Abstract
The authors examine the impact of public infrastructure on private capital formation in three countries of the Middle East and North Africa-Egypt, Jordan, and Tunisia. They highlight various channels through which public infrastructure may affect private investment. Then they describe their empirical framework, which is based on a vector autoregression (VAR) model that accounts for flows and (quality-adjusted) stocks of public infrastructure, private investment, as well as changes in output, private sector credit, and the real exchange rate. The authors propose two aggregate measures of the quality of public infrastructure and use principal components to derive a composite indicator. Their analysis suggests that public infrastructure has bothflowandstockeffects on private investment in Egypt, but only astockeffect in Jordan and Tunisia. But these effects are small and short-lived, reflecting the unfavorable environment for private investment in their sample of countries. Reducing unproductive public capital expenditure and improving quality must be accompanied by policy reforms aimed at limiting investment to infrastructure capital that crowds in the private sector and corrects for fundamental market failures. This will entail privatization and greater involvement of the private sector in infrastructure investment. While infrastructure (in the form of the provision of critical telecommunications, transport, and energy services) is important, other improvements in the environment in which domestic investment is conducted are crucial. These include the need to provide financing on adequate terms and guarantee a secure and efficient justice system.
Highlights
The poor growth and employment performance of the Middle East and North Africa (MENA) region is primarily due to the “slow, uneven and hesitant pace” of structural reforms launched in the late 1980s and early 1990s (see World Bank (2003a) and Richards and Waterbury (1996))
The low productivity of public investment is apparent in recent growth accounting exercises showing that contribution of physical capital accumulation to growth in MENA countries has declined over time, despite the fact that there has been no attempt in the existing literature to separate explicitly the growth in public and private capital
The extent to which exogenous changes in public infrastructure and other variables in the vector autoregression (VAR) model have affected the behavior of private capital formation can be gauged by computing the proportion of the variance of the forecast error for the private investment-to-GDP ratio that can be attributed to variations in each variable at different forecast horizons
Summary
The poor growth and employment performance of the Middle East and North Africa (MENA) region is primarily due to the “slow, uneven and hesitant pace” of structural reforms launched in the late 1980s and early 1990s (see World Bank (2003a) and Richards and Waterbury (1996)). In particular, governments in the region continue to dominate most economies, with pervasive involvement in production, labor markets, banking systems, and social services. The low productivity of public investment is apparent in recent growth accounting exercises showing that contribution of physical capital accumulation to growth in MENA countries has declined over time, despite the fact that there has been no attempt in the existing literature to separate explicitly the growth in public and private capital.. There have been few empirical studies focusing on these issues in the region (see Appendix A for a review of studies linking public investment to private capital formation and growth in developing countries). Existing studies are lacking in at least three respects They seldom make a clear distinction between the flow effect of public investment, and the stock effect of public capital. These studies do not always account for the simultaneous relationships between public investment and capital, private capital formation, and other variables like output growth, relative prices, and private sector credit. The last section draws together some policy implications of our analysis
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