features, good record-keeping, and quality control are all critical during procurement phases—including project evaluation and tendering—as well as contract performance. This ensures that financing is put to productive uses and not illicitly syphoned off or directed to low-value-added projects favored by political supporters. To deter fraud, governments must offer whistleblowers rewards and protection from retaliation.
Many emerging economies score poorly on indicators of the quality of the institutional setup for project selection and implementation. Corruption afflicts all countries, however, and advanced economies also need to protect infrastructure investment projects from undue private influence and arbitrary political interference.
Citizens would also benefit from new “green” construction choices. For example, favoring metro-railways and other public transportation over roads in new transportation networks will help reduce carbon emissions for decades.
Infrastructure investment holds enormous promise and potential. To realize its benefits, policymakers should adopt and safeguard appropriate checks and balances to make sure citizens benefit from the right choices.