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Public Capital and Infrastructure

So far, this discussion has treated investment as an entirely private matter, with individual investors competing for returns from investment opportunities. However, in reality the public sector is clearly responsible for many investment decisions – particularly in infrastructure. This section looks briefly at the large economic literature that considers public capital and productivity from a macroeconomic point of view. The main concern of this literature is the degree to which public capital in aggregate contributes to economic growth and productivity.[24] (There is, of course, also a huge literature on the microeconomics and regulation of investment in various sectors such as water, gas, electricity, transport, etc.)

How big is the public capital stock? 

One estimate suggests New Zealand’s public capital stock may be larger than the OECD average

Kamps (2006) estimates public capital stocks for 22 OECD countries, reported in Figure 10, which shows New Zealand with a fairly high level of public capital per capita: 5% above the OECD average and 13% above the OECD median. This data does, however, have to be treated with caution as Kamps’ estimates look to include investment of non-financial public enterprises in New Zealand but not in most other countries, including Australia. Kamps also reports that most of the 22 countries have experienced declining levels of public capital relative to GDP in recent decades. According to this data, New Zealand’s decline began in the early 1990s. This partly reflects New Zealand’s GDP, which accelerated about this time.

Public investment is often measured by cost, not by quality.  This makes it hard to judge the true size of the public capital stock

Comparisons of public investment and capital stocks across countries should be taken even more cautiously than estimates of overall capital stocks. The value of public investment is typically calculated in national accounts data based on public expenditures; while there is a theoretical case for equating investment expenditure with productive value in the case of private markets – specifically, private investors under the pressure of competition should only be willing to invest the value of what they will get out of the project – this often breaks down in the case of public investment due to inefficiencies and political considerations (Pritchett 1996). To give a stark example, sometimes public investment goes to projects that boost productivity and output, and sometimes public investment goes to “white elephants”; the kind of comparison shown in Figure 10 is unable to account for this. If country A has a lower proportion of white elephants than country B, then the true value of country B’s capital stock will be overstated. This type of overstatement may be partly the case in Japan (the country with the largest public capital stock according to Figure 10), which invested heavily in infrastructure in the 1990s, but often with the goal of choosing productive projects eclipsed by the goal of stimulating aggregate demand. It may also have been the case in New Zealand in the 1970s and early 1980s when (some) poor quality government investments boosted total investment as a share of GDP to over 30 percent (Figure 1).

Figure 10: Public Capital Stock Per Capita – OECD Countries, 2000
Figure 10: Public Capital Stock Per Capita – OECD Countries, 2000.
Source: Kamps (2006)

How much does the public capital stock contribute to productivity and growth?

Most international research finds a significant link between public capital and productivity

Ligthart and Suarez (2005) review 49 empirical studies on the link between public capital and economic growth. Not surprisingly, the strength of the link varies across countries and time periods. Overall, the many studies find a significant but not overwhelming effect of public capital on output: a one percentage point increase in investment adds 0.14% to GDP. This type of empirical analysis is complicated by the increasing-returns-to-scale nature of much infrastructure. That is, much infrastructure has network externalities: road systems, communications systems and electricity systems become more productive as they become larger. Much of the literature focuses on the concept of an “optimal” public capital stock. The idea is that any boost to aggregate productivity from new public investment should be weighed against any reductions in productivity associated with taxation (or borrowing) and the diversion of resources from other uses. However, the aggregate growth effect of taxation is a significant area of debate in its own right.

Kamps (2006) estimates the elasticity of aggregate output with respect to public capital for the entire period stretching from the early 1960s to the beginning of this decade. He finds that, for the OECD as a whole, a one percentage point increase in investment adds 0.2% to GDP. For New Zealand, however, he is unable to find evidence that increases add to GDP. This result should not be taken as an indication that the public capital stock is not productive in New Zealand; instead it hints that, given the existing level of public capital during this period, additional increments may not have had any effect.

There are few specific policy lessons that can be drawn from analysis of the aggregate public capital stock.  With infrastructure, the devil is in the details

Three recent reviews of the public capital literature conclude that the analysis at the aggregate level is probably too broad-brush to allow for concrete policy predictions (Prud’homme 2004, Romp and de Haan 2007, Straub 2008). In particular, the aggregate perspective is not well suited to addressing questions about the composition of public capital or the location of the border between private and public capital. These questions tend to differ in specific sub-sectoral details: for example, some countries have private ownership of electricity generation but not transmission (as is the case in New Zealand) while others (such as the UK) allow for private ownership of both. There is no substitute for close study of the microeconomics of public capital on a sector-by-sector basis.

Government policy has a role to play in ensuring efficient use of infrastructure. Subjecting public infrastructure spending proposals to the discipline of cost-benefit analysis is critical to ensure that funding is directed to the projects that are fit for purpose and offer the greatest benefits to the community. In addition, good regulation is vital while implementation of appropriate charging structures will both raise revenue from those who benefit from the investment and ration the infrastructure to those who generate the highest value added from using it.

Notes

  • [24]Like much of the literature, this section often talks about public capital and infrastructure in the same breath because governments traditionally play a large role in infrastructure investment. However, it is important to remember that private infrastructure investment has grown in importance in recent decades (for example, in electricity generation).
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