Spending on infrastructure is a foundation of economic growth. Infrastructure refers to those physical or non-physical assets required for stimulating economic growth and improving the quality of life. Transport networks, like roads, airports, ports, and railways, are examples of the physical assets that aid production and promote productivity in the economy. Non-physical capital includes education, healthcare, software and financial services.
How infrastructure drives actual economic growth
Actual economic growth is a rise in the Real Gross Domestic Product (GDP) by using more of existing resources. It represents current economic performance. This usually occurs in the short run when there are unused resources due to insufficient aggregate demand in the economy. The economy is within the Production Possibility Curve (PPC) in the short run, and its output is below its potential output.
When the government spends on infrastructure, such as roads, aggregate demand increases because government spending is a component of aggregate demand. Infrastructural development creates a lot of direct and indirect jobs. During construction, engineers, project managers, other construction workers, materials suppliers, and logistics companies are hired. Incomes are earned by those employed. In addition, good infrastructure attracts more businesses, which employ people who earn incomes. Aggregate demand rises as these incomes are spent on goods and services. This encourages businesses to respond by increasing their production across the economy, causing actual economic growth. In fact, GDP will rise by a larger amount than the initial spending due to the multiplier effect.
Good infrastructure development tends to lower business costs. A better transport network reduces the travel time and cost of raw materials and finished products. Lower costs will generally result in an increase in production, raise the GDP, and drive actual economic growth.
How infrastructure drives potential economic growth
Potential economic growth refers to an increase in an economy’s capacity to produce goods and services. It happens in the long-run when an economy has fully used its resources, and there are no idle resources. The economy is on the PPC in the long-run. Potential economic growth is caused by increasing the quantity or quality of an economy’s resources, causing the PPC to shift outward. Potential economic growth is capable of raising the maximum or potential output without creating inflationary pressure.
Since infrastructure is a capital good, spending on infrastructure increases the quantity of a country’s capital stock. With more capital, the productive potential or capacity of the economy receives a boost.
Furthermore, infrastructure makes businesses or existing resources more efficient. For example, the provision of education and healthcare improves the quality of the workforce by making them more skillful and productive. This promotes potential economic growth by shifting the long-run aggregate supply outward.
Advances in technology promote innovation, which enables businesses to produce new products or adopt more efficient methods of production. This expands the economy’s long-term productive capacity.
Why infrastructural spending may hinder economic growth
Spending on infrastructure may fail to stimulate economic growth if the projects are poorly designed. Rather, they increase national debt which makes both actual and potential economic growth difficult due to high debt servicing costs. A lot of resources are used for servicing debts instead of maintaining existing infrastructure or embarking on additional ones.
Long term infrastructural projects may become ‘White Elephant Projects” with costs exceeding benefits to the economy. These projects face significant unintended rise in costs which can erode the benefits from economic growth.
The construction of projects like roads comes with negative externalities such as loss of wildlife habitats, pollution and environmental degradation that adversely impact the health of the workers . Poor health translates to low productivity, and by extension, low potential economic growth in the long run.