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These arguments point to very large potential benefits of infrastructure which

nevertheless elude identification and measurement by conventional cost-benefit analysis.


Unless measured in a convincing way, however, we do not know whether the size of these
effects provides a case for expanding infrastructure beyond current levels, or even perhaps
for adopting a policy of infrastructure-led development. This remains true even under the
current trend of providing infrastructure though the private sector, or at least to have some
form of pricing mechanism. While public or private pricing schemes can recover at least
in part, the costs of a project, prices can only capture private benefits. If infrastructure has
large positive externalities, even under private provision we may wish to have a policy of
subsidies to ensure provision on an adequate scale.
Our approach to finding the benefits of infrastructure is to estimate an aggregate
production function for a panel of countries over the last 40 years, including as explanatory
variables physical capital and human capital as well as our infrastructure variables, paved
roads and electricity generating capacity. We can then calculate the marginal product of
infrastructure as its contribution to aggregate output. While this approach misses any
benefits to infrastructure that do not appear in Gross Domestic Product (for example, time
savings that lead to increased leisure) it should allow us to see if infrastructure has large
output effects.
Using aggregate production functions to estimate the contribution of infrastructure
has become quite common (for example, Andrews and Swanson (1995), Boarnet (1997),
Carlino and Voith (1992), DeFrutos, GarciaDiez and PerezAmaral (1998), GarciaMila,
McGuire and Porter (1996),or Pinnoi (1994)). The main problem with estimating these
function is reverse causality. An increase in income leads to increased demand for
infrastructure, and so a positive correlation between infrastructure stocks and output levels
may be simply due to increased demand, and may not reflect any supply side productivity
effect. To overcome this problem, we use the techniques developed in Canning (1999)
based on a panel data, cointegration, analysis, as outlined in 2.1 below. One appealing
feature of our approach is that the estimates we get for the productivity of human and
physical capital are close to those found in microeconomic studies of their private rates of
return. This suggests that the procedure does indeed remove the bias introduced by reverse