A. Introduction

1. There has been an increased emphasis by both the Commonwealth and State governments on infrastructure spending. There is a concerted effort, using advice from government agencies such as Infrastructure Australia (and their State equivalents), to choose projects that have a high level of benefits versus costs. However, it is not necessarily clear from a long-term perspective if all of Australia’s infrastructure needs are being met. This paper reports on the current and projected infrastructure investment gap for Australia, using the analysis of Oxford Economics, for the Global Infrastructure Hub. Moreover, given the magnitude of the gap, this paper demonstrates that there can be further gains in terms of growth in the near- and medium-term that can be achieved by fully closing said gap, using the IMF’s ANZIMF (Australia-New Zealand Integrated Monetary and Fiscal model).

2. The extent of the infrastructure investment gap is an important question, because it represents foregone gains in productivity that would allow for higher growth. There is an extensive literature that has demonstrated this theoretically (Aschauer, 1989), empirically (Bom and Ligthart, 2014) and through model simulation and consideration of fiscal policy (Abiad and others, 2016). Much of the literature generally concludes that infrastructure of sufficient quality and quantity can improve the quality of the workforce, the provision of capital, and firms’ access to domestic and foreign markets. Interconnectivity is particularly important in a geographically distant and large country like Australia, with concentrated but dispersed population nodes on east, south and west coasts (all the major cities except Canberra), and without any neighboring countries on land with which to trade. Governments can have an important role to play in closing the gap, or encouraging the private sector to do so.

B. A Baseline for the Infrastructure Investment Gap

3. The Global Infrastructure Hub is the primary source for the baseline infrastructure investment gap. It is a G-20 initiative, that has published a Global Infrastructure Outlook authored by Oxford Economics.² It forecasts current trends and needs for infrastructure investment until 2040 (a 25-year period, starting in 2016), deriving the infrastructure investment gap from calculating needed spending less spending based on current trends for seven sectors – roads, rail, airports, ports, electricity, telecoms and water – for 50 countries, comprising over 85 percent of global GDP. These seven sectors are only a subset of the standard definition of government investment in fixed capital in the national expenditure accounts, as it excludes structures (such as hospitals, police stations, schools, and the like) and capital equipment (for example, ambulances and police cars, and military equipment).

4. Current trends and needs for the future are determined from extensive calculations. Current trends for infrastructure investment extrapolate spending trends to 2040 through a thorough analysis of the data for each country, combined with regression analysis for each of three groups of countries (low and lower middle income, high middle income, and high income, of which Australia is a member). Infrastructure needs are computed for each of the seven sectors so that a country will match the 75^th percentile of current trends infrastructure stock per capita in their income group, adjusted for quality considerations. Box 1 gives a more detailed explanation of the methodology.

5. The global infrastructure investment gap is estimated at 2015 US$94 trillion between 2016 and 2040. ³ This is a gap of 19 percent against the current trend investment in infrastructure extrapolated to 2040, an average of 2015 US$3.7 trillion per year. It implies that global infrastructure investment spending as a share of GDP should be 3.5 percent, versus 3.0 percent now. All seven infrastructure sectors have higher needs than current trends, roads being the greatest (Figure 1).

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Global Infrastructure Needs versus Trends and Historical Averages

(Percent of global GDP per year)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Source: Global Infrastructure Outlook, Oxford Economics

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6. Australia has a small gap, but not relative to many other advanced economies. According to the Global Infrastructure Outlook, Australia’s overall gap from 2016 to 2040 is 10 percent of GDP, implying cumulative infrastructure investment needs of 2015 US$1.7 trillion, versus the current cumulative trend spending of 2015 US$1.54 trillion. This translates into additional infrastructure investment spending of almost 0.4 percent of GDP per year until 2040, similar in scope to New Zealand, but larger than other key advanced economies and China (Figure 2).

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Australia’s Infrastructure Needs versus Comparators

(Percent of GDP per year)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Source: Global Infrastructure Outlook, Oxford Economics

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7. Australia’s infrastructure investment gaps for the seven sectors differ from the global picture (Figure 3). There has been extensive investment in roads, and current trends continue to indicate this to be the case, matching the investment needs. Stronger needs exist in the rail and ports sector, since Australia historically has had weak rail linkages (due to great distances with little population inland). It is reliant on sea transportation to connect its major (coastal) population centers, as well as maintain its ever-growing trade linkages with China and the rest of emerging Asia. There is also a recognized need to upgrade and expand the power grid, although not all investment needs are being met by the current trends.

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Infrastructure Components for Australia

(Percent of GDP, per year)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Source: Global Infrastructure Outlook, Oxford Economics

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8. An aggregate infrastructure investment gap as a share of GDP is constructed from 2018 to 2040 (Figure 4). It uses the forecasts for GDP from the IMF’s World Economic Outlook, April 2017 (WEO) and infrastructure investment from the Global Infrastructure Outlook. The increased spending in the FY2016/17 fiscal outcomes and FY2017/18 fiscal budgets are roughly consistent with closing the gap in 2016 and 2017, so the gap used here is zero in 2016 and 2017. The gap from 2018 forward for Australia differs slightly from that of the Global Infrastructure Outlook as nominal GDP growth is more variable in the WEO until 2023, and then slightly higher afterwards. The two most important gaps are in rail (just over 0.1 percent of GDP year) and ports (almost 0.15 percent of GDP per year).

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Infrastructure Investment Gap for Australia

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Sources: Global Infrastructure Outlook, Oxford Economics and IMF staff calculations

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C. Benefits from Closing the Infrastructure Investment Gap

9. There are benefits to closing the gap for Australia. The closure of this gap would be driven by both the Commonwealth and State/Territorial levels of government. Furthermore, participation can be extended to the private sector. These benefits can be quantified with the help of ANZIMF, which a version of the IMF’s GIMF (see Box 2 for further details).

10. Any additional infrastructure spending requires funding. The type of funding is the choice of the Commonwealth and/or the State/Territorial governments. There are three feasible choices for financing – increasing the deficit, using funds from general revenues, or relying on private sector funding through public private partnerships (PPPs).

• In the case of deficit financing, the appropriate government level (Commonwealth or State) would borrow to finance their expenditures, through its standard mechanisms, and the resulting deficit spending would increase the level of debt permanently

• In the case of funding from general revenues, the most logical approach would be to further increase taxes – either one of, or some combination of, the personal income tax (PIT) if the funding is to come from the Commonwealth level, or the goods and services tax (GST) if the funding is to come from the State/Territory level. Given the division of responsibilities, the Commonwealth could also provide funding for the State/Territory level, by transferring additional funds to the States, likely using National Partnerships.

• In the case of PPPs, the assumption is that competitively-tendered private sector firms would be responsible for building the project, and covering the costs of construction. Furthermore, these firms would recoup their costs through a commitment of a future revenue stream from the resulting infrastructure, such as an airport improvement tax levied on air passengers, or road tolls levied on drivers. It is also assumed that the infrastructure would be government-owned, but maintained by the private sector. This minimizes the risks usually associated with PPPs, which if they were more costly or inefficiently implemented would reduce the real GDP gain (see, for example, Corbacho and Schwartz, 2008).

11. There are limitations to using model simulations to capture the economic outcomes from closing an exogenously specified infrastructure investment gap. First, most importantly, there is uncertainty as to quantification of the pass-through of infrastructure investment and stock to productivity growth. Second, and most obviously, whatever caveats are part and parcel of ANZIMF are limitations of this analysis, such as the under-responsiveness of trade flows (common to many DSGE models). Third, the methodological concerns for constructing the gap itself can produce misleading results if the gap is quantified incorrectly.⁴ Finally, because closing the gap will stimulate the economy, it will also increase GDP which would affect somewhat the demand for infrastructure, changing the investment needs, and hence the infrastructure investment gap – an effect that is ignored here, but may not be too important given Australia’s small gap.

12. Current infrastructure spending by the Australian governments is still consistent with the forecast of the gap used here. The Global Infrastructure Outlook dataset was built contemporaneously with the FY2015/16 budget paths. The fiscal budgets in FY2016/17 and FY2017/18 increased those years’ spending on average 0.4 percent of GDP, closing the gap for those two years. However, the FY2017/18 budgets do not appear to sustain these increases past FY2019/20.

13. Figure 5 illustrates the effects of closing the Australian gap. It shows the first 10 years (using lines) followed by snapshots for the end-point at 2040, and the long-term steady-state result from maintaining the new higher level of the infrastructure capital stock (using vertical bars). There are four variants for financing the closure of the gap: deficit financing by the Commonwealth and/or the States and Territories (blue line and bars); full financing by the Commonwealth using PIT (red line and bars); 50/50 financing by the Commonwealth and the States and Territories, using PIT and GST, respectively (green line and bars); and funding by PPPs exclusively (purple line and bars).

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Closing the Baseline Infrastructure Investment Gap by 2040

(Deviations from WEO-consistent forecasts)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Source: IMF staff calculations

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14. In the long term, real GDP would be as much as 0.7 percent higher than otherwise, for a long-term multiplier of about 2. The small gain reflects that Australia’s gap is small. With higher productivity, there is a slight long-term depreciation in the real effective exchange rate, allowing for stronger exports. Even though imports cost more, consumption is still between 0.1 to 0.4 percent higher in the long term. Higher infrastructure level means a permanent increase in the level productivity, passing to the level of labor demand and therefore wages and labor income, as well as demand for capital and therefore private business investment. Firms would have more income, and would be a source of further wealth to households, their owners, further stimulating consumption. However, there are variations among the four types of funding.

15. Deficit financing and PPP funding would provide the greatest gains. In the short term, deficit financing would be most advantageous, but it would be exceeded slightly by PPP in the long term, as PPP funding would prevent the government from facing a permanent 6.5 percent increase in the government debt to GDP ratio, which would slightly crowd out private business investment, offsetting some of the productivity gain from the additional infrastructure investment. However, the cumulative deficits required over the 25 years are closer to 9.6 percent of GDP, meaning that the additional growth from infrastructure investment reduces the government debt to GDP ratio in the long term by 3.1 percentage points. Both types of funding increase demand for private saving flows, some of which come from abroad, leading to a current account deficit. In the short term, this leads to an appreciation of the real effective exchange rate, until the economy-wide productivity gains are large enough to lead to a long-term depreciation.

16. Financing with PIT and/or GST would be less beneficial and reduce GDP gains. Such taxation would be a drag on consumption, especially during the initial phases of closing the gap, as LIQ households would adjust their spending downwards immediately. Using PIT financing alone would reduce the gains accruing to the economy the most, as it PIT not only reduced consumer buying power, it taxes a factor of production directly, and reduces labor productivity, counteracting some of the gains from the additional infrastructure investment. Overall, there is less demand for foreign financing – what remains is driven by borrowing for consumption, offset by weaker investment. Therefore, there is less of a short-term appreciation of the real effective exchange rate.

D. Closing the Gap as a Tool for Fiscal Policy

17. Closure of the infrastructure investment gap can be used as tool to further fiscal policy goals. If governments decide to close the gap, they could alter its timing to maximize the benefits in the short term, although long-term benefits would remain unchanged, as doing more than closing the gap would presumably accrue few extra benefits. Instead of closing the gap over 25 years, the governments could choose to help kick-start short-term growth by closing the gap in 10 years (Figure 6). Two cases are considered. First, there is the deficit-financing case (red line alone). However, governments would have to increase their debt load more quickly under this case, and this may pose a risk to credit ratings, and could impose additional sovereign risk premia. Therefore, the second case has the government maintain the same deficit financing path over 10 years as with the 25-year path, but adds in additional financing (red line with green bars). In both cases, it is assumed that moving from roughly 0.3 percent of GDP to 0.7 percent of GDP for infrastructure cannot be done easily (because of procurement processes, for example), so it is phased in over four years.

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Infrastructure Investment Gaps for Fiscal Policy

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Sources: Global Infrastructure Outlook, Oxford Economics, and IMF staff calculations

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18. Figure 7 illustrates the effects of making different fiscal policy choices. There is the benchmark scenario (blue line and bars), the 10-year scenario with deficit financing only (red line and bars), and the 10-year scenario with both deficit financing and PPP funding (green line and bars). The long-term real GDP gains around the same as in the benchmark scenarios, at 0.8 percentage points. The one notable long-term difference is for government debt – if the government uses PPPs to fund part of the infrastructure build-up when choosing to close the infrastructure gap more quickly, it only accumulates 4 percent of GDP in debt, instead of 6.5 percent of GDP.

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Closing the Infrastructure Investment Gap as Fiscal Policy

(Deviations from WEO-consistent forecasts)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Source: IMF staff calculations

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19. By shortening the time horizon, economic gains are moved forward, and there is much more fiscal stimulus in the short term. Real GDP lifts much more rapidly in the short term, adding twice as much to growth over the first 10 years relative the benchmark scenario. Consumption also lifts more strongly. However, if the government does it solely through deficit financing, there is greater crowding out of private business investment in the first several years, also leading to crowding out of labor demand and income, and therefore consumption. If the additional funding (relative to the benchmark scenario) is provided by PPPs, then there is no additional crowding out, and consumption can rise more strongly in the first five years, before moderating. Under both forms of financing, there is increased demand for foreign financing through the current account, leading to a stronger short-term appreciation, although the permanent productivity effects still lead to a long-term depreciation of the real effective exchange rate. Overall, changing the speed at which the gap closes can provide short-term benefits to growth, and fiscal policy can provide a more prominent role in short-term demand management, but with productive spending ensuring long-term gains.

20. In practice, changing the horizon for fiscal policy implementation requires careful planning and consideration. It may not be possible to reduce some projects to a shorter horizon, such as the ten-year example above, such as the western Sydney airport project. If the economy is already in an expansionary phase, it may be difficult to attract the resources, whether under the aegis of government or PPPs, required to carry out the investment. However, as of 2017, Australia still has spare capacity in its labor and capital markets, and is mostly likely to be able to absorb the needs of a faster expansion of infrastructure investment.

E. Other Considerations When Closing the Gap

21. Other infrastructure-related factors can augment the productivity of the economy when closing the infrastructure investment gap. First there is the issue of the quality of the infrastructure that is produced by the investment. Second, the broader definition of infrastructure can also be considered, which includes structures and other investments (as outlined at the beginning of Section B).

22. Two alternative scenarios are designed based on these issues. The outcomes from these alternative scenarios are only rough approximations, as they are complicated to implement within the extensive framework used to calculate the gap derived from the Global Infrastructure Outlook (recall Box 1 for the methodology used to calculate the baseline gap, and see Box 3 for the methodologies in detail used for the two alternative scenarios outlined below).

• Alternative Scenario 1 assumes that that Australia achieves the quality of infrastructure found in one of the leaders of the high-income group, Singapore. In this case, the infrastructure investment gap is unchanged, as is the spending is required to close it, but Australia experiences greater gains because of better quality outcomes from better use of funds and (presumably) better technology (quality scores are in Table 1).

• Alternative Scenario 2 assumes a broader definition for the infrastructure investment gap that includes the rest of infrastructure capital outside of the seven sectors examined thus far. The broader definition of the gap is presented in Figure 8. Note that the difference between the red line (the baseline gap, or the narrow definition) and the blue line (the broad definition) is the gap resulting from the needs for the rest of infrastructure investment (the green bars).

Table 1.

Infrastructure Quality Scores

(Range of 1 to 7; 7 is best)

Sources: Global Competitiveness Report, 2017-18

Table 1.

Infrastructure Quality Scores

(Range of 1 to 7; 7 is best)

	Australia	Singapore
Energy	5.7	6.9
Airports	5.2	6.9
Ports	4.9	6.7
Rail	4.1	5.9
Roads	4.1	6.3

Sources: Global Competitiveness Report, 2017-18

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Table 1.

Infrastructure Quality Scores

(Range of 1 to 7; 7 is best)

	Australia	Singapore
Energy	5.7	6.9
Airports	5.2	6.9
Ports	4.9	6.7
Rail	4.1	5.9
Roads	4.1	6.3

Sources: Global Competitiveness Report, 2017-18

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Infrastructure Investment Gaps

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Sources: Global Infrastructure Outlook, Oxford Economics, and IMF staff calculations

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23. Figure 9 below compares the scenarios. The first and second alternative scenarios are the red line and bars, and the green line and bars, respectively, while the benchmark scenario is the blue line and bars. For ease of comparison, only the case of deficit financing is considered. The differences between the alternative and the benchmark scenarios would be roughly the same under other variants for funding the gap.

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Alternative Scenarios for Closing the Infrastructure Investment Gap

(Deviations from WEO-consistent forecasts)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A002

Source: IMF staff calculations

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24. Australia can experience further gains under both alternative scenarios. If the quality of the newly-built infrastructure is higher than in past, then the productivity gain for the economy is larger, leading to real GDP being almost 0.9 percent higher in the long term, an additional gain of almost a third over the benchmark scenario. Similarly, the broader definition of infrastructure investment leads to real GDP being 0.8 higher in the long term, a gain of about a quarter over the benchmark scenario case. Most of the effects on the economy are the qualitatively the same as the benchmark scenario, but quantitatively amplified. There is one exception – the gains under the scenario with higher-quality investment does not incur any additional government spending, and consequently does not require any additional government debt. When the broader definition of infrastructure investment is considered, the crowding out effect of government debt will be amplified, including a weaker current account, and slightly lower GDP in the short term relative to even the benchmark scenario.

F. Conclusions

25. Summary. There has been high quality work done to quantify the infrastructure gap for Australia by Oxford Economics on behalf of the Global Infrastructure Hub, drawing on international experiences and local data sources. What is done in this paper is to provide further information about the effects of closing the infrastructure gap on the Australian economy. Closing the gap has quantifiable benefits, not just because it is a short-term stimulus to aggregate demand, but because of longer-lived effects on productivity in the economy, benefiting all sectors of the economy.

26. The form of funding for the additional spending matters. While there are economic gains in all cases, the magnitude of those gains depends on whether the spending uses debt (either public government debt which crowds in net foreign liabilities, or PPPs that either acquire net foreign liabilities directly, or crowd them in elsewhere in the economy as they draw on domestic resources) or tax financing (collected exclusively by the Commonwealth, or jointly by the Commonwealth and the States and Territories). In the long term, because of the small amounts required to finance the expenditure, financing by deficits and funding by PPPs are preferable to tax financing. If the infrastructure needs were much greater, the level of debt incurred would be costlier in the long term, by outweighing the productivity gains in the economy as it would crowd out too much investment, and possibly lead to an additional sovereign risk premium on Australian borrowing from abroad. In that case, tax financing would most likely be preferred.

27. Closure of the gap can be used to further fiscal policy objectives. By altering the time horizon over which governments work to close the infrastructure investment gap to achieve the same level of infrastructure stock in the long term, they can provide additional short-term stimulus to the economy. To help prevent short-term fiscal distress from increasing debt too quickly, a shorter time horizon could be coupled with the use of PPPs, thereby preventing a higher short-term debt burden of the government, and lowering its long-term level relative to the benchmark deficit-financing scenario.

28. There is uncertainty as to the magnitude of the effects of closing the gap. Two alternative scenarios illustrate some of that uncertainty, although there are additional sources of uncertainty not dealt with here related to the structure and parameterization of the model.

29. Nonetheless, there are prospective gains. Australia has improved its infrastructure spending in the last several years, but there is scope to expand it further, to reduce its (admittedly small) infrastructure gap to match other advanced and leading economies in the world.