Effectiveness of public investment on growth in sub-Saharan Africa

Abstract

The aim of the paper is to explain why public investment may not be as effective as expected in promoting growth in some countries, especially in low-income countries of sub-Saharan Africa. Given the unquestionable importance of public investment for private capital accumulation and economic growth, this low effectiveness of public investment can lead to serious problems in economies, such as low-investment trap. In the literature, there are several different reasons given, such as the quality of institutions, as possible determinants of the productivity of public capital and investment. While controlling for other possible factors, this paper provides two new explanations for the low effectiveness of public investment: the threshold effect and the volatility effect of investment. It is proposed that public investment can effectively promote economic growth only if it is high (threshold effect) and stable (volatility effect) enough. In the paper, a simple growth model illustrates the possible impacts of the volatility and the level of public investment on economic growth. Empirical analysis then follows. The analysis covers the period of 1980–2014 and a large set of sub-Saharan countries where the negative consequences of the threshold and the volatility effects of public investment have been felt strongly. In order to identify the possible negative impacts of the high volatility and the low level of public investment on growth, the countries are first classified based on their income levels. In the empirical analysis, some indicators of the quality of governance, which are also expected to be important determinants of the effectiveness of public investment, are included to control for the impact of corruption. The empirical results indicate that public investment is indeed much lower in per capita terms as well as highly volatile in relatively low-income countries. For this group of countries, even though public investment is still a statistically significant determinant of economic development, it is relatively less effective in increasing economic growth. The economic impact of public investment on growth is much larger and highly significant for relatively middle- and high-income countries. The regression results provide a clear evidence that the effectiveness of public investment significantly declines when its per capita level is below a threshold. The findings also indicate that a higher volatility of public investment can lower growth rates significantly, especially in the low-income group where volatility is highest.