Infrastructure development has long been touted as the key to larger economic development. The impact of infrastructure on output works through two distinct channels—direct and indirect. While the direct impact can be discerned from its contribution to gross domestic product (GDP) formation and also from being a factor of production in the production process, the indirect impact arises from enhanced efficiency in the use of inputs as a result of improved total factor productivity. In this way, infrastructure can take the form of “economic infrastructure” which includes power supply, transportation, telecommunication and water and sewage or the form of “social infrastructure” which includes hospitals, schools and social housings.

Traditionally, infrastructure was mostly, if not entirely, funded by the government given its nature. The non-exclusive as well as non-rivalry attribute of infrastructure services, essentially making them public goods, meant that private investors had little incentive to allocate resources towards this sector. However, in recent years, in an effort to curb fiscal pressure, various attempts have been made to incorporate private participation in infrastructure development. In this regard, public-private partnership (PPP) has gained ground as an alternative financing model to increase the penetration of private capital in infrastructure projects.

While it is understandable for economies with already high levels of public capital stock—or infrastructure stock—to cut back on government spending and make room for private investments, as additional public investments could potentially entail a crowding-out effect, the same may not hold true for countries with low levels of existing public capital stock. In fact, a fixed effects regression run on 138 countries over the period of 20 years shows that an increment in public capital stock has a significant and positive impact on the total output of low income and emerging economies. Furthermore, public spending is found to have a crowding-in effect on private investments among this cohort, contrary to the popularly held assumption that government expenditure crowds out private sector investments.

A renowned economist David Alan Aschauer in 1989 attributed this phenomenon to increasing marginal return of private capital in the presence of public infrastructures. On the other hand, the relationship between public capital stock and GDP is found to be insignificant among advanced economies indicating that any increment in public capital has no influence on their aggregate output.

The notion that public capital reinforces the productivity of private capital is widely prevalent in existing literature. The World Bank’s Growth Commission Report shows that nations with a higher share of public investment accounting for their GDP demonstrate faster growth than those with a lower share. Moreover, infrastructure investment works also as a macroeconomic stabiliser. The multiplier effects that arise from fiscal interventions are significantly higher for infrastructure investment than any other government expenditure. Also, the relationship between the public capital ratio (ratio of public and private capital stock) and economic growth is strictly non-linear. According to Aschauer, the economy grows at the fastest rate when public capital stock is 61 percent of private capital stock, which has come to be known as the growth maximising ratio.

Infrastructure has continued to be one of the major roadblocks in Nepal’s economic progress. While there has been plenty of discourses around the need to strengthen infrastructure investment within the country, they are often misguided at best. The country’s parochial focus on promoting private sector investment by emulating the policies of its richer counterparts fails to meaningfully address the contextual challenges of infrastructure financing specific to Nepal.

The primary components of production function are labour and capital. Nepal’s economy, like many Third World countries, is heavily dependent on labour and faces a massive capital constraint. It is imperative that the country strengthen its capital stock in order to undergo sustained economic growth. To this end, Nepal has been excessively focusing on creating a conducive environment for private investments. However, the role of public capital in improving the efficiency and return to private sector investment has been largely overlooked. As a handful of studies suggest, there needs to be a sizable investment in infrastructure and a proper infrastructure system in place for private investments to perform well.

Public capital is a complement—not a substitute—to private capital. Accordingly, government spending on infrastructure is essential. In fact, the East Asian success with regard to a rapid drive in infrastructure development and the region’s subsequent economic prosperity can be ascribed to hefty investments made in infrastructure on the part of the government. Comparing the public capital share of GDP from a 2019 International Monetary Fund dataset puts into perspective how far behind Nepal is in terms of infrastructure investment; as of 2017, the country's public capital stock stood at 43.5 percent of GDP while the figures were 63 percent and 120 percent for the United States and Japan, respectively.

Moreover, the country’s public capital ratio stands at approximately 30.8 percent, meaning that public capital stock of Nepal is just 30.8 percent of private capital stock, which is well below the growth maximising ratio. The Nepal government evidently has enough fiscal space to finance infrastructure development without having to worry about crowding out private sector investments.

The multiplier effect of infrastructure investment in terms of kick-starting economic growth in the short run largely depends on the degree of utilisation of local inputs. Big infrastructure investment spent on procuring external inputs would not have the expected multiplier effect. However, in Nepal, the policy focus is just on external or internal financial capital with a complete disregard for building internal capacity for infrastructure development.

Resource constraint is not the key issue behind the lack of infrastructure finance in Nepal. Rather it is the inability to mobilise available capital towards infrastructures that generate notable social and economic return in the long run; it is the failure to recognise public spending on infrastructure as a stimulus to private sector investment. With this being said, it is equally imperative to keep in mind that infrastructure development must ultimately enhance social, economic and environmental equity.

Implementation method

In addition, the country typically struggles to complete infrastructure projects in a timely manner even if these projects were to receive adequate funding. The Melamchi Water Supply Project is a case in point, which took well over two decades for completion. To break the recurring pattern of nationally significant projects being left in limbo, the current project implementation method must undergo profound restructuring and reform.

Politicians and policymakers have limited their efforts to coercing implementing agencies and project managers with periodic mandates and directives. This overtly political approach sees the issues in project implementation as a zero-sum game, and consequently fails to understand the core problem in the underlying incentive structure. Adopting economists’ positive-sum outlook whereby the implementation framework is integrated with appropriate incentive mechanisms could generate better outcomes with the same amount of financial and human resources.