Public Investment Management. gy = (I/Y)/k. Harrod Domar Growth Model. Role of Investment in Economic Growth. Savings, Investment and Growth

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1 Public Investment Management Role of Investment in Economic Growth Gross Domestic Product (GDP): (Market Prices) Dr. Roy Kelly Duke University Y = C + I + G Y = Cp + Cg + Sp + Sg (Sources of Income) (Uses of Income) I p + I g = S p + S g Where Sg = Taxes - Cg Leadership for Results Program for Mid-Level Officers in the Nepalese Civil Service Kathmandu, Nepal 21 September 2 October 2015 Where C p is private consumption C g is government consumption I p is private investment I g is government investment S p is private savings S g is government savings Savings, Investment and Growth Simple growth model (Harrod-Domar) Y = GDP gy = growth rate in Y in a year = dy/y k = incremental capital-output ratio or ICOR = dk g /dy K = capital stock in economy I = dk g = gross investment gy = (I/Y)/k Thus: growth depends upon investment rate (I/Y) and ICOR (k). ICOR is a long-run measure of overall efficiency of economy (or how much investment is required to create increase in GDP.) Ranges of k and I/Y Fiscal policy can affect k and I/Y. Need to focus on I. Harrod Domar Growth Model K = Change in Capital Stock (Net Investment) Y = Change in GDP ICOR = K / Y (by definition) or Y = K / ICOR or Y/Y = K /Y / ICOR or gy = I/Y / ICOR (Harrod Domar Equation) ICOR measures the efficiency of the productive process in a country. It defines how many units of capital are needed to increase national income by 1 unit 3 1

2 Practical Example Harrod-Domar Equation: gy = I/Y ICOR IF: Investment rate = 15% ICOR = 5 Then gy = 15%/5 = 3% (growth rate) Factors affecting ICOR include: Mix of investments Government, SOE, private Public Investment Management efficiency Planning, Allocation and Implementation Social capital: transaction costs of doing business arising out of informal/formal legal and regulatory systems (security, contracts, financial infrastructure, regulation) Key is to improve savings rate and ICOR (investment productivity) Cost of capital Political institutions and governance Economic and financial management Nepal ICOR was approx. 5.1 from (see Bhandari, Potential Output and Output Gap in Nepal, Economic Review, Capital intensity of economy 6 Public Investment Management (PIM) Sub-national Debt Demand Issues : 17% to 4% of GDP (globally) : 32% to 10% (mid & low income countries) Since 2000, reemergence in Public Investment: EU Structural Funds in advanced countries Public Private Partnerships (PPP) Financial Crisis ( ) / countercyclical fiscal policies & stimulus package for ready-to-go projects Decentralization trend worldwide Rapid urbanization Each year, over 60 million people move into cities. By 2030, 1.8 billion more people will become urban, mostly in developing countries Characteristics of infrastructure investment Globalization, capital mobility, and more competitive financial markets Fainboim, Last and Tandberg, 2013, p. 312 See OECD, Recommendations on Effective Public Investment Across Levels of Government,

3 Public Investment Modalities Physical Infrastructure Investments Large, capital-intensive projects tend to be natural monopolies Infrastructure can generate positive externalities; thus, social returns can exceed private returns Incur large up-front costs, with benefits accruing over time; this poses a challenge to private financing and provision. Typically leads to investment under-provision and thus, infrastructure has historically been provided by the public sector, public-private partnerships, or regulated private entities Brumby, Kaiser and Kim (2013) in International Handbook of Public Financial Management, 2013, p IMF, Is it Time for an Infrastructure Push The Macroeconomic Effects of Public Investment, (2014) Poole, et al, Public Infrastructure: A Framework for Decision-Making : (Australia Central Bank, 2014) 10 Low Efficiency in Public Investment (1) Low Efficiency in Public Investment (2) Poor Planning, Appraisal, Implementation, Monitoring (white elephants) Multi-year nature budget allocation process, failure to link capital and recurrent linkages, Design and Implementation Delays Procurement Corruption: weak management Multi-sector: technical capacities & coordination Cross-cutting nature: weak ownership Public and private sectors: regulatory capacity Incomplete projects, poor quality of completed infrastructure, failure to effectively operate and maintain assets, World Bank, The Power of Public Investment Management: Transforming Resources into Assets for Growth, 2014, p. 19 World Bank, The Power of Public Investment Management: Transforming Resources into Assets for Growth, 2014, p

4 New South China Mall (Dongguan, China) Yuma Desalting Plant in Arizona (USA) New South China Mall is the largest shopping mall, ranked second in total area to The Dubai Mall. It opened in 2005 and up to 2012 was 99% empty. Est. original cost: US$402 million Problem: Location in Dongguan, developer hometown, mostly factories and factory workers, lack of demand In 2015, CNN reported mall filled with shops after extensive renovations and remodelling of the facility. See also empty new towns in China: Source: Airport in Castellón (Spain) PIM System Components An airport in Castellón, Spain, has been open since March There have been no scheduled flights. Costs: $213 million International Herald Tribune (24 June 2011) Source: 15 World Bank, The Power of Public Investment Management: Transforming Resources into Assets for Growth, 2014, p

5 PIM Country Case Studies Nepal Key Aspects of the Public Investment Management Index (PIMI) PIM Index has four components (17 dimensions) Strategic Guidance and Project Appraisal Project Selection and Budgeting Project Implementation Project Evaluation and Audit Measured in 71 Middle and Low Income Countries Footnote: Red (bad), Green (good) Source: World Bank Country Case Studies Rajaram, et al (WBG 2010): 17 Dabla-Norris, E. et al. Investing in Public Investment: An Index of Public Investment Efficiency, IMF Working Paper, Strategic Guidance and Project Appraisal Nature of strategic guidance and sector strategies Transparency of appraisal standards Observed conduct of ex ante appraisals Independent review of appraisals conducted 2. Project Selection and Budgeting MTPF and its integration to the budget Inclusion in budget (or similar) for donor funded projects Budget integration of recurrent & investment expenditures Level of scrutiny & funding by legislature, including its committees Public access to key fiscal information Project Implementation Degree of open competition for award of contracts Nature of complaints mechanism relating to procurement Funding flows during budget execution Effectiveness of internal controls, such as commitment controls Effectiveness of internal audit system 4. Project Evaluation and Audit Degree of ex-post evaluations Degree that external audits are timely and scrutinized by the legislature Degree of asset register and/or asset value maintenance 20 5

6 PIMI Performance Index (2010) Bangladesh and Mongolia PIMI Scores Overall Score 2.04 Bangladesh: Low Score Mongolia: 1.72 Source: Dabla Norris et. al (2011), Investing in Public Investment: An Index of Public Investment Efficiency, Washington, DC: IMF Working Paper, WP 11/37 21 Source: Dabla Norris et. al (2011), Investing in Public Investment: An Index of Public Investment Efficiency, Washington, DC: IMF Working Paper, WP 11/37 22 IMF Findings on Infrastructure Investment Improving Public Investment Management: The Public Investment Management Assessment (PIMA) Tool International Monetary Fund, Making Public Investment More Efficient, June 2015, The stock of public capital (a proxy for infrastructure capital) as a share of output has declined significantly over the past three decades all economies. Increased public investment raises output (GDP), in short term because of demand effects and in long term as a result of supply effects. Many low-income economies have a pressing need for additional infrastructure to support economic development. But increasing public investment may lead to limited output gains, if PIM efficiency is not improved

7 Improving Efficiency and Productivity of Public Investment Constructing the Public Investment Efficiency Frontier Efficiency: Relationship of investment and capital stock to the quality and coverage of infrastructure assets See IMF, Making Public Investment more Efficient, June 2015, p. 7 Productivity: Relationship between investment and economic growth (measured as the ratio of average real rate of capital stock growth to the average real rate of economic growth.) 25 See IMF, Making Public Investment more Efficient, June Public Investment Management (PIM) Public Investment Efficiency Index IMF finds that there is about 30% potential gain for improving efficiency in PIM processes ( efficiency gap ) Efficient public investors get twice the economic return than the least efficient Efficiency Gap: AE: 13% EM: 27% LIDCs: 40% Average: 27% Where: AE: Advanced Economies EM: Emerging Markets LIDCs: Low Income Development Countries See IMF, Making Public Investment more Efficient, June 2015, p. 7 See IMF, Making Public Investment more Efficient, June 2015, p

8 PIM Reform Strategies PIM reform strategies vary: AE to ensure fiscal and budgetary frameworks provide stable and sustainable basis for investment planning across all govt levels EMs to adopt rigorous and transparent appraisal, selection and approval of projects LIDCs to strengthen institutions related to funding, management and monitoring of project implementation All countries to improve oversight of PPP and better integration of national strategic planning and capital budgeting. Strong benefits from Investing in Investing (Strengthening PIM) LIDC Priority: Strengthen Investment Implementation Enhance budget execution / procurement transparency and improve cash management efficiency to improve investment stability and predictability and reduce rent seeking opportunities. Protect investment expenditures within ministry and agency budgets by appropriating total project costs at the commencement of the project, preventing those budgets from being raided to meet current pressures, and allowing some carryover of unspent appropriations to future years. Enhance transparency and accountability on project management, monitoring, and evaluation to strengthen incentives to deliver projects on time and on budget and ensure value for money and integrity in use of public resources. See IMF, Making Public Investment more Efficient, June 2015, p. 17, IMF, Making Public Investment more Efficient, June 2015, p Project Selection, Implementation and Outcomes PIM Assessment (PIMA) Project Implementation Planning sustainable levels of investment across the public sector Project Selection Good Projects Poor Projects Well Executed A C Poorly Executed B D Allocating investment to the right sectors and projects Implementing projects on time and on budget Adapted from World Bank, The Power of Public Investment Management: Transforming Resources into Assets for Growth, 2014, p.33 PIMA focuses on 15 Key Institutions Affecting Planning, Allocation and Implementation

9 The PIMA Framework Institutional Overall Score by Country Group PLANNING 1. Fiscal Rules 2. National & Sectoral Planning 3. Central-Local Coordination 4. Management of PPPs 5. Company Regulations Weakest Areas IMPLEMENTING 11. Protection of Investment 12. Availability of Funding 13. Transparency of Execution 14. Project Management 15. Monitoring of Assets ALLOCATING 6. Multiyear Budgeting 7. Budget Comprehensiveness 8. Budget Unity 9 Project Appraisal 10. Project Selection Project Selection Project Appraisal IMF, Making Public Investment More Efficient, 2015, p IMF, Making Public Investment More Efficient, 2015, p Correlation of Public Investment Institutions Countries that monitor public assets also tend to manage PPPs. Implementation institutions (eg, transparency of budget execution, management of project implementation, and availability of financing, tend to be developed in tandem. Countries with strong project selection appraisal tend to be strong in management of PPPs thus indicating benefits of strong project evaluation for both public and PPP projects IMF, Making Public Investment More Efficient, 2015, p. 25 Strong link between budget comprehensiveness, investment protection, and funding highlights link between sound budgeting and efficient capital project financing; National and sectoral planning correlates relatively weakly suggesting planning often in a vacuum, not well integrated with budgeting. 35 IMF PIM Support Time Table July 2015: Fall 2015: Spring 2016: Ongoing: Launch at Financing for Development Conference Addis Ababa Piloting PIMA in selected countries, public consultation and revisions Finalize PIMA Diagnostic operational IMF Technical Assistance on strengthening PIM institutions in coordination with WB and others. Source

10 Summary Thoughts Public finance plays important role in stabilization, distribution, and allocation. PFM focuses on ensuring macroeconomic stabilization, allocative efficiency and operational efficiency Investment is critical for economic growth and providing service-generating physical and social infrastructure assets. PIM covers planning, allocating and implementation (8 must haves with 15 key institutions) Public Investment Management Appraisal (PIMA) and Public Investment Management Index (PIMI) are useful frameworks Key Take-Away Points Questions Comments Discussion Countries need to Invest in Investing 37 10