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Effectiveness of public investment on growth in sub-Saharan Africa

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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.

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Notes

  1. For example, Bayraktar and Fofack (2011) show that one of the essential determinants of private capital and economic growth is public capital, independent of whether the country belongs to relatively low-, middle-, or high-income groups in Sub-Saharan Africa.

  2. In the literature, the low effectiveness of public investment and capital has been already linked to different variables, such as corruption, trade openness, and financial systems. In the empirical part of this paper, in addition to the level and volatility of public investment, corruption indicators, institutional quality indicators and other variables are added to the analysis to control for the impacts of other possible determinants of the effectiveness of public investment. The empirical results support the importance of the level and volatility of public investment for growth even after controlling for other possible factors.

  3. In the paper, the level of public investment is measured in per capita real terms.

  4. For example, Chakraborty and Dabla-Norris (2011) show that higher corruption lowers the quality of public capital and discourages specialization as well as development. Similarly, Calderon and Serven (2004, 2010) and IMF (2015) point out the importance of the quality of government institutions in determining the productivity of infrastructure. Spencer and Yohe (1970) show that the impact of increasing public spending on output may get lower over time if the public sector crowd-outs the private sector in this process. The mechanism works as follows: Higher economic growth, resulting from higher public spending, increases the demand for money and loanable funds and then interest rates. These higher interest rates raise the cost of borrowing for the private sector. As the private sector cuts investment due to higher costs of borrowing, output starts declining. Thus, the effectiveness of public investment on growth may decline due to the possible crowding-out effect of public spending. It should be also noted an empirical paper by Aschauer (1989) shows that despite the existence of the crowding-out effect, the net effect of increasing public capital on private capital is positive because public capital complements private capital in the production and distribution of private goods and services and this later effect is dominant.

  5. Museru et al. (2014) also show the significance of public investment on economic growth of 26 Sub-Saharan African countries has been eroded by volatility in public investment. The difference between their paper and this one is that they do not consider different income groups and the importance of the level of investment (threshold effect) for higher effectiveness of public investment. Similarly, Bayraktar and Moreno-Dodson (2018) show the negative effect of the volatility of public investment on growth, but their focus was only on the West Africa Economic and Monetary Union countries.

  6. In order to keep the model simple with the pure focus on the impact of the level and volatility of public investment on growth, the effects of institutional qualities, budget restrictions, and financial markets are only partially included in the process of private capital accumulation, as explained below.

  7. In the empirical section of the paper, human capital accumulation is measured as a weighted function of the share of population attending different levels of schools, where the highest weight is assigned to tertiary schools.

  8. It is especially important to include corruption indicators in the empirical part of the paper because corruption is a variable that can also significantly determine the effectiveness of public investment, in addition to its level and volatility.

  9. In the model, the same depreciation rate is taken for all types of capital in all countries. The depreciation rates are mostly time varying and depend on country income groups. For simplifying reasons, the same depreciation rates are assumed in the model, but if alternative rates, as suggested in the literature, had been considered in the model, the differences in the simulation results of the two groups would be even more striking. For example, Bayraktar and Fofack (2011) consider the following rates are considered for simulation purposes: 10% in the higher-income countries, 15% in the middle-income countries, and 20% for the lower income countries (similar differences in depreciation rates are suggested by Gupta et al. 2014). These rates lead to higher divergences in growth rates across groups as long as investment remains low. The higher depreciation rates in lower-income countries reflect the fact that such countries face higher budget constraints and tend to allocate much lower revenues to maintenance of capital stocks. In general, higher depreciation rates are assigned to less-income developing countries. For instance, Beddies (1999) chose a rate of 15% for capital depreciation for Gambia. The depreciation rate on private could be taken slightly higher than the depreciation rate on public capital, but this would not change the main result of the model: relatively high and stable public investment leads to exponentially higher growth rates. The robustness of results to the different values of public and private depreciation rates is presented in Arslanalp et al. (2010).

  10. It should be noted that the numerical values are assigned randomly and any alternative values do not change the main message of the example.

  11. The same set of analysis can be done for the other regions of the world in future studies.

  12. In addition to being an indicator of macroeconomic conditions, the inclusion of the real interest rate also controls for the possible crowding-out effect of public investment on private investment. Higher public spending can lead to higher interest rates in the financial system as the economy improves, leading to increases in the demand for funds and money. Then, higher interest rates can cause lower private investment and, as a result, lower growth rates, reducing the net effectiveness of initial public investment on growth.

  13. It should be noted that the presence of the growth rate of the variables in the set of independent variables makes the specification dynamic as explained in Beck et al. (2000). It should also be noted that, since the number of countries is limited, especially after grouping based on the level of income, it could not be possible to adjust the methodology to account for short- and long-run determinants of growth, such as pooled mean group estimator (Pesaran et al. 1999).

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Acknowledgements

I thank the anonymous reviewer and Maggie Mehalko for helpful comments and suggestions. Errors remain my own.

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  1. School of Business, Penn State University, Harrisburg, USA

    Nihal Bayraktar

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Bayraktar, N. Effectiveness of public investment on growth in sub-Saharan Africa. Eurasian Econ Rev 9, 421–457 (2019). https://doi.org/10.1007/s40822-018-0119-z

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