What can we learn from Brazil about optimizing infrastructure investment?

As they grow, countries need better transportation, energy, and communications networks. But how should a country go about prioritizing these investments? Are there synergies from coordinating them? Should they be done simultaneously or sequentially? Two recent World Bank studies focusing on Brazil, a country that has rolled out massive infrastructure investments over the past decades (Figure 1), address these questions. 

Figure 1: Changes in Brazil’s infrastructure Access (1970-2000)

1970

2000

Infrastructure investments matter and can achieve a lot if properly done.

Economists tell us that infrastructure is key to development. Not only is infrastructure crucial for people to go about their daily lives, but it also has major impacts on productivity (think, e.g., electrification of production) and access to markets (through faster and cheaper transportation of goods). Even more importantly, infrastructure investments are needed for countries to transition from agrarian to more diversified industrial and service-oriented economies, offering more economic opportunities to improve living standards and reduce poverty.

The impact of infrastructure investments may not necessarily benefit every location and can strongly vary. For example, some municipalities may lose workers to the benefit of others, or productivity increases may be limited by the skill level of local workers.

The extent of the impacts also depends on how well different infrastructure projects complement each other. For instance, places with big investments in electricity but weak or nonexistent transport connections to the rest of the world can only derive so much benefit resulting from the energy infrastructure. This is why projects should be strategically aligned with local economic advantages to maximize impact. It is often the case, however, that investment decisions prioritize political objectives over economic outcomes.

Key Insights from Brazil’s Infrastructure Investment

• Infrastructure complementarities can be large.

In Brazil, investments in different types of infrastructure types were not always well-coordinated. Our research finds that the joint provision of electricity and highways increased local GDP by 29 to 61 percent in affected municipalities. In line with this finding, we simulated an optimal plan of national investments in the quality of roads and electricity services. The government can achieve sizeable welfare gains by independently optimizing the provision of electricity (7.5 percent) or road (11 percent) investments relative to those observed in the data. However, a fully optimal plan that accounts for complementarities and coordination would increase consumer welfare even further by an additional 3.5 percent.   

• Impacts mostly percolate through productivity increases.

In the case of Brazil, we find that the increase in economic output following infrastructure investments was largely driven by productivity gains rather than labor and capital reallocation. Over a decade from 1970 to 1980, during which the bulk of infrastructure investments were made, electrification and highway provision boosted aggregate productivity in targeted municipalities by 18 and 44 percent, respectively, compared to municipalities that did not have access to electricity or highways. The productivity gains from electrification percolated mainly through the industrial sector, where the TFP was 86 percent larger than in unelectrified municipalities. The provision of electricity increased the industrial share of local GDP by 9.2 percent. These results show how infrastructure provision contributed to structural change towards more diversified and robust economic activities.

• Impact may have been reduced by misallocation.

A significant portion of the benefits of infrastructure provision may have been lost due to the misallocation of infrastructure investment. The reasons for misallocation can be diverse and include poor planning capacity, regional equalization policies, fiscal decentralization, deforestation prevention policies, and the complex political economy of infrastructure provision, among others. Understanding the impact of all of them requires further investigation.

Policy Implications for Developing Countries

The insights from Brazil’s experience with infrastructure investments offer three main policies:

• Policymakers should adopt a strategic approach to infrastructure planning that considers the synergies between different types of infrastructure and their impact on productivity, local labor markets, and local GDP.
• Policymakers need to optimize the spatial and fiscal allocation of infrastructure investments. In addition to potential social cohesion objectives, this involves prioritizing regions with the highest potential for economic growth and aligning investments with local needs and economic conditions rather than political considerations. Objective, data-driven approaches should be employed to ensure that investments are directed where they are most needed and can have the greatest impact.
• Infrastructure has the potential to support productivity gains. Prioritizing infrastructure investments with high productivity impacts will achieve a greater multiplier and more efficient use of scarce public money. This is all the more important as infrastructure investments are costly.

Source: blogs.worldbank.org