Politics and Public Investment

• Author: Sanjeev Gupta, Estelle Xue Liu, and Carlos Mulas-Granados

Politics and Public Investment Finance & Development, December 2015, Vol. 52, No. 4

Sanjeev Gupta, Estelle Xue Liu, and Carlos Mulas-Granados

Catering to voters as elections approach can upend intelligent decisions on infrastructure spending

Virtually all countries need additional infrastructure such as roads, bridges, airports, telecommunications networks, power plants, and public transportation. With interest rates low—and, as a result, cheap financing for government spending—many analysts and policy advisors advocate increasing public investment in infrastructure to promote growth, which would both lower the debt-to-GDP ratio and expand an economy’s long-term productive capacity (IMF, 2014).

However, even if shovel-ready projects have been identified and decision-making processes for public investment are working efficiently, investment still may not happen. Why?

Political considerations get in the way. When elections loom, policymakers choose to provide immediate benefits to the electorate through lower taxes or increased income transfers—at the expense of public investment, which takes time to come to fruition. Other factors can also play a role in discouraging needed investment. For example, the political orientation of parties that form a government may favor a lower level of public investment.

When there are no political or institutional constraints, public investment should be determined mainly by development needs—to meet the requirements of a growing population and to reduce infrastructure bottlenecks. Occasionally, public investment can be triggered by demand management considerations—for example, when an economy has spare capacity and policymakers believe investment would increase aggregate demand and raise employment in the short term. In reality, however, political considerations often strongly influence public investment decisions.

Bad incentivesWilliam Nordhaus (1975) provided early modeling of how political cycles could affect economic decision making. He argued that incumbents have incentives to stimulate the economy before elections to achieve a temporary reduction in unemployment, an outcome preferred by voters, who in general have a short-term view. Research on the political economy of budget and fiscal policy has burgeoned. Four factors have been cited as possible ways political factors affect public investment:

Politicians are opportunistic and, as a result, launch investment projects only at the beginning of the electoral term to be able to inaugurate them before the next election. As elections near, politicians choose to woo voters with public sector wage increases, tax cuts, and cash transfers, finding the wherewithal to do that by cutting back on...