Infrastructure and
Development: The present
Challenges
Ajitava Raychaudhuri
Department of Economics
Jadavpur University
Kolkata 700032
Public Capital and Infrastructure –
definitional issues
 Does public capital mean a stock
variable like private capital or does it
mean the services which flow out of
this government owned capital?
 Is public capital a pure public good of
Samuelson’s variety which is nonrival and non-excludable?
 If we equate public capital with
infrastructure, how do we measure its
quantity?
Infrastructure and public capital is
interchangeably used since contribution of
private infrastructure is difficult to
measure.
Growth Rates under planner’s and
individual investor’s solution
 Standard economic theory suggests if we
compare the two growth rates the two growth
rates, clearly:
 p   c where the first one is Planner' s growth
rate while the latter is individual investor' s
growth rate.
The main reason is that competitive
solution considers only the private marginal
product of capital whereas the social
planner considers the social marginal
product which does not have the tax
deduction from the marginal product. Is
there any way to bring about pareto optimal
growth in the competitive solution? It is
possible if the government replaces the
distortionary income tax by either a lumpsum income tax or simply a consumption
tax which is by definition lump-sum since it
does not vary with income.
Barro and Sala i Martin (1990) discuss a
case where a public good is rival but not
excludable. A common example is total
highway mileage, which is the services
from a publicly owned infrastructure
denoted as G. The output is total highway
traffic, and let this be denoted by Y. The
problem is congestion which precludes the
use of highway for some individuals at
times of high traffic.
Here lump-sum tax produces the opposite
result than the earlier model of Barro. The
reason is that lump-sum tax is equivalent
to zero user fee so that it does not
discourage individuals to overuse the
public capital’s service, hence is
distortionary. However, the proportional
tax is equivalent to user fee which
internalises the congestion distortion
Public Private Partnership – Emerging
Issues in Modelling
 The major issues in this emerging literature on
PPP may be summarised as below:
 What should be the conditions when
government procurement through its own
agency/department through hiring of different
contractors is better than PPP which bundles
construction and operation with a single
contractor?
 What are the implications of the mode of
financing the private sector investment under
PPP?
PPP versus conventional government
procurement
Assume that an infrastructure project
has an accounting (or revealed) cost
given by C =  - e, where  is an
intrinsic efficiency parameter of the
firm, such that ‘high ’ firm has low
productivity and vice versa, and e is an
unobservable effort level. Here C is
composed of two unobservable
quantities, namely hidden information 
and hidden action e.
The first is the case of adverse selection
and the second is the case of moral
hazard. Also suppose there is cost of
effort denoted by (e), having (e)>0
and (e)>0. Thus, any cost saving
generates an additional surplus for the
firm. If the firm is provided a fixed sum
of money then for any cost saving
surplus, the firm is the residual
claimant.
If the firm minimizes its true cost with
respect to e, then productive efficiency
requires the condition (e)=1. Such an
outcome is always achievable through a
fixed-price contract. However, a generous
contract will attract a high intrinsic
productivity firm who will outbid the low
productivity ones but a low price contract
will do exactly the opposite. So the
government has the onerous task of
choosing the optimal price for the contract
To overcome this while guaranteeing the
work is done, the government may have a
contract which has a low fixed component
and a variable component which is costplus if the firm declares that it has a low .
Thus the high  firm will still opt for a high
fixed price scheme while those with low 
will go for a partial cost-plus scheme.
Essentially the firms are offered a menu
which reduces the informational rent.
Hart (2003) has the following scheme in
his model – two firms, one called the
‘builder’ and the other called the ‘operator’
compete for an infrastructure project. The
government can have a procurement
policy which will utilise both the firms,
while under PPP, the operation will be
bundled and the builder will get the project
for both building and maintaining it
Comparing the government procurement
(unbundling) with PPP (bundling), we find
that under unbundling the builder
internalises neither Social Benefit B nor
Cost C, so that there is underinvestment in
both socially productive investment like
use of best quality materials and
techniques in building a bridge and
applicable unproductive investment like
promoting a design which reduces costs
but increases traffic congestion
In case of bundling, he again fails to
internalise B but internalises C. So in this
case there is comparatively more
productive investment (although less than
first best) but at the same time there is
more unproductive investment of e too (in
fact, it is more than the first best solution).
This shows that when quality of building
can be well specified but not the
consequent operations, government
procurement is better, but when quality of
operation and maintenance could be
completely specified, PPP is better.
PPP and Public Finance
There is a belief that once a PPP model
(by implication, it is bundled) is adopted
over the general procurement, the
government is saved of that amount. This
does not make sense once one
remembers Ricardian Equivalence. The
costs incurred by the private party is
consequently recovered through user fees
and government subsidies (alternatively
known as minimum revenue guarantee).
Engel, Fischer and Galetovic (2008) show
that the form of payment to the private
party is irrelevant as far as social planner’s
optimum is concerned. What matters is the
total payment made to him and not the
division between user fee and subsidy.
The intuition is that either way the
government has to finance either the loss
of user fee or provision of subsidy by
distortionary tax defined as (1+) for each
rupee foregone or spent.
Empirical work on Public Infrastructure,
Growth and Inequality
 Munnell (1990) estimated an equation which is: ln Q - ln
L = c0 + c1ln L + c2ln Kp + c3ln Ki + c4CU + u, where u
is taken to be a first order autoregressive error term.
Munnell used two alternative definitions of infrastructural
capital- One is what she calls the core infrastructure
capital, and it consists of highways, airports, mass transit
facilities, electric and gas plants, water supply facilities
and sewers; a second measure is more general, and it
includes not only the core infrastructure capital, but also
non-military public buildings such as schools, hospitals,
police and fire stations, courthouses, garages and
passenger terminals, and those used in conservation
and development.
As Munnell pointed out, the initial results
indicated an implausibly high elasticity for
the public capital or infrastructure, much
higher than the private capital. The critics
raised such issues as non-stationarity of
data suffering from common long-term
time trends, and simultaneity bias.
Economists have tried to incorporate all of
these but the debate has not subsided.
Barro himself ran cross country
regressions earlier and reported them at
the end of his 1990 paper. In Barro’s
theory, in case the countries are close to
their respective maximal growth, gross
public investment (gi) as a ratio to total
investment including private and public (i)
should not have significant association
with growth of per capita income.
For 76 countries for which data on public
investment is available, the estimated
coefficient of regression of average annual
growth rate of per capita GDP on gi/i ,
controlling for initial real per capita GDP in
1960 school enrollment rates and other
indicators of political stability and market
distortions, came out to be 0.014 and
insignificant. This implies that the typical
country was having public investment (in
infrastructure) close to that maximizing
respective growth rates.
There is not much empirical study on the
PPP models presented earlier. One study
by Hammami, Ruhashyankiko and Yehoue
(2006) on PPP did not go into the contract
theory issues so much discussed in the
theoretical models, but has tried to identify
the variables which influence PPP the
most in a cross-country framework. The
paper used ordered probit and logit
analysis among other more standard
techniques to ordinally scale the private
sector participation in a project in a scale
of 1 to 12
Empirical work on India
Barro’s approach has influenced some of
the studies on this. In a paper jointly
written by the author of this paper (Roy
and Raychaudhuri, 2009), Barro’s
approach is modified to incorporate rent
seeking motive of the public agents (like
managers of government agencies) in
charge of providing infrastructure services.
 The rent seeking arises because it is enabled by
law, the infrastructure is owned by government
and as such there arises an institutional
monopoly rent which the public agents equally
divide among themselves
 In this model, as already mentioned, it is
assumed that the public sector enjoys monopoly
power of supplying public capital. Government
provides public capital through some
decentralized public agents. Role of the
government here is only to collect and transfer
funds to the agents.
As government does not know the actual
cost of producing public capital
government allows the agents to impose
some user fees for the public capital. The
user fee as defined above is equal to the
value of marginal product of the public
capital net of taxes. As a result they earn
some monopoly rent over above their
wages.
Now to discipline the public agents
government transfers funds to the agents
so that they allocate resources as
efficiently as possible. Thus the premium
is comprised of monopoly rent as well as
the incentive given by the government.
Monopoly rent is not taxable whereas
incentive is taxed by the government. The
premium function under decentralised
agents’ model is defined as the difference
between the revenue earned from user fee
and incentive net of taxes and cost of
providing public goods.
 In this paper the period considered is 1981 to
2005, using data on seven states of India
 The results indicate that in all the seven
states in India public capital affects growth
of SDP significantly. The authors find that
the elasticity of SDP with respect to public
capital is positive and significantly different
from zero in all the seven selected states.
Different estimated elasticity values of the
public capital over the states indicate that
efficiency of public capital in raising output
differs from state to state in India
Comparison of actual allocation rates with
the decentralised agents’ allocation rates
as well as that of social planner’s
allocation rates indicates that rent seeking
motive exists in all the selected states in
India. This also vindicates the fact that the
rent seeking motive operates among the
public agents.
The estimated elasticity coefficients and
the optimum allocation rates differ from
state to state but the paper does not say
anything about why such a difference
exists over the seven selected states. For
this one needs to study the compositional
difference in expenditure in different
states. The compositional difference that
is, how much a state spends on the
maintenance of existing capacity might
need to be focused as this expenditure is
expected to affect growth of public capital
significantly.
Lessons Learnt
The distinction between stock and flow
regarding public capital, along with its
monetary and real dimensions should be
clearly highlighted in any work, either
theoretical or empirical. Otherwise, there is
always a possibility of mis-interpretation
and mis-specification.
Understanding relation between private
and public capital as well as private party’s
participation in public capital building and
maintenance needs a clear understanding
of rent seeking nature of the activity. In
addition, some micro-foundation based on
contract theory and optimizing behavior of
agents is necessary to portray some of the
theoretical and empirical developments
One needs to extend some of the
excellent empirical work done for crosscountry studies or specific developed
countries, for analysing Indian data. These
works are based strongly on an underlying
theory, trying to endogenise many of the
variables which determine the investment
in public capital.
India and PPP
 Umbrella definition of PPPs in India
 PPP means an arrangement between a government or statutory
entity or government owned entity on one side and a private
sector entity on the other, for the provision of
 public assets and/ or related services for public benefit,
through investments being made by and/or management
undertaken by the private sector entity for a specified time
period, where there is
 a substantial risk sharing with the private sector and the private
sector receives performance linked payments that conform (or
are benchmarked) to specified, pre-determined and measurable
performance standards.
Arrangement with Private Sector Entity: The asset and/or service under
an arrangement will be provided by the Private Sector Entity to the
public.
(a) ‘Public Services’ are those services that the State is obligated to
provide to its citizens (towards meeting the socio-economic objectives)
or where the State has traditionally provided the services to its citizens.
For example, provision of security, law and order, electricity, water, etc.
to the citizens.
(b) ‘Public Asset’ is that asset the use of which is inextricably linked to
the delivery of a Public Service. For example, public road which is linked
to public transportation. OR, those assets that utilize or integrate
sovereign assets to deliver Public Services. For example, right of way
on highways, shore-land of about 0.5 km abutting the ocean, or use of
river / water bodies, etc. Note: Ownership by Government need not
necessarily imply that it is a PPP. For example, a captive jetty is not a
PPP even though it uses a sovereign asset, while a common user port is
a PPP as in the latter case the service is provided for use by public.
 Operations or management for a specified period: Provides an
element of time period after which the arrangement with the private
sector entity comes to a closure. Hence, the arrangement is not in
perpetuity.
Substantial risk sharing with the private sector: It is typically
specified to differentiate PPPs from mere outsourcing contracts. For
example, a facility service contract is also an outcome based reward
contract but not a PPP.
Performance linked payments: It is to provide central focus on
performance and not merely provision of facility or service. A mere
deferred payment contract should not get qualified as a PPP.
Conformance to performance standards: It is to provide a strong
element of service delivery aspect and the concepts of quality and
compliance to pre-determined and measurable standards to be
specified by the sponsoring authority.
PPP initiative in the Roads Sector has been largely on
the BOT basis. The policy framework for toll-based
BOT projects was approved in 1997. In 2005 it was
decided that all future programmes/projects under
NHDP would be awarded only on BOT basis. Contracts
based on BOT model are inherently considered
superior to the traditional Engineering Procurement
and Construction (EPC) contracts as BOT projects
ensure higher quality of construction and maintenance
of roads and completion of projects without cost and
time overrun.
Also, to attract the private sector to projects that are
not commercially viable but considered essential, the
government has established a Viability Gap Funding
(VGF) mechanism to provide a grant of up to 40% of
the project cost
Mainstreaming of PPP in the Roads Sector has
been significant as shown below:
• Requisite
model documents, namely, Request for
Qualification, Request for Proposal, Manuals for
Specifications & Standards, Model Concession
Agreements (for National Highways, State Highways
and Operations and Maintenance of Highways), etc.
have been standardized.
• Bidding procedures are systematic.
• Availability of certain financial schemes/guidelines –
Viability Gap Funding Scheme and India
Infrastructure Finance Company Limited (IIFC)
Some of the key constraints from the recent attempts in
developing power projects on PPP mode include:
Lack of understanding on PPP structure
 Land acquisition issues
 Lack of standardized documents leading to diverse
interpretation of issues at the states (lack of knowledge of
available standardized documents)
 Tighter access to liquidity
 Arbitrary norms of pre-qualification primarily adopted by
state entities
 Inability to stick to set deadlines by the state entities
conducting project development activities
Thank You