Financing Public Infrastructure in Sub-Saharan Africa: Patterns and Emerging Issues

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized BACKGROUND PAPER 15 (PHASE I) Financing Public Infrastructure in Sub-Saharan Africa: Patterns and Emerging Issues Cecilia Briceño-Garmendia, Karlis Smits, and Vivien Foster JUNE 2008

2 2009 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC USA Telephone: Internet: feedback@worldbank.org All rights reserved A publication of the World Bank. The World Bank 1818 H Sreet, NW Washington, DC USA The findings, interpretations, and conclusions expressed herein are those of the author(s) and do not necessarily reflect the views of the Executive Directors of the International Bank for Reconstruction and Development / The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development / The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA USA; telephone: ; fax: ; Internet: All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street, NW, Washington, DC USA; fax: ; pubrights@worldbank.org.

3 About AICD This study is a product of the Africa Infrastructure Country Diagnostic (AICD), a project designed to expand the world s knowledge of physical infrastructure in Africa. AICD will provide a baseline against which future improvements in infrastructure services can be measured, making it possible to monitor the results achieved from donor support. It should also provide a better empirical foundation for prioritizing investments and designing policy reforms in Africa s infrastructure sectors. AICD is based on an unprecedented effort to collect detailed economic and technical data on African infrastructure. The project has produced a series of reports (such as this one) on public expenditure, spending needs, and sector performance in each of the main infrastructure sectors energy, information and communication technologies, irrigation, transport, and water and sanitation. Africa s Infrastructure A Time for Transformation, published by the World Bank in November 2009, synthesizes the most significant findings of those reports. AICD was commissioned by the Infrastructure Consortium for Africa after the 2005 G-8 summit at Gleneagles, which recognized the importance of scaling up donor finance for infrastructure in support of Africa s development. The first phase of AICD focused on 24 countries that together account for 85 percent of the gross domestic product, population, and infrastructure aid flows of Sub- Saharan Africa. The countries are: Benin, Burkina Faso, Cape Verde, Cameroon, Chad, Côte d'ivoire, the Democratic Republic of Congo, Ethiopia, Ghana, Kenya, Lesotho, Madagascar, Malawi, Mozambique, Namibia, Niger, Nigeria, Rwanda, Senegal, South Africa, Sudan, Tanzania, Uganda, and Zambia. Under a second phase of the project, coverage is expanding to include as many other African countries as possible. Consistent with the genesis of the project, the main focus is on the 48 countries south of the Sahara that face the most severe infrastructure challenges. Some components of the study also cover North African countries so as to provide a broader point of reference. Unless otherwise stated,

4 therefore, the term Africa will be used throughout this report as a shorthand for Sub-Saharan Africa. The World Bank is implementing AICD with the guidance of a steering committee that represents the African Union, the New Partnership for Africa s Development (NEPAD), Africa s regional economic communities, the African Development Bank, the Development Bank of Southern Africa, and major infrastructure donors. Financing for AICD is provided by a multidonor trust fund to which the main contributors are the U.K. s Department for International Development, the Public Private Infrastructure Advisory Facility, Agence Française de Développement, the European Commission, and Germany s KfW Entwicklungsbank. The Sub-Saharan Africa Transport Policy Program and the Water and Sanitation Program provided technical support on data collection and analysis pertaining to their respective sectors. A group of distinguished peer reviewers from policy-making and academic circles in Africa and beyond reviewed all of the major outputs of the study to ensure the technical quality of the work. The data underlying AICD s reports, as well as the reports themselves, are available to the public through an interactive Web site, that allows users to download customized data reports and perform various simulations. Inquiries concerning the availability of data sets should be directed to the editors at the World Bank in Washington, DC.

5 Contents Summary Public infrastructure spending: the headlines The anatomy of public spending General government expenditure Budget efficiency The hidden cost of utilities inefficiencies Emerging messages 1 Motivation for this study 1 2 Description of tools: data and methodology, key definitions 5 General government expenditures sourced from budget documents 7 Expenditures of public, nonfinancial corporations, sourced from financial accounts 8 Introducing a country typology 3 Public infrastructure spending: headlines 11 Country efforts and purchasing possibilities Anatomy of public infrastructure spending 4 General government expenditures 23 The macro outlook and its fiscal implications for infrastructure Prioritizing within the infrastructure budget envelope Budget efficiency: execution and maintenance 5 The hidden costs of utilities inefficiencies 39 6 Conclusions and policy implications 52 References Appendixes Appendix 1. Sector scope, functional classification Appendix 2. Sources of data on infrastructure expenditures Appendix 3. Country groups Appendix 4. Primary fiscal balances Appendix 5. Net change in central government budget: breakdown by source Appendix 6. Net change in central government budget: breakdown by use Appendix 7. Expenditure on main road network Appendix 8. Variance around the trend line of road expenditure Appendix 9. Contributions to QFCs (country aggregates) water sector Appendix 10. Contributions to QFCs (country aggregates) power sector Appendix 11. Water: efficiency and production indicators, 2006 Appendix 12. Electricity: efficiency and production indicators, 2006 Appendix 13. Annual maintenance and preservation expenditures, Appendix 14. Average annual maintenance expenditures on main road network, iv v v vii viii ix x iii

6 Summary To be credible, any plan for scaling up infrastructure in Africa must rest on a thorough evaluation of how fiscal resources are allocated and financed. Because in every plausible scenario the public sector retains the lion s share of infrastructure financing, with private participation remaining limited, a central purpose of such an evaluation is to identify where and how fiscal resources can be better used if not increased without jeopardizing macroeconomic and fiscal stability. The stakes are high, because the magnitude of Africa s infrastructure needs carries a commensurate potential for misuse of scarce fiscal resources. We analyze recent public expenditure patterns to identify ways to make more fiscal resources available for infrastructure. We do this in three ways. First, we quantify the level and composition of public spending on infrastructure so as to match fiscal allocations to the particular characteristics of individual subsectors and to countries macroeconomic type (low-income fragile, low-income nonfragile, oil-exporting, and middle-income). Second, we evaluate public budgetary spending for infrastructure against macroeconomic conditions to get a sense of the scope for making additional fiscal resources available based on actual allocation decisions in recent years. And, third, we look for ways to make public spending for infrastructure more efficient, so as to better use existing resources. The Government Finance Statistics of the International Monetary Fund are neither comprehensive nor disaggregated enough to support an analysis of the fiscal costs of infrastructure for the period For that reason, our analysis is based on a new, standardized cross-country dataset of fiscal indicators for infrastructure that covers, but also extends beyond, spending from central government budgets. Stateowned enterprises (SOEs) and extrabudgetary financing vehicles are also covered, as are private operators, as long as the assets they operate belong to the state or the operator continues to rely on public subsidies. Expenditure by subnational jurisdictions is only partially covered, however. Data are collected in such a way as to permit cross-classification by economic categories (including capital and current spending) as well as functional categories information and communication technologies (ICT), power, roads, water, and sanitation. As far as possible, both budgeted and actual expenditures are recorded. Any exercise of this kind encounters data limitations. First, because it was not feasible to visit all subnational entities, some decentralized infrastructure expenditures probably have been underrepresented, with particular implications for the water sector. Second, it was not always possible to fully identify which items of the budget are financed by donors, and contributions by nongovernmental organizations (NGOs) to rural infrastructure projects are likely to have been missed completely. Third, it was not always possible to obtain full financial statements for all of the infrastructure special funds that we identified. Fourth, accurate recording of annual changes in fixed capital formation (capital expenditure) of SOEs remains a methodological challenge. Fifth, accurate measurement of existing public infrastructure stock will require further methodological development.

7 Public infrastructure spending: the headlines Most governments in Sub-Saharan Africa spend about 6 12 percent of their gross domestic product (GDP) each year on infrastructure, understood as comprising ICT, power, roads, water, and sanitation (figure A). Roughly half spend more than 8 percent of GDP, while only a quarter of countries spend less than 5 percent, the level commonly encountered among the countries of the Organisation for Economic Co-operation and Development. Cape Verde, Ethiopia, and Namibia spend well above 10 percent of their GDP on infrastructure. In the few middle-income countries of the region for which comparative information is available the level of public spending is known to be between 6 and 8 percent of GDP. Expressed as shares of GDP, these fiscal efforts seem larger than when put in dollar terms. Most countries of the region spend less than $600 million a year on infrastructure services less than $50 per person. Among landlocked countries, whose infrastructure needs tend to be particularly high, the annual total is less than $30 per capita. These annual expenditures pale in comparison with the amounts needed. An investment budget of US$100 million purchases no more than about 100 MW of electricity generation, or 100,000 new household connections to water and sewerage, or 300 kilometers of two-lane paved road. Figure A. Fiscal flows devoted to infrastructure Spending %GDP Cote d'ivoire Rwanda Nigeria Cameroon Niger Chad Tanzania Uganda Benin Madagascar Senegal Malawi Mozambique Zambia Ghana Kenya Ethiopia GDP Share (%) Spending per capita Source: Africa Infrastructure Country Diagnostic, Fiscal Baseline (2008). Note: Based on annual averages for the period Lesotho South Africa Namibia Cape Verde Spending USD per capita The anatomy of public spending Most public spending on infrastructure in Sub-Saharan Africa passes through SOEs. SOEs have a particularly large role in the middle-income countries, where they account for over 70 percent of all public infrastructure spending. In Namibia, for example, 90 percent of expenditures on infrastructure are made by SOEs. In non-oil-exporting low-income countries, the share of expenditures realized by SOEs is close to 60 percent, or just below two-thirds of total infrastructure spending. The bulk of the fiscal resources that pass through SOEs go for current spending. Current spending includes spending on operations and maintenance, which is essential to harness the economic returns of capital. However, most of recorded current spending relates to so-called nonproductive expenses, namely wages and salaries. High levels of recurrent spending may indicate that operational inefficiencies are diverting resources away from investment. v

8 Governments are the most prominent financiers of infrastructure Figure B Public infrastructure spending by sector and institution Investment investment in Sub-Saharan Africa. Except in the middle-income countries, governments are SOEs Gral Govern't 1.5 responsible for between percent of total 0.5 capital investment, - consistently allocating at least 80 percent of their infrastructure budgets to Water Power ICT Transport investment. In low-income countries that are aiddependent or that export Current Spending SOEs oil, the prevalence of governments as investors is driven by their role in channeling external funds and/or natural resource royalties. Most external development funds are earmarked by donors for investment. The dominant role of the central government as an investor is consistently found in Gral Govern't most subsectors: accounting for 80 percent of total public investment in transport and water Water Source: AICD, Fiscal Baseline (2008). Energy ICT Transport supply, and about 40 percent in energy (figure B). The noticeable exceptions to this pattern are the ICT sector and, as noted, the middle-income countries. GDP Shares GDP Shares MIC Oil Exporting LIC-NoFragile LIC-Fragile MIC Oil Exporting LIC-NoFragile LIC-Fragile Even though capital budgets may fall far short of actual needs, on average, most countries are not able to spend more than one-third of the budgeted amounts. For a number of countries we were able to compare actual capital spending with the amounts originally budgeted. The budget execution ratios that emerged ranged from 28 percent (Benin) to 89 percent (Madagascar), with the average being 66 percent. This means that capital spending in the region might be 50 percent higher if only government agencies had the capability to spend all of the resources allocated to them. The problems behind the low execution rates include poor planning, deficiencies in project preparation, and delays in procurement. Budget execution ratios for current spending are, on average, a little higher. MIC MIC Oil Exporting LIC-NoFragile LIC-Fragile Oil Exporting LIC-NoFragile LIC-Fragile MIC Oil Exporting MIC Oil Exporting LIC-NoFragile LIC-NoFragile LIC-Fragile LIC-Fragile MIC Oil Exporting LIC-NoFragile MIC Oil Exporting LIC-NoFragile LIC-Fragile LIC-Fragile vi

9 Transport and energy sectors together absorb the lion s share of infrastructure spending about 80 percent in low-income countries. The heavy spending on power is a response to the widely recognized power crisis on the continent. The efforts of the middle-income countries to support energy development contrast starkly in absolute spending terms with those of the poorer countries. Middle-income countries spend almost 5 times more on power than do aid-dependent low-income countries. Actual spending for water may be higher than shown here, because of difficulties in capturing spending data from municipal water utilities. Sectoral allocations differ markedly across different groups of countries. Aid-dependent countries tend to show relatively high levels of investment in roads and water, which together account for percent of donors allocations to infrastructure in the region. Funds from donors make up about 50 percent of water spending and 25 percent of roads spending. By contrast, donors commitments to the energy sector have been low or inexistent in sharp opposition to the efforts of low-income countries that by themselves have been allocating close to 25 percent of their public infrastructure budgets to power to redress chronic underinvestment in that sector. General government expenditure For several years running, a favorable external environment (notably high commodity prices) and sustained domestic economic growth averaging at least 4.5 percent annually have expanded the resources available to the governments of Sub-Saharan Africa. The economies of oil-producing countries have grown at the fastest pace (up to 15 percent a year), for obvious reasons. Non-resource-intensive countries benefited from debt relief and successful policy reforms that offset the negative impacts of higher oil prices. Even heavily indebted poor countries (HIPC) grew at an annual average rate of 5.5 percent. Domestic revenues have been the largest source of additional funds for resource-intensive countries, whereas external grants played the most significant role for the poorest countries in the region. The favorable external environment helped many countries expand their budgets. In the period , Sub-Saharan governments budgets grew by almost 1.9 percent of GDP, with the regional average driven largely by increases in middle-income countries (table A). Not all countries benefited, however. Zambia s budget contracted by more than 8 percent, while that of the Democratic Republic of Congo chalked up a 9 percent increase. The additional budgetary resources helped low-income aid-dependent countries to bolster capital investments, including infrastructure. As a share of GDP, capital investment increased in the low-income countries by more than 1 percent in About 40 percent of the additional resources were allocated to clearly favored infrastructure sectors. It is striking that the oil-exporters and middle-income countries decreased their investment despite having more fiscal resources available. The oil-exporting countries lowered their capital expenditures on average by 3.3 percent of GDP. In oil-exporting countries, the decrease in budgetary expenditure was largely absorbed by a significant reduction in infrastructure expenditures. To a large extent this reflects developments in Nigeria, where infrastructure expenditures decreased by 2.2 percentage points of GDP during the study period. The middle-income countries appear to have chosen to devote more resources to vii

10 maintenance. Most of their additional capital budget was allocated outside infrastructure, but not to health and education, as the table shows. Table A Net change in central government budgets by country group, financing source, and destination, % GDP Country group Net central government expenditure budget Financing sources Of which domestic revenues Of which donor grants Spending allocations Of which infrastructure Of which health and education Middle-income (0.03) Oil-exporting (3.73) 5.25 (0.07) (1.43) (0.34) Low-income, nonfragile Low-income fragile Africa average (0.14) 0.24 Source: AICD, Fiscal Database, 2008; IMF Statistical Appendixes, WB DDP. Note: Averages weighted by national GDP. Totals may not add up. = data not available. Budget efficiency Infrastructure stocks in many of the region s countries are sorely in need of rehabilitation after years of poor maintenance. The percentage requiring rehabilitation ranges from 12 percent (Burkina Faso) to 48 percent (Democratic Republic of Congo) the average for the survey group is 30 percent. Rehabilitation needs are significantly higher for rural infrastructure (35 percent) than for other types (25 percent), reflecting the difficulty of maintaining assets in isolated rural areas. Because rehabilitating assets is much more costly (in present-value terms) than maintaining them well, the magnitude of the rehabilitation backlogs indicates substantial inefficiency in lifecycle spending on infrastructure. Maintenance is the most challenging aspect of road spending. In environments characterized by weak fiscal management (nontransparent and politically dominated budget processes), assets often are neglected. Because maintenance yields little observable immediate benefit and is easily deferred, its budgetary allocations often are not protected by the executive or parliament. Furthermore, in Africa, donors have a dominant role in channeling funds to the sector. They earmark much of their funding, extended on concessional terms, for investment, which has the effect of making maintenance more costly than investment, because most maintenance funds must be raised domestically. Although the share of external financing that is allocated to road rehabilitation has increased in recent years, road spending in Sub-Saharan Africa is dominated by new construction, leaving maintenance a secondary priority. Roughly half of the countries in the sample have shortfalls of 40 percent or more in annual maintenance. Expenditure shortfalls are greater than 60 percent in Chad, Uganda, and Niger. Countries that have established well-functioning road funds tend to be more successful at maintaining their road networks and reducing the volatility of spending. viii

11 The hidden cost of utilities inefficiencies Reducing inefficiencies in infrastructure operations is perhaps the most practical and realistic way of making more resources available for infrastructure in the region. While most countries are devoting considerable effort to improving infrastructure, they are severely constrained in what they can spend. They have trouble raising domestic revenue and in reallocating revenue from other uses, which often requires structural reforms. By contrast, efficiency improvements can quickly enlarge governments availability of funds, allowing them to provide new services. Because spending on infrastructure consumes a significant share of GDP, even small efficiency gains can contribute large savings. For electricity, water supply, and, to some extent, telecommunications, we measure inefficiencies by quantifying their hidden costs. For the water and power sectors, hidden costs are estimated by using the end-product approach. The methodology identifies three relevant quasi-fiscal activities in utilities: underpricing (charging less than the economic cost of the good), undercollection (where bills are never sent or allowed to go unpaid), and excessive unaccounted losses (to leaks or theft, for example). Hidden costs are then estimated by comparing actual indicators of a functioning SOE against ideal norms of costrecovery, collection ratios, and distribution losses. For telecommunications utilities, we quantify the hidden cost of labor redundancies by comparing partial labor-productivity ratios of existing telecom incumbents against worldclass fixed-line providers in OECD countries. Figure C Hidden costs for water and power utilities as share of GDP Water 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Tanzania Nigeria Benin Cape Verde Ethiopia Uganda Namibia Kenya Burkina Faso Rwanda Sudan Niger South Africa Lesotho Mozambique Cote d'ivoire Senegal Madagascar Zambia Malawi Ghana DRC Mispricing Unaccounted Losses Collection Inefficiencies Quasi-fiscal activities in Africa represent average annual hidden costs of the following (minimum) magnitudes: 0.5 percent of GDP in the water sector (figure C), 0.8 percent in the power sector, and 0.3 in the telecom sector. The smaller economic size of water utilities, together with skewed coverage in the Power 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% South Africa Benin Kenya Mozambique Chad Cape Verde Madagascar Lesotho Nigeria Burkina Faso Rwanda Ethiopia Uganda Cameroon Zambia Tanzania Senegal Ghana Niger Malawi DRC Congo Under-Pricing Unaccounted Losses Collection Inefficiencies Source: Authors own calculations ix using data from the AICD Database.

12 sample because of decentralization and fragmentation, partially explains their lower hidden costs. Underpricing is the main source of hidden costs in both power and water utilities. Not only is underpricing inefficient, but the associated capital subsidies are hugely inequitable because access to these services is skewed toward the better off, with substantial shares of the poor remaining unconnected to the electrical grid and water supply network. In middle-income countries, unaccounted losses stand out as the greatest source of inefficiency for power utilities, particularly maintenance-deprived distribution networks. Aid-dependent countries show slightly higher levels of hidden costs relative to their peers, largely because of mispricing, and, in the water sector, poor collection practices. In the telecom sector, countries that have maintained state ownership of telecommunications incumbents, thereby deterring competition, not only are forgoing future tax revenues from expanded business activity but also are creating an additional burden of hidden costs from inefficiency (usually a bloated workforce). Such costs can exceed 0.3 percent of GDP. Emerging messages The countries of the region are devoting substantial shares of their GDP to infrastructure (6 12 percent when all sources are taken into account), but that does not amount to much in absolute terms, because the economies in question are small. On average, low-income countries are spending less than $50 per capita per year, with public investment being only a fraction of this. There is a marked division of labor between SOEs and central governments. While SOEs account for the bulk of infrastructure spending in most countries, they undertake very little capital spending. Most public investments for infrastructure continue to be made through central government budgets, with the resulting assets often transferred to SOEs for subsequent operation and maintenance. Despite a favorable budget environment, only aid-dependent countries seem to be allocating additional resources to infrastructure. The combination of a commodity boom and widespread debt relief has created substantial buoyancy in government budgets. In the case of aid-dependent countries, about 30 percent of the additional funds have been allocated to infrastructure. However, in middle-income countries almost none of the additional resources gleaned from the recent good years have gone for infrastructure. In oil-exporting countries infrastructure investment has actually fallen even as resource revenues have surged. Regardless of how windfall revenues are spent, governments in the region could substantially enlarge their fiscal space by redressing inefficiencies in infrastructure psending. Three major sources of inefficiency have been identified here: inattention to maintenance, failures to spend budgeted funds, and hidden costs. There is substantial direct and indirect evidence of undermaintenance, which leads to higher costs over the infrastructure lifecycle. On average, almost a third of the infrastructure assets of the countries of the region are in need of rehabilitation. With the present value of rehabilitating infrastructure exceeding the cost of preventive maintenance, it is easy to see that, over time, countries are spending more than they need to spend to preserve a fixed amount of infrastructure stock. x

13 Second, very low ratios of execution of capital budgets point the way to an easy and budget-neutral increase in public investment if only execution ratios can be raised. Addressing the causes of low budget execution deserves very serious attention, as solving the problem could increase public investment by 50 percent without any increase in budgeted resources. Moreover, until such deficiencies are addressed it will remain difficult to achieve higher levels of investment, even if more external resources are injected. Third, the hidden costs of utilities absorb some 1.8 percent of GDP, indicating a major potential dividend in return for the right set of actions. Underpricing is by far the largest contributor to hidden costs in power and water utilities, although, as noted, unzealous bill collection and distribution losses are also important. xi

14 1 Motivation for this study The coordinated efforts of African countries and the international community toward achieving the Millennium Development Goals (MDGs) has drawn attention to an enormous funding challenge. The cost of achieving the MDGs is estimated at 13 percent of average GDP in Sub-Saharan Africa (Sachs and others, 2004). Looking beyond the MDGs, recent research 1 estimates Sub-Saharan Africa s aggregate infrastructure needs both new investment and operations and maintenance (O&M) at $75 billion a year for , or 11.7 percent of average GDP (table 1.1). Estimates for power alone are about $43 billion a year, or 7 percent of GDP, half for the investments needed to overcome chronic shortages and to propel trade in power. For low-income countries, infrastructure needs quickly add up to 20 percent of GDP (in fragile states, this reaches an impossible 70 percent). For middle-income countries, investment needs are two-thirds of O&M, while most low-income countries have investment needs percent higher than O&M costs. Table 1.1 Sub-Saharan Africa infrastructure needs , by sector US$ billion a year GDP share (%) Shares Water supply and sanitation Energy ICT Transport Total Middle income Oil exporting LIC-nonfragile LIC-fragile Africa Source: Africa Infrastructure Country Diagnostic, 2008 Note: Averages weighted by country GDPs. Totals may not add up because of rounding. The private sector s historically limited contribution to infrastructure provision and financing underscores the importance of the public sector in meeting infrastructure needs, at least for the foreseeable future. Despite efforts and good intentions, until recently the scale of private finance was not as great as anticipated in the 1990s and early 2000s (up to 2006). Nor has it extended beyond the more lucrative areas of infrastructure, such as telecommunications, power generation, railways, and ports or the larger and wealthier economies, such as South Africa, Nigeria, and Kenya. Since the late 1990s, a number of Sub-Saharan African countries have raised private finance for traditionally state-funded infrastructure. But this has amounted to roughly 0.8 percent of GDP per year minuscule when compared with the approximately 4 percent needed to fill the infrastructure financing gap, or, in other words, the funds still needed after factoring in known financing sources (cost recovery, public expenditure, official development assistance, and financing from the private sector and countries not in the Organisation for 1 Infrastructure needs estimates per sector within the Africa Infrastructure Country Diagnostic (2008).

15 Economic Co-operation and Development, OECD). Private sector contributions are also hindered by stagnation in domestic capital accumulation, traceable to aggregate savings rates that are many times lower than in other developing regions. Average saving rates from national income accounts are 11 percent in Sub-Saharan Africa, compared with 20 percent in Latin America and the Caribbean, 18 percent in South Asia, 19 percent in the Middle East and North Africa, and 34 percent in East Asia and the Pacific. The characteristics that make infrastructure industries prone to government intervention in the form of public ownership, regulation, or both are also widely accepted. From the supply viewpoint, infrastructure service provision is characterized by large, fixed investments (usually site- and industryspecific) and sharply increasing returns to scale. From the demand viewpoint, infrastructure services range from those with the characteristics of private goods, such as telecommunications (for which prices could be set efficiently by markets), to those that are closer to public goods, such as rural roads. Shifting fiscal resources to and from infrastructure is not free of controversy. Easterly and Servén (2003) point out the growing evidence that, in developing countries, fiscal stabilization has been achieved by compressing productive public investment notably in infrastructure thus sapping the potential for long-run economic growth. The authors propose a shift away from the short-term preoccupation with fiscal deficits, toward a longer-term focus on fiscal solvency. 2 But the International Monetary Fund (IMF, 2004) questions the assumption that public infrastructure spending in developing countries is necessarily growth-enhancing, and suggests that efforts to make more resources available for infrastructure should focus on reallocating spending within the current fiscal envelope. Recent empirical work finds that the growth-enhancing effects of public investment in infrastructure are not always greater than those of public investment in health and education (Estache and Muñoz, 2007). Such controversy is attributable to the very nature of infrastructure, whose characteristics complicate its treatment in public finances. Infrastructure investments are large, lumpy, and infrequent; they often take more than one budget cycle to complete. They are therefore difficult to accommodate within a single budgetary cycle and much better suited to a medium-term expenditure framework. In addition, budget allocations for multiyear investment projects may not be sustained over time, thus delaying implementation and reducing projects eventual rate of return. Even worse, interruptions in funding may leave a country with a graveyard of incomplete public works that never materialize into a productive asset. Infrastructure assets require sustained preventive maintenance. Failure to maintain such assets eventually leads to deterioration and the need for major rehabilitation, which costs considerably more in present-value terms than does preventative maintenance. Nevertheless, deterioration is a gradual process, and maintenance has low visibility, creating a permanent temptation to defer such spending to accommodate more politically rewarding expenditures. Some efficiency gains from long-lived assets materialize only with time, as higher marginal returns begin to appear. This applies to assets constructed according to year demand projections there 2 At around the same time, Blanchard and Giavazzi (2003) advanced a similar argument with respect to the European Union s Stability and Growth Pact, which limited budget deficits to 3 percent of GDP and formed the macro-economic underpinning of European Monetary Union. 2

16 delivered low returns early in their life cycle. Other efficiency gains depend on the successful implementation of policy decisions aimed at a more efficient execution of multiyear projects (to ensure that costs are kept to a minimum and that countries begin to reap their benefits as soon as possible), and at making sure that periodic maintenance of relatively lightly used assets (such as new roads) is not postponed. The debate over the availability and allocation of fiscal resources has particular relevance for Sub- Saharan Africa, which is faced with burgeoning infrastructure needs, limited private participation, and meager public budgets. It is in this context that fiscal space becomes relevant. The IMF has defined fiscal space as the budgetary room that allows a government to provide resources for a desired purpose without imperiling its financial position. 3 The concept focuses on the linkages between fiscal policy tradeoffs and the availability of resources in the medium-term to ensure fiscal sustainability. There are several ways to make more fiscal resources available for development needs (including infrastructure), utilizing both domestic and external sources. The Development Committee of the World Bank Group (World Bank, 2006) has proposed a framework that defines four options for central governments: (i) raise additional tax revenues, (ii) increase public sector borrowing, (iii) obtain more international aid, and (iv) improve the efficiency of current expenditures. Making fiscal resources available has an important intertemporal component, since effective use of resources today leads to increased productivity, thus generating more resources to fund tomorrow s policy choices. Countries that make more fiscal resources available by cutting development expenditures may undermine long-term growth, thereby restricting their fiscal space in the future. Aid-dependent countries face the challenge of using donor financing to remove bottlenecks to growth and, in so doing, to expand their future fiscal space. This paper analyzes recent spending patterns to identify ways to increase the availability of fiscal resources. We do this in three steps. First, we quantify the level and composition of public infrastructure expenditures. By examining how infrastructure spending is allocated across subsectors, institutions, and expense categories, we characterize past patterns and levels of fiscal allocations in terms of subsector specificities and country types (such as resource-rich, aid-dependent). This helps identify forward-looking options for fiscal expansion and other financing alternatives Second, we assess public spending on infrastructure against the background of overall fiscal resource availability. The initial fiscal conditions for infrastructure spending are framed in a macroeconomic context so as to give the reader a realistic sense of the scope for creating additional fiscal space by increasing budgetary allocation. Fiscal resources are broken down into three observable aspects: revenue effort, access to aid, and access to financial markets. Third, we look for ways to increase the efficiency of public infrastructure spending. Changing the composition and increasing the efficiency of public spending for infrastructure are two of the most practical ways of increasing governments resource envelope. This study provides a cross-country comparison of the efficiency of expenditures in the water, electricity, and communications sectors. In the 3 For details, see Heller and others (2006). 3

17 water and electricity sectors, potential efficiency gains are quantified by measuring the hidden costs of state-owned service providers. To achieve our purpose, we assembled a detailed database of public spending flows, the absence of which had prevented systematic evaluation of the quality and impact of public spending in infrastructure. 4

18 2 Description of tools: data and methodology, key definitions The Government Finance Statistics (GFS) compiled by the International Monetary Fund (IMF) do not provide a detailed or comprehensive picture of infrastructure spending. At present, the GFS constitutes the main source of cross-country data on public finance. But the information on infrastructure presents a number of problems, particularly for Africa. First, the GFS focuses on tracking general government expenditure, whereas a large share of infrastructure spending passes through nonfinancial public corporations (parastatals). Second, even within the category of general government spending, the GFS is limited in practice to central government spending, with little reporting of subnational and special funds two other important channels of infrastructure spending. 4 Lastly, the GFS does not break down infrastructure spending by subsector or expense category. In response to these limitations, we built a new database of standardized cross-country data that seeks to give a detailed yet comprehensive picture of infrastructure spending. 5 Our analysis is based on a systematic, cross-country study of public spending on infrastructure both within and beyond the bounds of central government budgets. The data-collection process is based on a standardized methodology developed and explained in detail by Briceño-Garmendia (2007). To ensure the cross-country comparability of the data, detailed templates guided the data-collection process in the field. The methodology is designed to be comprehensive in the sense of covering all relevant budgetary and nonbudgetary areas of infrastructure spending. The collection of data on fiscal spending was grounded in an overview of the institutional framework for delivering infrastructure services in each of the countries while aiming at identifying all of the channels through which public expenditure on infrastructure flows. The work began with a detailed review of the central government budget. Thereafter, financial statements were collected from all the parastatals and special funds that had been identified in the institutional review. In countries where infrastructure service providers are highly decentralized (as in the case of municipal water utilities), it proved possible to collect financial statements only from the three largest service providers. Privatized infrastructure service providers were included if a majority of their shares remained government owned, or if they continued to depend on the state for capital or operating subsidies. Thus, telecommunications incumbents are typically included, whereas mobile operators are not. In some countries, local governments have begun to play an increasing role in infrastructure service provision. It was not possible to collect comprehensive expenditure data at the local government level. However, in some cases the central government produces consolidated local government accounts. Where these do not exist, an alternative source of information is the fiscal transfers from central to local governments, which are reported in the budget and on which local governments rely heavily, given 4 Based on IMF (2001), the public sector can be roughly divided into general government and public corporations. General government comprises central, state, and local governments. Public corporations can be grouped, according to the nature of their activities, into financial corporations (engaged in providing financial services for the market) and nonfinancial corporations (engaged in producing goods and nonfinancial services). 5 Soon available online at

19 limited alternative sources of revenue. In some cases, transfers are earmarked for infrastructure-related spending, whereas in others the share allocated to infrastructure could only be estimated. 6 Data were collected in such a way as to permit both classification and cross-classification by economic and functional categories. That is, a matrix was established so that spending on each functional category could be decomposed according to the economic nature of the expense, and vice versa. Functional classification followed as closely as possible the 4-digit category or class level of the functional classification (COFOG) proposed in the IMF s Government Financial Statistics Manual 2001 (GFSM, 2001), 7 which allowed us to identify all the major infrastructure subsectors. 8 The economic classification of expenses also followed the IMF framework, permitting us to distinguish to some extent between current expenditures, capital expenditures, and various subcategories thereof. 9 The institutional scope of the study builds on the definition of the public sector spelled out in the system of national accounts described by the United Nations (1993), that is, all units of general government and all public corporations. The system of national accounts defines public corporations as those in which the public authorities are considered the owners by virtue of owning all, or a majority of, shares, equity, or other form of capital (table 2.1). 10 Table 2.1 Institutional distribution of gross national expenditure General government A. Public expenditures of which public expenditures on infrastructure Financial corporations B. Expenditures of public financial corporations C. Expenditures of private financial corporations Source: United Nations, Note: Shaded area reflects expenditures of public sector. Nonfinancial corporations D. Expenditures of public nonfinancial corporations of which expenditures on infrastructure E. Expenditures of private nonfinancial corporations Nonprofit institutions serving household sector F. Expenditures of nonprofit institutions serving households sector Household sector G. Household current and capital expenditures 6 For a quick summary of sources of data and information, see table Definitions and explanations of the infrastructure cost elements figuring in the database can be found in Briceño- Garmendia (2007). 8 The main categories covered in the study are electricity (0435), road transport (0451), water transport (0452), railway transport (0453), air transport (0454), pipeline and other transport (0455), communication (0460), waste water management (0520), and water supply (0630). Irrigation spending is estimated as a share of agriculture (0421). 9 Current expenditures are broken down into compensation of employees, use of goods and services, consumption of fixed capital, interest, subsidies, grants and transfers, social benefits, and other current expenditure. Capital expenditures are broken down into buildings, structures, machinery, and equipment; other fixed assets; other capital expenditure: and transfers of capital expenditures to lower levels of government. 10 See United Nations (1993) for details. The system of national accounts also states that enterprises in which the government holds less than half of the shares may still be classified as public corporations if the government controls the business by influencing all principal aspects of management. 6

20 General government expenditures sourced from budget documents As far as possible, both budget estimates and actual expenditures were recorded for the period There are usually three stages in the public expenditure process. First, resources are budgeted for particular purposes. Second, funds are released from the Ministry of Finance (MoF) to the responsible institutions. Finally, resources are spent by the recipient institutions. Expenditure patterns can differ substantially across these three different stages. While actual spending is the variable of greatest interest, and the main focus of the results presented in this report, it is also important to understand how infrastructure spending is affected by the budget execution process. To this end, both budgeted and actual expenditures are recorded wherever possible. Attempts were also made to capture release figures but with very limited success. For countries that have not yet fully implemented GFSM 2001 standards, it was necessary to perform a line-by-line recoding of the budget in consultation with the corresponding line ministries. In several countries, national budget expenditures are grouped according to programs for each line ministry (such as in Zambia). In these cases, expenditures had to be disaggregated according to infrastructure subsectors. The advantage of using GFSM 2001 functional codes is that they reflect the purpose of the expenditure in a consistent pattern that is not distorted, for example, by changes in institutional responsibilities over time. Functional areas can be spread across many institutions and are subject to reallocation from one institution to another, contingent on changes over time in institutional responsibilities and institutional frameworks. It is difficult to ensure that expenses are analyzed and classified according to their economic use. On the one hand, there is no clear-cut separation between what should be considered a capital expense, a rehabilitation expense, or even a maintenance expense. So, capital and current expenditures can be mistakenly accounted under inappropriate budget categories by the lack of clear definition of the expenditure s nature. There may also be deliberate misclassification done in order to increase the chances of budgetary approval. 11 As much as possible, the economic classifications used in each country were remapped in accord with the GFSM 2001 framework to develop a common understanding across countries. Efforts were made to avoid double-counting of transfers across levels of government. There is a danger that transfers from the central government to parastatals, special funds, and subnational governments may be reported twice: once as a central government transfer and once as an expenditure by the recipient institution. Great care was taken to match up these line items across institutions and ensure that they were counted only once as an expenditure made by the recipient institution. Similar care was taken to eliminate double-counting subsidies that originated as central government transfers to stateowned enterprises (SOEs). 11 Unfortunately, the GFMS 2001 leaves many economic categorizations open to interpretation, particularly with regard to the uses of the expenses that are most relevant to infrastructure services (for example, rehabilitation, operations, and maintenance). In this first report, the analysis will be limited to establishing the broad distinctions between current and capital expenses. 7