Together with private investment, public investment, especially investment in infrastructure, plays a major role in economic development both for developed and developing, low-income countries.
Despite significant potential benefits of public investment on an aggregate level, its management in practice comes with many challenges, with the size and direction of public capital investment impact on output remaining an issue of debate. Naturally, the economic benefits of individual projects are estimated by appropriate analysis (i.e. cost-benefit analysis). However, on an aggregate level, the impact of public investment on economic growth is determined by several factors, e.g. source of financing, economic cycle, type of investment and country development level:
- With respect to source of financing, public investment can be financed in two ways: through a deficit or neutrally. Deficit financing requires that a rise in investment does not result in cutting other expenses and/or higher taxes, while financing is neutral if higher investment is compensated by lowering other expenses and/or increasing taxes;
- With respect to the economic cycle, the public investment impact on economic growth significantly depends on the economic situation, i.e. the economy’s cyclical structure;
- With respect to the type of investment, we can differentiate two types: core (economic) and other (social). Core infrastructure investment comprises roads, railway, airports and utility services, while other investment – hospitals, schools and other types of buildings. It should be noted that the impact of different types of investment might be different as per the country development level.
Drawing conclusions from empirical research, the short run impact of public investment is maximal when it is deficit financed, during a recession and of core type. However, the picture might be different for the long run: the impact might be larger when investment is neutrally financed. Moreover, in developing, low-income countries the long run return of social infrastructure might eclipse that of economic infrastructure.
As for infrastructure expenditures specifically on local level, according to research, local government institutions and human resources are the major factors that both themselves determine the region development level and, also, make sure the funds are distributed in an effective manner: after surpassing a certain expenditure threshold, the main factor that determines regional growth is government institution quality and management effectiveness – simply increasing infrastructure expenditures does not translate into economic growth.
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