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J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 9(3), 440-466
FALL 1997
PUBLIC INVESTMENT, PRODUCTIVITY, AND
ECONOMIC GROWTH IN DEVELOPING COUNTRIES
Mohsin S. Khan and Manmohan S. Kumar*
ABSTRACT. This paper estimates a neoclassical model of growth in which investment is
separated into its public and private components. Estimates are also obtained for the effects
of public and private investment on total factor productivity. The paper then examines
whether the speed of convergence in real per capita incomes across developing countries is
influenced by the shares of the two types of investment. The results show that both public
and private investment have different effects on economic growth and productivity -- a
relatively high share of public investment is associated with a decrease in the speed of
convergence.
INTRODUCTION
The role of public sector investment in determining private sector
productivity and long-run economic growth has been the subject of a number
of recent studies (Aschauer, 1989a, 1989b; Ford and Poret, 1991; Munnell,
1990; Rubin, 1991). This interest has been marked in industrial countries,
particularly in the United States, where the productivity slowdown after the
first oil-price shock in 1973-74 has been regarded as due, in part, to
inadequate public investment in infrastructure (Munnell, 1990). In the case
of developing countries, the respective roles of public and private investment
in the growth process have come under increasing scrutiny. The conventional
wisdom is that in these countries public investment in infrastructure and in
human capital formation is likely to increase the productivity of private capital
and have a beneficial
_______________
* Mohsin S. Khan, Ph.D., and Manmohan S. Kumar, Ph.D., are in the
International Monetary Fund.
Dr. Khan's research interest is in
macroeconomics of developing countries. Dr. Kumar's research interest is in
finance in emerging capital markets.
Copyright © 1997 by PrAcademics Press
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
441
effect on growth. But, equally, public investment expenditures can crowd out
private investment by using scarce resources and thus have an adverse effect
on growth.
At the empirical level, a number of studies on developing countries have
concluded that public investment has a smaller impact on growth than does
private investment (Coutinho and Gallo, 1991; Khan and Kumar, 1993;
Serven and Solimano, 1990). Others maintain that this effect may even be
negative (Khan and Reinhart, 1990). However, these studies have not looked
specifically at the effects of the components of investment on total factor
productivity. Also, to examine the relative effects of public and private
investment, a number of other important issues related to differences in the
two components of investment across developing country regions or across
countries in different income groups need to be considered.
From a policy perspective, if public investment does have a weaker
impact on growth than private investment, it would highlight the need to
rationalize public investment and the privatization of state-owned activities.
From a theoretical perspective, if public and private investment have
differential impacts on growth, there would be important implications for the
determination of the steady-state growth path as well as for the convergence
of real per capita incomes. (1)
The empirical analysis in this paper covers a sample of 95 developing
countries for the period 1970-90. The large sample allows for tests of the
hypothesis that there are marked differences in the effects of the two
components of investment on growth and productivity for four developing
country regions--Africa, Asia, Europe and the Middle East, and Latin
America. Such an examination is of considerable interest in view of the
marked differences in the performance of developing countries during the last
two decades. Asian countries, for instance, have in general had a significantly
superior performance compared to African or Latin American countries (see
Kumar, 1992; Ossa, 1990). To the extent that the steady-state conditions
underlying the differential growth performance--reflecting, for example, the
rate of technological change and population growth--are likely to be more
similar across developing countries, looking specifically at these countries can
yield additional insights into the process of convergence.(2)
This article will first note the extent to which public and private
investment may be complements or substitutes in developing countries, and
describe the estimation equations used in the empirical analysis. Second, the
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KHAN & KUMAR
effect of public and private investment on growth as well as on total factor
productivity will be empirically analyzed. Third, it will examine the
implications of the results, in particular of the differential impact of public and
private investment, for the speed of convergence to a steady state. Lastly,
some concluding remarks will be made.
THE ROLE OF PUBLIC INVESTMENT
As indicated in Table 1, public sector investment in developing countries
during the 1970s and 1980s accounted for nearly half of total investment
(which was around 20% of GDP). This contrasts sharply with the situation
in the industrial countries where, during the 1980s, public investment
accounted for less than one-fifth of the total (of around 18% of GDP).(3) Of
course, since the requirements in developing countries for infrastructure and
related capital may have been greater than in the industrial countries, and
given the indivisibilities entailed in the provision of such capital, the share of
public investment in developing countries might be expected to be higher.
But these data do raise the issue of the efficiency of public sector investment
and its effect on output and productivity growth.
It could be argued that public investment in infrastructure, by being
complementary to private investment, could increase the marginal product of
private capital. (4) This is most likely to be so in those developing countries
where the existing stock of infrastructure capital is regarded as inadequate.
Nevertheless, it has become evident over the last few years that public
investment in infrastructure may not automatically have had a beneficial
impact. In many cases, political-bureaucratic motivations led to excessive
expenditures in infrastructure facilities. This occurred in part because the
concern was with maximizing employment than with creating these facilities
at low cost. Further, regional or other political considerations often resulted
in the uneconomic location, size, or even sector of the investment projects.
The above factors were reflected in several Latin American countries,
for instance, where many of the public infrastructure investment projects in
the late 1970s could not be justified on economic grounds. There were
examples of this in the 1980s in Asia and Africa as well, particularly in the
case of projects in the energy and transportation sectors (see, for instance,
Krueger and Orsmond, 1990).
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
443
444
KHAN & KUMAR
A significant proportion of public sector investment in developing
countries is also undertaken by state-owned enterprises. In most countries,
industrial policy and the regulatory framework have linked private sector
production directly to public sector activities both in goods and factor
markets. For instance, an expansion of the capacity of public enterprises to
produce industrial inputs--including production of basic metals, chemicals,
and so on--is necessary before the private sector can undertake investments
in sectors that are dependent on these basic inputs. On the other hand, given
the pervasive role of public enterprises in many countries, capacity expansion
by such enterprises can itself lead directly to an increase in private sector
investment to provide additional inputs. (5)
The above considerations suggest that while the public sector capital
stock may be complementary to the private sector and have a positive effect
on growth, its efficiency may be somewhat questionable. Moreover, in many
developing countries public sector enterprises compete directly with the
private sector in the provision of goods and services. In these cases, an
increase in public investment could have an adverse effect on private
investment both directly, as well as indirectly via the public sector budget
constraint. In the case of the latter, financing public investment by increasing
taxes, for instance, could further exacerbate distortions in the economy and
increase the costs of inputs, leading to an adverse effect on future output
growth and private investment. If financed by market borrowing, public
investment could have an adverse effect on both the cost and availability of
credit to the private sector.
In order to evaluate the differential impact of private and public sector
investment on growth, the empirical analysis undertaken in this paper utilizes
a variant of the neoclassical growth model. In this well-known model, capital
accumulation, growth of labor force, and technical change are the key
determinants of real per capita income. The formal specification of the model
is as:
where Y and L denote real output and labor respectively,
á refers to the share of aggregate capital in income,
S is the aggregate saving (and investment) rate,
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
445
n and ã are respectively the exogenously given growth rate of labor and
technology,
ä denotes the rate of depreciation of the capital stock, and
å is an error term. (6)
The above model was extended by introducing separately public and
private capital stock. Assuming that both types of capital stock depreciate at
the same rate ä, real output per capita can be specified as follows:
where, in addition to the above variables, Sg and Sp now denote public and
private investment respectively, and á and â denote the shares of public and
private capital in income, respectively.
The specification of equations 1 and 2 assumes that all countries are at
their steady states. However, it is possible to extend equation 2 in a more
general way to assess the effects of various explanatory variables on per
capita growth, rather than on the level of income per capita.
Following Mankiw, Romer and Weil (1992), equation 2 can be
transformed into an equation for the steady- state growth path as follows:
where the left-hand side of the equation is now the growth of per capita
income, ë = [(n+ã+ä)(1-á-â)] is the speed of convergence, y(0) is income per
effective worker at some initial date, and the other variables are defined as
before.(7)
Equation 3 forms the basis for the empirical analysis of the effect of
public and private investment on per capita growth in this paper. However, in
view of the recent literature on growth, human capital--which has received
considerable emphasis in explaining cross-country differences in long-run
growth--was also incorporated as an explanatory variable.(8) Secondly,
macroeconomic instability, which has also been shown to adversely affect
446
KHAN & KUMAR
long-run growth, was taken into account in assessing the effect of the
different forms of investment. (9) This was done by introducing the average
value of budgetary deficits--one of the main indicators of macroeconomic
instability--as an additional explanatory variable. It should also be noted that
since high budgetary deficits are often associated with high public investment,
by excluding them from the empirical estimation, one may obtain biased
results of the effect of public investment on growth.
EMPIRICAL RESULTS
Equations 1 and 2 for the level of per capita real income are two of the
main estimating equations. The former equation provides a "reference" by
which the significance of the estimates obtained from equation 2 of the
impact of private and public sector investment can be assessed. Estimates
were also obtained for several variants of equation 3, which describes the
behavior of per capita growth of real income.
Determinants of Per Capita Real GDP
The main estimates of equations 1 and 2 are given in Table 2. These
results show the role of aggregate investment as well as of public and
private investment, population growth, and technological change during the
last two decades, in explaining the cross-country differences in the levels of
per capita real GDP in 1990. As noted earlier, while this framework assumes
that countries were in their respective steady states in 1990, still the estimates
do provide a useful starting point for an assessment of both the relevance of
the neoclassical model for developing countries, and the relative importance
of public and private sector investment. (10)
The first two columns in Table 2 correspond to equation 1, while
columns 3 and 4 correspond to equation 2. Consider first the former set of
results, which provide estimates of the basic neoclassical model with
aggregate investment. Column 1 shows that two basic variables—the
investment ratio and population growth--account for over 40 percent of the
variation in real per capita GDP in 1990 across the full sample of developing
countries. (11) The coefficients of the investment ratio as well as of population
growth have the expected signs and are highly significant.
The extent to which the importance of capital investment differs across
the four developing country regions of Africa, Asia, Latin America (including
Caribbean countries), and Europe and the Middle East is examined by
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
447
TABLE 2
Determinants of Real Income Per Capita(1)
____________________________________________________________
(1)
(2)
(3)
(4)
------------------------------------------------------------------------------------------Constant
3.20
-0.32
-2.63
0.41
(1.40)
(1.29)
(1.35)
(1.19)
Investment (total)
1.40(a)
(0.20)
Investment (public)
0.39(a)
(0.13)
Investment (private)
0.86(a)
(0.11)
Population and
-2.49(a) -1.44(a) -2.80(a) -1.63(a)
technical change
(0.52)
(0.47)
(0.50)
(0.44)
Investment dummies
Africa
(Total) (Public) (Private)
1.21(a)
0.41(a)
0.67(a)
(0.18)
(0.16)
(0.12)
Asia
1.35(a)
0.20
1.00(a)
(0.18)
(0.23)
(0.20)
Latin America
1.48(a)
0.20
1.17(a)
(0.18)
(0.18)
(0.16)
Middle East
1.46(a)
0.85(a)
0.54(a)
(0.17)
(0.17)
(0.21)
R
-2
0.45
0.62
0.50
0.67
S.E.E.
(0.60)
(0.51)
(0.59)
(0.47)
___________________________________________________________
(1) For detailed description of the data see the Appendix. Standard errors
are given in brackets; (a) denotes statistically significant at the 5 percent
level.
including slope dummies for total investment for each of the regions. (12) The
results in Column 2, which allow for slope differences, indicate a considerable
improvement in the overall fit of the equation, which now explains over
60 percent of the variation in the 1990 per capita real income. While each of
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KHAN & KUMAR
the slope dummy variables is statistically significant, the coefficients across
regions show large variation. For instance, for Africa, the coefficient of
investment is around 1.20, whereas for the Middle East and Latin America it
is around 1.45, suggesting a marked difference both in the efficiency of
investment, and in the share of capital in total income.
The differential effect of public and private sector investment is
examined in columns 3 and 4 of Table 2. The first of these columns shows
that there is a very large difference between public and private investment in
explaining the cross-country levels of per capita real GDP. Specifically, the
coefficient on private investment is twice as large as that on public
investment, and highly significant, whereas public sector investment has a
more limited impact. Thus, the hypothesis that public and private sector
investment have a similar impact is decisively rejected.
The differential impact of the two components of investment across the
four developing country regions is examined in column 4 by introducing slope
dummies for each of the regions for both public and private sector
investment. The equation now explains nearly two-thirds of the crosscountry variation in per capita real GDP. The impact of private sector
investment is statistically significant for all regions, although it differs widely
across them, with the largest impact in Asian and Latin American countries.
On the other hand, in all regions, except Europe and the Middle East, public
sector investment has a markedly smaller impact; the coefficient in fact is not
significantly different from zero for Asian and Latin American countries.
Determinants of Per Capita Real Growth
A more realistic framework is to consider the transition to the steady
state and the roles played by public and private sector investment. This is
undertaken by estimating equation 3, which allows for an investigation of the
convergence issue. The dependent variable now is the growth of per capita
real GDP in developing countries.
The basic results obtained by estimating equation 3, with aggregate
investment as the main explanatory variable for the period 1970-90 and the
two sub-periods--1970-80 and 1980-90--are provided in Table 3. Column 1
shows that nearly a third of the cross-country variation in per capita GDP
growth over the 20-year period is explained by the aggregate investment ratio,
initial per capita real income, and population growth, and all the variables
have the expected signs and are statistically significant. The first variable of
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
449
key interest is the initial income variable, which yields a rate of convergence
of 0.01. This last result implies that once the cross-country variation in the
investment and population growth variables is taken into account, the poorer
developing countries (measured by their per capita income in 1970) narrowed
the gap between them and the richer countries at a rate of one percent a
year.(13) This is a somewhat higher rate than that obtained in existing studies
which are based on a combined sample of developing and industrial
countries. (14)
The second variable of special interest is the investment ratio. The
coefficient of this variable suggests that a one percentage point increase in the
investment ratio across developing countries is associated with an increase in
per capita GDP of three-quarters of a percentage point. This is again
somewhat larger than the value reported in the earlier studies.
Next, consider the separate roles played by public and private sector
investment in determining per capita growth. As indicated in column 4 of
Table 3, for the period 1970 to 1990, while both types of investment had a
positive impact, their magnitude differed considerably, with private
investment having a much stronger impact than public sector investment.
However, there are marked differences between the two sub-periods.
For instance, during the 1970s, both public and private investment had a
similar effect and it was only during the 1980s that the greater impact of
private sector investment emerged. It could be argued that in the earlier
period the stock of infrastructural capital was lower in most developing
countries, and thus the returns from such investment were higher. This
would suggest greater complementarity between private and public investment
than may have been the case during the last decade.(15)
Finally, consider two additional sets of variables, which the earlier
discussion noted could be expected to have an impact in explaining the crosscountry differences in per capita GDP growth. The first is the stock of
human capital, which is measured by the proportion of population with school
enrollment at the secondary school level, at the beginning of the period.(16)
The second variable is the government's budgetary balance. As Column 7 in
Table 3 shows, for the period 1970-90, both variables have a positive and
statistically significant coefficient suggesting that the higher the school
enrollment or fiscal balance (that is, the lower the fiscal deficit), other things
equal, the higher the subsequent growth in per capita real income.
450
KHAN & KUMAR
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
451
Two-Stage Least Squares Estimates and Panel Data
There are two types of extension that can be made to the above analysis.
The first is econometric and arises from the fact that since the estimation
procedure does not take into account the correlation between the right-handside variables, such as private investment and the error term, the estimates
could be biased and inconsistent. The reason for using OLS is that, as
Madalla (1977), and Chow (1983) have emphasized, other techniques are
much more sensitive to model mispecification; in that sense OLS is robust.
Nevertheless, in order to examine whether using alternative estimation
procedures alters the results in any marked manner, estimates using TwoStage Least Squares (TSLS) were also obtained.
A second extension concerns the use of cross-sectional data. It could be
argued that the use of these data means that information on the dynamics of
the growth process is not taken into account. It should be noted, however,
that the main issues examined in the paper are more appropriately
examined in a cross-sectional context; for instance, the issue of convergence
of per-capita incomes across countries is by definition concerned with
differences in the long-run growth rates across countries. Nevertheless, the
relationship between public and private investment and growth was examined
using pooled time-series cross-section data to assess the robustness of the
results reported above.(17)
The results from using TSLS, which are shown in Table 4, suggest
conclusions that are broadly similar to those obtained using the OLS. There
is clear evidence of convergence, but the speed of convergence is lower.
Private investment has a decidedly higher impact on growth compared to
public investment, and the human capital variable has a positive coefficient
that is not statistically significant.
With regard to the use of panel data, there are two additional issues that
should be noted. The first is the period over which the time series data are
averaged--since the use of annual data would be clearly inappropriate for
analyzing the growth process and in any case would exhibit excessive noise.
The procedure adopted was to average growth over a period ranging from 3
to 5 years. (18) This is a more general procedure than that used in the literature
where growth has been arbitrarily averaged over five-year periods. The
second issue concerns the use of specific model estimation procedures for
panel data: the results presented use OLS on full sample.(19)
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KHAN & KUMAR
Since the panel procedures assume common slope coefficients for all
observations, they are rather restrictive. Nevertheless, even with this
restriction, the results presented for the three- and five-year horizons
reinforce the earlier findings using cross-sectional data (Table 4, columns 3 to
6). A number of additional interesting results also emerge. For instance,
given the shorter time horizon, there is now virtually no relationship between
initial GDP and subsequent growth. The human capital variable, while
positive, still has a statistically insignificant effect. The result that stands out is
the relatively similar effect of private and public investment have on growth in
Asia, and the Europe and Middle East region. In these regions it would
appear that in the short run public investment can provide a boost to growth,
much as does private investment, but this effect is not sustained over time.
Effects on Productivity
As noted earlier, the two main channels through which public investment
may affect growth is by influencing factor accumulation and by promoting
or hindering the efficiency of resource use. While there has been
considerable discussion of how public investment may affect private
investment in developing countries, its effect on the efficiency of resource use
has been analyzed much less. If public investment in infrastructure is
complementary to private investment, one would expect to see a positive
relationship between economy-wide efficiency and the share of public
investment in total investment. If, however, public investment resources are
misallocated or are utilized suboptimally, they may have only a limited, or
even a negative, effect on efficiency.
A commonly used proxy for efficiency of resource use is total factor
productivity (TFP), obtained residually as that part of output growth not
accounted for by changes in capital and labor (that is, the “Solow residuals”).
As shown by the International Monetary Fund (1993), growth in TFP has
accounted for over a quarter of overall growth in developing countries over
the last two decades, and over a third of the growth in the fastest-growing
developing countries. Despite the importance of this factor, there has been
limited analysis of the determinants of long-run TFP in developing countries
generally, and more specifically the relationship between economy-wide
efficiency and the share of public investment in the total. The studies that
have tried to address this issue have found a negative relationship between
total government expenditures (consumption plus investment) and proxies for
efficiency, such as incremental capital-output ratios (Gallagher, 1991; King
and Levine, 1992; Odedokun, 1992),(20) but they have not looked at the
efficiency effects of public investment.
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
453
TABLE 4
Public and Private Investment: TSLS and Panel Data Results(1)
___________________________________________________________
Two-stage least squares
Panel data
3 years
5 years
(1)
(2)
(3)
(4)
------------------------------------------------------------------------------------------Constant
-9.08(a)
-8.01(a)
-0.38(a)
-0.53(a)
(2.62)
(0.61)
(0.14)
(0.20)
Initial per per capita
GDP
0.13
(0.13)
-0.16
(0.12)
-0.003
(0.01)
-0.001
(0.10)
Population and
Technical change
-3.21(a)
(0.89)
-2.10(a)
(0.10)
-0.11(a)
(0.04)
-0.15(a)
(0.07)
Human capital(2)
0.02
(0.01)
0.003
(0.01)
0.001
(0.01)
Trade orientation
0.32
(0.36)
Foreign direct
investment
0.03
(0.05)
0.01
(0.02)
0.54(a)
(0.18)
0.05(a)
(0.01)
0.06(a)
(0.01)
0.19(b)
(0.12)
0.02(a)
(0.01)
0.02(b)
(0.01)
Asia
0.13
(0.20)
0.05(a)
(0.01)
0.06(a)
(0.02)
Latin America
0.08
(0.14)
0.01
(0.01)
0.01
(0.01)
0.12
(0.19)
0.04(a)
(0.01)
0.04(a)
(0.01)
0.37
0.12
0.12
Private investment
0.57(a)
(0.28)
Public investment
0.36(a)
(0.13)
Dummies:
Africa
Middle East and Europe
R2
0.25
0.02
(0.04)
S.E.E.
(0.27)
(0.33)
(0.13)
(0.16)
________________________________________________________________
(1)The Panel data results, in Columns 3 and 4 use data averaged over 3 years (6 observations per
country) and 5 years (4 observations per country). (a) and (b) denote statistically significant at the 5
and 10 percent level. (2) Secondary school enrollment ratio .
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KHAN & KUMAR
The relationship between TFP and the share of public and private
investment was investigated here in the context of an estimating equation
which takes into account other determinants of TFP. A number of studies
have examined the impact of macroeconomic variables on productivity
growth and found that the inflation rate, budget deficit, terms of trade, and
the degree of outward orientation of the economy appear to have some weak
influence on the overall rate of productivity growth (see Fischer, 1993; King
and Levine, 1992).(21) In view of these findings, the following equation was
estimated:
where TFP denotes average total factor productivity in any given country,
and Ð, TOT, X, and D denote inflation, terms of trade, degree of trade
orientation and debt to GDP ratios respectively; Sg and Sp as before denote
the shares of public and private investment.
The results of estimating this equation for the entire period 1970-1990,
as well as for the two sub-periods 1970-1980 and 1980-1990, are presented
in Table 5.(22) As indicated in column 1 of Table 5, for the period 1970 to
1990, while both public and private investment had a positive effect on
productivity, their magnitude differed markedly, with private investment
having a much stronger, and statistically significant, effect. The addition of
other explanatory variables, while improving the goodness-of-fit of the
equation, does not change this result markedly (column 3). As indicated in
columns 5 and 7, a similar result holds over the two sub-periods. However, it
is noticeable that in the second period, the difference between the effects of
the two types of investment is less marked although again it is only the effect
of private investment that is statistically significant.
IMPLICATIONS FOR THE SPEED OF CONVERGENCE
This section looks at the implications of the above empirical findings for
the speed of convergence among developing countries. Since private
investment appears to have had a considerably larger impact on per capita
growth than public investment, the steady-state growth rate of an economy
would increase in proportion to the share of private investment. However,
this result says very little about the speed with which the steady-state path is
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
455
attained, or the speed of convergence among countries. For instance, even if
the steady-state growth is significantly higher because of private investment,
the speed of transition towards this steady state, or the rate of convergence,
may remain unaffected.
From the policymaker's perspective, whether or not the speed can be
affected by policy changes may perhaps be as important as the effect of
policy changes on the growth path itself. This is so since the transition to an
optimal growth path, in the framework utilized above, is likely to last a
considerable length of time, and any measures that can speed up that process
would be regarded as highly desirable. Hence, in the literature on the
determinants of long-run growth and convergence, while the emphasis has
been mainly on factors determining the steady-state growth path, the issue of
the speed of transition has also received significant attention (see, for
example, Barro, 1991; Barro and Sala-i-Martin, 1992; Lucas, 1988; Mankiw,
Romer and Weil, 1992; Romer, 1989).
The methodology for examining this issue is to introduce an additional
regressor in equation 3, which is an interactive term consisting of the
product of the log of initial income and public investment ratio. The specific
form of this equation is as:
As suggested by equation 5 above, if the coefficient on this interactive
term, plus the coefficient on the initial income term, is smaller than that on
the initial income term alone (without the additional regressor), it would mean
that countries with more public investment have a higher speed of
convergence.(23) If the combined coefficient is unchanged, it would mean that
the share of public investment does not affect the speed of convergence. If,
however, it is larger, then public investment slows down the rate of
convergence. This procedure is then repeated with private investment and a
comparison is made of the speed of convergence.
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KHAN & KUMAR
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
457
The results of estimating equation (5) are given in Table 6. Column (1)
of this table indicates that without separating the impact of public and private
investment, the implied rate of convergence among the developing countries
was 0.013. However, as column 2 indicates, when the interactive term is
TABLE 6
Public and Private Investment and Speed of Convergence(1)
___________________________________________________________
(1)
(2)
(3)
-----------------------------------------------------------------------------------------Constant
-2.59(a) -3.34(a) -2.31(a)
(0.89)
(0.84)
(0.85)
Initial per Capita
GDP
-0.23(a)
(0.07)
-0.18(a)
(0.07)
-0.31(a)
(0.07)
Investment ratio
(total)
0.76(a)
(0.12)
1.01(a)
(0.16)
0.61(a)
(0.14)
-0.03(a)
Initial GDP and Public Investment
(0.01)
0.03(a)
Initial GDP and Private Investment
(0.01)
Population and technical Change
-0.79(a)
(0.32)
-0.89(a)
(0.31)
-0.92(a)
(0.32)
Human Capital
0.18(b)
(0.10)
0.17(b)
(0.09)
0.18
(0.11)
Implied rate of Convergence
0.013
0.01
0.017
R2
0.35
0.39
0.39
S.E.E.
(0.33)
(0.41)
(0.41)
___________________________________________________________
(1) The dependent variables is per capita GDP growth during 1970-90. For
other notes see Table 2.
458
KHAN & KUMAR
introduced, although the coefficient on this term is negative, the combined
effect (in terms of the coefficient on the initial income) is now smaller. This
yields a speed of convergence that is somewhat slower than the speed of
convergence without the interactive term. However, as column 3 shows
when a similar procedure is undertaken with private investment, although the
coefficient on private investment is positive, the net effect is greater. Thus an
increase in private investment increases the speed of convergence by around
a third compared to an increase in public investment.
CONCLUDING REMARKS
This paper has attempted to assess empirically the role of public and
private investment in explaining differences across developing countries in the
level of per capita real GDP, in real GDP growth, and in total factor
productivity. In the context of a neoclassical framework, the empirical
analysis provides clear evidence that during the last two decades, public
sector investment had a markedly smaller role in explaining cross-sectional
differences in growth and productivity than private investment. Although
there are significant regional differences in the impact of the two types of
investment, the broad results are robust to the use of panel, rather than crosssection, data and alternative estimation techniques. Moreover, the empirical
evidence not only suggests that the steady-state growth rate of an economy
may have increased in proportion to the share of private investment in the
total, but also that the speed with which the steady-state path was attained
may have been faster.
The above results suggest that there is a need to enhance the productivity
of public sector investment by identifying the types of investment that are
likely to have positive net returns. At the same time, measures should be
undertaken to remove impediments to private sector investment. This has
been done since the early 1990s by many developing countries that have
undertaken macroeconomic stabilization, as well as structural reforms in the
financial, labor, fiscal and trade sectors. A continuation of these reforms
would further reduce distortions, have positive incentive effects, and stimulate
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
459
private investment. This would in turn lead to faster economic growth and
increased economy-wide efficiency.
NOTES
1. In the recent literature on convergence of real per capita incomes across
countries, only the role of aggregate investment has been emphasized.
No attempt has been made to examine the respective roles of public and
private investment. See, for instance, Barro and Sala-i-Martin (1992);
Mankiw, Romer, and Weil (1992).
2. Existing studies have combined developing and industrial countries, and
thus their results are applicable to both groups; see Barro (1991) and
Barro and Sala-i-Martin (1992).
3. This is based on an unweighted average for the OECD countries,
excluding Turkey.
4. See Blejer and Khan (1984). For industrial countries, Aschauer (1989a,
1989b) finds that investment in infrastructure has had a very strong
positive effect on private sector productivity. However, these findings
remain controversial largely because the marginal productivity of
infrastructure implied by his estimates is considered implausibly high [see,
for example, Ford and Poret (1991), and Rubin (1991)].
5. See, for instance, Chibber and van Wijnbergen (1988), who show that in
Turkey in the 1980s, despite high real cost of capital, private investment
boomed because of public enterprise investment.
6. This equation can be derived from a Cobb-Douglas production function.
For details, see Khan and Kumar (1993).
7. For the derivation of equation (3) and the discussion of issues related to
the speed of convergence, see Khan and Kumar (1993).
8. For a discussion of the importance of human capital in the growth
process, see Barro (1991), Levine and Renelt (1992), and Lucas (1988).
9. For an analysis of the relationship between macroeconomic instability and
growth, see Fischer (1993), and Frenkel and Khan (1990).
10. The sample of countries and the data are described in the Appendix.
PUBLIC
460 INVESTMENT IN DEVELOPING COUNTRIES
460
KHAN & KUMAR
11. Standard errors based on White's (1980) heteroscedasticity-consistent
covariance matrix differed little from those obtained by OLS and reported
here.
12. The slope dummies take the value of the investment ratio for countries in
the given region and zero otherwise.
13. See Barro (1991) for the relationship between the rate of convergence,
and the speed with which the gap between rich and poor countries is
narrowed.
14. See, for example, Mankiw, Romer, and Weil (1992).
15. An analysis of the regional differences in the impact of public and private
investment on growth yielded results that were similar to the ones
obtained above concerning determinants of per capita GDP. For details,
see Khan and Kumar (1993).
16. This is similar to the proxy used by Barro (1991).
17. See Knight, Loayza, and Villanueva (1993) for a detailed discussion of
estimates of the basic Solow model using panel data.
18. When the average is for 3 years, there are 6 observations per country,
giving a pooled sample for the 95 countries of 570 observations. With a
5-year average, there are 4 observations per country giving a sample of
380 observations.
19. See Cheng (1986) for a discussion of the different procedures that could
be used to estimate the model.
20. The study by Gallagher only examined the African countries, while the
other two studies have examined a wider range of countries over the last
two decades.
21. Fischer (1993) finds that it is only in the case of pooled time series crosssection data, rather than in the cross-section regressions, that the effect of
inflation and budget deficit on productivity growth is significant,
concluding that the significant results mainly reflect the time-series
variation between these regressors and productivity growth.
22. The estimates of productivity residuals were obtained for each of the 95
countries in the sample for each year between 1970 and 1990, using
estimates of total capital stock obtained by applying the perpetual
inventory method, and labor force. The Solow residuals were computed
using a common Cobb-Douglas production function (see Appendix for
details).
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
461
23. From equation (5) it can be seen that the partial effect of initial income
on growth is given by two components: first, the coefficient on the initial
income variable by itself; and secondly, the coefficient on the initial
income variable times the share of public investment.
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APPENDIX
Sample and Data Definitions
1. Sample of developing countries
The sample consists of 95 developing countries divided into the
following four geographical regions:
a. Africa: Algeria, Benin, Botswana, Burkina Faso, Burundi,
Cameroon, Cape Verde, Central African Republic, Chad, Comoros,
Congo, Cote d'Ivoire, Djibouti, Equatorial Guinea, Ethiopia, Gabon,
Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia,
Madagascar, Malawi, Mali, Mauritius, Mauritania, Morocco, Niger,
Nigeria, Rwanda, Sao Tome and Principe, Senegal, Seychelles, Sierra
Leone, Somalia, Sudan, Swaziland, Tanzania, Togo, Tunisia, Uganda,
Zaire, Zambia, and Zimbabwe.
b. Asia: Bangladesh, China, Fiji, India, Indonesia, Korea, Malaysia,
Myanmar, Nepal, Pakistan, Papua New Guinea, Philippines, Sri Lanka,
and Thailand.
c. Latin America: Argentina, Barbados, Bolivia, Brazil, Chile, Colombia,
Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala,
Guyana, Haiti, Honduras, Jamaica, Mexico, Nicaragua, Panama,
Paraguay, Peru, Surinam, Trinidad and Tobago, and Venezuela.
d. Europe and Middle East: Cyprus, Egypt, Hungary, Jordan, Malta,
Oman, Poland, Syria, Turkey, Yemen, and Yugoslavia.
2. Data Definitions and Sources
y:
n:
I:
Ig :
real GDP per capita (in 1985 international prices);
population growth;
ratio of total fixed investment to GDP;
ratio of public sector fixed investment to GDP (public sector includes
general government, nonfinancial state enterprises, and principal
autonomous agencies);
Ip : ratio of private sector fixed investment to GDP;
Hs : gross enrollment ratio at secondary level; and
PUBLIC INVESTMENT IN DEVELOPING COUNTRIES
465
GBG : public sector balances as a percent of GDP.
For Tables 2 and 3, all ratios and growth rates are averages for the
period 1970-80, 1980-90, and 1970-90; Hs is for the beginning of each
period. In Table 4, the ratios are averages for 3 and 5 years, and H s is again
for the beginning of each period.
Data on y were obtained largely from Summers and Heston ((1988)
and (1991)) for the period up to 1985 and were extended to 1990 using per
capita growth rates from the IMF's World Economic Outlook (WEO)
database; for some low-income countries data were obtained from Ahmad
(1992). Data on n were obtained from the WEO database. Data on I, Ig, Ip,
Kg and Kp were obtained from the World Bank, supplemented by data from
the International Finance Corporation database on private investment and
from the WEO database. Data for H s for the period up to 1980 are from the
UNESCO publication "Trends and Projections of Enrollment by Level of
Education and by Age" (March 1983), and from UNESCO Statistical
Yearbooks thereafter.
Estimates of public and private capital stock were obtained using the
perpetual inventory method, data on public and private gross investment, and
estimates of initial capital stocks in 1960. The depreciation rate for the two
types of capital stock was assumed to be similar and varied between 4% and
5% per annum. Estimates for total factor productivity were obtained as
Solow residual using aggregate capital stock (public plus private) and labor
force. Calculation of the Solow residuals imposes a common Cobb-Douglas
production function across all developing countries in which the share of
capital is higher (0.4) than in the industrialized countries (see, IMF, 1993;
Fischer, 1993). An experimentation with the share of capital ranging from
0.35 to 0.45 yielded results that were very similar to those reported in the
text.