The role of infrastructure in spurring Chinese growth

Wendy Dobson, IFF Academic Committee member and former Canadian associate deputy minister of finance, highlights three lessons that can be applied to the Silk Road initiative
Wendy Dobson

Not all infrastructure investment has the same impact on growth. When making decisions about where to channel funds, there are important lessons to be learned from past experience, in particular for the Silk Road initiative and the Asian Infrastructure Investment Bank (AIIB).

The economics of infrastructure investment are straight forward, albeit with some qualifications. In a severe cyclical downturn, such as in 2008-09, coordinated expansionary monetary policy can help offset the recessionary impacts of lower demand. In that instance, deficit financing helped to maintain consumption and stimulated growth through investment spending on real assets, which increased aggregate demand, aggregate supply, productivity and generated future economic returns.

Note that fiscal expansion of this kind was most effective when part of a cooperative strategy among countries rather than in isolation by one government. Moreover, such spending was more likely to have the desired impact if applied to pre-approved projects that are likely to expand aggregate demand quickly.

Not all forms of infrastructure have the same growth impacts, however – energy, communications and transportation investments facilitate greater economic activity, while maintaining and renewing infrastructure stock often provides higher returns compared with new investment. Location also matters, since investments in one place can spill over to others, especially in urban areas.

It is possible to overinvest in infrastructure. Public finance decisions should be subjected to a test of their strategic importance – including whether a project generates returns. It has been shown that efficient public investment can double the growth impact. Investment should go far beyond short-term stimulus to enhance both productivity and growth prospects over time.

Efficient public investment can serve as a catalyst for growth by supporting or enabling the delivery of key public services and connecting firms and citizens to economic opportunities.

With public investment increasing in emerging markets, more so than in advanced economies, there are major funding requirements. Some worry a rush into infrastructure investment could have negative financial, environmental and social impacts. An International Monetary Fund study points to the importance of institutions – ones that improve public investment management, especially at the planning phase – in the allocation of capital and implementation of projects.

Rigorous and transparent arrangements for the appraisal, selection and approval of projects are required; stronger institutions are needed to carry out funding and management and monitor project implementation. Strict oversight of public-private partnerships is required, alongside better integration between national strategic planning and capital budgeting.

Key lessons

I would like to highlight three significant lessons, which can be applied to the Silk Road initiative and performance of the AIIB. Firstly, the overriding objective of greater growth requires structural changes, not just more lending. Secondly, now China has assumed the presidency of the G20, it has the opportunity to stress its ‘responsible' initiatives: those in which the AIIB makes high quality and inclusive lending decisions.

Finally, inclusion is especially important in maintaining Chinese legitimacy, especially in the early days of AIIB-funded projects, when precedents are created. There may be a temptation to achieve a ‘multiplier' effect by relying on other Chinese financing sources such as the China Investment Corporation and China Development Bank, or private sources, instead of turning to ADB or World Bank.

Such a strategy could have significant negative consequences. It could create the perception of China hijacking projects. Instead of expanding China's international influence, it could create a backlash against a ‘Chinese embrace' as smaller countries hedge by seeking closer relationships with other large countries. This can also happen if the perception develops, rightly or wrongly, of differences in quality controls in AIIB projects.

The Silk Road initiative is a long-term vision, one that will bear fruit only if the investments are in projects of value to people in the region, as well as providing payoffs to Chinese and other foreign investors.

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