Public Investment and Growth in The

Public Investment and Growth in The

AfDB 2016 www.afdb.org Working Paper North Africa Policy Series CONTENTS Public Investment and Growth in the Introduction p.2 I – Historical Evolution of Maghreb Countries Public Investment in the Maghreb Countries p.3 II – Measuring the Effects of Public Investment on Key Messages Growth p.8 II-1 Empirical Methodology p.8 In the wake of the Arab Spring, governments in the Maghreb countries have found themselves forced to undertake major economic and social reforms aiming at alleviating poverty, creating equal opportunities, and achieving higher growth and a II-2 Results p.9 better standard of living. One of the main obstacles facing some of these countries is the significant decline in foreign direct II-2.2.1 IV estimation p.9 investment that they suffered as a result of higher uncertainty. II-2.2.2 GMM estimation p.9 II-2.2.3 Estimation results with In this context, a natural question is whether governments of the Maghreb countries should increase public investment in lagged investment ratios p.10 order to fill the investment gap, in a context where social spending has often increased sharply constraining the fiscal space available. III – Public Investment as a Catalyst to Private Investment This study shows that public investment enhances growth via an indirect channel whereby it acts as a catalyst to private p.11 investment. Public investment makes it possible to indirectly enhance job creation by the private sector and support the social and economic transformation of the region in the long term. This investment should be strengthened to achieve the III-1 How does public long term development objectives even if budgetary constraints exist in the short term. investment affect private investment? p.11 In addition to the extent that policymakers’ objective is to maximize long-run growth, the policy recommendations in terms III-2 How does the interaction of public investment can be summarized as follows: of private and public investment affect growth? p.11 • Governments in the Maghreb countries should target sectors in which public investment is least likely to crowd out private investment. These include: transportation infrastructure, public transit, water and energy infrastructure, education, and IV – Conclusion and Policy health. Implications p.13 • Private provision of infrastructure should be encouraged by giving fiscal and non-fiscal incentives to private companies Appendix p.14 to enter into public-private partnerships. A - Estimating the effects of public investment on growth • Public investment should not only target new projects but also the adequate and effective maintenance of existing capital. p.14 • Given the relatively high level of public debt in the Maghreb countries, they should strike a balance between increasing B - Public Investment as a public investment and maintaining a sustainable level of indebtedness. Catalyst to Private Investment p.18 Bibliography p.20 Jacob Kolster This paper was prepared by Hafedh Bouakez (HEC Montréal and CIRPÉE) and Sami Dabbegh (Tunisia Polytechnic School - Director ORNA University of Carthage), under the supervision of Vincent Castel ( Chief Country Economist, ORNA ) with the support of [email protected] Samia Mansour. Overall guidance was received from Jacob Kolster (Director, ORNA). +216 7110 2065 This document was prepared by the African Development Bank (AfDB). Designations employed in this publication do not imply the expression of any opinion on the part of the institution concerning the legal status of any country, or the limitation of its frontier. While efforts have been made to present reliable information, the AfDB accepts no responsibility whatsoever for any consequences of its use. African Development Bank Working Paper AfDB North Africa Policy Series 2016 • www.afdb.org Introduction n the wake of the episode of unrest that erupted in Tunisia in January Autoregressions or Vector Error Correction Models to estimate I2011 before spreading to a number of North African countries, the dynamic effects of public capital (and in some cases public governments in the Maghreb countries have found themselves forced investment) shocks on output or output growth (e.g., Pereira (2000), to undertake major economic and social reforms aiming at alleviating Everaert (2003), Kamps (2004b), Pereria and Andraz (2005, 2012), poverty, creating equal opportunities, and achieving higher growth Agénor et al. (2006), etc.). They generally find that shocks to public and a better standard of living. One of the main obstacles facing investment affect output positively and significantly. A third strand some of these countries is the significant decline in foreign direct of literature estimates cross-country growth regressions, allowing investment (FDI) that they suffered as a result of higher uncertainty public investment to be one of the explanatory variables. This at the level of the North Africa region. For instance, FDI inflows fell approach yields mixed results regarding the effect of public from US$2,300 million in 2010 to US$1,500 million in 2012 in Algeria investment on growth: Easterly and Rebelo (1993) find a positive and from US$1,334 millions in 2010 to US$432 million in 2011 in effect while Devarajan et al. (1996) and Milbourne et al. (2003) report Tunisia 1. At the same time, the financing capacity of the domestic a negative one. banking sector, which was already insufficient to fulfill the investment needs in this region of the world, was further hindered by a Perhaps surprisingly, the bulk of existing empirical work on the growth sluggish . implications of public investment has focused almost exclusively on developed economies, thus neglecting the group of countries for In this context, a natural question is whether governments of the which the issue is most relevant, i.e., developing countries 3. The latter Maghreb countries should increase public investment in order to fill the are indeed less likely to rely on technological progress or human gap left by capital outflows. Proponents of such a policy argue that capital to achieve economic growth, compared to advanced governments should take advantage of the low-interest-rate economies. By focusing on the Maghreb countries, our project aims environment that continues to prevail to borrow at a low cost and invest to contribute to fill this gap in the empirical literature. in infrastructure. Opponents of this policy choice, on the other hand, invoke the additional debt burden brought about by higher public Our analysis is based on the estimation of a dynamic panel growth spending, the possibility that public investment may actually crowd out equation that includes public investment in addition to a familiar set private investment ―which would be detrimental for growth, and the of explanatory variables, such as the level of financial development, inefficiency that has historically plagued state-owned enterprises in the school enrollment rates, openness, and life expectancy at birth. In Maghreb countries. order to deal with reverse causality and simultaneity problems, we estimate the equation using the method of Instrumental Variables and The goal of this paper is to empirically investigate whether public the Generalized Method of Moments. Our results provide no evidence investment stimulates growth in the Maghreb countries. The question that public investment in infrastructure has a direct positive effect on of whether capital accumulation by the public sector is productive growth in the Maghreb countries. Depending on the set of explanatory has received considerable interest in the empirical literature. Building variables taken into consideration, the estimated coefficient of public on the original work of Aschauer (1989), several studies estimated, investment is either negative or positive but statistically insignificant. within a production-function framework, a large positive elasticity Yet, we find that public investment enhances growth via an indirect of output with respect to public capital (e.g., Munnel (1990a), Fernald channel whereby it acts as a catalyst to private investment. This result (1993), De Frutos and Pereira (1993), Canning et al. (1994), Esfahani is corroborated by the strong and robust evidence that public and Ramirez (2003), etc.) 2. Other researchers instead used Vector investment crowds in private investment in the Maghreb countries. 1 United Nations Council of Trade and Development (UNCTAD). 2 See Sturm et al (1998), Romp and de Haan (2007), Pereira and Andraz (2013), and Bom and Ligthart (2013) for critical surveys of these studies. 3 Notable exceptions include papers by Agénor et al. (2006) and Cavallo and Daude (2011). 2 African Development Bank Working Paper North Africa Policy Series AfDB 2016 • www.afdb.org The rest of the paper is organized as follows. Section 1 presents some discusses the role of public investment as a catalyst to private empirical facts about public investment in the Maghreb countries. investment. Section 4 concludes and discusses some policy Section 2 discusses the estimation strategy and results. Section 3 implications. 3 African Development Bank Working Paper AfDB North Africa Policy Series 2016 • www.afdb.org I. Historical Evolution of Public Investment in the Maghreb Countries efore proceeding with the formal analysis of the effects of public evolution of public investment, which fluctuated between 6% and 8% Binvestment on economic growth, it is instructive to take a of GDP. preliminary look at the historical evolution of public investment on infrastructure in the

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