Links between infra & growth

Source: The post is based on an article “Links between infra & growth” published in the Business Standard on 10^th July 2022.

Syllabus: GS 3 Indian Economy; Infrastructure; Investment models

Relevance: Issues in Infrastructure Investment in India

News: In the 1990s, India removed barriers to globalization and opened the country to the outside world. This unleashed the growth episode of 1991-2011.  However, in recent periods, the high infrastructure investment is not producing the same result.

In 1991, India left behind its policies around themes of autarky (Self-reliance) and hostility to the West. During 1991-2011, the performance of the Indian economy was good compared to the past. Many theories claim that infrastructure development was the sole factor behind this development and that India should continue to do so.

What are the past arguments for the link between infrastructure and economic growth?

Example: Most global production takes place in “global value chains”. Production takes place step by step at cost-efficient global locations, where Multi-National Companies (MNCs) set up their base.

In the case of India, low wages, are the attractive factor, thus, India has many companies in the hinterland. Now companies require ports/airports to deliver goods to India, and then roads to production sites with low wages.

Thus, the above example suggests that connectivity to remote locations with low-wage labor will create conditions for private investment and then sustained employment.

What are the issues in the above-mentioned theory?

Infrastructure investment is just a means to an end, that creates conditions in which private investment can create employment growth. Private investment is the key to domestic product growth, prosperity, and employment. Thus, Infrastructure investment is impactful when it is followed by private investment.

If we take an example of India, in the early years, many commendable steps were taken. The government ended state control and established institutional apparatus to improve infrastructure. It led to the constitution of the NHAI (National High Authority of India), Delhi Metro Rail Corporations, Cochin airport, Jawaharlal Nehru Port Trust, etc. Thereafter, the government pushed significant capital into these mechanisms. It all resulted in the following developments:

1. The metro cities like Bombay and Delhi have decent airports and some metro lines.
2. Remarkable surge in highway commissioning in the last six years.
3. As a result of airway infrastructure, the plane ticket prices have come down and the middle class is flying.
4. The improvement in telecom infrastructure like decent bandwidth has led to the growth of IT and ITES industries.

In the 1990s, transportation was a constraint. The development of infra then created a new set of possibilities for private investment in global value chains. But, it is not the case today.

However, since 2011, infrastructure growth has not resulted in growing private investment. Instead, Pvt. Investment is on the decline, since 2011. Reduced cost of transportation is definitely one of the factors, but not the only factor behind the development of the private investment.

What are the factors that suggest against state-led infrastructure development?

First, if a private company feels that it can make money by building an asset, it can take the risk and build an asset.

Second, state-led infrastructure development in India is facing the Chinese problem of declining incremental capital-output ratio. It means each investment is giving a lesser return to the government. Furthermore, every Rs 1 spent by the government imposes a cost of perhaps Rs 3 upon the economy.

Third, the factors that are leading to the low private investment are the following:

1. An interventionist state in India, which indulge in sudden policy change.
2. Faults in the taxation system.
3. Lack of rule of law followed by coercive state agencies, such as regulators.
4. The wage remains high in many pockets of the population, probably because the labour supply has been distorted due to the welfare programs.
5. Many non-economic factors like social issues hamper women’s labour supply in the labour market.

Thus, instead of state-led infra development, government should focus on other aspects that are hindering growth.