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Infrastructure and Fiscal Policy Specific Challenges

This article discusses the challenges of infrastructure funding and budgetary mechanisms, highlighting the high costs and maintenance dilemmas. It also explores funding sources and budgetary boundaries that affect infrastructure development.

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Infrastructure and Fiscal Policy Specific Challenges

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  1. Infrastructure and Fiscal PolicySpecific Challenges Marianne Fay Many thanks to Vivien Foster on whose 2005 PEAM course presentation this is largely based

  2. Outline • Stylized facts • Funding sources • Budgetary boundaries • Budgetary mechanisms

  3. I. Stylized facts

  4. Infrastructure is “big money” • Stocks • Equivalent to about 100% of developing country GDP • Dominated by electricity (45-55%), and transport (30 to 40%) • “cheaper” telecom (5-15% and growing) and W&S (5 to 15%) • Maintenance: • About 2 to 3% of GDP per year

  5. Infrastructure is “big money” • Output: • About 6% of GDP for electricity (MICs) • The same for telecom & transport? • Much smaller for W&S

  6. Expensive when poorly managed • Electricity: • Total hidden costs (underpricing; technical and commercial losses) estimated in ECA at 4% of GDP • In Mexico – untargeted subsidies amount to 1% of GDP • Rail and public transport: historically huge drains on public coffers • Water and sanitation: typically much smaller (0.4% of GDP in ECA)

  7. Much of it, public responsibility • Differences across sectors: • Fairly universal trend for privatization of telecom, air transport, possibly rail • More varied with electricity, public transport • Limited potential for roads • W&S – complicated…

  8. Distinguishing features • Investment • Highly capital intensive (60%+) • Long term planning horizons (30 yrs) • Infrequent lumpy investments • Long lead times (Up to 5yrs) • Unpredictable investment costs

  9. Distinguishing features • Maintenance • Long asset lives (Up to 30 yrs) • High maintenance (2-3% AV) • Exponential cost of deferred maintenance • Catch-22 • Decision to invest based on estimated rate of return, itself conditioned by whether maintenance occurs

  10. The maintenance dilemma 100 Very Good 90 -Filling Cracks 80 70 Good -Geotextile and Strengthening 60 Condition of Pavement (%) -Reconstruction of the Surface -Reconstruction of the partial base course Fair 50 40 Poor -Complete Reconstruction 30 20 Very Poor 10 0 0 2 4 6 8 10 12 14 16 18 20 22 24 26 Lifetime of Pavement (years) If maintenance on a 20 year road is not done by the end of the 12th year. It starts to deteriorate eight times faster than in the early years

  11. Fiscal consequences • For all of these reasons, ill-suited to unpredictable annual budgetary cycle • Moreover, particularly vulnerable to budgetary downturns • Politically soft target for budget cuts • Maintenance less attractive than investment • Long lived assets delay hour of reckoning • Even investments can always be deferred

  12. The infrastructure public finance paradox • Maintenance and investment are prime candidates for cuts • Subsidies – however poorly targeted - are difficult to eliminate • Some countries spend more on consumption subsidies than on either investment or maintenance…

  13. A complication – no data • No country systematically collects investment data on infrastructure • “infrastructure” a broad and vague category – unlike health and education • Poor fit with IMF GFS categories • Public investment data notoriously poor – hard to distinguish from O&M • A few valiant efforts (Calderon & Serven; specific country studies) • The implication – no monitoring

  14. II. Funding sources

  15. Only three possible sources • Tax payers (fiscal transfers) • Users: • fees • cross-subsidies • Asset depletion: • quality • non-expansion of service…

  16. Historic under-pricing Ratio of revenue to costs Source: WDR 1994

  17. Cost recovery: water Degree of cost recovery Source: Foster & Yepes, forthcoming

  18. Cost recovery: electricity Degree of cost recovery Source: Foster & Yepes, forthcoming

  19. Who really gets the subsidy? In Hyderabad (India), employees capture 40% of the subsidy, and consumers 60%, half of which they spend on alternative providers

  20. What distributional incidence? Source: Komives et al., forthcoming

  21. III. Budgetary Boundaries

  22. Budgetary boundaries • Infrastructure has a tendency to creep off the budget for both good and bad reasons • There are a number of mechanisms through which this takes place • Extra-budgetary funds (fuel tax, USL) • State Owned Enterprises • Public Private Partnerships

  23. Earmarked funds • Loved by sectoralistsprovide a stable source of financing in sectors without possibility of user fees, isolated from budgetary and political interference • Loathed by macroeconomistsreduce budgetary flexibility and optimization of public resources, often lead to poor governance, lack of transparency

  24. Argentina: exploding funds Source: Argentina PER, 2003

  25. Argentina: weak governance

  26. State Owned Enterprises • Often represent a large percentage of public investment in infrastructure • May or may not be consolidated into fiscal accounts • May be net contributors or drains on the public purse • Operate in restricted environments that limit their autonomy and commercial orientation • Management may be guided by macroeconomic concerns

  27. Colombia: drains vs. cash cows Source: REDI Colombia, 2004

  28. Public Private Partnerships • Potential for PPPs varies substantially across sectors • Key criterion for judging whether extra-budgetary is extent of risk transfer • However, unless 100% risks can be transferred contingent liabilities remain • Complex fiscal accounting issues arise regarding the treatment of • Contingent liabilities • Private investment • Committed future public subsidies

  29. LAC: private relative to total Source: Calderon, Easterly and Serven, 2003

  30. LAC: private relative to total

  31. Colombia: new policy after $4.4 Bn bailouts • New policy guidelines on risk allocation between public and private partners • Mandatory estimation of contingent liabilities using Monte Carlo (continuously updated) • Required payments to cover liability are ‘smoothed out’ into a Deposit Plan • Deposits are made from budget to Contingency Fund in individual accounts • Aggregate estimates reported annually to parliament (infrastructure >0.5% GDP)

  32. IV. Budgetary mechanisms

  33. Budgetary challenges • Project selectiondeficiencies in technical capacity for project evaluation, plus political attraction of ‘white elephants’ • Multi-year planninglong term projects required multi-year budget envelope to assure execution • Implementation bottleneckscomplex procurement plus unforeseen delays [cash budgeting!] make it difficult to execute budget

  34. Peru: project selection • SNIP • MinFin unit does (pre-)feasibility studies • CBA methodology with min. IRR 14% • Declares viability without prioritization • Coverage • 2/3 of projects with regulated exceptions • Smaller local projects with domestic financing • Projects supported by Supreme Decree • Too many projects leads to budget constraints, delays and declining IRRs

  35. Colombia: low execution

  36. Conclusions • Cost structure of infrastructure services leads to fiscal complications • Wide variety of potential funding sources for infrastructure • Tendency for infrastructure to be on the boundaries of the budget • Infrastructure poses challenges from a budgetary perspective

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