All thesis 25.8..10

Abstract
A major source of economic growth is the accumulation of capital. One
form of capital is infrastructure. Infrastructure is essential in achieving the main
development targets of developing countries, such as urbanization,
industrialization, export promotion, equitable income distribution, and sustainable
economic development. In addition, the availability of an efficient infrastructure
network can stimulate new investment in other sectors. Conversely, either a
shortage or an over-expansion of infrastructure in certain areas can raise costs and
create incentives to refrain from investing.
This dissertation starts with the definitions and type of infrastructure,
followed by some development theories with respect to the role of infrastructure,
and then analyzes the developmental effects of infrastructure investment. The
definition used in this paper is: the basic facilities and services for functioning of
community or society. Almost all types of infrastructure are studied in this paper
except smart (soft) infrastructure. In the case of development theories with respect
to the role of infrastructure, vent for surplus theory, privatization and
commercialization strategy, wage-goods strategy, theory of unbalanced growth,
cumulative causation theories, neoclassical theory and the new growth theory are
explored.
Infrastructure has two positive effects on growth. First, its availability
should increase the productivity of physical and human capital. Second,
infrastructure also serves as a direct factor input. The pressures generated by
infrastructure investment by bidding up the cost of labor and inputs may crowd out
direct productive investment is the negative effect of infrastructure.
This dissertation also attempts to review the studies dealing with
productivity impact of infrastructure and the linkage of infrastructure to economic
growth. Different approaches such as production function approach, cost function
approach, growth model, general equilibrium model and data oriented models are
explored to investigate the relationship between infrastructure and productivity.
Development strategies and infrastructure policies in Myanmar are also mentioned.
Both Cobb Douglas and translog production models are applied to estimate
the effects on infrastructure on growth. Diagnostic testing suggests that the
empirical results are correctly specified and that the translog production function
specification is to be preferred to the Cobb-Douglas model. The results of the
estimations show that economic infrastructure has both direct and indirect effects
on output/productivity. The empirical analysis using official data and EIU /IMF
data shows evidence that economic infrastructure is positively and significantly
associated with economic growth except for 2002-03 and 2003-04. Both empirical
results confirm that Myanmar economy demands both more infrastructure
investment and economic investment for future economic growth and
infrastructure investment has crowd-out effect on economic investment. Myanmar
is needed to investment not only in economic infrastructure development but also
in human resource development. Moreover, macroeconomic and political stability,
and the development of legal and financial infrastructure are imperative to support
saving and investment that are essential for economic growth.
i

Acknowledgement
I am greatly indebted to all those who constantly supported me both in spirit and
indeed without which this research dissertation would not have been completed. I would
like to express my sincere thanks to Yangon Institute of Economics, the Japan Foundation
and Waseda University for giving me permission to do this research. I particularly owe a
profound gratitude and deep respects to Dr. Kan Zaw, the Rector of Yangon Institute of
Economics and all my teachers for their continual encouragement and support throughout
the study to the completion of the dissertation.
I am deeply indebted to my supervisor Prof. Daw Nyunt Nyunt Swe from Yangon
Institute of Economics, Prof. Dr. Takeshi Daimon from the Waseda University, and Prof.
Dr. Naoyuki Yoshino from the Keio University whose help, stimulating suggestions and
encouragement helped me in all the time of research for and writing of this dissertation.
I want to thank U Myat Thein, Rector (Retired), Yangon Institute of Economics; Dr.
Hla Maung, Consultant and Senior Economist; U Kyaw Min Htun, Pro-rector, Yangon
Institute of Economics and all my teachers in PhD Prelim Course, for attending my
seminars using their precious time, all their help, support, interest and valuable
suggestions. Especially I am obliged to U Kyaw Myint, Senior Economist, for correcting
English grammar and offering suggestions for improvement.
.
ii

Table of Contents
Chapter Page
Abstract................................................................................................................................................i
Acknowledgement..............................................................................................................................ii
Table of Contents..............................................................................................................................iii
List of Tables.......................................................................................................................................v
List of Figures...................................................................................................................................vii
List of Appendix Tables and Box..................................................................................................viii
Abbreviations.....................................................................................................................................ix
Introduction........................................................................................................................................1
1.1 Objectives of the Study..............................................................................................................3
1.2 Scope and Limitations...............................................................................................................3
1.3 Methods of Study.......................................................................................................................4
1.4 Organization of Study...............................................................................................................4
Theoretical Reviews on Infrastructure Provision and Economic Development .........................5
2.1 Definition and Types of Infrastructure......................................................................................5
(a) Definition of Infrastructure: .................................................................................................5
(b) Types of Infrastructure:........................................................................................................7
2.2 Development Theories with respect to the Role of Infrastructure ...........................................7
2.3 The expected impacts of Infrastructure on Economic Development.......................................18
2.4 The role of government in infrastructure provision................................................................24
2.5 The role of private sector and community in infrastructure provision...................................30
Review of Studies on the Effects of Infrastructure Development...............................................36
Development Strategies and Infrastructure Policies of Myanmar .............................................53
4.1 Myanmar Development Strategies and Infrastructure Policies..............................................53
4.2 Infrastructure development In Myanmar................................................................................61
4.2.1 Development of Physical Infrastructure..........................................................................61
4.2.2 Development of Public Utilities......................................................................................66
4.2.3 Development of Technological Infrastructure.................................................................72
4.2.4 Development of Industrial Infrastructure Structure.........................................................74
4.2.5 Development of Social Infrastructure..............................................................................82
The Econometric Analysis on the Effects of Infrastructure on Economic Growth of Myanmar
............................................................................................................................................................98
5.1 The Concept............................................................................................................................98
5.2 Theoretical Framework...........................................................................................................98
5.3 Models.....................................................................................................................................99
iii

5.4 Data Description...................................................................................................................101
5.5 Testing and estimating procedure.........................................................................................105
5.6 Main Model...........................................................................................................................109
5.7 The Results............................................................................................................................112
Conclusions and Recommendations.............................................................................................122
References.......................................................................................................................................130
Appendices......................................................................................................................................142
iv

List of Tables
Table 4.1- 24 Development Zones in Myanmar............................................................................55
Table 4.2- Infrastructure Investment in Myanmar (1988-89 to 2003-04)( in current prices) ..59
Table 4.3- Percent of Infrastructure Investment in Public Investment by Sector (in constant
prices)................................................................................................................................................60
Table 4.4-Constructions of Dams and Reservoirs and Affected Irrigated Areas, 1988-2003...62
Table 4.5- Construction of Roads (1988-2005)..............................................................................63
Table 4.6-Construction of News Bridges with a length of 180-feet and above, 1989-2005........64
Table 4.7- Improvement in Railroad transportation between 1988 and 2005............................65
Table 4.8- Improvements in Water Transportation.....................................................................65
Table 4.9- Improvements in Air Transportation ..........................................................................66
Table 4.10(a)-Improvements in Communication..........................................................................66
Table 4.10(b) - Growth of Telecommunications in Myanmar ....................................................67
Table 4.10(c)-Inter-regional Variation in the Telecommunications in Myanmar ....................67
Table 4.11- Communication System Utilization in Asian Countries (2002)...............................68
Table 4.12-Progress Production and Used of Electric Power .....................................................70
Table 4.13- Building of Electrical Power Supply Plant (2003)...............................................70
Table 4.14- Provision of Rural Water Supply (1997-2003)..........................................................72
Table 4.15- User of Internet (2002-2003) ....................................................................................74
Table 4.16- Registered Industrial Works of Industrial Zones (2003) .........................................76
Table 4.17- Number of schools, students, and Teachers in Basic education Sector in Myanmar
(1988-89 and 2003-04) .....................................................................................................................85
Table 4.18- Universities and Colleges by Ministry (1988 and 2005)............................................85
Table 4.19- Skills Training in Vocational Education...................................................................86
Table 4.20- Increase in Health Personal and Health Facilities (1988-2004)...............................89
Table 4.21- Health Service Workers and Utilities.........................................................................89
Table 4.22-Indicators of Health and Nutrition..............................................................................89
Table 4.23- Infrastructure Access and Stocks in Selected Asian Countries (%)........................91
Table 4.24- The Union of Myanmar’s Key Economic Indicators................................................96
v

Table 4.25- State Share of Myanmar’s Financial Resources.......................................................97
Table 5.1-GDP, Real GDP, Employment, Deflator, Capital Stock, and Infrastructure Stock of
Myanmar (1980-81 to 2003-04) (Millions)...................................................................................103
Table 5.2- The Result for Cobb-Douglas Production Function (equation 2)............................105
Table 5.3 -The Result for Equation (10).......................................................................................107
Table 5.4-The Result for Equation (10) in First Difference Model...........................................108
Table 5.5-The Result for Equation (11)........................................................................................108
Table 5.6-The Result for Translog Production Function in Centering Methods (1)...............109
Table 5.7-The Result for Translog Production Function in Centering Methods (2)...............110
Table 5.8-The Results of Translog Production Function Regression in Centering Methods (2)
..........................................................................................................................................................111
Table 5.9-Estimated Output Elasticities (in Average)................................................................114
Table 5.10-Estimated Output Elasticities (1988-89 to 2003-2004).............................................114
Table 5.11-The Results of Regression using IMF/ EIU Real GDP............................................115
Table 5.12 Estimated Output Elasticities using IMF/EIU Data ( in average)..........................115
Table 5.13-Effect of Infrastructure on Productivity in Myanmar.............................................118
Table 5.14-Marginal Product of Infrastructure .........................................................................118
Table 5.15-Import by Commodity (1996-97 to 2002-03)............................................................119
Table 5.16-Effect of Infrastructure on Productivity in Myanmar (using market exchange rate)
..........................................................................................................................................................120
vi

List of Figures
Figure 2.1-(a)Balanced and Unbalanced Growth; (b) Induced Investment...............................10
Figure 2.2-Conceptual Framework: Relationship between Infrastructure Provision and
Economic development....................................................................................................................23
Figure 2.3-Private Sector Participation in Infrastructure by Sector..........................................32
Figure 4.1-Industrial Zones in Myanmar......................................................................................78
Figure 4.2-Hlaing Tharyar Industrial Zone Occupancy Rate (2004).........................................79
Figure 4.3-Mingalardone Industrial Park Occupancy Rate........................................................80
Source: Ministry of Industry (1), Myanmar..................................................................................80
Figure 5.1- Real GDP per Capital Stock, Labour and Infrastructure Stock in Myanmar.....103
Figure 5.2-Real GDP, Capital Stock, Infrastructure Stock (million kyats in 1985-86 price)and
Employment (Thousands)..............................................................................................................104
Figure 5.3-Actual and Estimated Value of lnY ...........................................................................111
Figure 5.4-The Net Inflow of FDI into Myanmar (1989-2004)..................................................113
Figure 5.6-Direct and Indirect Effects of Infrastructure............................................................116
vii

List of Appendix Tables and Box
Table 3.1- Average Ex-Post Economic Rates of Return World Bank projects .........................48
Table 3.2- Ex-ante and Ex-post Economic Rates of Return of Infrastructure Projects
Completed in FY1999-2003(World Bank).....................................................................................49
Table 3.3- Estimates of Returns to Infrastructure Investment....................................................49
Table 3.4- Average Economic Rates of Return FAO (IFAD) projects .......................................49
Up till 2005, a total of 5005.4 miles of new roads were constructed including tarred, gravel,
metallic and earth ones for better transportation. Some of them are undertaken by private
companies such as Asia World, Diamond Palace, Hompan, Dawe Development, etc. under
BOT system. 209 bridges with a length of 180-feet and above including seven Ayeyawady
River crossing bridges have been constructed throughout the nation between 1989 and 2005.
............................................................................................................................................................63
Table 1. Millennium Development Goals (MDGs)......................................................................142
Table.2- Chow test for structural change (between 1980-81 to 1989-90 and 1990-91 to 2003-
04).....................................................................................................................................................143
Tests result for equation 2.............................................................................................................145
Tests result for equation 10...........................................................................................................146
Test results for translog production function in centering methods.........................................147
Box 1. Corruption...........................................................................................................................149
Table. 3- Expected Annual Investment and Operations and Maintenance Needs, 2005-
2010(percentage of GDP)...............................................................................................................149
viii

Abbreviations
ARCH Autoregressive Conditional Heteroskedasticity
ASEAN Association of South East Asian Nation
BOL Build, Operate, Lease
BOO Build-Operate-Own
BOT Build-Operate-Transfer
CIS Commonwealth Independent States
DPA Directly Productive Activity
EIU Economist Intelligence Unit
EMENA Europe, Middle East, North Africa
EOC Economic Overhead Capital
EPZs Export Processing Zones
ESCAP Economic and Social Commission for Asia and the Pacific
EU European Union
FAO Food and Agriculture Organization
FEC Foreign Exchange Currency
FDI Foreign Direct Investment
GDP Gross Domestic Product
GEMs General equilibrium models
ICT Information Communication Technology
IMF International Monetary Fund
JICA Japan International Cooperation Agency
LDCs Less Developing Countries
MICT Myanma Information and Communications Technology
MIDC Myanma Industrial Development Committee
ix

OECD Organization of Economic Cooperation and Development
OLS Ordinary Least Square method
PEs Public Enterprises
PIM Perpetual Inventory Method
PMP Product Marginal Product
PPI Private Participation in Infrastructure
PPPs Public-Private Partnerships
RESET Ramsey regression specification error test
SEEs State Economic Enterprises
SEZs Special Economic Zones
SMIs Small and Medium-sized Industries
SMP Social Marginal Product
SOC Social Overhead Capital
SOEs State-owned Enterprises
TFP Total Factor Productivity
UN United Nations
UNDP United Nation Development Programme
UNICEF United Nations International Fund for Children
VIF Variance Inflation Factor
x

Chapter 1
Introduction
For a nation’s economic development, apart from the main
resources such as natural resources, physical resources and human resources,
technological improvement, efficient institution and infrastructure
development are essential. Infrastructure development is an essential wheel
to generate economic activities of all nations. Therefore, infrastructure
provision may be regarded as “Hardware” of a nation’s economic
development. Infrastructure facilitates and integrates the economic activities.
Infrastructure investment is an important instrument employed by the
governments of developing countries over the past forty years to affect
economic development (Krueger1992). A World Bank study examining a
cross-section of developing countries shows that infrastructure typically
represents about 20 percent of their total investment and 40 to 60 percent of
their public investment. Although only 7 percent of infrastructure investment
($14 billions) originated from the private sector (World Bank, 1994), private
sector participation in infrastructure services delivery is rising. Between
1990 and 2001 more than $750 billion was invested in 2,500 private
infrastructure projects in developing and transition economies. Since the
governments in most developing countries do not have the necessary
institutions to implement many fiscal policies to facilitate economic growth
and influence income distribution, infrastructure policy is often seen as an
effective tool to achieve those ends (van de Walle and Nead 1995, Israel
1992, Broadway and Marchand 1995). It is widely recognized that an
adequate supply of infrastructure services is an essential ingredient for
productivity and growth. Infrastructures are basic essential services that
should be put in place to enable development to occur. Socio-economic
development can be facilitated and accelerated by the presence of social and
economic infrastructures. If these facilities and services are not in place,
1

development will be very difficult and in fact can be likened to a very scarce
commodity that can only be secured at a very high price and cost. In
addition, the availability of an efficient infrastructure network can stimulate
new investment in other sectors. Conversely shortage of infrastructure or its
over-expansion in certain areas can raise costs and create disincentives to
invest. The main message of World Development Report 1994 was that the
infrastructure can deliver major benefit in economic growth, poverty
alleviation and environmental sustainability- but only when it provides
services that respond to effective demand and does so efficiently.
Before 1988, Myanmar economy lacked in infrastructure and its
infrastructure development projects were far behind schedule due to
insurgency and insecure conditions. Since 1989, Myanmar government has
invested in various sectors in order to establish Myanmar as a peaceful,
modern and developed nation. The government of Myanmar believes that
the geographical and communication factors play significant role in the
development of physical and economic relations between regions. Therefore,
the government has allocated most of its budget for infrastructure
development.
Since the opening up of the economy in 1989, Myanmar has
realized the importance of infrastructure and has made considerable progress
in developing transportation, communications, and energy infrastructure
despite the heavy capital investments required to develop. Infrastructure
development was carried out by the state to achieve a balanced and
proportionate growth between regions and to achieve the solidarity of the
national races. Highways known as Union Highways and National
Highways have been constructed and upgraded. Construction of major
bridges across the rivers: Ayeyarwaddy, Than Lwin and Chindwin are being
implemented under the Special Projects Implementation tasks. They are also
considered as part of the border area development to narrow the gap between
2

the regions and to build more confidence and understanding among the
nationalities.
As Myanmar government constructed a number of infrastructures
which form the essential foundation for the nation's economic development,
there is a need for analyzing the effects of mass investment in infrastructure
provision, examining the strengths and weaknesses of these investments and
formulating appropriate policies and reforms to be of international standards.
1.1 Objectives of the Study
The aims of this study are
• to describe the development strategies and infrastructure policy in
Myanmar
• to find the linkage between infrastructure and economic growth
• to explore the implication about the role of infrastructure for
economic development of Myanmar
• to measure the effect of infrastructure on economic development
of Myanmar.
1.2 Scope and Limitations
This dissertation encompasses changes and improvements of
infrastructure provision and economic development of Myanmar between
1988 and 2004. This dissertation studies the productivity of infrastructure
investment as a return on infrastructure provision for the national level. Data
on GDP, employment, and investment in various sectors spanning the years
from 1980 to 2004 were used. The period from 1980 to 2004 were used to
get a sufficient observation set. Both region-wise and sector-wise analysis
cannot be conducted because of difficulty in getting reliable data. Although
social infrastructure is conducted in impact analysis, econometric analysis
adopts a narrower focus encompassing only on economic infrastructure as
defined by the World Bank, World Development Report (1994).
3

1.3 Methods of Study
Literature reviews with respect to infrastructure in development
theories and development strategies of Myanmar are carried out through
various sources such as libraries, lectures, and Internet websites. For
qualitative approach, exploratory research method and impact analysis are
applied. Econometric tools will be used for quantitative study using
secondary data from various sources.
1.4 Organization of Study
This study comprises six chapters. The first chapter is the
introduction chapter in which objectives of study, scope and limitation and
method of study are mentioned.
Chapter 2 reviews the definitions of infrastructure and various
development theories with respect to the role of infrastructure. Moreover, it
also presents the expected impacts of infrastructure on development. Then
the role of government, private sector and community participation in
infrastructure development are briefly mentioned.
Chapter 3 represents a brief review of recent literature concerned with
the effects of infrastructure development on growth.
Chapter 4 analyzes the development strategies and infrastructure
policies of Myanmar. Subsequently infrastructure development in Myanmar
by types of infrastructure and its impacts on development are described
using impact analysis method.
Chapter 5 contains econometric estimates of the effects of
infrastructure on economic growth in Myanmar using Cobb-Douglas
production function and translog production function. Factors elasticity of
GDP and marginal productivity of infrastructure are estimated using official
data and EIU/IMF data.
Chapter 6 endeavors to provide a conclusion chapter which gives
critical evaluations and policy recommendations based on the findings.
4

Chapter 2
Theoretical Reviews on Infrastructure Provision and Economic
Development
This Chapter begins with review of definitions and types of
infrastructure. It is then followed by a discussion of some development
theories with respect to the role of infrastructure. Finally, a conceptual
framework is set out in order to analyze the developmental effects of
infrastructure investment.
2.1 Definition and Types of Infrastructure
(a) Definition of Infrastructure:
The term infrastructure has been used since 1927 to refer
collectively to the roads, bridges, rail lines, and similar public works that
are required for an industrial economy, or a portion of it, to function. The
term also has had specific application to the permanent military
installations necessary for the defense of a country. Perhaps because of
the widespread technically advancement, people now use infrastructure
to refer to any substructure or underlying system. Big corporations are
said to have their own financial infrastructure of smaller businesses, for
example, and political organizations to have their infrastructure of
groups, committees, and admirers. Nowadays think tanks and research
foundation are also regarded as infrastructure.
Infrastructure has different definitions in different dictionaries and
usages. They are as follows:
(1) The fundamental systems and services essential for a country
or organization.
(2) Physical structures that form the foundation for development.
(3) The basic facilities and services for functioning of
community or society.
5

(4) Services and facilities that support day-to-day economic
activities.
(5) The foundation on which economic development is based.
(6) Goods and services, which, while in themselves not normally
directly productive, are regarded as essential to the
functioning of an economy.
(7) Things and systems that support economic activity, and are
often fixed in place.
(8) The basic public works in a city including roads, parks,
bridges, schools, utilities and communication systems in a
community.
(9) The base or foundation of a world system (i.e. economy,
society, organization). It is the basic equipment required for
a particular system to function.
World Bank has divided infrastructure into two types1
. They are:
economic infrastructure and social infrastructure. Economic Infrastructure
includes Public Utilities (Power, Telecommunications, Piped water supply,
Sanitation and Sewerage, Solid waste collection and disposal, and Piped gas)
,Public Works (Roads and Major Dam and Canal works for irrigation and
Drainage; Economic Zone, Industrial Zone, Technology Zone, Science
parks) and Other transport sectors (Urban and Interurban Railways, Urban
Transport, Port and Waterways, and Airports). Social Infrastructure includes
Universities, Schools, Hospitals, Parks Gymnasiums, libraries, Recreation
Centers. This study is conducted within the framework of this definition.
The term economic development used in this study refers to "increase
in GDP, access to better education and health, reduction in inequality, more
employment opportunities save and secure environment".
1
World Bank, World Development Report, 1994: Infrastructure for Development
6

(b) Types of Infrastructure:
Although World Bank categorized infrastructure as mentioned in
chapter one, Infrastructure can also be classified according to their
usefulness as follows:
(1) Physical Infrastructure: e.g. Roads, Bridges, Dams,
Canals, Transportation.
(2)Public Utilities Infrastructure: e.g. Power, Communication,
Water supply, Sanitation, Solid waste collection.
(3)Technology Infrastructure: e.g. Technology Zones,
Microwave Centers, Internet net works, Communications.
(4)Industrial Infrastructure: e.g. Industrial Zones, Export
Promotion Zones, Special Economic Zones
(5)Human Capital Infrastructure: e.g. Universities, Hospitals,
Gymnasiums, Libraries.
(6)Smart (soft) infrastructure: e.g. business networks, venture
capital pools, and training
2.2 Development Theories with respect to the Role of Infrastructure
Vent for Surplus Theory2
, developed by Adam Smith and revised for
developing countries by Hla Myint, mentioned that unemployed resources of
LDCs, especially labour, can be mobilized to produce goods and services,
both public and private, to push the economy closer to, or onto its
production–possibility frontier. Using this idea with respect to infrastructure,
the vent for surplus is in the form of mobilization of surplus labour (the open
and the disguisedly unemployed) to expand the stock of economic and social
infrastructures in the less developed economies to promote economic
growth. The production possibility frontier would shift with the expansion of
2
Hla Myint: “The Classical Theory of International Trade and the Underdeveloped
Countries”, Economic Journal, vol.68, pp. 317-31
7

the economic infrastructural base, thereby accelerating the rate of economic
growth and enhancing the pace of socio-economic development.
Improvements in maintenance enhance the quality of existing infrastructure
and give rise to a Vent for surplus.
Privatization and commercialization strategy3
is a latter-day form of
the classical laissez–faire policy or strategy of development. The concept
embraces deregulation of the economy so as to encourage private initiative
and boost productivity and efficiency. The key elements are the
“disengagement of government from the ownership of hitherto state-owned
enterprises (SOEs) and the concomitant sale of such to private
entrepreneurs”. The organized private sector becomes the driving force or
the engine of development and growth while the government’s role is
reduced to that of a catalyst responsible for the creation of an enabling
environment for the growth of the economy. From a global perspective, this
is a strategy of development through a more efficient pattern of resource
allocation by a free interplay of market forces. Deregulation encourages
competition and in this way, a greater quantum of economic and social
overhead capital or infrastructures will be built up in a more efficient and
competitive market environment. This is the strategy of the new millennium
as governments try to shed their economically inefficient and unproductive
overloads to generate more revenue from the sale of the SOEs. This,
expectedly, would enable the governments, especially LDC governments, to
reduce their public expenditures, generate more revenue and balance their
budgets, at least. This would enable these governments to focus more
attention to and fund more adequately infrastructures that create substantial
external economies through the provision of public goods.
The wage-goods strategy of development4
is an “extension of the
Nurkesian thesis of concealed saving-potential in rural disguised
3
Familoni, K. A.: The Role of Economic and Social Infrastructure in Economic
Development: A Global View, Nigeria, 2000
4
Vakil, C. N. and P.R. Brahmanand : Planning for An Expanding Economy, India, 1956
8

unemployed” in LDCs. Vakil and Brahmanand felt that an effective use
could be made of the ‘saving potential’ by employing the disguised
unemployed at the project sites by supplying them with wage-goods defined
as “consumption necessities required for subsistence and performance of
work”. Capital goods required for the production of these wage-goods
should be accorded priority in production and the supply of wage-goods plus
capital goods needed for their production must grow at a considerably higher
rate than the growth rate of population to absorb the disguised unemployed.
The implementation of this strategy is to be started with economic overheads
(Infrastructure) in rural areas, investing in them, providing wage-goods to
workers and mobilization of savings. Even though this strategy was
formulated for India, it is an attempt to build an analytical scheme for
solving the triple problems of unemployment, poverty and inequality. It is
akin to the concepts of Community Development and Integrated Rural
Development. This strategy can be generalized as follows: Development
requires the mobilization of surplus labour to generate both urban and rural
capital in the form of economic and social infrastructures.
According to the theory of unbalanced growth5
, Albert O. Hirschman
(1958) discussed the links between what he termed as “directly productive
activity (DPA)” and “social overhead capital (SOC)” (essentially public
utilities). In his interpretation of the development process unbalanced growth
in the form of infrastructure growing ahead of productive activity, or vice
versa, is essential to stimulate new investment. Growth arises through
maximizing the incentive to invest. Hirschman set out clearly the argument
that one of the major roles of infrastructure is to provide inducements to
additional investment in other sectors. Since the infrastructure sector
provides profit opportunities to other activities these are externalities or
benefits that accrue to others and the generation of such external benefits is
often seen as a key aspect of infrastructure development. The question that
5
Hirschman, Albert O: The Strategy of Economic Development. New Haven: Yale University Press. 1961
(1958), chapters 4 – 7.
9

Hirschman asked is whether investment in infrastructure should lead or
follow expansion of private economic activity. His answer was that it
depends on which sequence creates the strongest pressures to develop and
results in the strongest responses. Investment in infrastructure first, as a
strategy of cumulative causation would suggest, would be expected to make
a region attractive to private investors. The alternative, derived from
neoclassical theory, would be to wait for private investment and then put in
the necessary support infrastructure. Hirschman suggests that disequilibrium
and oscillation between the two approaches is natural and good.
The argument is illustrated in Figure 2.1, adapted from Hirschman
(1958). The figure illustrates the tradeoff between the costs of directly
productive activity (DPA) and the costs of social overhead capital (SOC).
Figure 2.1-(a)Balanced and Unbalanced Growth; (b) Induced Investment
Source : reproduced form Hirschman(1958)
In Figure 2.1 (a), the curved lines represent investment levels and the
45º line represents a balance between public and private costs for
development. As described above, infrastructure may be provided ahead of
demand, in anticipation of growth. Hirschman called this "development via
surplus". This strategy requires picking winners in terms of regions and
Shortage Strategy
Surplus Strategy
OC level and Cost
Induced DPA and
Total investment
Induced SOC
investment
SOC/DPA ratio
10

industries, represented by the heavy solid line. A strategy of "development
via shortage" would involve waiting for enough productive activity to create
effective pressure for the right investment in infrastructure. This strategy is
represented by the dotted line.
Either strategy, of shortage or surplus, creates developmental tensions
and leads to "induced" decision making. This is illustrated in Figure 2.1 (b).
A high SOC/DPA ratio creates a pull on private investment, whereas a low
ratio leads to demands for higher public investment. The question is which
one creates the strongest pressures to develop and results in the most reliable
responses.
As Hirschman (1958) argues, moderate infrastructure shortages will
not do much harm in areas likely to develop, but infrastructure surpluses will
do no good in lagging areas that are unlikely to develop anytime soon. It is
also clear that balanced growth would create no pressure for induced
decisions.
With limited resources, developing regions cannot afford mistakes.
Nonetheless, there would be expected to find a minimum SOC/DPA output
ratio, a point at which no further aggregate DPA output can take place
without SOC expansion. At this point, the neglect of public investment
becomes a serious drag on development. If such a point exists, further
investments in infrastructure would be expected to produce gains in output
and attract large increments of private investment. This line of argument
provided the basis for recognizing that development phases might be
important for the kinds of impacts expected.
The existence of distinct phases was articulated by Hansen(1965a)
who theorized that the impact of infrastructure on future development would
vary according to the existing level of development in a region. He classified
regions as either congested, intermediate, or lagging. Congested regions are
characterized by a high level of productive activity compared to the level of
infrastructure. Consequently, additional benefits that might be generated by
11

further infrastructure provision can be partly counter-balanced by congestion
costs and other negative externalities. Intermediate regions are characterized
by high potential (e.g. endowments of natural resources or abundant labour),
but a deficiency of core infrastructure, which leads to bottlenecks in
transportation, communications, and power networks. In this case, an
expansion of infrastructure would facilitate economic growth without
congestion costs outweighing the benefits. Lagging regions are characterized
by a shortage of human capital and thus a low ability to exploit their
resources. In these regions there is little to attract productive activity and
therefore no immediate reason to expand the stock of core infrastructure6
.
These regions, however, could benefit from investments in social services
such as health care and education in preparation for eventual expansion of
productive capacity. Hansen's thesis provides a basis for planning the type of
infrastructure investment needed in a region. Hansen divided infrastructure
into two categories. According to this scheme, increased provision of
"economic overhead capital"(EOC) such as roads and power supplies,
should benefit intermediate regions, while increased provision of "social
overhead capital"(SOC) such as schools and clinics should benefit lagging
regions. Congested regions also require increased EOC, targeted at specific
congestion problems. Eventually lagging regions will become intermediate
and intermediate regions may tend toward congestion. As regions develop,
through the phases, both types of investment will exhibit diminishing
returns.
Hirschman’s (1958) analysis contributed to the evolution of the
cumulative causation approach, and Hansen’s (1965) analysis refined it.
Both agree that regional growth is driven by agglomeration economies, and
can be either limited or promoted through infrastructure investments.
Cumulative causation theories, as summarized by Richardson and
Townroe (1986), explain regional growth as beginning from an initial
6
means roads, power, communication, water, and sanitation
12

stimulus such as an endowment of natural resources. Initial high returns to
investment attract still more investment, and regional advantages are
reinforced by returns to scale and agglomeration economies. Early planners
who advocated promoting regional development through this approach
included Myrdahl (1957) and Hirschman (1958) among others. More
recently, there has been a resurgence of interest in this type of growth
theory, beginning with Romer (1986) and continued by Lucas (1988),
Krugman (1991), and Arthur (1994) among others. In the more recent
literature, cumulative causation is commonly described as endogenous
growth through increasing returns and path dependence. In this conceptual
approach, infrastructure investments can promote regional development
through effects on firm location decisions, growth rates of private capital,
and agglomeration economies. Firms are attracted by better public facilities
that offer the possibility of increased profits and complementarity between
public and private factors of production. Infrastructure provision can also
reinforce agglomeration economies by eliminating capacity constraints and
reducing external diseconomies of scale such as congestion. The positive
externalities of transport and communication networks foster increasing
returns to scale and further urbanisation and localisation economies.
Infrastructure investments also represent amenities (such as reduced
congestion or pollution) for households, which attract workers as they seek
to improve their welfare through location decisions. Social agglomeration
economies due to scale and diversity of opportunity create further benefits
from higher income and better access to health and education services.
Greater investments may thus be able to boost the growth rate of the labour
force as well as productive capital. Cumulative causation theories also
explain disparities between regions, as those without adequate attraction for
private investment will tend to stagnate, and public policies intended to
maximize growth will tend to reinforce a pattern of inequality. However, if
maximum growth is not a top priority, spatial equality may be
13

deliberately promoted through expanded provision of infrastructure in
lagging areas and the creation of growth centres and industrial estates
to attract industry.
Neoclassical theory explained regional growth in terms of the
availability and use of productive factor inputs. In this conceptual approach,
developed initially by Solow (1956), development proceeds as firms and
households make increasingly more efficient use of their labour, capital and
natural resources. Good transport and services lower production costs, while
infrastructure deficiencies represent higher costs and require private
investment in substitute capacity. According to this approach, promotion of
regional development via infrastructure investment is possible through
improvements to the workings of factor markets. In this framework,
infrastructure has two positive effects on growth. First, its availability
should increase the productivity of physical and human capital. To the
extent that this results in lower production and logistics costs, demand and
prices for the industrial and agricultural output of the region should increase.
Second, infrastructure also serves as a direct factor input. Higher levels
of infrastructure provision should raise regional output. Both effects increase
demand for labour and the wages paid to it.
Furthermore, the new growth theory7
suggested that by investing in
complementary investments such as human capital, infrastructure, and
Research and Development that can improve production function from one
of diminishing returns to that of increasing or constant returns to accelerate
sustained growth. The provision of economic infrastructure can expand the
productive capacity of the economy by increasing the quantity and quality of
such infrastructure. Romer endogenous growth model addresses spillovers
from complementary investment. Todaro concluded that Romer model is not
only the seminal model of endogenous growth but one of particular
relevance for developing countries. Romer model begins by assuming that
7
See Todaro, Michael P. and Stephen C. Smith, Economic Development,9th Edition, Addison-Wesley
Higher Education Group, 2006, Chapter 4
14

growth processes derive from the firms or industry level. Each industry
individually produces with constant returns to scale. However, he included
economywide capital stock K , (public capital stock including infrastructure
stock), positively effects output at industry level, so that may be increasing
returns to scale at the economy wide level. Then, the aggregate production
will be
Y= f (Kp, L, K )
Where Kp = private capital stock, L= Labor, K = public capital stock
This model will be used in order to analysis the effect of
infrastructure investment in economic growth of Myanmar in Chapter 5.
Earthscan (2005) mentioned that investing in core infrastructure,
human capital and good governance8
accomplishes: (i) it converts
subsistence farming to market oriented farming, (ii) it establishes the basic
for private sector- led diversified exports and economic growth (iii)it enables
a country to join the global division of labour in productive way (iv)it set the
stage for technological advance and eventually for an innovation-based
economy.
Under macroeconomic theories, the financing of infrastructure has
important implications for macroeconomic stability. As a countercyclical
tool, infrastructure investment can generate employment and consumer
demand in the short term, as well as in the longer term (when the investment
is well chosen). However, the modes of financing infrastructure investment,
operations and maintenance can also contribute to internal and external
imbalances. In many countries, the persistent deficits of railways, airlines,
8
Good governance can be understood as a set of 8 major characteristics: participation, rule of law,
transparency, responsiveness, consensus orientation, equity and inclusiveness, effectiveness and
efficiency, accountability (from www.Wikipedia).
15

and power utilities have contributed measurably to fiscal and financial
instability.
Kessides (1993) explained that, there is also a set of important
economic effects which do occur specially from the flows of expenditure on
investment in infrastructure. The first is the multiplier effect of the
expenditure on wages and inputs used in the construction infrastructure and
the derived demand generated for the output of other sectors. Under certain
conditions (such as where markets are rigid and factors not mobile), the
pressures generated by infrastructure investment may ‘crowd out’ direct
productive investment by bidding up the cost of labour and inputs. The
second linkage concerns the way in which the infrastructure is financed.
Expenditure on infrastructure investment affects the availability of financial
capital for other uses; it may also affect fiscal balance and external
creditworthiness, and therefore macroeconomic stability. The potential of
infrastructure investment to raise the cost of capital is described as financial
‘crowding out’.
In other way, in the short term, an increase in the stock of public
capital in infrastructure may have an adverse effect on activity, to the extent
that it displaces (or crowds out) private investment. This short-run effect
may translate into an adverse growth effect if the drop in private capital
formation persists over time.
Crowding-out effects may take various forms. For instance, if the
public sector finances the expansion of public capital through an increase in
distortionary taxes, the reduction in the expected net rate of return to private
capital, may lower the propensity to invest. A similar, and possibly more
detrimental, effect on private capital formation may occur if the increase in
public infrastructure outlays is paid for by borrowing on domestic financial
markets, as a result of either higher domestic interest rates (in countries
where market forces are relatively free to operate) or a greater incidence of
rationing of credit to the private sector. Moreover, if an investment induced
16

expansion in public borrowing raises concerns about the sustainability of
public debt over time and strengthens expectations of a future increase in
inflation or explicit taxation, the risk premium embedded in interest rates
may increase. By raising the cost of borrowing and negatively affecting
expected after-tax rates of return on private capital, an increase in the
perceived risk of default on government debt may have a compounding
effect on private capital accumulation. In particular, private investors may
revise downward their investment plans because of anticipated hikes in tax
rates to cover the increase in public investment.
In principle, crowding-out effects associated with public
infrastructure should be short term in nature; to the extent that an increase in
the public capital stock raises output growth in the medium and longer term,
future government borrowing needs may actually fall as a result of higher
tax revenues. In that sense, deficits today will pay for themselves tomorrow,
a common logic when discussing tax cuts and increases in expenditure in a
growth context. However, as noted earlier, these effects may also persist
beyond the short term, and turn into longer-run (adverse) effects on growth.
For instance, if higher tax rates create permanent incentives for tax evasion,
lower resources may reduce durably the government’s capacity to invest in
infrastructure and other areas in the future, or its ability to ensure adequate
maintenance of the public capital stock. If so, then, despite the
complementarily effect mentioned earlier, the net effect of an increase in
public infrastructure may well be to hamper, rather than foster, economic
growth. Therefore appropriate financing policies are necessary to ensure that
the infrastructure expenditures required for development do not threaten
macroeconomic stability through fiscal or financial imbalances, or
distortions to the labour market.
Kessides (1993) then offers four conditions necessary to realize the
positive impacts of infrastructure on economic development:
17

a) A macro-economic climate conducive to efficient resource allocation,
avoiding distortions in service provision, inflationary funding
arrangements and “crowd-out” of other more rewarding investment.
b) The presence of sufficient other input factors (such as labour) to raise
factor productivity in the presence of infrastructure, because
infrastructure cannot create economic potential, only develop it where
appropriate conditions exist.
c) An orientation to economic demand considerations such as service
prices and demand elasticity, not just projections of physical
capacities and consumer needs, because infrastructure with the most
enduring benefits is that which provides the reliability and quality of
services that users need.
d) Application of user charges that reflect supply and demand conditions
and non-market externalities as far as possible, to ensure
infrastructure will be more economically efficient and favourable to
the environment.
Infrastructure investments confront risks of corruption and
mismanagement. What has Infrastructure is a classic venue for corruption.
Public works exhibit corruption at all stages from definition of the
investment to choice of the contractors to dealing with change orders and
cost overruns. Typically, politicians are involved along with civil servants
and business people. According to R Kiltgaard investigations in Indonesia
and the Philippines, rural public works are believed by citizens and local
officials to be contaminated by systematic corruption. The costs can be 25
percent or more of the infrastructure budget, plus the distortion of
investments and reduced quality. Calling for better agents, improved
incentives, better information, more competition, less official discretion, and
higher moral costs is well and good.
2.3 The expected impacts of Infrastructure on Economic Development
The term economic development used in this study refers to "increase in
GDP, access to better education and health, reduced inequality, more
employment opportunities, safe and secure environment". Economic Growth
18

(increase in GDP) is necessary condition for economic development
although it is not sufficient condition. Economic growth is the basic
condition for effective poverty alleviation, as it can improve the living
standards of the population and promote infrastructure development. First of
all, economic growth raises the average income of households. It also has an
indirect influence (not related to income) on poverty reduction by giving
more attention to the improvement of social and physical infrastructure
through increases in state investments for education, health care, and
infrastructure development needs.
Infrastructure has two positive effects on economic growth. First, its
availability should increase the productivity of physical and human capital
e.g. smooth transportation and better communication make easy access to
both product markets and factor markets and can get more efficient factor
combination for production. To the extent that this results in lower
production and logistics costs, demand and prices for the industrial and
agricultural output of the region should increase. Second, infrastructure also
serves as a direct factor input e.g. power is used as a necessary input in
commodity production. However, in the short run, an increase in the stock of
public capital in infrastructure may have an adverse effect on economic
activity, to the extent that it displaces (or crowds out) private investment.
This short-run effect may translate into an adverse growth effect if the drop
in private capital formation persists over time. For example, if an investment
induced expansion in public borrowing raises concerns about the
sustainability of public debt over time and strengthens expectations of a
future increase in inflation or explicit taxation, the risk premium embedded
in interest rates may increase and then raising the cost of borrowing and
negatively affecting expected after-tax rates of return on private capital that
give disincentive for private investments. There should be an efficient policy
and implementation to out weigh positive than negative effects.
19

The effects of infrastructure provision on economic development
diagrammed in Figure 2.2 can be divided into two categories too, direct
effects and indirect effects. Firstly, as direct effect, infrastructure
development creates demand for labour and materials that can motivate
regional and local economic activities. Secondly, as indirect effects,
infrastructure contributes to development through improved infrastructure
service as productivity effects, complementary or substitution effects, and
location effects. Improved transportation and utilities also reduce the costs
of production and transactions. This happens through improved technology
and lower costs of inputs, leading to higher quality goods and services. Both
effects should result in increased demand for output. It stimulates market
creation and expansion. Firms benefit by earning profits according to the
value of the contribution made to production by public facilities. This is
clearly the case because, in the absence of public provision, firms pay
directly for infrastructure services through purchase of private substitutes.
As levels of infrastructure provision increase, output levels are also expected
to rise. The broad role of infrastructure in social development can be viewed
through regional economic theory. Regions grow through the use of
resources available to them, including labour. More and better infrastructure
should facilitate increasingly productive use of those resources. As a result,
infrastructure investment should lead to more employment, higher incomes
and agricultural output, and better access to social services.
Moreover, high quality infrastructure give incentives for new
investment by reducing cost of production and on the other hand, higher
levels of infrastructure investment may be able to boost employment
opportunities and raise incomes, which should translate into higher per-
capita incomes. Infrastructure construction and maintenance raise job
opportunities, improve labour productivity, and result in higher wages and
incomes for the majority of the people.
20

Infrastructure is important for ensuring that growth is consistent with
poverty reduction. Different infrastructure sectors have different impacts on
improving the quality of life and reducing poverty. Access to clean water
and sanitation has the most obvious and direct consumption benefit in
reducing mortality and morbidity. Access to transport and irrigation can
contribute to higher and more stable incomes, enabling the poor to manage
risks. Improvements in public utilities such as power, communication, water
supply, sanitation, accompanied by improvements in social infrastructure
and transportation create better environment and higher living standards for
people.
In addition to delivering major benefits in economic growth and
poverty alleviation, infrastructure provision affects interregional
development. Growth theories suggest that the provision of infrastructure
can promote regional development and reduce disparities. The majority of
empirical studies showed that positive relationships between
infrastructure and development have been found to be smaller at the
national level than at the regional level . This means for the same amount
of investment, returns are higher in underdeveloped regions than in more
developed regions.
If better infrastructure does improve worker’s productivity, it is
expected that wages will increase and attract workers. The direct and
multiplier effects of infrastructure construction are to raise incomes.
Construction and maintenance has multiplier effects as public spending on
wages and material, stimulates demand. Workers also realize higher incomes
through greater and more diverse opportunities for employment. Better
transportation and communications also mean improved access to health
care, education, and markets for producer and consumer goods.
In brief, the results of infrastructure development end up with
reducing regional gap (increase equity) and poverty, creating more
21

employment, promoting GDP growth which indicates economic
development. Therefore, the role of infrastructure provision is very crucial in
nations’ economic development from multidimensional aspects. On the
other hand, when a nation attains economic development, it can invest
more in infrastructure construction , and maintenance , and thus lead to
rapid infrastructure development.
However, in macroeconomic point of view the impact of public
capital accumulation on private investment can be regarded as falling into
two broad categories, depending on whether the public investment ‘crowds
out’ or ‘crowds in’ private investment. The ‘monetarist’ view is that public
capital expenditure simply ‘crowds out’ private expenditure by a number of
direct and indirect mechanisms, including higher inflation (see Lewis and
Mizen (2000, chapter 7)). To the extent that publicly provided capital is a
substitute for private capital in private production technologies (public
health facilities leaving less room for private initiatives), firms require less
private capital to produce the same level of output. In addition, higher public
sector demand in the capital goods-producing sector raises the price of
capital goods, thereby lowering the quantity of these goods demanded by the
private sector. Finally, the increased government demand in the economy
creates a general scarcity of current resources, inflationary pressures, a rise
in nominal and real interest rates, and a further contraction of capital
spending. But the crowding out argument is based on the assumption of an
unchanged rate of return to private capital in the face of higher public capital
accumulation. If public capital devoted to infrastructure purposes is in fact
complementary rather than competitive to private capital in the production
of goods and services, then a rise in the public capital stock makes private
capital more productive.
Thus, World Bank (1994) gives the following suggestion to realize
the effective return from infrastructure investment as follows:
22

Once developed, the infrastructure can offer considerable benefits in
addition to economic growth, such as assistance for the poor or weak, or
environmental safe guards. But this is only true when the infrastructure
responds to effective demand by providing efficient services. In other words,
the services made available are the actual objective of infrastructure
development, and these services may be adopted as a yardstick of
achievements. Consequently, it is impractical to separate the physical
infrastructure from the service it makes possible. Infrastructure investments
alone cannot be a precondition for growth and that "… the economic impact
of infrastructure investments varies not only by sector but also by its design,
location and timeliness".
Therefore, infrastructure provision should be at the right time, right
location and fulfill strong user demand. Some infrastructure may result in
low user demand and excess capacity and it will entail greater costs than
benefits and larger maintenance costs if it neglect or does not consider user
demand.
Figure 2.2-Conceptual Framework: Relationship between Infrastructure
Provision and Economic development Workers’ Productivity
Better education,
Healthy, Adequate Nutrition
Higher income
Infrastructure
Development
(Construction &
Operation)
Improved Infrastructure
Services
Availability, Cost reduction,
Time saving, reliability
Procurement
Materials
Labor demand
Market creation/ expansion
Increased Incentive to entry
Opening up new economic activity
Improved productivity of existing activities
International Trade
Social Dimension
Improved access to basic
social/Public services
Regional Economic activity
Rural ↔ Urban
Agriculture, off-farm business,
services, manufacturing
,export,etc.
New Investment
Local Investment, FDI,
reduce regional gap
GDP GrowthPoverty Reduction
Employment Creation
Increased
Employment
Equity
23

Source: constructed by Thida Kyu from reviewing various infrastructure models
Note: all effects showed by arrows may be positive or negative depending on situations.
In many countries, capital spending often receives a disproportionate
share of outlays on infrastructure from politicians and donors, given their
relatively higher visibility and political importance. In order to trigger the
desired results, the composition of public spending in infrastructure must
take into account the needs of the population, and not be biased by political
priorities. Priority should be given to rehabilitate and improve demand-
driven infrastructure services, which already serve the population,
sometimes at a very high cost in terms of risk, time and poor quality, or have
the potential to do so immediately.
2.4 The role of government in infrastructure provision
Traditionally, most infrastructure financing, construction and
operation are performed by government in both developed countries and
24

developing countries. There are major characteristics of most infrastructures
which are market failures and the rationales for government intervention.
First, infrastructure frequently provides public goods. Households
and companies often benefit from effective infrastructure, whether they
directly pay for it or not .This means the benefits are shared across the
community in such a way that those who do not wish to buy the service
cannot be excluded from the benefits created by those who do. Generally,
competitive markets will tend to underproduce these services. Other types of
activity, for example, technological or information infrastructure may have
many of the characteristics of a public good. First, technology is a non-rival
good. When one entity uses technology to produce a good or a service, this
action does not preclude others from doing so, even simultaneously. This
feature distinguishes technology from, say, a piece of capital equipment,
which can only be used in one place at a time. Second, technology in many
cases is a partially non-excludable good. That is, the creators or owners of
technical information can experience difficulty in preventing others from
making unauthorized use of it, at least in some applications.
Second, there may be network externalities, whereby benefits and costs
are conferred on those not a party to the transaction (e.g. spillovers, such as
those discussed above). In general, competitive markets are likely to
overproduce goods imposing negative externalities and underproduce those
with positive externalities. Many goods may have both positive and negative
spillovers. A road, for instance, confers positive externalities to those firms
whose distribution system has been improved, even though they have not
paid for the road. In contract, the road may generate a negative externality,
for example on residents around a new road who have their views spoiled, or
peace disturbed, and have not been recompensed for the cost they are
bearing. The difficulty with externalities is that they arise to a greater or
lesser degree in virtually all economic activities, and if every service that
produced external benefits or costs had to be supplied by government, it
25

would produce virtually everything. Nevertheless, the network characteristic
of infrastructure, which links it to many parts of the economy, means that
the spillovers arising from an infrastructure project are of a much larger
order of magnitude than for many other activities. Indeed, they almost define
the nature of infrastructure (Threadgold, 1996).
A third important feature of infrastructure is the way that the ideal
composition of this infrastructure changes over time. The long-life character
of much traditional infrastructure can foster a divergence between actual and
ideal structures. Different forms of infrastructure can (sometimes
imperfectly) substitute for each other to meet emerging demands. Telecoms
and the Internet provide alternatives to some of the services previously
sought from transport and postal infrastructure; technology in the form of
wireless communications can substitute for wire networks; smart technology
in exchanges can sometimes deliver broadband through ‘old technology’
copper wires, rather than requiring wholesale expansion to the wires
networks.
Fourth, infrastructure gives rise to natural monopolies, when scale
economies make it practicable to have only one provider (for example, of an
electricity grid to a particular area). It is more cost effective to have one
provider of an electricity grid, rather than multiple small providers who
individually cannot realize the economies of scale involved. Because of the
high fixed capital costs involved, the competitive provision of the
infrastructure itself is costly, often prohibitively so. Related to this
characteristic, the development and delivery of many infrastructure services
require the acquisition of land for transport routes or rights above or below
ground to install conduits, pipes and cables. Often only government has the
capacity to cede these negotiation rights. Nevertheless, the natural monopoly
characteristic need not exclude competition in the use of infrastructure, and
public control over property rights does not necessarily require government
to own or operate the infrastructure services.
26

Fifth, there is the presence of network services, providing activities that
bind economic activity together. The notion of a network providing
integrative threads is often identified with the facilities of communication,
energy supply, water supply, sewerage treatment and transport. Often these
services constitute a small, but indispensable, part of the total cost of the
wide range of products in which they are used, yet the losses that result from
service failure can be very large relative to the basic cost of service
provision, due to the integrated grids and transnational interconnectors,
failure of a number of local power lines created power losses over much
larger areas that lasted almost a day in each case. In this respect, these
infrastructure services can be described as being of ‘strategic importance’
(Kay, 1993, p. 55).
Sixth, infrastructure usually involves very large investments. Capital
costs of infrastructure are generally large relative to the running costs, and
the sunk costs of establishing an infrastructure asset are substantial. This
means that a high proportion of the total cost of a service has already been
irrevocably committed before the service is made available. Many of the
items widely recognized as infrastructure – such as the distribution networks
of public utilities and the development of road and rail systems – generally
meet all five of these conditions. Other activities, still widely regarded as
infrastructure, such as postal services and financial payment systems, have
several features in common with utility distribution facilities: they involve
networks, have significant sunk costs and are widely used, are indispensable,
and have a relatively low user cost.
Together, these six characteristics traditionally have been seen as
casting doubt on the viability of private-sector, competitive market
provision, despite the fact that some infrastructure is privately owned and
operated. two of the characteristics, natural monopoly and the predominance
of sunk costs, simply suggest that competitive supply is unlikely to emerge.
The network feature of infrastructure raises the possibility that efficient
27

provision will not be achieved unless mechanisms of central coordination
are put in place. Finally, the strategic importance of the service to the
economy means that governments traditionally have been unwilling to rely
on supply by the competitive private sector. In the presence of externalities
and public good features, the benefits of an increased supply of the good in
question may be greater than what can reasonably be charged to users. Toll
roads and inland waterways are the classic illustration. In theory, these could
be, and in the past have been, built by private entrepreneurs charging tolls.
But the charges might have to exceed the cost of the existing modes of
transportation, so the profitability of the venture would be threatened by the
unwillingness of users to switch to a higher cost mode of transport.
Nevertheless, the greater efficiency of the new transportation facility would
provide considerable benefits to many non-users across the whole
geographical area. Public finance and public provision have thus been seen
as necessary to ensure that these efficiency gains will be realized, and in
most countries the outcome was that a large number of infrastructure
activities were owned, managed and financed by the public sector.
In developed countries, most infrastructure are provided by private
sector, while government not only manages and monitors using rules and
regulation, quality standards, taxes, but also creates and facilitates good
environments for private sector to be able to provide infrastructure
efficiently and effectively. In developing countries, however, governments
own, operate, and finance nearly all infrastructure, primarily because its
production characteristics and public interest involved were thought to
require monopoly and hence government provision. Social infrastructure has
enormous externalities. Education and health are social goods in which
social marginal productivity (SMP) exceeds private marginal productivity
(PMP). Therefore, private investment capital in such social infrastructure is
likely to fall far short of what is needed. In that case, it is imperative for the
state to provide the finance and other complementary resources for the take-
28

off of such social infrastructural projects. The state does not necessarily have
to operate or manage a social infrastructure, but it is necessary for the state
to provide guidelines for and monitor its operation. Economic infrastructure
has played a very significantly positive role in the growth performance of
countries in recent times. Where development of economic infrastructures
has followed a rational, well-coordinated and harmonized path, growth and
development has received a big boost. Examples are Korea and Japan9
.
Where the growth of infrastructures has not followed such a rational and
coordinated path, growth and development has been stunted. Examples can
be found in most African countries and other LDCs. “Public infrastructure
does three things:
(1) it provides services that are part of the consumption bundle of
residents;
(2) large-scale expenditures for public works increase aggregate
demand and provide short-run stimulus to the economy; and
(3) it serves as an input into private sector production, thus
augmenting output and productivity.
Although the public sector will remain the major provider of
infrastructure services in most developing countries for the foreseeable
future, an increasing number of those countries are now considering ways of
attracting increased private sector investment. In developing and transition
economies a main cause of deteriorating infrastructure performance was
underinvestment, which was largely due to the failure of governments to
prescribe cost-reflective tariffs, especially during periods of high inflation.
Under state ownership, prices fell to levels that could not cover the
investment needed to meet growing demand. This problem was deferred as
9
The Japanese economy and Korean economy are known for accomplishing high economic growth in the
postwar era and at the same time realizing a commendable degree of equality in the distribution of income.
This Miracle Growth was the completion of a protracted historical process involving enhancing human capital,
massive accumulation of physical capital including infrastructure and private manufacturing capacity, the
importation and adaptation of foreign technology, and the creation of scale economies since after World War
II. Domestic investment in industry and infrastructure was the driving force behind growth in Japanese output.
Both private and public sectors invested in infrastructure, national and local governments serving as
coordinating agents for infrastructure build-up.
29

long as governments were able to provide subsidies and international
financial institutions were willing to bail them out. But years of under
funding and failure to address systemic problems led to a significant
infrastructure deficit in the developing world, generating substantial welfare
losses. Infrastructure inefficiencies constrained domestic economic growth,
impaired international competitiveness, and discouraged foreign investment.
In the early 1990s, for example, developing countries incurred annual losses
of about $180 billion due to mispricing and technical inefficiency in water,
railroads, roads, and electricity - nearly as much as annual investments in
these sectors (World Bank 1994b). With growing budget deficits and the
resulting inability of governments to maintain and expand infrastructure
services, most developing and transition economies simply could not sustain
state-owned utilities. Debt and fiscal crises, combined with extraordinarily
weak performance, stimulated strong pressures for infrastructure reform.
2.5 The role of private sector and community in infrastructure
provision
Investing in a country’s physical infrastructure can contribute to
economic growth, improve human welfare and has considerable potential for
directly reducing poverty. Yet current investment in the poorer developing
countries, whether internally or externally sourced, is insufficient to fund
infrastructure needs, leaving hundreds of millions without access to decent
basic services. Although the public sector will remain the major provider of
infrastructure services in most developing countries for the foreseeable
future, an increasing number of those countries are now considering ways of
attracting increased private sector investment.
Financing for infrastructure provision and maintenances should be
supported by both government and private sectors. Government has been
bearing more of the burden of infrastructure expenditure than they can
reasonably be expected to manage. Governments bear virtually all risks
associated with infrastructure financing. Private financing is needed to ease
30

the burden on government finances, but, more important, it will encourage
better accountability, monitoring, and management in infrastructure
provision. Private sponsorship and financing offer the twin benefits of
additional funds and more efficient provision- especially valuable because
substantial new investments are needed to meet pent up demand.
Today competition can be used directly in more infrastructure
activities because of technological changes. In telecommunications, satellite,
microwave, and cellular radio transmission of telephone signal is
revolutionizing the industry making the economies of scale (Natural
monopoly) with cable-based transmission less important. In power
generation, combine-cycle gas turbines operate efficiently at lower output
levels than other generation technologies. For activities of sunk costs,
competing for the right to operate a monopoly can capture many benefits.
In addition to taking steps to improve the performance of
infrastructure provision under direct control, governments are responsible
for creating policy and regulatory frameworks that safeguard the interests of
the poor, improve environment condition, and coordinates cross-sectoral
interactions, whether services are produced by public or private providers.
Therefore, nowadays, operation of infrastructure service delivery,
levying tools and fees, and maintenance are permitted to private sector under
contract system, such as BOT (build ,operate, transfer) system, BOO (build,
operate, own) system, and BOL (build, operate, lease) system that can
improve efficiency of infrastructure provision. Moreover, the state
encourages community-based infrastructure development works like
construction of roads, bridges, health centers and schools and installations of
electric transformer on a self reliance basis.
According to a World Bank study, between 1990 and 2005, private
investors committed US$ 961 billion through more than 3,200 projects
although actual investment may have been somewhat lower due to some
canceled projects. That is an average of US$ 64 billion per year. Those
31

projects were implemented under a wide array of schemes including
management contracts, divestitures and greenfield facilities under build-
operate-own (BOO) contracts, build-operate-transfer (BOT) contracts, or
merchant facilities. The projects are in a range of sectors including transport,
energy (electricity and gas), telecoms, and water and sewerage. Figure 2.3
and 2.4 shows that private participation in infrastructure projects in
developing countries peaked in 1997. The Asian crisis caused a broadly
declining trend for several years afterward. However, in 2004 and 2005
investment recovered. At its 1997 peak, private investment amounted to
about 53% of total infrastructure investment in developing countries. Even
when private investment was at its highest, there was an ongoing need for a
large volume of public investment. Private investment was strongly
concentrated geographically (although most countries experienced some
forms of private participation in infrastructure). The top five recipients of
private infrastructure investment (Brazil, Argentina, China, Mexico, and
Malaysia) received 49% of all private infrastructure investment in 1984-
2004.The top twenty countries received 85% of all private investment. Less
than 10% of private investment has been made in low income countries.
Private investment was also strongly concentrated by sector, with
telecommunications absorbing 46% of investment, energy 33%, transport
16% and water and sewerage just 5%. The 2003 low-point in private
infrastructure investment amounts to 22% of total investment in
infrastructure.
Figure 2.3-Private Sector Participation in Infrastructure by Sector
32

Figure2.4-Private Participation in Infrastructure by Country Group
0
10
20
30
40
50
60
70
80
90
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
US$Billions
Upper Middle Lower Middle Low
Source: World Bank, PPI Database
However, although private sector participation in the provision of
infrastructure services has become the new orthodoxy, many remain
concerned about its social implications. There are growing concerns about
how infrastructure privatization and market liberalization have affected low-
income households in developing economies (Estache, Foster, and Wodon
2002). It is often argued that privatization leads to tariff hikes that make
services unaffordable for the poor and that profit-oriented multinationals are
unwilling to provide services to urban slums and remote villages.
Thus, Estache and Fay (2007) suggested that the emerging new vision
is no longer a dichotomous choice between public and private on the full
spectrum of dimensions associated with infrastructure service delivery.
Instead, pragmatism dominates. The public sector is expected to retain an
33

important financing role while the private sector can help in meeting the
very significant needs associated with infrastructure construction, operation
and/or to some extent financing in sectors such as telecoms, energy
generation and transport services. This evolution is actually observed around
the world, in developed as well as in developing countries.
Corporatization is an additional tool. This is designed to strengthen
SOE autonomy, through a separate statutory authority, with a distinct legal
identity, separate accounts and its own board of directors (preferably
including members from the private sector and stakeholder groups as well as
government). Full corporatization requires the enterprise to be incorporated
under the same laws that govern private corporations. Management is given
considerable autonomy in areas such as human resources, financial
management, pricing (under regulation) and service provision. However, the
experience of developed countries suggests that corporatization alone is a
necessary but not sufficient condition to improve performance.
This new pragmatism also involves an acceptance of the vital role for
the institutions of sector governance whether provision is in public or private
hands. In a set of industries where monopoly provision is likely to remain
the usual model –including transport infrastructure as well as water and
sanitation alongside electricity distribution—the role of government remains
vital whether services are provided privately or publicly. If there is an
attempt to attract private investors, in a set of industries where payback
periods are long, the institutional environment covering prices and the
broader investment climate will be a key to attracting finance. If
infrastructure remains in the hands of the state, then the quality of the
government institutions managing the infrastructure stock will be vital to
determining outcomes.
Development theories suggested that investing in a country’s physical
infrastructure can contribute to economic growth, improve human welfare
and has considerable potential for directly reducing poverty. Under
insufficient government infrastructure provision and investment, to achieve
34

the Millennium Development Goals(see Appendix Table 1), the attraction of
increased private sector investment in infrastructure service provision in the
poorer developing countries will be essential. In other words, integrated
development policies and public private partnerships in infrastructure
development are crucial for long term development of a nation.
35

Chapter 3
Review of Studies on the Effects of Infrastructure Development
In this chapter, an attempt is made on a review of the studies dealing
with the productivity impact of infrastructure and of the studies, which link
infrastructure to economic growth. Since the mid-1980s, many researches
were conducted to analyze the linkage between infrastructure and economic
development. The impact of public infrastructure on output or productivity
is a subject of continuing debate among economic policy-makers,
politicians, and the public in both developed and developing countries.
Much of the formal research on the linkages between infrastructure and
economic growth has looked at macroeconomic or industry-wide variables
(e.g. aggregate public capital investment). These studies, most of which have
been done with respect to developed countries, generally find that
infrastructure capital has a significant, positive effect on economic output
and growth.
Economists have taken at least five different approaches to
investigate the relationship between infrastructure and productivity:
(1) production function approach;
(2) cost function approach;
(3) growth models;
(4) general equilibrium models; and
(5) data oriented models.
The production function approach models the amount of output that
can be produced for each factor of production, given technological
constraints. The cost function approach is different from the production
function approach in that it takes into account factor prices such as the price
of labour, machinery and finance. Growth models are constructed to
estimate the impact of all factors of production on output using total factor
productivity. These models are used to understand the relationship between
total productivity and production inputs, like public capital. General
36

equilibrium models (GEMs) are considered to be more comprehensive than
the models above, as they provide an understanding of the whole economy,
using a bottom up approach. GEMs model behaviour of individual agents in
a price changing market environment. Theoretical models are restrictive and
do not take certain elements into account. Consequently, to identify the
direction of causality between infrastructure and productivity, several
researchers resort to data oriented models. Data oriented models analyze
relations between several data series and do not rely heavily on economic
theory.
The growing interest in infrastructure was triggered by Aschauer
(1989a) who has considered the relationship between aggregate productivity
and stock and flow of government spending variables in the US economy for
the period 1949-85. He estimates a general Cobb-Douglas production
function and treated government spending on public capital as one of the
input in the production function. Estimation has been done using OLS and
from this equation, productivity estimates are also derived. His results
suggest that there is a strong positive relationship between output per unit of
capital input, the private labour capital ratio and the ratio of the public
capital stock to the private capital stock.
Aschauer (1989b) focuses on the question of higher public capital
accumulation that has ‘crowd out’ effect on private investment. He argues
that higher public capital accumulation raises the national investment rate
above the level chosen by rational agents and induces an ex-ante crowding
out of private investment. An increase in public capital stock also raises the
return to private capital, which crowds in private capital accumulation. He
carries out the empirical analysis for the U.S. economy and the results
suggest that private capital accumulation responds positively to an increase
in the rate of return to capital.
Munnell (1992) points out that the implied impact of public
infrastructure investment on private sector output is too large to be credible.
37

He looked at the relationship between public capital and measures of
economic activity at the state level for U.S. economy. He found that public
capital had a significant positive impact on output, although the output
elasticity was one-half the size of national estimate. Public capital enhances
the productivity of private capital, raising its rate of return and encouraging
more investment. But on the other hand, from an investor’s perspective
public capital acts as a substitute for private capital and “crowds out” private
investment.
Lynde and Richmond (1992) also analyse the impact of the stock of
public capital on costs of production in the private sector using annual data
for US nonfinancial corporate sector over the period 1958-1989. They had
estimated a translog cost function and found public capital to be a significant
input. This also implies that public capital has an important role to play in
the productivity of the private sector. Lynde and Richmond (1993) presented
evidence which showed that stock of public capital had played a significant
role in production in the manufacturing sector of the U.K. economy.
Shah (1992) has utilized a restricted equilibrium framework to
analyze the contribution of public investment in infrastructure to private
sector profitability. A restricted cost function in translog form is estimated,
which treats labour and materials as variable inputs and private capital and
public sector as quasi-fixed inputs. A system of non-linear equations
comprising of variable cost function and derived input demand equations is
estimated using data from 1970-1987 for twenty-six Mexican three-digit
industries. Empirical results suggest that Mexican industrial structure has
increasing returns to scale, short-run deficient capital capacity and declining
productivity growth. Results indicate that public infrastructure has a weak
complimentary with infrastructure in both short and long run with degree of
complimentary being higher in short run as compared to the long run. Public
infrastructure is observed to have a small but positive effect on output.
38

Mas et al. (1996) reports the regional dimension and temporal
dimension of the impact of public capital on productivity gains. Using data
for Spanish regions over the period 1964-91, it estimates Cobb-Douglas type
production function by means of panel data techniques to control for
unobserved state- specific characteristics. This dissertation concludes that
economic infrastructure has a significant positive effect on productivity, but
social infrastructure does not. There are spillover effects associated with
public infrastructure and the effect of public capital on productivity has
tended to decline over time.
Nadiri and Mamuneas (1994) have examined the effects of publicly
financed infrastructure and R&D capitals on the cost structure and
productivity performance of twelve two-digit US manufacturing industries.
The result suggests that there are significant productive effects from these
two types of capital as shown by cost elasticity estimates which range from
0.02 to –0.21 for infrastructure and –0.04 to –0.01 for R&D capital. Their
effects on the cost structure vary across industries. Not only is the cost
function shifted downward in each industry, generating productive effects
but factor demand in each industry is also affected by two types of public
capital suggesting bias effect.
Demetriades and Mamuneas (2000) utilize an intertemporal
optimization framework to study the effects of public infrastructure capital
on output supply and input demands in twelve OECD countries. They found
that in all the twelve countries, public capital has positive long run effects on
both output supply and input demands and infrastructure has been sub-
optimally provided in most countries examined. Both in the short-run and
long run private capital was found to be more productive than the public
capital.
Joshi (1990) provides a comprehensive account of the development
of infrastructure in India. He showed that interstate disparities in level of
development did not decline between 1960-61 and 1985-86. Joshi found a
39

clear and strong association between the level of infrastructure and the level
of development.
Deepika Goel(2002)’s finding supports one of the propositions of the
new growth theory that developing economics benefit significantly from free
trade with developed economies through free flow of new ideas and
technologies and externalities. Estimated productivity effects of
infrastructure suggest that both economic and social infrastructure
significantly affects the cost and productivity of registered manufacturing
sector in India. Moreover his results show that economic infrastructure is
capital using but labour saving and intermediate input saving, while social
infrastructure is capital saving and labour and intermediate input using.
Further, economic infrastructure is a substitute to capital, while
complementary to labour and intermediate inputs. Marginal benefit of social
infrastructure is higher than that of economic infrastructure and net rates of
return are also higher for social infrastructure, Hence they concluded that
infrastructure plays a positive and significant role in affecting the
productivity in the industrial sector in India and thus contributes towards
economic growth.
Fabrizio Felloni, and others (2001)’s study used cross-sectional data
from 83 countries and 30 provinces in China to assess the effect of
transportation infrastructure and electricity on agricultural production and
productivity. Evidence from this research suggested that, in accordance with
economic theory, the density of roads and the availability of electricity are
significant predictors of production and productivity in agriculture. These
results are particularly interesting for China, where, in the past twenty years,
the increase in Chinese agricultural output, specialization and mobility in
rural areas has been impressive. Results of this analysis suggested that
access to transportation infrastructure and electricity are crucial in the
modernization of Chinese agriculture.
40

Pavlo Sugolov, Boris Dodonov and Christian von Hirschhausen’s
dissertation provided initial evidence of the relation between infrastructure
policies and economic development in the transition countries of Eastern
Europe and the Commonwealth Independent States (CIS-15 countries, 1993-
2000). They used an aggregate production function to test how GDP in
transition countries is related to total capital (proxy by net electricity
consumption), infrastructure capital (proxy by telephone mainlines), and the
speed of liberalization in major infrastructure sectors (telecommunication,
transport, energy, water). The basic model is estimated using panel data
fixed effects. In the second model, by estimating a stochastic frontier
production function, they also estimate the technical inefficiencies of the
individual countries. Although significant data problems remain, the models
suggest that early liberalization of infrastructure sectors is conducive to
economic growth. As transition progresses, most countries increase their
productive efficiency. Unexpectedly, investments in telecommunication do
not seem to impact growth particularly. This research concluded that
institutional reform in infrastructure sectors is at least as important as the
modernization of physical capital.
Maria Jesus Delgado and Inmaculada Alvarez (2001) provided
evidence that productive infrastructure encourages private investment and
positive elasticity on economic growth using a translog production function
for the 17 Spanish regions for the period 1980-1995. Lucio Picci1(1999)
finds out the role of public capital is significant, the more so for those
categories of public goods, such as roads and railways, that form the so
called core infrastructure in determining factor productivity in the Italian
regions using panel data econometric techniques.
For Japan, Koichi Mera (1973) carried out the first study which found
that public infrastructure, including transport and communications
infrastructure contributes to aggregate private production in ways similar to
that of privately supplied inputs and that its impact on productivity could be
41

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