Public Investment in Emerging Economies: Efficiency and Fiscal Health as Key to Growth

The World Bank study finds that public investment in developing economies boosts economic growth, especially with efficient spending and ample fiscal space. However, high public debt and inefficient spending reduce these benefits, highlighting the importance of fiscal and institutional readiness.

The latest World Bank working paper, authored by researchers from the World Bank’s Development Economics Prospects Group, revisits the role of public investment in driving economic growth across emerging markets and developing economies (EMDEs), examining data from 129 countries over nearly four decades. By developing a new measure of public investment shocks, the study provides fresh insights into how public spending translates into growth, particularly under varying economic conditions. The analysis reveals that public investment increases of 1% of GDP typically raise economic output by 1.1% after five years, though the effects become more pronounced—up to 1.6%—when countries exhibit high efficiency in public spending and have ample fiscal space. Conversely, where fiscal space is limited, or investment efficiency is low, public spending shows limited or statistically insignificant growth effects, underscoring the importance of initial economic conditions in influencing public investment outcomes.

Stronger Public Investment Impacts During Downturns

The analysis identifies significant variability in the impacts of public spending on economic growth across different types of economies and stages of the business cycle. In times of economic downturn, or recession, public investment effects tend to be stronger, allowing governments to mobilize unused private sector capacity and reduce unemployment. By contrast, during economic expansions, when many resources are already allocated to private sector activities, public investment has a relatively smaller impact on growth. Importantly, countries with limited fiscal space—typically those with high public debt—experience less positive, and often insignificant, effects of public investment. In these high-debt environments, additional public spending can raise concerns about fiscal sustainability, potentially leading to increased interest rates and stifling private sector borrowing and investment. This research shows that fiscal conditions heavily mediate the benefits of public investment, influencing both immediate demand effects and longer-term impacts on productivity and potential output.

Crowding in Private Investment Through Public Spending

One crucial finding of the study is the relationship between public investment and private investment, as the former can “crowd in” private sector activity by raising private sector returns and reducing risk and uncertainty. For instance, infrastructure projects that improve transportation networks, energy access, or digital connectivity tend to stimulate complementary private investments, especially in industries reliant on infrastructure and logistics. The study finds that a 1% of GDP increase in public investment often correlates with a 2.2% rise in private investment over a five-year period. This multiplier effect highlights the potential of public investment to catalyze broader economic activity beyond its immediate impact on GDP, provided that investment projects are well-designed, implemented efficiently, and aligned with national growth objectives. However, in settings where public debt levels are high, the crowding-in effect weakens, with private investment often being “crowded out” as rising sovereign risk and borrowing costs limit private sector access to affordable credit.

Efficient Spending is Key to Economic Benefits

The efficiency of public spending also plays a central role in determining its growth impacts. Countries with higher efficiency in public investment processes tend to experience more substantial growth returns from each dollar spent on public projects. In countries with high investment efficiency, a 1% of GDP increase in public spending yields around a 1.6% boost in GDP over five years. In contrast, low-efficiency countries struggle to realize similar returns, as issues such as corruption, governance challenges, and inadequate project management often erode the economic benefits of public investments. For these countries, poorly designed or implemented projects may result in infrastructure that either fails to enhance productivity or requires substantial ongoing maintenance, leading to fiscal strain without adding long-term value. This finding emphasizes that while increasing the volume of public investment is important, prioritizing efficient allocation and management is essential to ensuring these funds translate into tangible economic benefits.

The Impact of Existing Infrastructure on Investment Outcomes

The study also underscores the importance of a country’s initial public capital stock in shaping the returns from public investment. EMDEs with lower levels of public infrastructure relative to their GDP typically see greater marginal gains from additional investment. Countries with limited initial capital stock, where infrastructure gaps are pronounced, tend to experience higher multipliers, as the returns from essential infrastructure improvements, such as roads, energy systems, and water infrastructure, are much larger. By contrast, in countries with already substantial public capital stocks, additional investments yield diminishing returns, contributing relatively less to growth.

Strategic Investment for Sustainable Development

These findings hold several important implications for policymakers. Given the critical role of fiscal conditions, EMDEs are encouraged to build fiscal space during periods of economic growth, providing room to undertake countercyclical public investment projects during economic downturns. Without ample fiscal buffers, countries face difficulties in using public spending effectively to stabilize the economy during crises or recessions. Strengthening fiscal space requires consistent efforts, including reforms to increase tax collection efficiency, reduce unproductive spending, and manage debt levels to prevent fiscal imbalances. Moreover, the study highlights the importance of prioritizing public investment efficiency to maximize growth outcomes. By addressing institutional challenges, improving governance, and enhancing project planning and evaluation, countries can increase the productivity of public spending, achieving better outcomes with fewer resources. For low-income EMDEs facing deep structural challenges, international support, both technical and financial, is essential for building capacity and addressing significant infrastructure gaps that otherwise hinder growth and development prospects.

Ultimately, the World Bank paper advocates for a policy framework where public investment is not only scaled up but also optimized for efficiency, particularly in environments where fiscal space and private sector engagement are limited. In addition to highlighting the importance of timing and state-dependent economic impacts, the findings reinforce the view that public investment, when managed strategically, can serve as a critical tool for achieving sustainable, inclusive growth across developing economies. However, without targeted reforms to enhance efficiency and strengthen fiscal positions, the potential of public investment to drive development may remain constrained, particularly in EMDEs that face enduring challenges such as weak institutions and limited resources.