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Development Policy Review, 2006, 24 (2): 175-202
Private Provision of Infrastructure in EmergingMarkets: Do Institutions Matter?
Sudeshna Ghosh Banerjee, Jennifer M. Oetzeland Rupa Ranganathan
Governments in developing countries have encouraged private sectorinvestment to meet the growing demand for infrastructure. According toinstitutional theory, the role of institutions is paramount in privatesector development. A longitudinal dataset of 40 developing economiesbetween 1990 and 2000 is used to test empirically how differentinstitutional structures affect private investment in infrastructure, inparticular its volume and frequency. The results indicate that propertyrights and bureaucratic quality play a significant role in promotingprivate infrastructure investment. Interestingly, they also suggest thatcountries with higher levels of corruption attract greater privateparticipation in infrastructure.
1 Introduction
Globalisation provides enormous opportunities for domestic and multinational firms to
serve the billions of aspiring poor, the so-called bottom of the pyramid, in emergingmarkets that are joining an increasingly integrated world (Prahalad and Hart, 2002).
However, after more than two decades, it is clear that private sector development does
not occur in a vacuum, but requires facilitating conditions to unleash its potential. A
significant literature has evolved in the past few years evaluating the causes and the
impact of private investment in infrastructure. Two interesting perspectives arise: what
characterises countries that open up for infrastructure investment, and what
characterises countries that are successful in attracting infrastructure investment. We
contribute to these arguments by examining the factors that might explain the differing
levels of private sector participation in infrastructure projects. We evaluate the drivers
of private investment in infrastructure in developing countries, in particular the role ofinstitutions. How have institutions made the transition to markets smoother for some
countries than for others? Does the unique nature of infrastructure investments high
sunk costs, economies of scale, high levels of risk and uncertainty and high transaction
Respectively, Economist, Africa Region, World Bank, Washington, DC; Assistant Professor, Kogod
School of Business, American University; and Operations Evaluation Department, World Bank,
Washington, DC. Correspondence address: S. G. Banerjee, 1818 H. Street NW, Washington, DC 20433
([email protected]). The authors are grateful to Shokraneh Minovi and Shelly Hahn of the World
Bank for making its private participation in infrastructure database available to them, and to Kalpana
Seethepalli and Jorge Rivera for commenting on previous drafts of this article. The opinions andconclusions are, however, theirs alone, and should not be attributed to the organisations with which they
are affiliated
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176 S. G. Banerjee, J. M. Oetzel and R. Ranganathan
costs change the way institutions affect private infrastructure investment relative to
other forms of investment?
Researchers have argued that institutions play an important role in supporting
market economies and may help to explain differing levels of growth, development and
private sector interest around the world (North, 1990; Hoskisson et al., 2000; Rodrik et
al., 2002). Institutional differences across countries may explain differences in
economic development, productivity and overall business risk. Hall and Jones (1999)
find that social infrastructure, that is, institutions and government policies, explain the
large variation in output per worker across countries. Rodrik et al. (2002) argue that,
compared with geography or trade, the quality of institutions is the most important
factor explaining income differences. Acemoglu et al. (2001) take a step further in
understanding the exogenous variation in institutions explaining their impact on
economic performance. Taking a sample of countries colonised by Europeans, they use
the mortality of settlers (soldiers, sailors, and clergy stationed in colonies during the
seventeenth to nineteenth centuries) as an instrument to measure the current state of
institutions, and this variation in colonial experience to explain the large effects of
institutions on income per capita.
For obvious reasons then, the role of institutions is paramount in private sector
development. Protection of property rights, the operation of effective capital markets,
and the rule of law can reduce investment uncertainty and promote private sector
development. Private enterprise is also thought to flourish in environments with low
levels of corruption and a high degree of political and economic stability. Investors need
to understand how specific institutions impact on their business ventures and how
managers should assess the institutional environment while engaging in the process of
site selection. Institutions are said to provide the rules of the game that structure humaninteractions in societies (North, 1990). By reducing uncertainty, institutions reduce
transaction and information costs in an economy. The absence of market-supporting
institutions can create added risk for private firms and possibly threaten firm survival.
This type of risk may have a significant effect on the willingness of the private sector to
participate in infrastructure projects (Ramamurti and Doh, 2004; Doh and Ramamurti,
2003).
While there have been a significant number of studies examining the effect of one
or two institutional variables (or categories of variables) on firms strategy (Doh et al.,
2003; Wan and Hoskisson, 2003) or private sector development (Banerjee et al., 2003;
De Soto, 2000; Bergara et al., 1998), few, if any, have simultaneously examined theeffects of a wide variety of institutional variables on private participation in
infrastructure projects. Such an examination is important because institutions do not
operate in isolation from one another. For example, effective property rights protection
requires a strong set of laws and the bureaucratic ability and political will to enforce
them. Univariate studies of institutions and their impact on markets can thus lead to
incomplete and even inaccurate findings.
The purpose of this panel study is to examine how the institutional environment
affects private sector participation in infrastructure projects in developing economies.
This question is particularly important, given the recent decline in the levels of such
private participation. The results of this analysis suggest important implications forformulating foreign firms site selection strategies. We develop a number of theoretical
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Private Provision of Infrastructure in Emerging Markets 177
related to higher levels of private sector investment in infrastructure projects. In the
following section, we discuss how the nature of infrastructure lends itself to both a
complex risk profile and a promise of high returns. Next, we develop the hypotheses
relating institutions to infrastructure investment. We then proceed to discuss the data
and present the descriptive statistics. In the final two sections, we present the results and
discuss our findings.
2 Background on private participation in infrastructure
2.1 Trends in private participation in infrastructureGiven the linkages between infrastructure, development and poverty reduction,
providing good quality infrastructure has emerged as a top priority of development
policy in the past two decades. In an analysis of the relationship between infrastructuredevelopment and economic growth and income distribution across 100 countries
between 1960 and 2000, Calderon and Serven (2004) note that infrastructure stock
positively affects growth, and superior quality and quantity of infrastructure reduce
income inequality. As Prudhomme (2004) writes, It is a space shrinker, it enlarges
markets, and operates like the lowering of trade barriers. The need for infrastructure is
urgent and enormous in developing countries. For instance, Fay and Yepes (2003)
predict that producer and consumer demand for infrastructure in emerging markets will
grow exponentially, based on a growth projection of 2.7% per year between 2005 and
2010. At this growth rate, $465 billion worth of infrastructure investment will be
required to meet demand, with almost 90% of it going towards telecommunications,power and roads. Electricity demand alone is expected to increase by 4% per year for
the next 20 years (Lamech and Saeed, 2003).
In the vast majority of emerging market economies, the public sector does not
have the resources to meet this growing infrastructure need. To fill the gap between
service demand and service provision, governments have encouraged private sector
investment in infrastructure projects. In response to the opening up of new markets,
private firms rushed to invest in infrastructure projects in emerging markets during the
1990s; one-fourth of total investment in infrastructure was financed by private capital,
and infrastructure investment became the fastest growing segment of private flows to
developing countries (World Bank, 2003; Dailami and Leipziger, 1998). As Izaguirre
(2002) notes, 132 low- and middle-income countries welcomed private investment in
infrastructure during the period 1990-2001, when the investment commitment totalled
almost $750 billion for 2500 infrastructure projects in emerging market countries. In
terms of the sectoral infrastructure projects undertaken, telecommunication projects are
far and away at the head of the pack, followed by energy, transportation and water.
Although private firms are participating in infrastructure projects all over the globe, the
highest levels of investment have occurred in Asia and Latin America. Since reaching
its peak in 1997, private investment in infrastructure has been declining steadily; the
investment level in 2001 was less than half that in the early 1990s. The recent
renegotiation and cancellation of private contracts, though relatively few in number
only 48 projects (2%) were cancelled out of a total of 2500 that reached financial
closure in the past decade reinforced the notion that investment may not be
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178 S. G. Banerjee, J. M. Oetzel and R. Ranganathan
2.2 The nature of infrastructure projects
Foreign investment in natural resource and infrastructure projects has long been among
the most sensitive of all international corporate activities (Moran, 1998). Though there
is potential for significant first mover advantage given the rising customer base, the
underserved population in developing countries, and the low price elasticity of
infrastructure these projects are problematic for several reasons. First, given the high
sunk costs, the need for long-term debt capital, and the irreversible and non-tradeable
nature of most infrastructure investments, mistakes can be very costly for investing
firms. Furthermore, there are massive forecasting errors associated with these
infrastructure projects, specifically in terms of the cost of construction and the ultimate
size of the consumer base. These forecasting errors can arise out of substantive
economic, technical and institutional errors (Prudhomme, 2004).
High levels of uncertainty surrounding an investment and political or economic
instability in the host country can prove to be serious barriers to entry. Attempts at
forecasting political and economic risk events have fallen short, thereby increasing the
need for effective management of these ventures (Oetzel et al., 2001). Credible host
government support of private investment, such as tax incentives, direct financing,
guarantees and other risk-mitigating arrangements, can serve to reduce uncertainty and
encourage private investment (Dailami and Leipziger, 1998). However, a less than
credible policy reform might not lead to an investment response, unless the promise of
returns is very high (Rodrik, 1991; Serven, 1997).
Second, the risk-return relationship is different for infrastructure projects from that
of other business ventures. This is because there is strong public pressure on
governments to ensure that the returns to investors remain within certain socially
acceptable bounds. The management of returns at the back end after the project is
successful and earning what with hindsight looks like a very healthy economic rent is
widespread in both developed and emerging markets (Moran, 1998). The tendency of
host country governments to manage returns implies that private investors in
infrastructure projects will face unique challenges especially related to the complex
nature of infrastructure pricing. Despite assuming above-average risks, private investors
may be prohibited from earning above-average returns. This is also true for late movers,
who have to bear the higher cost of entering a well-established market (Ramamurti and
Doh, 2004). Private investors argue that over the past decade increased competition in
the industry has led to downward pressure on profits. Industry returns are shrinking as
more players enter the market, more capital chases projects and as a consequence a
more demanding consumer (both host country government and end user) of
infrastructure emerges.
Third, the economic and political pressures associated with natural resource and
private infrastructure projects make firms in these industries vulnerable to the dynamics
of the obsolescing bargain (Vernon, 1980; Kindleberger, 1969; Penrose, 1959). The
theory of the obsolescing bargain suggests that at the outset a foreign firm may receive
favorable concessions and benefits for locating in the host country. After the firms
investment has been made, however, the host country may be able to renegotiate the
initial terms of the investment (Kindleberger, 1969). This is especially likely when the
investment is characterised by a low degree of mobility and heavy sunk costs, as is the
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Private Provision of Infrastructure in Emerging Markets 179
3 Hypotheses
3.1 Legal and regulatory institutions
Infrastructure investments, characterised by large sunk costs, low mobility of assets and
site specificity, face the risk of opportunistic behaviour on the part of host country
governments ex post investment (Williamson, 1985). To avoid being held hostage ex
post FDI, investors utilise contracts to reduce this risk. The legal and regulatory
environment governing contracts, contract enforcement, property rights protection and
the rule of law is obviously a critical factor for prospective investors. North (1990) has
emphasised the existence of an effective legal system as a precondition for investment
and growth. As he asserts, the inability of the societies to develop effective, low-cost
enforcement of contracts is the most important source of both historical stagnation and
contemporary underdevelopment of the third world . Low security of property willstunt the incentives to invest, innovate and obtain foreign technology (Mauro, 1995).
Rules of the game that lead to transparent and accountable economic transactions would
improve the overall returns to investment (Isham and Kaufman, 1999). Scully (1988)
comes to the empirical conclusion that politically open societies that subscribe to the
rule of law, private property, and market location of resources grow at three times the
rate of societies in which such freedoms are abridged, and are two and a half times as
economically efficient. There is significant empirical evidence that economies with
stronger property rights systems perform better with respect to private investment
(Knack and Keefer, 1995; De Soto, 2000). Establishing a legal framework is critical for
facilitating a healthy investment climate for reform (Pargal, 2003).The regulatory environment can have a significant effect on infrastructure service
firms, since these firms are often subject to regulatory intervention by the host country
government. Governments may be concerned about the monopoly position that many
infrastructure firms hold, as well as their impact on public health and safety or their
environmental impact. The regulatory framework also has a significant impact on a
countrys ability to implement major sectoral reforms successfully. Countries with
established regulatory institutions in place before privatisation experienced increased
private telecommunication investment post-privatisation (Wallsten, 2002). Adopting
regulations that liberalise the investment regime is paramount in attracting private
investment (Pargal, 2003). Furthermore, Tam (1999) noted the significant role of sound
regulatory systems and transparent and honest infrastructure investment procedures in
attracting private investors in build-operate-transfer arrangements in Asia. In fact, past
research has shown that a predictable system of regulatory enforcement is important for
reducing investment uncertainty (Brunetti and Weder, 1998). A countrys regulatory
capacity plays a significant role in attracting private investment in infrastructure by
minimising the risk of expropriation and increasing the certainty of property rights
protection.
Even more important to private investors than the presence of market-supporting
laws and regulations is the credibility of the governments commitment to enforcing
them. The uncertainty created by the arbitrary or capricious application of regulations
and laws may result in a great deal of uncertainty and institutional risk for the firm.
Furthermore, it is important to private investors that the host government avoids
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180 S. G. Banerjee, J. M. Oetzel and R. Ranganathan
long-term development (Henisz, 2000; 2002a; 2002b). Polarised interests as a result of
multiple veto players raise the credibility of government commitment (North and
Weingast, 1989; Keefer and Knack, 2002). Thus, we hypothesise that:
Hypothesis 1: The effective enforceability of the rule of law is positively
associated with private participation in infrastructure projects in emerging
markets.
3.2 Corruption
Political corruption the abuse of public power for private benefit (Tanzi, 1998) can
be an important deterrent to private investment (Brunetti et al., 1997; Brunetti and
Weder, 1997). Corruption can create distortions in industrial activity, raise uncertainty
and increase the cost of investment (Habib and Zurawicki, 2002). Foreign investors may
avoid corrupt investment environments in order to minimise operational inefficiencies
(ibid.) and avoid the added costs of doing business (Shleifer and Vishny, 1993).
Furthermore, in a study of foreign direct investment from 14 countries to 45 host
countries, Wei (2000) finds that corruption indeed reduces the inward flow of
investment. Even when corruption does not deter investment, it may have an impact on
the nature and composition of FDI as well as on a firms market entry strategy. For
example, researchers have found that corruption reduces inward FDI and leads firms to
prefer wholly-owned subsidiaries over joint ventures (Smarzynska and Wei, 2000;
Uhlenbruck et al., 2004).
While corruption may deter FDI in the aggregate, market avoidance is not always
an option for multinational corporations, which may at times feel compelled to enter
corrupt markets to follow or pre-empt competitors or to increase revenues. This is
especially true in infrastructure projects where the first mover can pre-empt competitors
and gain a monopoly position in the market. Since there is relatively less empirical
research on MNC behaviour in such situations, it is uncertain how firms will respond to
host country corruption. Although few if any studies have found that firms actually seek
out corrupt environments in which to do business, it is possible that, in the infrastructure
sector, firms may be able to buy stability and protection for their investment by
bribing host country officials. Nevertheless, given the lack of empirical evidence for
such practices, and the preponderance of evidence suggesting that firms tend to avoid
corrupt markets, we hypothesise that private participation will tend to be lower in
markets characterised by high levels of corruption. Thus, we hypothesise that:
Hypothesis 2: Corruption is negatively associated with private participation
in infrastructure projects in emerging markets.
3.3 Political institutions
Political institutions that are generally unreliable, unstable and/or ineffective may hinder
private sector participation, particularly in infrastructure projects (Howell, 1998;
Bergara et al., 1998), and may constitute political risk for the firm. Political risks,
defined as risks that are primarily the result of forces external to the firm and which
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Private Provision of Infrastructure in Emerging Markets 181
investors in infrastructure projects, given their high sunk costs, the need for long-term
debt capital, and the irreversible and non-tradeable nature of these investments. The risk
of nationalisation or expropriation of assets, war or civil strife, ethnic tension, and the
inability to repatriate profits can compromise a firms profitability and even survival.
Countries that are more politically stable and predictable are thus more desirable for
private sector investors.
Another measure of the political institutional environment is the political
effectiveness, or quality of the governance, in a country (Howell, 1998; Henisz, 2000;
2002a; 2002b). Research on FDI in the power generation sector has shown that political
ineffectiveness and the risk of political expropriation of foreign assets in the host
country may deter FDI unless firms have a significant level of international experience,
particularly in developing countries (Holburn, 2001; Henisz, 2002a; 2002b). Bergara et
al. (1998) have also argued that the existence of a highly credible and effective
bureaucratic infrastructure in a country should enhance private investors willingness to
participate in infrastructure projects. Thus, we hypothesise that:
Hypothesis 3: Political stability is positively associated with private
participation in infrastructure projects in emerging markets.
Hypothesis 4: Political effectiveness is positively associated with private
participation in infrastructure projects in emerging markets.
In recent years, some researchers have argued that democracies are more
conducive to private enterprise than other forms of government. Empirical analysis of
the transition economies has found that democracy facilitates the adoption of market-oriented reforms, and the checks and balances implicit in the democratic system help to
lock-in privatisation reforms (Dethier et al., 1999). Market-oriented reforms have been
critical for enabling private sector participation in infrastructure projects. The checks
and balances penalise self-interested politicians (by reducing their chances of re-
election) and hence limit rent-seeking opportunities (Aslund et al., 1996; Bergara et al.,
1998).
The presence of democracy is the meta-institution for the existence of other non-
market institutions (Rodrik, 2000). Democracy also changes the incentives for rent-
seeking. Scully (1988) has argued that nations that have chosen to suppress economic,
political and civil liberties have greatly affected the standard of living of their citizens.Isham et al. (1997) empirically demonstrate that higher civil liberties are associated with
better economic returns on government projects. In an empirical study of the transition
economies, Dethier et al. (1999) conclude that the existence of a vibrant civil society is
the most important factor in explaining the adoption of economic liberalisation
measures. Recent evidence has indicated that civil and political freedom may encourage
foreign direct investment. Harms and Ursprung (2002) find that the host countrys
superior political institutions and workers representation as measured by effective
unionisation affect the location decision of foreign investors, and presumably the
participation of private sector firms in infrastructure projects. For these reasons, we
hypothesise that:
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182 S. G. Banerjee, J. M. Oetzel and R. Ranganathan
Hypothesis 5: Democratic political ideologies are positively associated with
private participation in infrastructure projects in emerging markets.
3.4 Economic and financial institutions
Another important category of institutional risks is economic and financial risks. High
levels of economic instability are associated with greater institutional and investment
risks for private investors. Financial risks can arise from volatile currencies (Geczy et
al., 1997; Allayannis and Weston, 2000) and the absence of a well-functioning capital
market (Ramanadham, 1993; De Soto, 2000). Inflation and real exchange volatility have
a negative impact on private investment in emerging markets (Serven and Salimano,
1993; Cardoso, 1993; Larrain and Vergara, 1993; Aizenmann and Marion, 1995). Both
can affect the value of a companys investment in infrastructure as well as consumers
ability to pay for utility services. According to Ghura and Hadjimichael (1995),
uncertainty and instability explain the weak investment performance in Africa. Using
variabilities in inflation and the real exchange rate as indicators of macroeconomic
volatility, they find that macroeconomic uncertainty adversely affects investment.
Taken together, economic and financial risks increase investment uncertainty and pose a
serious risk to large capital-intensive investments that are immobile, like those made in
infrastructure projects. As a result, we hypothesise that:
Hypothesis 6: Economic instability is negatively associated with private
participation in infrastructure projects in emerging markets.
4 Research methodology
4.1 Country sample
To study the relationship between institutions and private infrastructure investment, we
use a panel of 40 developing countries over the period 1990-2000. Four regions around
the world are represented in our sample: 18 countries from Latin America, 11 countries
from Asia, 5 countries from Europe and 6 African economies (see Appendix 1). The
selection of countries was driven by data considerations. We started out by using the
maximum number of countries in the private participation in infrastructure (PPI) datasetof the World Bank, but finally settled on these 40 countries once the explanatory
variables were added. Also, the database does not allow us to untangle domestic and
foreign flows, though foreign investors have undertaken a significant proportion of
private investment. We used the PPI database instead of traditional national accounts
data because, through the national accounts, we are not able to disaggregate how much
of the private investment has gone into infrastructure. The PPI database is specialised in
the sense that it provides information on private investment in infrastructure
specifically.
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Private Provision of Infrastructure in Emerging Markets 183
4.2 Dependent variables
The dependent variables have been constructed from the World Banks PPI database1
which includes the following sectors: electricity and natural gas, telecommunications,
transport, and water supply and sanitation. In the case of the dependent variables, the
data on investment and revenue are measured only on financial closure and not
incrementally in the dataset, further reducing the number of observations. The
maximum number of observations is 300 country-years for 40 countries in the sample.
Private participation in infrastructure includes divestiture revenue, project cost,
and investment in Greenfield and Operations and Maintenance (O and M) projects.2In
nominal terms, the average private participation is US$1,450 million, with the
maximum being US$33,352 m. (Brazil in 1998). Deflating the nominal values by US
inflation, we used a (log) real private participation in infrastructure as the primary
dependent variable. A caveat is important here. A better dependent variable would be
infrastructure investment as a share of GDP, but the share is negligible for all countries
with very little variation. In addition, to understand if the institutional determinants
affect the disaggregated components differentially, we included (log) real divestiture
revenues, project cost, and investment. Finally, we included (log) real private
participation in the telecommunications and energy sectors.
The average contribution of private infrastructure investment in GDP is 2%, with
the maximum being 28% in Bolivia in 1998. In addition, we used the (log) real
divestiture revenues, (log) real project cost, and (log) real investment as dependent
variables to understand whether explanatory factors affect the various investment
components differentially. Furthermore, we estimated the determinants of private
participation in specific sectors that have attracted the maximum private investment
energy and telecommunications. The average participation in the telecommunications
and energy sectors is US$903 m. and US$932 m. respectively. Given the split nature of
this sample, we used only the International Country Risk Guide (ICRG) dataset that has
the highest number of institutional explanatory variables. Finally, we included the total
number of infrastructure projects in each year as a dependent variable and the number of
projects in the telecommunications and energy sectors respectively, as these are the
sectors that have attracted the most investment compared with other infrastructure
sectors such as transport and water. A description of the dependent variables, the
descriptive statistics, and the region-specific frequency and total investment of
infrastructure projects statistics are presented in Tables 1, 2 and 3 respectively.
1. Available from http://rru.worldbank.org/PPI/index.asp.2. Broadly, a private investor can enter the market by buying an existing public utility (divestiture), investing
in a new venture (greenfield) or participating in a contract with the public entity (such as an operations and
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184 S. G. Banerjee, J. M. Oetzel and R. Ranganathan
Table 1: Dependent variables: private participationin infrastructure indicators
Variable DescriptionVolume of private participation
Total Total private participation
Addition of COST, REV, and INVEST
Cost Project cost
Rev Divestiture revenues
Invest Investment in Greenfield and Operations and
Maintenance contracts
Number of private projects
Freq Total number of projectsSource: PPI database, World Bank.
Table 2: Dependent variables: descriptive statistics
Variable Obs Mean Std Dev. Min. Max.
Total 296 1579.25 3054.13 2.9 33352
Cost 296 791.21 1329.18 0 9131.2
Rev 296 471.97 1857.13 0 23540.5Invest 296 316.07 853.28 0 8192
Freq 296 7.13 9.03 1 54
Table 3: Project count and total investment
Region Project count Mean
project count
Mean total
investment US$ m.
Latin America and
Caribbean
141 7.39 1791.85
Africa 17 2.29 624.64
Europe 43 6.06 828.76
Asia 95 8.09 1774.23
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Private Provision of Infrastructure in Emerging Markets 185
4.3 Explanatory variables
The widely used institutional variables from the ICRG of the Political Risk Services
Group have been primarily used to test the hypotheses. There are other recent datasets
on institutional indicators Kaufmann et al. (2003) and Index of Economic Freedom
but the Kaufmann data3 are available for 1996, 1998 and 2000 and the Index of
Economic Freedom dataset includes values from 1995 to 2000. Running the regression
models using these alternative institutional datasets would significantly reduce the
number of observations.
Our primary institutional variables of interest are legal and regulatory institutions,
corruption, and economic and political institutions. To test hypothesis 1 on legal and
regulatory institutions, we include Rule of Law (RULELAW) from the ICRG database;
for hypotheses 3 and 4, we include government stability (GOVSTAB), ethnic tension
(ETHTEN) and bureaucratic quality (BURQLTY) from ICRG, and political rights
(POLRTS) and civil rights (CIVRTS) from the Freedom House dataset. Corruption
(CORR) from the ICRG dataset is employed to test hypothesis 2. Multicollinearity does
not appear to be a serious threat as the bivariate correlation between the institutional
variables ranges from 0 to 0.44 (Table 5); we also estimated the variance inflation factor
(VIF) for the regressions (reported in Tables 7 and 8). Finally, for macroeconomic
indicators and financial institutions, we included the following variables: lagged
inflation (INFLA), lagged GDP growth rate (GDPGR), lagged official exchange rate
(EXCH) and market capitalisation as share of GDP (MCAP) from World Development
Indicators (2004). One-year lagged values of macroeconomic variables such as
inflation, exchange rate, and GDP growth were entered in the system of equations, as
they may be endogenous to the model. Since the variations in inflation and exchange
rates are very high, we used the natural log values of these variables. Given the
differences in exchange-rate regimes in developing countries, a real effective exchange
rate would be more suitable for a comparative picture, but such data are very sparse and
significantly reduce the number of observations. We therefore decided to use the official
exchange rate. Further explanation of the definition, description, and sources of the
explanatory variables are presented in Tables 4 and 6 and correlations are depicted in
Table 5.
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186 S. G. Banerjee, J. M. Oetzel and R. Ranganathan
Table 4: Explanatory variables: institutional and control variables
Variable Description
Macroeconomic and financial institutionsINFLA
a Inflation (lagged)
EXCHa Official exchange rate (lagged)
MCAPa Market capitalisation as share of GDP
GDPGRa Gross domestic product annual growth rate (lagged)
Legal and regulatory institutions
RULELAWb Rule of law: higher values mean degree to which the citizens of a
country are willing to accept the established institutions making and
implementing laws and adjudicating disputes; varies from 0 to 6
Political institutions
GOVSTABb Government stability; ability of government to stay in office and
carry out its policies. Ranges from 0 to 6. Higher values mean higher
government stability
ETHTENb Ethnic tension: measures degree of tension within a country
attributable to racial, nationality and language divisions. Ranges from
0 to 6. Higher values mean lower ethnic tension
BURQLTYb Quality of bureaucracy: measures the regulatory environment
domestic and foreign firms must face when seeking approvals and
permits. Ranges from 0 to 6. Higher values mean superior
bureaucratic quality
POLRTSc Political rights: higher values mean fewer political rights
CIVRTSc Civil rights: higher values mean fewer civil rights
Corruption
CORRb Corruption in government: degree to which business transactions
involve corruption or questionable payments. Varies from 0 to 6.
Higher values mean lower corruption
Quality of public investment
POWERLOSSa Distribution and technical losses as share of total output
TELELINESa Number of telephone lines
ROADSa Paved roads as share of total roads
LITa Adult literacy
Specific host country indicators
GDPPCa Log of GDP per capita
D_LACa
D_AFRICAa
D_Europea
Dummies for Latin America, Africa and Europe
(Asia is the reference category)
Sources: a) World Development Indicators(2004); b) ICRG database (2003); c) Freedom House (2003).
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Private Provision of Infrastructure in Emerging Markets 187
Table 5: Correlation among institutional variables inICRG institutions dataset
GOVSTAB CORR RULE BURQLTY ETHNGOVSTAB 1
CORR 0.12 1
RULE 0.33 0 1
BURQLTY 0.32 0.23 0.39 1
ETHTEN 0.05 0.15 0.19 0.44 1
Table 6: Descriptive statistics of explanatory variables
Variable Obs Mean Std dev. Min. Max.
Economic and financial institutions
INFLA 292 89.45 396.17 -1.4 3398.68
EXCH 292 3926.88 30599.93 0.002 418782.9
MCAP 269 33.22 48.68 0.02 328.87
GDPGR 296 3.55 4.55 -13.12 14.26
Legal and regulatory institutions
RULELAW 294 3.73 1.11 1 6
Political institutionsGOVSTAB 294 7.98 2.12 1 12
ETHTEN 294 4.28 1.35 1 6
BURQLTY 294 2.19 0.77 0 4
POLRTS 296 3.15 1.95 1 7
CIVRTS 296 3.56 1.53 1 7
Corruption
CORR 294 3.2 0.94 1 5
Quality of public institutions
PAVED 266 44.32 30.13 3.3 100TELELINE 296 108.53 87.94 5.92 379.63
POWERLOSS 296 14.78 6.20 1.32 30.41
Control variables
GDPPC 296 5258.39 2842.61 750.54 15947.46
4.4 Control variables
Both public and private investments have positive relationships with economic growth,
but recent research suggests that private investment is more efficient than publicinvestment (Khan and Reinhart, 1990; Serven and Salimano, 1990). In the context of
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Private Provision of Infrastructure in Emerging Markets 189
projects varies from 49 in Latin America (Brazil in 2000), 54 in Asia (China in 1997),
and 35 in Europe to 4 in Africa. The average number of projects is highest in the energy
sector. To model the count properties of the data, we employed a Poisson specification.
Previous empirical research has proved that the Poisson specification is well suited to
handling integer properties of count data directly and accommodating counts that areaggregated over time periods. One of the most restrictive assumptions of the Poisson
model relates to the equality of mean and variance. We tested for the appropriateness of
the Poisson assumption using the poisgof5 function for each of the regression
specifications; the large value of Chi-squared suggested that there is overdispersion and
that a more generalised negative binomial specification should be used. The mean
structures of both the Poisson and negative binomial models are the same, but the
standard errors of the Poisson model would be biased downwards because of
overdispersion (Long and Freese, 2001). In a negative binomial model, the Poissonparameter
itis distributed randomly across countries and time, according to a gamma
distribution with shape parameters (,) (Hausman et al., 1984).
it is assumed to be distributed randomly in the sample and follows a gamma
distribution. When a gamma distribution is assumed, the pr(nit) reduces to a negative
binomial distribution. can be assumed to be an exponential function of the explanatoryvariables.
5 Results
Stable rule of law is important in attracting private infrastructure investment.Economies with a stable judicial system and a low risk of expropriation provide a safe
haven for private investors. For a standard deviation rise in the rule of law index
(RULELAW), a countrys expected mean private projects rise by 31%, with other
variables remaining constant. A one unit increase in the index entails a higher project
cost of 22%, all other variables remaining constant. This is not surprising. For instance,
in a recent survey of international equity investors in the power sector, Lamech and
Saeed (2003) found that investors seek reform-minded governments that can ensure
respect for property rights and the rights of investors, the rule of law, and a fair
regulatory and legal system. They concluded that the investment climate has to
improve; that is, investors want the rules of the game to remain credible and
enforceable.
)2()|( KKKKKKKititit XV =
)3(!
)(Pr( KKit
ititititit
ef
==
)4()exp( KKKKKKK
itit X=
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Table 7: Determinants of total private infrastructur
1 2 3 4 5 6 7
Total private investment Divestiture revenues Project cost Addi
INFLA -0.10 -0.15 0.23 0.15 0.00 0.03 -0
0.10 0.10 (0.135)a 0.14 0.09 0.09 (0
EXCH -0.01 -0.02 -0.04 -0.04 -0.08 -0.11 -0
0.05 0.05 0.07 0.07 (0.042)a
(0.048)b
0
GDPGR 0.06 0.08 0.08 0.08 0.03 0.06 0
(0.031)a (0.031)
b (0.042)
a(0.039)
b0.03 (0.027)
b0
MCAP 0.01 0.01 0.00 0.00 0.01 0.01 0
(0.003)b (0.003)
c -0.01 0.00 (0.002)
b(0.003)
c0
GDPPPP 1.19 2.77 1.33 2.14 1.07 2.02 1
(0.311)c (0.419)
c (0.549)
b(0.626)
c(0.306)
c(0.408)
c(0
LITERACY RATE 0.00 0.00 -0.02 -0.01 0.00 -0.01 -0
0.01 0.01 0.02 0.02 0.01 0.01 0
POLRTS -0.03 0.09 -0.10 -0.08 0.01 0.09 0
0.14 0.14 0.20 0.25 0.14 0.15 0
CIVRTS 0.48 0.53 0.73 0.90 0.30 0.35 -0
(0.235)b (0.258)
b (0.333)
b(0.402)
b0.22 0.25 0
GOVT STABILITY 0.14 0.12 0.11 0.05 0.06 0.04 0(0.080)
a 0.08 0.13 0.14 0.08 0.08 0
CORRUPTION -0.31 -0.32 -0.38 -0.41 -0.33 -0.35 0
(0.169)a (0.179)
a 0.27 0.27 (0.159)
b(0.176)
b(0
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RULE OF LAW 0.09 0.30 -0.11 0.02 0.23 0.38 -0
0.14 (0.139)b 0.21 0.26 (0.124)
a(0.126)
c(0
ETHNIC TENSION -0.12 -0.14 -0.13 -0.15 -0.15 -0.13 00.12 0.12 0.18 0.19 0.12 0.13 (0
BUREAUCRATIC
QUALITY 0.25 0.27 0.51 0.58 0.41 0.45 -0
(0.149)a (0.149)
a (0.249)
b(0.303)
a(0.141)
c(0.155)
c(0
D_AFRICA -0.59 -1.04 0.39 -0.52 -1.45 -1.70 0
0.41 (0.460)b 0.86 0.99 (0.353)
c(0.428)
c0
D_LAC 0.05 -0.25 0.84 0.35 -0.71 -0.81 0
0.40 0.45 0.60 0.83 (0.397)a
(0.485)a
(0
D_EUROPE 0.31 1.74 1.23 2.05 -1.30 -0.13 10.64 (0.619)
c 0.89 (1.051)
a(0.559)
b0.60 (0
POWER LOSS 0.09 0.08 0.03
(0.031)c (0.043)
a 0.03
TELELINE -0.01 -0.01 -0.01
(0.002)c 0.01 (0.002)
c
PAVED -0.01 -0.01 -0.01
(0.005)b 0.01 (0.005)
b
CONSTANT -7.77 -21.66 -8.14 -16.34 -6.57 -14.71 -8
(2.537)c (3.587)c (4.194)a (4.983)c (2.383)c (3.495)c (3
OBSERVATIONS 264.00 235.00 137.00 123.00 250.00 221.00 116
R2 0.34 0.49 0.37 0.41 0.41 0.48 0
MEAN VIF 3.16 3.57 3.47 3.97 3.22 3.63 5
Notes: Robust standard errors in parentheses. a)significant at 10%; b)significant at 5%; c)significant at 1%. Includes time
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192 S. D. Banerjee, J. M. Oetzel and R. Ranganathan
Table 8: Total private infrastructure flows in energy and telecom
1 2 3 4
Total private investment in energy Total private investment in telecomINFLA -0.037 -0.153 0.064 0.157
0.105 0.122 0.123 0.12
EXCH -0.01 -0.029 0.002 -0.055
0.044 0.054 0.049 0.048
GDGR 0.091 0.106 0.053 0.083
(0.037)b (0.039)
c (0.030)
a (0.029)
c
MCAP 0 0.001 0.004 0.008
0.003 0.003 0.003 (0.004)b
GDPPPP 0.868 1.39 1.646 3.597(0.391)
b (0.537)
b (0.306)
c (0.405)
c
LITERACY RATE -0.007 -0.011 0.002 0.002
0.013 0.014 0.011 0.012
POLRTS 0.133 0.219 0.003 0.124
0.163 0.18 0.15 0.146
CIVRTS 0.02 0.238 0.338 0.202
0.247 0.282 0.266 0.261
GOVT
STABILITY
0.179
(0.095)a
0.118
0.099
0.059
0.081
0.055
0.076CORRUPTION -0.531 -0.48 -0.03 -0.295
(0.170)c (0.169)
c 0.199 0.203
RULE OF LAW 0.202 0.466 0.061 0.356
0.16 (0.196)b 0.156 (0.158)
b
0.003 0.075 -0.184 -0.309ETHNIC
TENSION0.12 0.129 0.128 (0.119)
b
BUREAUCRATIC
QUALITY
0.161
0.161
0.139
0.197
0.292
(0.175)a
0.269
0.181
D_AFRICA -2.143 -2.546 -0.125 -0.76
(0.638)c (0.629)
c 0.409 0.589
D_LAC -0.919 -1.517 0.239 -0.396
(0.438)b (0.554)
c 0.409 0.433
D_EUROPE -1 -0.279 0.076 1.76
0.622 0.924 0.642 (0.592)c
POWER LOSS 0.058 0.099
0.041 (0.035)c
TELELINE -0.002 -0.015
0.004 (0.002)
c
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Private Provision of Infrastructure in Emerging Markets 193
Table 8: Contd
1 2 3 4
Total private investment in energy Total private investment in telecomPAVED -0.025 -0.017
(0.008)c (0.005)
c
CONSTANT -4.131 -9.302 -12.318 -27.838
-2.784 (4.245)b (2.766)
c (3.358)
c
OBSERVATIONS 166 146 228 203
R2 0.42 0.5 0.34 0.53
MEAN VIF 3.83 5.94 3.34 3.65
Note: As for Table 7.
More corrupt countries attract more private infrastructure participation. The signof the relationship is surprising in the case of corruption; it is negative for the total of
private participation and two of its components (project revenue and project cost). More
corrupt economies invite more infrastructure investment 31% more for a one-unit
increase in the corruption index. For every additional rise in the index, which implies
the prevalence of less corrupt practices, a countrys mean private projects decline by
17%, with other variables held constant.
Political institutions have an ambiguous effect on government stability.(GOVSTAB), a measure of a governments ability to stay in office and carry out its
policies significantly, has an impact on private infrastructure flows, but the effect issignificant only for total flows and not for their disaggregated components or the
frequency of projects. Bureaucratic quality is a significant determinant of total private
investment. Before the onset of market-friendly policies, bureaucrats in a number of
developing economies benefited from the maze of regulations that constrained private
enterprise and gave them enormous power. Economic liberalisation and private activity
benefited when the quality of the bureaucracy was superior, with bureaucrats acting in
the larger interest.
The political rights and civil liberties indexes, which range from 1 for countries
with complete freedom to 7 for those which are not free, reveal an interesting pattern.
Political rights hardly matter in total private flows, but civil rights adversely affectprivate flows. There is some evidence to suggest that private investment is more secure
in countries with less civil freedom. The civil liberties variable (CIVRTS), where higher
values mean fewer civil rights, has a positive coefficient suggesting that countries with
more civil rights have less overall infrastructure investment and fewer infrastructure
projects. For a standard deviation increase in the civil liberties index, a countrys
expected mean private projects reduce by 37%, with other variables held constant.
Greater civil rights often mean that companies must go through a process of civic
approval, in addition to a structured and potentially lengthy process in order to gain
approval for each project. This raises the transaction cost of the project and can delay
the final award of contracts or sale.
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194 S. D. Banerjee, J. M. Oetzel and R. Ranganathan
Macroeconomic indicators and financial institutions influence privateinvestment positively. Not surprisingly, a higher exchange rate (local currency unit per
dollar) affects private flows negatively, as it makes the local economy uncompetitive.
Stock-market development has a positive impact on private infrastructure flows, though
its effect is negligible. Market capitalisation has a positive impact on project cost and
total infrastructure flows. A 1% rise in market capitalisation as a share of GDP increases
private infrastructure flows by 1%. There is some evidence that inflation affects the
additional private investment negatively, though it positively affects the divestiture
revenues. For instance, a one-unit rise in (log) inflation lowers the private additional
infrastructure investment by 53%. High-growth countries attract more private projects
and higher flows. For a standard deviation increase in the GDP growth rate, the
expected private projects rise by 28%, with other variables held constant, and total
private flows rise by 8%. Furthermore, a 1% rise in the GDP growth rate increases the
private flows in energy by 9% and in telecommunications by 5%.
GDP per capita has a significant impact on private infrastructure flows.Intuitively, countries with higher GDP per capita are more attractive to private
investors, given their higher purchasing power and greater projected demand for
infrastructure. This variable is significant across all specifications. Countries with
superior well-being with respect to GDP per capita (GDPPC) experience higher telecom
and energy investment, higher additional private investment, divestiture revenues,
greater total private infrastructure investment and a larger number of projects. For every
international dollar increase in GDP per capita, a countrys expected private projects
rise by 237%. The former public utilities in emerging markets have a long history of
charging below-cost recovery tariffs. As such, private involvement in these sectors
would mean a move towards aligning prices with market rates, which can be politicallyvery sensitive in poor countries, given the low price elasticity especially for water and
electricity. GDP per capita is a good indicator of market size and affordability. Higher
GDP per capita would mean greater ability to pay for infrastructure services, making
such emerging markets attractive destinations for private investment.
Quality of public investment might be crowding out private investment. There
is some evidence of the crowding-out of private investment in the presence of a superior
quality of public investment. Our results suggest that countries with a higher share of
paved roads and telephone mainlines attract lower private infrastructure flows. For
instance, a higher ratio of paved roads to total roads (PAVED) reduces total private
investment by 1% and the private investment in energy by 2.5%. For every additionalpercentage rise in paved roads as a share of total roads, a countrys mean private
projects decline by 1.6%, holding all other variables constant. A higher number of
telephone lines per 1000 persons (TELELINES) reduces private infrastructure
investment by 1.3%. A higher percentage of transmission and distribution losses
(POWERLOSS) raises total divestiture revenues by 8.6% and total telecom private
investment by 9.9%. There can be two processes at work here. Public investment may
be crowding-out private investment or the demand for private investment may be lower
in economies with better quality public investment. Agosin and Mayer (2000) note the
possible negative relationship between FDI and domestic investment. However, the
evidence is not consistent across different types of public investment, suggesting thatparticular types of domestic infrastructure might be more valuable to investors than
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Private Provision of Infrastructure in Emerging Markets 197
hoped that future research will add valuable insights into the relationship between
corruption, ethnic tension and private investment.
first submitted February 2005
final revision accepted December 2005
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202 S. D. Banerjee, J. M. Oetzel and R. Ranganathan
Appendix 1
The countries in the sample are:
Latin America (18) Argentina, Mexico, Chile, Colombia, Bolivia, Dominican
Republic, Venezuela, Ecuador, Peru, Brazil, Honduras, Guatemala, Nicaragua,
Paraguay, Panama, Uruguay, Trinidad and Tobago, and Costa Rica;
Africa (6) Botswana, Zambia, Kenya, Tunisia, Zimbabwe, and South Africa;
Europe (5) Bulgaria, Czech Republic, Hungary, Poland, Romania;
Asia (11) China, India, Indonesia, Iran, Pakistan, Sri Lanka, Malaysia, Mongolia,
Philippines, Thailand, and Turkey.
Appendix 2
Table A1: Common private sector participationmodes in infrastructure
Dependent variable Definition Source
Concession A private entity takes over the management
of a state-owned enterprise for a given period
during which it also assumes significant
investment risk.
PPI database
Divestiture A private entity buys an equity stake in a
state-owned enterprise through an asset sale,
public offering or mass privatisation
programme.
PPI database
Greenfield projects A private entity or a public-private joint
venture builds and operates a new facility for
the period specified in the project contract.
The facility may return to the public sector at
the end of the concession period.
PPI database
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