Forward-looking funding policy needed for infrastructure

NEW DELHI: We may become the makers of our fate when we have ceased to pose as its prophets, noted philosopher Karl Popper. The more down to earth may want more concrete answers when it comes to circumstance and consequence. Consider, for instance, the supply scenario for infrastructure. A recent paper on the political economy of infrastructure investment in India uses modelling and simulation to show that the provision of public goods is very much dependent on subsidies and leakages, or rather the lack of them. Also, lowering the fixed costs of accessing the “modern sector” seems to rev up the demand for infrastructure.\

The fact remains that there is a huge and growing investment gap in infrastructure, pan-India. The recent seven-member Deepak Parekh committee on infrastructure estimates the funding requirement at $475 billion over the next five years. And in a bid to step up participation of banks and financial institutions in infrastructure funding, the panel has suggested policy change to usher in unrated bonds, the scope for borrowing overseas for onward project lending and has also called for relaxing statutory liquidity ratio norms.

The research paper on infrastructure rightly assumes imperfect capital markets to explain investment behaviour in public goods across states. The rationale for the study is that recent empirical work does suggest that per-capita income in the states have diverged due to skewed distribution of infrastructure investments.

What is the requirement in public policy design to incentivise the executive and policymakers to shore up funds flow into infrastructure? The study uses the latest available data sets to model variation in infrastructure and development expenditure across states.

The key finding is that the way to incentivise higher development expenditure is to put in place proactive policy so as to allow the average or “median” voter to invest and have a stake in the modern, infrastructure-intensive exchange sector. The modelling exercise shows that four variables can potentially explain the differential infrastructure investment among — and even within — states. They are: the fixed cost of accessing the modern, formal sector; the initial stock of infrastructure already in place; median voter wealth and corruption or leakages in infrastructure spending.

The number-crunching has revealed an infrastructure index using the technique of principal component analysis, and based on state-wise development expenditure data against the average growth of real per capita GDP from 1980-1998, of 25 states for which data is available. The expenditure heads include education; public health; water supply and sanitation; housing; urban development; agricultural and allied activity; rural development; energy; industry and minerals; transport and communication; social security and welfare.

For the sake of analogy, the structure of the economic model in the study is as follows. Tax proceeds from the modern sector is used to finance one of the two policies: a per capita consumption subsidy (which by definition is unproductive) and productive infrastructure. And it has been clearly shown that a “zero subsidy policy corresponds to more infrastructure investment”.


The model reveals that “positive subsidy” levels do imply sub-optimal infrastructure investment on the ground. What is also demonstrated is that a policy of zero subsidy is the preferred option if and only if the median voter can access the modern sector. Next, what is incorporated in the model is corruption or leakages in infrastructure spending, including monies “wasted in the disbursement of the consumption subsidy”. The model shows that higher corruption makes it all the more likely for the system to have a positive subsidy regime, and which in turn imply lower investment levels as a consequence and post-facto response.

The implication that follows is that stepped-up development expenditure calls for a policy that will ensure the median voter has a growing stake in the modern, income-generating sector. Also, that reducing the fixed costs of accessing the modern sector does boost infrastructure spending. And further, that reducing and stemming corruption and leakages in the development delivery mechanism invariably rev up infrastructure investment. The idea is that political parties would strive to provide the optimal set of policies preferred by the median voter, and if the latter sees sustained gains in the sound provision of public goods it would increase supply of infrastructure on a sustained basis.

The paper also makes the point that boosting infrastructure investments requires appropriate sectoral and credit policies, so as to reduce “the fixed costs of investing in the modern sector”. The paper underlines the fact that credit markets “show considerable evidence of market failure”. It cites the World Bank Development Policy Review, 2006, which notes that “the vast majority of India’s rural poor still do not have access to formal finance”. The modelling in the study does suggest, however, that better infrastructure will improve realisations in engaging and investing time, effort and money in the modern sector. It would also cut down on the fixed costs of accessing and investing in the modern sector too. Hence the pressing need for forward-looking infrastructure policy. As for stamping out leakages by way of corruption and giveaways in infrastructure projects, what is proposed is “vigorous auditing of funds”, third-party performance evaluation and “incentives to whistle blowers”. Over and above, what is advised are “performance monitoring” and “special investigations” at block and district levels to scuttle rampant leakage. About time, surely!

(The Political Economy of Infrastructure Investment in India by Chetan Ghate, Indian Statistical Institute, New Delhi, January 2007, and published by Max Planck Institute of Economics, Jena, Germany)