Infrastructure and Prosperity

By: Sam Vaknin, Ph.D.

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In the past, if you were to mention the word "infrastructure", the only mental association would have been: "physical". Infrastructure comprised roads, telephone lines, ports, airports and other very tangible country spanning things. Many items were added to this category as time went by, but they all preserved the "tangibility requirement" - even electricity and means of communication were measured by their physical manifestations: lines, poles, distances.

Today, we recognize three additional categories of infrastructure which would have come as a surprise to our forefathers:

Social infrastructure - laws, social institutions and agencies, social stratification, demographic elements and other social structures, formal and informal.

It is amazing to think that previously no one thought of the legal code as infrastructure. It has all the hallmarks of infrastructure: it spans the entire country, it dynamically evolves and is multi-layered, without it no goal-orientated human activity (such as the conduct of business) is possible. A foreign investor is likely to be more interested to know whether his property rights are protected under the law than what are the availability and accessibility of electricity lines.

An investor can always buy a generator and produce his own electricity - but he can never enact laws unilaterally. The country's denizens are bound to encounter the law (or resort to it) sometime in their lives, even if they never travel on a road or use a telephone.

The second category of infrastructure is the human infrastructure. What is the mentality of the people? Are they lazy, industrious, submissive, used to improvise, team-spirited, individualistic, rebellious, inventive and so on? Are they conservative, open-minded, xenophobic, ethnically radicalized, likely to use brute force to settle disputes? Are they ignorant, educated, technologically literate, seek information or reject it, trustful and trustworthy or suspicious and resentful?

An educated workforce is as much part of a country's infrastructure as are its phone line.

The last category of infrastructure is the information infrastructure. It is all the infrastructure which tackles the manipulation of symbols of all kinds : the accumulation of data, its processing and its dissemination. Words are symbols and so are money and computer bytes. So banks, computers, Internet linkups, WANs and LANs (Wide and local area computer networks), standardized accounting, other standards for goods and services - all these are examples of the information infrastructure.

The development of all these types of infrastructure is intimately linked. They usually evolve almost concurrently. They form feedback loops. The slow or hindered development of one of them prevents the flourishing of all the others.

This is really quite reasonable. If the workforce is not educated, it will not be keen or qualified to manipulate data and symbols. It will buy less computers, use the Internet less, bank less and so on. This, in turn, will reduce the need for phone lines, office buildings and so forth. There seems to be an "infrastructure multiplier" at work here.

This multiplier is a two way street: an increase or decrease in each type of infrastructure adversely or positively influences the others.

The West itself is in dire need of infrastructure. Its current infrastructure is crumbling, either owing to advanced age or to over-usage. Roads in large parts of the USA are in poorer condition than they are in some countries of Africa. In 1997, America-On-Line, a major Internet provider, was unable to provide services to its customers for weeks on end because communication lines in the USA were totally jammed. Certain places in Israel could receive television signals only in the last few years, as infrastructure reached them. Infrastructure is a universal problem.

The West invests in the infrastructure of developing countries through two venues:

Through international finance organizations (such as the World Bank and the European Bank for Reconstruction and Development). The terms and conditions of this kind of financing are very lenient. Those are really grants more than credits.

The implementation of these infrastructural projects is awarded to contractors via international tenders, with bids submitted from the world over. Rarely does a local firm outbids its better financed, better equipped and better motivated first world rivals.

Alternatively, multinational firms get involved in local projects directly. But this kind of financing comes with a lot of strings attached. The multinationals expect to recoup both their investment and a reasonable return on it. They come heavily subsidized by the governments of their countries. Their contribution to the local economy, during the construction of the infrastructure, is fleeting, at best. They prefer to employ their own crews and equipment. They do not trust the locals too much or too often.

But whichever way the infrastructure is created, problems arise at the host country.

Consider international, multilateral, finance organizations. Inevitably, think and plan on a global scale. They invest in infrastructure only if and when it services - or has the potential to service in the larger scheme of things - a cluster of neighboring countries.

Clear regional benefits have to be unequivocally demonstrated in order for multilateral organizations to get involved. They neglect, overlook, or outright reject investments in much needed local infrastructure.

Such financial institutions always prefer to invest in a cross-border highway rather than in a cross-country road, for instance.  The benefit to the domestic economy of the aforementioned local road could be appreciatively more sizeable. Still, the international fund would encourage the cross border highway. This is its charter - to promote multilateral investments - and this is what it does best. The interests of the host country are a secondary consideration.

On the other hand, the private sector invests only in countries with well developed infrastructure in all the aforementioned categories. But this is a conundrum: if the infrastructure is already developed, investments by the private sector are less beneficial. The result is that straightforward investments by the private sector - not subsidized, not partial, not co-funded by international institutions - mainly flow to the developed, industrial world.

Studies unearthed four disadvantages of countries with under-developed infrastructure:

Such countries suffer from interminable bottlenecks in all the levels of economic activity, especially in the production and distributions phases (principally in the transportation of raw materials to factories and of finished products from industry and field to the marketplace).

This adversely affects the availability of the country's domestic produce in both local and foreign markets. Agricultural produce is most affected but, to a lesser extent, so are industrial goods. If the communications infrastructure is decrepit, the service sector is similarly impacted.

A second issue is the distortion of the price mechanism. Prices increase owing to the wastage of resources when trying to overcome problems in infrastructure. Prices are supposed to reflect inputs and values and thus to assist the markets to optimally allocate resources. If the prices reflect other, unrelated, issues, then they are distorted and, in turn, distort economic activity.

The third problem is that one country's disadvantage is another's advantage. Other countries, with better infrastructure benefit : they attract more foreign investment, they conduct more business, they export more, they have lower inflation (cheaper prices) and their economy is not distorted by irrelevant, ulterior, non business considerations.

The fourth - and maybe largest and longest term - handicap is when the country's image is affected. Infrastructure is much easier to fix than a country's image. If the country acquires a reputation of a mere transit area, an underdeveloped, inefficient, non productive, hopeless case, it suffers greatly until these impressions change. The image problem has the gravest possible consequences: repelled investors, reluctant financiers, frightened bankers, disgruntled foreign investors.

There are eight known solution to the problems of a country with underdeveloped infrastructure:

It can privatize its infrastructure (commencing with its energy and telecommunications sectors, which are the most attractive to foreign and domestic private investors alike).

Then, it can allow the business sector to operate parts of the national infrastructure. The usual arrangement is that firms invest in creating infrastructure and then collect fees for operating and maintaining it. The fees collected are large enough to cover both the investment and the maintenance costs and to return a pre-determined profit. The most famous example are toll roads, often constructed by the private sector.

Another way is to commercialize the infrastructure (to collect fees for using the telephony network, or the highways) and to plough back the proceeds exclusively into projects of infrastructure. Thus, all the income generated by cars passing on a highway can be dedicated to the construction of additional highways and not funneled into the general budget.

The fourth method is to adapt the prices of using the infrastructure to the real costs of constructing and of operating it. In most developing countries, consumers pay only a fraction of these real costs. Prices are heavily subsidized and the infrastructure is left to decay and rot away. This, obviously, is a political decision to be taken by the political echelons. In many countries, such readjustment of prices to reflect real costs frequently creates social unrest and has severe political ramifications.

The country could condition investments in multilateral infrastructure projects upon investments in its own, local infrastructure. A multinational firm which wishes to invest in a highway (and thus reap considerable rewards), can be required to invest a portion of its future profits in local roads and other forms of infrastructure. A multinational fund interested to invest in a telecommunications project which involves three countries can be asked to commit itself to a "local investment" clause, a "local content purchase" clause, or an "offset" arrangement (the purchase of local goods against any import of goods connected to the project to the country).

The country must open its markets to domestic and foreign competition by de-regulating. It must dismantle trade barriers : tariffs, quotas, restrictions, anti-investment regulations, restrictive standardization and so on. Competition both lowers the costs of infrastructure and improves its quality, as rival firms strive to supply more value at a lower price.

An important condition is that the country does not prefer one kind of infrastructure to another. All categories of infrastructure should be simultaneously and similarly stimulated. This will carry favor with the international business community and is bound to alter the image of the country for the better. It will also create a positive feedback loop whereby an improvement in one category of infrastructure yields improvements in all the others.

Last - but far from least - the country must promote international agreements which facilitate reductions in the costs of cross-boundary transport of goods, services and information. Less documentation, less one sided fees, less bureaucracy will reduce the costs of doing businesses (transaction costs) and the total damage to the national economy. The less encumbered by red tape, the more a country tends to prosper.

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