Infrastructure and Growth: Comparing Latin America and East Asia

Infrastructure and Growth: Comparing Latin America and East Asia

Derya Yılmaz (Uludag University, Turkey) and Işın Çetin (Uludag University, Turkey)
DOI: 10.4018/978-1-5225-2361-1.ch006
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Abstract

Infrastructure plays a critical role in explaining the growth differentials between regions. The growth performances of Latin America are lagged behind East Asia and this fact is often attributed to the infrastructure gap between these regions. It is advised to Latin America to increase its infrastructure investments in order to record high growth rates. But as infrastructure is multidimensional, in which sector the investments should be channeled? This study tries to determine this with an empirical model. The empirical model in this study is a growth function and the infrastructure variables are added as an input to this function. Empirical results suggest that the long-run elasticity of transportation is higher than the long run elasticities of telecommunications and power. Thus, in order to catch-up East Asia quickly, Latin America should invest in transportation.
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Introduction

Infrastructure consists of basic systems as well as services that a country uses in order to sustain efficient production. Infrastructure has been viewed as a critical agent to address the development challenges. It is accepted that the availability of infrastructure is vital in the growth of private sector. In this manner, after the Global Financial Crisis, governments have invested in infrastructure in the context of countercyclical policies.

The link between infrastructure and growth could be explained via direct and indirect channels. Directly, infrastructure investments contribute positively to the relevant year’s output. However, indirect channels have more important and lasting effects on growth. First of all, infrastructure raises general productivity of other inputs. Better electricity could lead to better education as well which in turn boost the growth rate. Second, infrastructure is a necessity for private investment. Better infrastructure ends up with higher investment – both domestic and foreign. Finally, infrastructure lowers transaction costs which enhance the effectiveness of markets and augments trade.1

Infrastructure and growth nexus has been studied empirically in the literature till 1980s. The seminal work of Aschauer (1989) finds strong and substantial effect of infrastructure on productivity in US. This study has been criticized on various – especially methodological-grounds.

1Several channels could be presented here. For details, see Agenor and Moreono-Dodson (2006) and Straub (2008).But generally studies exhibit a positive link between infrastructure and growth. Furthermore, it is accepted that the adequacy of infrastructure helps to determine the income differentials. The growth differential between East Asia and Latin America is often attributed to the infrastructure gap between these two regions. In the aftermath of the debt crisis in Latin America, governments had to consolidate their fiscal balances. They cut back their infrastructure investment spending accordingly. However; in East Asia, infrastructure investments have exiled even though the Asian crisis. The infrastructure gap has mounted as well. To close the stated infrastructure gap, Latin America should raise its infrastructure stocks. But in which sector should the investment be channeled? According to World Bank (1994) we could classify the infrastructure into four broad categories: power (or energy), transportation, telecommunications and water and sanitation. It is important to detect the sector that is more effective in promoting the growth as the resources of the countries are scarce.

The aim of this study is to analyze the growth effects of different sectors2 of infrastructure in order to determine in which sector to invest. With this aim we construct a panel data from Latin American and East Asian countries between 1990 and 2014. We model Latin America and East Asia separately to compare the growth effects. Accordingly, we develop a growth model and add infrastructure as an input to the growth function along with capital and labour. It is important to note that, the relation with infrastructure and growth may run in reverse. The countries that grow faster could devote more resources to infrastructure investments. In order to take this endogeneity problem into account, we use panel cointegration and Vector Error Correction (VEC) methodology. We try to capture the long-term relationship between infrastructure sectors and growth. As we are working with different countries, we have to consider heterogeneity. For this reason, we use fixed effect estimators.

According to the empirical analysis utilized in this chapter, all infrastructure sectors positively contributes to growth in the long run. In Latin America the growth effect of the transportation slightly higher than the growth effect of telecommunications. In East Asia, the elasticity of transportation is greater than the elasticity of telecommunications. The elasticity of the power infrastructure is the smallest in both regions.

Key Terms in this Chapter

Panel Data: In statistics and econometrics, the term panel data refers to multi-dimensional data frequently involving measurements over time. Panel data contain observations of multiple phenomena obtained over multiple time periods for the same firms or individuals.

Production Function: It is estimated to create a framework in which to distinguish how much of economic growth to attribute to changes in factor allocation (e.g. the accumulation of capital) and how much to attribute to advancing technology.

Transportation Infrastructure: It refers to the framework that supports transport system. Transport infrastructure consists of the fixed installations including roads, railways, airways, waterways, canals and pipelines and terminals such as airports, railway stations, bus stations, warehouses, trucking terminals.

Vector Error Correction Model: It is a restricted VAR designed for use with nonstationary series that are known to be cointegrated. The VEC has cointegration relations built into the specification so that it restricts the long-run behavior of the endogenous variables to converge to their cointegrating relationships while allowing for short-run adjustment dynamics. The cointegration term is known as the error correction term since the deviation from long-run equilibrium is corrected gradually through a series of partial short-run adjustments.

Power (Energy) Infrastructure: It consists of generation, transmission, and distribution systems that are essential to all other infrastructures and every aspect of the economy.

Panel Cointegration Analysis: If two or more series are individually integrated but some linear combination of them has a lower order of integration, then the series are said to be cointegrated. If the series cointegrate, the relationship between variables should be interpreted as a long run equilibrium, as deviations are mean reverting. Panel tests make progress in this respect. Since time series dimension is extended by the cross section, inference relies on a broader information set.

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