Increase Investment in Infrastructure

Posted by: Ishwar Khatiwada

Economic indicators reveal that Nepal possesses one of the most limited stocks of economic infrastructure (airports, communication, electric power,roads, sewerage, water etc) among the many developing nations. The existence of such an extremely poor infrastructure situation is due to low-investment and poor maintenance of capital. The post-conflict economic policy should prioritize the development of the economic infrastructure.

Infrastructure spending in Nepal accounts for less than 4 percent of Gross Domestic Product (GDP) annually. This meager share of output devoted to infrastructure has shrunk in recent years, declining from 3.6 percent in 1998/99 to only 2.1 percent in 2003/04. The decline was attributable largely to an unfavorable socio, economic and political environment coupled with government budget constraints. In addition, like many developing nations, Nepal is also facing a shortfall in financing public infrastructure that is in high demand in the modern economy. A study by the World Bank projects that current investment, operation, and maintenance needs for infrastructure in low-income countries is estimated to be 7 to 9 percent of GDP. The major obstacles in obtaining the required resources for investing in infrastructure are the under-developed state of the country’s capital market and government’s inability to attract private and foreign investment.

Nepal has a relatively low share of GDP spending in infrastructure in comparison to other Asian nations. Annually, China spends 8 percent of GDP on economic infrastructure while India’s share hover around 5 percent. Many East Asian countries spend 7 percent or more of their GDP on such investments. India in recent years has been aggressively pursuing an economic policy of increasing investment in infrastructure development after assessing the fact that it might be losing 3 to 4 percentage points of economic growth annually due to the underdeveloped state of its economic infrastructure. Nepal could learn a great deal by observing policy trends in these countries.

In the absence of a strong economic infrastructure, the economic growth of a nation is severely constrained. Numerous cross-country studies have consistently supported this fact. The infrastructure helps foster economic growth by raising productivity, integrating the national and global economies, increasing urbanization, reducing poverty and inequality, and raising living standards of the population. Previous studies on the role of infrastructure in economic growth across both developed and developing nations have found that the economic returns from investment in infrastructure are extremely high. A World Bank 1994 study found that a 1 percent increase in the share of infrastructure increase GDP across all countries by 1 percent. Furthermore, social returns from investment in economic infrastructure often exceed private economic returns by creating positive economic externalities for society as a whole.

There are substantial challenges in providing the needed economic infrastructure in our nation. Extremely difficult topography and low utilization of infrastructure, particularly roads, make it difficult to provide infrastructure services to a highly scattered population in rural areas where slightly under 90 percent of the population currently live. Private sector involvement in building infrastructure in rural areas is almost non-existent. In the urban areas where the market is bigger for capital, labor, outputs and services, private firms are able to profit from economies of scale and scope. Besides, in scattered poor rural areas, high fixed costs incurred in providing infrastructure over a small customer base increases unit costs and depresses revenues from the services provided by the infrastructure, hence, discouraging private sector involvement. There are some successful government initiatives involving private parties in the hydropower and communications sectors, but services offered in these sectors largely exclude the rural population- the core target of economic development.

For policymakers, striking an appropriate balance in providing infrastructure in rural areas of Nepal at minimum economic, social and environmental costs are other key challenges. The following policy frameworks are suitable for taking on these substantial challenges. First, a clear strategic vision and an optimal policy consensus is needed in developing the right infrastructure services to the right population at the right cost. Railroad networks and roads could be suitable for urban areas and Terai regions whereas aerial hydropower ropeways could be the best option for high mountain regions. However, the rural population must have universal access to communications, electricity, and water and sewerage, which have been found to have significant impacts on poverty reduction and income generation. The choice of a labor-intensive technology in building infrastructure in rural areas seems appropriate in generating employment in these areas.

Second, formulating policies to promote spending on infrastructure are desirable. These policies should encourage private sector financing by offering private parties incentive mechanisms, such as tax breaks in service revenues, clearly defined tariffs on services etc. Drawing from the experiences of other countries, Build-Operate-Transfer (BOT) policy seems to be very effective in this sector where government involves private parties at the beginning to build, then to operate and finally handover the project to the government after some period. In the U.S., the original railway system was built by private sector financing while government provided subsidies mostly in the form of land grants and bond guarantees. In recent decades, there have been some successful private sector initiatives in the U.S. and in some European countries in financing, building and operating highways through toll revenues. Policymakers in Nepal can learn from the success and failures of infrastructure development projects in other countries.

Third, since the government does not have sufficient resources to finance all of the required infrastructure, policies to attract private and foreign investors should be devised. This could be done by having the government focus on the clarity of policy, including well-defined legal and contractual agreements, a credible regulatory system, and protection of rights for investors. In the long run, the focus should be on developing a strong capital market for financing investments in this sector, encouraging local communities to manage their infrastructure, and less reliance on foreign aid and debt.

Fourth, to utilize government spending efficiently in providing infrastructure, strict monitoring and management of large-scale projects is very crucial, given the high “corruption prone” nature of activities associated with building infrastructure in developing countries, resulting in an inferior quality of service. An independent regulatory body, civil society, and NGOs working together can act as a watchdog for corruption in these ventures.

Fifth, introduce competition where possible by putting infrastructure services on a commercial footing. It is only through competition that innovation is spawned and efficient service is delivered to consumers. The government should encourage the private sector’s involvement in water, sewerage and road operations in both urban and rural areas. It is also equally important to make sure that the poor benefit from these services. Many poor households may not be able to pay the full price for such services; however, subsidies and cross-subsidies of these services in the short-run are desirable.

The article was published in the Editorial section of the Kathmandu Post.

Increase Investment in Infrastructure was last modified: December 23rd, 2014 by Ishwar Khatiwada

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