Social and Economic Infrastructure Impacts on

Economic Growth in South Africa

Infrastructure and Growth Conference29-31st May 2006

C. Kularatne

The information is intended for the recipient's use only and should not be cited, reproduced or distributed to any third party without the prior consent of the author. Any comments or statements made herein do not necessarily reflect the views of the National Treasury. Although great care is taken to ensure the accuracy of the information, neither the author nor the National Treasury can be held responsible for any decision made on the basis of the information cited.

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Outline

Introduction

Economic & Social Infrastructure : A Historical Perspective

Theoretical Background

Empirical Literature

Econometric Methodology

Association between Infrastructure Measures, Output and Private Investment

Results

Non-linear Results

Policy Conclusions

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Introduction Examine relationship between infrastructure (economic and social)

and growth in SA

WHY?

•DTI: Targeting of infrastructure expenditure is crucial –one of key constraints to growth given the fact that the relative logistics cost of South Africa (15% of GDP) versus those of its trading partners (8,5% of GDP).

•No of containers per gross crane hr: Singapore = 25, Nagoya = 32, Hamburg = 24

AsgiSA document outlines 6 salient topics that need immediate address - one is investment in infrastructure.

•Cabinet approval for Eskom & Transnet - R121-billion worth of investment over the next five years.

•Approximately R107-billion needed 2005-2009 for SA energy

•AsgiSA: Lower costs & improve SA competitiveness – Planned infrastructure investment will contribute to this

Planned rate of growth of the capital budget of government at between 15% and 20% per year

•SA: Durban & Cape Town = 16, Port Elizabeth = 12

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A Description of Data

• Some Notes on SARB Infrastructure Data

• SARB gets capital stock data from StatsSA categorized into: Construction, machinery, residential, non-residential,etc.

• Non-residential investment => Social infrastructure

• Construction and machinery => Economic infrastructure (by public corporations & general govt)

• Depreciation is calculated based on these categories provided by StatsSA using a linear rate of depn - Explains negative infrastructure investment

Description Source

Log of Gross Value-Added per capita at 2000 prices SARBLog of Private Investment Rate at 2000 prices SARBLog Social Infrastructure Investment Rate at 2000 prices SARBLog skills ratio QuantecInterest rate (long-term) differential between US and SA SARBLog Economic Infrastructure Investment Rate at 2000 prices SARBLog of Price of Capital SARBLog of the Savings Rate at 2000 prices SARBLog Corporate Tax Rate National TreasurySchooling Infrastructure measures DoERail Infrastructure StatsSA, SpoornetRaod Infrastructure StatsSA, CSIR, Roads Agency

Economic & Social Infrastructure in SA

Economic & Social Infrastructure

-50

0

50

100

150

200

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300

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1000

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Investment in Social Infrastructure per capita

Investment in Economic Infrastructure per capita

Oil Crisis

Sanctions

Asian crisis

Historical View of Economic Infrastructure

Average Investment in Economic Infrastructure per capita (R)

Average Investment in Economic Infrastructure-to-GVA (%)

1960s 618 3.60

1970s 976 4.91

1980s 445 2.20

1990s 59 0.33

1994-2004 92 0.49 2000-2004 89 0.45

Demonstrate a long-term deterioration: from mid-1970s for economic and social investment capital stock

Investment in economic infrastructure per capita fell from R1 304 in 1976 to R52 in 2002.

Economic infrastructure investment rate fell from 5 % to 0.27%

Recovery of infrastructural investment in the 1990s & subsequent slump• Expansion programs by Telkom & Eskom to areas which were under-serviced,

(SARB annual economic reports, 1996 -2000).

Historical View of Economic Infrastructure

Decline in infrastructural investment mid-1970s & 2002 - Part of overall decline in GFCF SA's gross savings (% of GDP) fell during 1980s & 1990s.

After 1980 govt consumption expenditure increased at expense of government investment (Merrifield, 2000: 98) - reflecting the government’s desperate attempts to prop up a political system that was economically unsustainable.

Growing consumption expenditure possible through investment cutbacks & fiscal deficit - budget deficit as prop of GDP rose from 2.9% in 1980–1986 to 4.9% in 1987–1994

In post-apartheid period, consumption & investment constrained to reduce deficit. Averaged 4.5% in 1995–1998 & 1.8% in 1999–2003. See Mariotti (2002).

Phases of Expansion

1. Railways from 1875–1930 period,

2. Inter-city roads- reached plateau 1940, after which focus was on paving national & provincial roads.

3. Port capacity was constrained to 1970s.

4. Telephones and electricity in 1980s

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An Index of Infrastructure Monetary vs Physical measures

Physical measures: quantity of pertinent structures and facilities and covering a broader definition of this stock

• Why?

1. Government may not always be subject to competitive markets, & public infrastructure endowments are not allocated through a price mechanism

2. Expansion of infrastructure takes place in stages wrt type of infrastructure

3. Expansion of infrastructure expenditure may not be matched by proportionate increases in physical infrastructure

Historical View of Economic Infrastructure

Railway lines (km), Rail locomotives (number), Rail goods stock (number),Rail carrying capacity (tonnes), Rail freight (tonnes), Total roads (km), Ports: cargo handled (harbour tons), South African Airways passengers (number), Total telephone lines (mobile & fixed), & Electricity generated (gigawatt hrs)

Index of Economic Infrastructure & per capita GVA

-10.00

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

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0.00

5,000.00

10,000.00

15,000.00

20,000.00

25,000.00Index of Infrastructure

Gross Value-Added per capita

Historical View of Economic Infrastructure

GVA per capita & Index of Infrastructure

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-6

-4

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2004 0

5000

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15000

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25000Index of Infrastructure

GVA per capita

Index of capacity utilization of railroad and road infrastructure - incorporates different measures of rail infrastructure

Rail infrastructure measures include railway lines, locomotives and coaching stock per ton of freight & road infrastructure (both paved and unpaved) per vehicle.

Indicates a declining trend.

Imply that infrastructure capacity is declining or that infrastructure is being more efficiently used.

More km of road does not necessarily imply improvements in infrastructure - vehicular transportation may be more efficiently utilized.

Historical View of Social Infrastructure

Average Investment in Social Infrastructure per capita (R)

Average Investment in Social Infrastructure-to-GVA (%)

1960s 162 0.95

1970s 234 1.18

1980s 111 0.55

1990s 2 0.01

1994-2004 5 0.02 2000-2004 11 0.05

Social infrastructure investment per capita also decline from R263 in 1976 to R2 in 2002.

Social infrastructure investment rate in 2004 is 0.2%.

Renewed effort from year 2000 to increase social infrastructure investment expenditure - rising to R39 per capita in 2004.

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Social Infrastructure: Schools

Declining trend

Trend in infrastructure expenditure on schools portrays a gloomy picture since 1997

Most of education budget spent on recurrent expenditure

Have we caught-up with the backlog of physical infrastructure in schooling system?

Classrooms and New Schools

-3

-2

-1

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1

2

3

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Schools Index

Theoretical BackgroundInvestment in economic infrastructure increase growth potential,

raising productive capacity via TFP directly or indirectly by increasing the return to private capital

Direct effect: as a factor of production

Indirect effect: productive infrastructure and private capital are "complements" in production, i.e, partial derivative of marginal product of private capital services with respect to the flow of infrastructure capital services is positive.

Effect of Social infrastructure???

Barro (1990) theoretical model to underpin the interaction of government expenditure on growth

Nuance to Barro (1990) model is inclusion of public investment in social infrastructure and economic infrastructure.

Infrastructure (economic and social) used in production of final output - financed by a tax on output.

Theoretical Background

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• as augmenting technological progress.

•Social infrastructure represents schools and hospitals - argue productivity of individuals in the economy will improve with improvements with increasing access to health care and educational facilities.

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EESS 11

0

Sg

iff S

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Theoretical Backgroundα =0.2, A=1, gS = 20-100, k = 20-100

Literature Review• Academic debate on public infrastructure was stimulated by Aschauer (1988.1989)

• Various papers using a variety of methodologies in analysing the impact of infrastructure

STUDY AGREGATION LEVEL DATA CONCLUSIONS

Aschauer (1989) US Time series, 1949-85 Strong and positive relationship between productivity and public investment

Shioji (2001) US & Japanese regions Panel data, 1958-78 Infrastructure capital has a significant positive effect on long-run output in both countries

Shah (1992) Mexico Time series, 1970-87 Public infrastructure has positive multiplier effect on output

Rioja (1998) 7 Latin American countries Time series Infrastructure investment has sizeable positive effects on GDP and private investment

Ramirez (1998) Chile Time series, 1960-93 Public investment has a positive and highly significant effect on growth

Kneller, Bleaney & Gemmell (1998)

22 OECD countries Panel data, 1970-95 An increase in productive expenditure significantly enhances growth

Ram (1996) 53 developing countries Panel Data, 1973-80, 1980-85, 1985-90

Public investment appears more productive than private investment

Ford & Poyet (1991) US Time series, 1957-89 Public investment has a significant and positive effect on private output

Toen-Goet & Jongeling (1994)

US Time series Public investment on infrastructure has a significant and positive influence on output

Nourzad (2000) 12 developing/ developed countries

Panel Data, 1976-1989 Public capital exerts a positive and statistically significant effect on labour productivity

Devarajan et al. (1996) 43 developing countries Time series, 1970-90 Total government expenditure has a positive but statistically insignificant effect on growth

Literature Review• Perkins (2003) finds significant long-run relationships between infrastructure and GDP in South Africa – SA’s GDP growth tends to drive growth in individual measures of infrastructure-related goods and services.

•Fedderke et al. (2005) find investment in infrastructure (using various measures of physical infrastructure) does appear to lead economic growth in SA both directly and indirectly (raising the marginal productivity of capital); weak evidence of feedback from output to infrastructure; while the finding of an infrastructure growth impact is robust.

•Bogeti´c et al. (2005) using panel data for the SA manufacturing sector find empirical links between infrastructure and productivity. Specifically, infrastructure affects output directly, while it exerts more limited impact on factor productivity.

Summary

1.Public capital probably enhances economic growth,

2.Direction of association???

3.We are less certain about the magnitude of the effect and this is a disappointing outcome, given the enormous amount of research in this field.

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Econometric Methodology 2. PSS F-Test

• Explore the directions of association between the variables

• Where the estimated test statistic exceeds the upper bound value, we infer presence of a long-run equilibrium relationship and vice versa.

• Test is indeterminate:

1. Where test statistic lies between the upper & lower bound values (in which case it is not clear whether a long-run relationship between the variables is present),

2. Where more than one variable is confirmed as outcome variable of long-run equilibrium relationship (in which case the long-run relationships between variables not unique).

• In current application - relationship tested is between GDP and/or private investment & individual measures of economic infrastructure, and/or private investment & social infrastructure

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Econometric Methodology 3. Johansen Vector Error Correction Methodology

• Estimate a structural model for the linkages between economic and social infrastructure and other macroeconomic variables the paper employs Johansen estimation technique

• Estimating a Vector Error-Correction Mechanism (VECM)

4. Threshold autoregressive estimation - Potter (1995), Pesaran and Potter (1996)

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•How do we determine threshold?

tmtmtt zAzAz ...11 ( 1 )

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11

k

itktitit zzz ( 2 )

':1 rH ( 3 )

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Discussion of Results

• Existence of feedback effects between physical infrastructure and per capita output;

• Existence of feedback effects between physical infrastructure and per capita private investment expenditure;

• Physical infrastructure (possibly) affects per capita output indirectly via per capita private investment expenditure; and

• Social capital affects per capita output, per capita private investment expenditure and physical economic infrastructure directly.

Y

INV INF

S

• The PSS F-test was conducted to determine the relationship between per capita infrastructure investment expenditure, per capita private investment expenditure and per capita output.

• We discover that infrastructure manifests (in one dimension) the possible absence of per capita output and per capita private investment affecting per capita investment expenditure.

• Does output affect infrastructure development?

Y

INV INDX

S

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EstimationGross Value-Added per capita

Private Investment Rate

Economic Infrastructure Investment Rate

Per capita GVA - 7.44 10.7Private Investment Rate

0.082 - 0.55

Economic Infrastructure Investment Rate

- 0.024 -

Social Infrastructure Investment Rate

0.06 - -

Skills Ratio 0.31 - -Instability -0.08 - -Price of Capital - -0.14 -0.95Savings Rate - 0.034 -2.51Corporate Tax rate - -1.57 -1.82ecm -0.19 -1.38 -0.67

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Threshold effects

•Social infrastructure-to-GVA – No critical threshold reached at 1.3%

•Economic infrastructure-to-GVA- No critical threshold reached at 6%

Social Infrastructure-to-GVA Level 1% 1.3% On per capita GVA 0.05 0.05 Threshold 0.01 0.04 Sum 0.06 0.09

Economic Infrastructure-to-GVA Level 5% 6% On Private Investment rate 0.26 0.23 Threshold -0.14 -0.15 Sum 0.07 0.08

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Conclusion and Policy Analysis

•Neither Economic nor Social infrastructure expenditure thresholds could be reached as a percentage of GVA when taking into account the highest it has been since 1960 (as a percentage of GVA)

•Both economic and social infrastructure expenditure still on a linear path

•Social infrastructure has a positive direct effect on GVA

•Appears that economic infrastructure investment does not lead output but rather lags GDP growth from 1965 onwards

•Economic infrastructure investment appears to respond to economic growth rather than driving economic growth since 1960

•Investments undertaken were a response to capacity constraints being reached

•Feed back effects of economic infrastructure wrt to private investment

•Other investments like petrol refineries which occurred in 1960s may have had a negligible effect on GDP growth – inefficient investments

• Economic Infrastructure still on linear path – further investigation

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Quality of Schooling & Infrastructure

Composite Schools Index vs Degrees in Math & Science

-1

-0.5

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1.5

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3.5

1995 1996 1997

0.36

0.38

0.4

0.42

0.44

0.46

0.48

0.5

2000 2001 2002

Composite Schools Index

Proportion of Students with degrees in Natural Sciences

New Schools, Total of classrooms, Total of workshops, Total of toilets, Administrative areas: offices and storerooms, Media centres, Halls, Number of schools provided with fences, Number of schools provided with water, & Number of schools provided with electricity

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SavingsEconomic Infrastructure Investment rate vs Savings rate

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Economic Infrastructure Investment rate

Savings Rate vs Economic Investment rate (+4)

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Savings rate

Economic Infrastructure Investment rate (+4)