Thursday, January 12, 2012

Beyond Keynesianism: global infrastructure investments in times of crisis

As the world recovers only slowly from the 2008 financial crisis and Europe is facing a looming debt crisis, concerns have increased that the "new normal" -- a period of high unemployment, low returns on investment, high risks, and low growth -- may become protracted in advanced economies. If growth remains weak, unemployment rates and debt levels will be slow to recede. Consequently, the global recovery may continue to be fragile for years to come. What the world needs now is a growth-lifting strategy. 

This strategy could take the form of a global infrastructure initiative. Since debt levels are high, governments in the United States and Europe could increase demand and support growth through investments in bottleneck-releasing infrastructure projects that are self-financing. An infrastructure initiative should, however, go beyond the borders of advanced countries and include developing countries. Economic and social returns to infrastructure investments tend to be high in developing countries, which have become increasingly important drivers of global growth.  At the same time, infrastructure investments require capital goods, most of which are produced in high-income countries. Scaling up infrastructure investment in developing countries could therefore help generate a virtuous cycle in support of a global recovery.
Although the financial crisis of 2008 officially came to an end in the United States in June 20092, its repercussions continue to be felt across the globe. In many advanced economies, industrial production lingers below pre-crisis levels. Unemployment remains stubbornly high and balance sheets of governments, European financial institutions and U.S. households continue to be weak. In continental Europe’s highly-indebted economies, a crisis of confidence has led to plummeting stock markets and widening spreads. Signs of vulnerability are also surging in emerging market economies. The anxiety over a weak global growth outlook is rising. World growth is expected to slow down from 4 percent in 2010 to around 2.5 percent through 2012, as growth in advanced economies is projected to contract (World Bank 2012). The combination of excess capacity, low returns on investment, high risks and lower growth in advanced economies has been referred to as the ―new normal.‖3 If this ―new normal‖ becomes entrenched, several advanced countries may face a lost decade4—with negative consequences for the entire world.

What the world needs now is a growth lifting strategy. With a looming public debt crisis in Europe and high public debt levels in the U.S., the private sector should ideally become the driver of growth; however, as long as excess capacity persists and investment risks remain high, private sector investment is likely to remain subdued. In order to reduce debt levels, many governments have turned their attention to implementing austerity measures and structural reforms, but austerity measures bear the danger of further weakening growth and worsening unemployment. Structural reforms, while key to boosting growth in the medium term, will only gain traction once demand increases. This raises the question of how governments can support demand and employment without adding further to debt levels in the medium run. Investments in green technology, education, and infrastructure come to mind. Under current economic circumstances, however, investing in bottleneck-releasing infrastructure projects that are self-financing may be the best option. Infrastructure investments create jobs in sectors such as construction and manufacturing, which have been hit hard by the crisis, while also enhancing countries’ future competitiveness and growth. In addition, countries could explore innovative financing mechanisms to bring in the private sector and minimize the impact of these investments on the public debt burden.

Any growth lifting strategy would need to encompass developing countries which have become increasingly important drivers of global economic growth. Opportunities for investing in bottleneck-releasing infrastructure are limited in advanced economies, which on average tend to already have rather well developed infrastructure. As discussed below, infrastructure needs in developing countries are large and lack of infrastructure is often a key bottleneck to growth. Since infrastructure projects require capital goods, many of which are produced in advanced economies, infrastructure investments in developing countries would also support the manufacturing sector in advanced economies. In addition, as growth in developing countries is lifted, their demand for products produced in advanced economies would increase further, possibly triggering a virtuous circle of mutually reinforcing growth.

In the aftermath of the recent crisis, several economists and politicians have expressed skepticism that Keynesian-type stimulus really works. A global infrastructure investment initiative, which scales up bottleneck-releasing infrastructure projects in advanced as well as developing countries, would go beyond the traditional Keynesianism stimulus along several key dimensions. First, instead of increasing government spending in times of crisis ―by digging a hole and filling a hole,‖ it emphasizes that any growth-lifting solution should focus on implementing bottleneck-releasing investments which will not only increase demand in the short-term but also raise longer term growth prospects. Second, the traditional Keynesian stimulus directs spending toward the domestic economy, while this proposal recommends a globally coordinated investment initiative. Finally, a global infrastructure initiative would not necessarily be financed through additional government spending. The government could, however, use existing financial resources, technical assistance and improvements in policies and the institutional environment to make infrastructure projects more attractive for private investors.

World Bank. Author: Lin, Justin Yifu ; Doemeland, Doerte. Document Date: 2012/01/01.Document Type: Policy Research Working Paper.Report Number:WPS5940

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