How much is too much?

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On the absorption capacity of public investments: how much is too much?

Author / Publisher:

Daniel Gurara; Kangni R Kpodar; Andrea F Presbitero; Dawit tessema

Publication date:

February 28, 2020

Electronic access:

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Warning: IMF Working Papers describe ongoing research by the author (s) and are published to elicit commentary and encourage debate. The views expressed in IMF Working Papers are those of the authors and do not necessarily represent those of the IMF, its Executive Board or its management.

Summary:

While increasing public investment can help bridge infrastructure bottlenecks, increasing too much and too quickly often leads to inefficient results. This article rationalizes this result by examining the association between cost inflation and public investment in a large sample of road construction projects in developing countries. Consistent with the presence of absorption capacity constraints, our results show a non-linear U-shaped relationship between public investment and project costs. Unit costs increase as soon as public investment is close to 10% of GDP. This threshold is lower (around 7% of GDP) in countries with low investment efficiency and, in general, the effect of increased investment on costs is particularly strong during investment booms. .

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