Role of transport in accelerated development

By Dr. Lauthasiri Gunaruwan

Part two

The Puzzle and the Solution

The challenge is therefore evident. On the one hand, the pressure on the ports, customs, warehousing, roads, transportation and other logistics related operations, in aligning with the imperatives of this accelerated growth scenario would be quite significant, and a failure to live up to expectation would put the entire growth process at risk. On the other hand, investment requirements to develop transport infrastructure and logistics in view of successfully meeting the demand would be quite substantial, and such high levels of investment, funded through external borrowings, would be unsustainable, and could drive the economy to instability. Either way, the outcome would be undesirable.

Would it be strategically possible for the economy to find a way out of this apparent ambivalence? The key to solve this puzzle is found in capital productivity itself, where improved capital productivity would reduce the degree of factor inputs needed to achieve a given output target, both at aggregate and sectoral level.

Let us consider, for the sake of analysis, an improved overall capital productivity scenario represented by an ICOR value lowered to 4.0. What would be the implications on the macroeconomic parameters?

The investment demand to achieve the 9% growth rate drops by 11%, bringing the required investment ratio to more realistic, but still ambitious, 36%. The resource gap thus drops to 9% from 14% under the prevalent ICOR of 4.5.

The growth path thus becomes more sustainable as the long-term effects of having to borrow to finance resource gap would be less. The horizon becomes much more realistic and achievable.

This transpires into the transport sector as well. Reduced resource gap would mean a comparatively lesser rate of growth of imports required for a given rate of export growth.

The economy therefore would become less foreign trade intensive, and the resultant total international trade growth over the five year period, required to achieve the economic growth target of 9%, would be little over 117%. This implies a reduced trade requirement in volume terms of approximately 9% compared to 11% required under the ICOR of 4.5. The burden on ports and other trade-related transport and logistics services would be eased to that extent, making the entire growth scenario achievable in the ground level as well.

Capital Productivity: How to approach?

Enhancement of capital productivity at the macro level pre-requires capital efficiency gains in the level of individual sectors and industries. Thus, the transport sector, securing a significant share of the State’s capital resources, shoulders a special responsibility to be more productive in its capital.

Capital productivity improvement requires a long-term and persistent strategic intervention to ensure (a) high productivity of new investment, and (b) improved productivity of the existing capital stock. The former is relatively easier as it is regarding decisions to be made. The latter, however, concerns of decisions taken during bygone era, and hence difficult to change.

This applies to all sectors of the economy. Making the existing capital stock in the sector more productive, and exercising diligence in planning and implementing transport related new investment, therefore become extremely important if the transport sector is to realistically shoulder the challenges of accelerated economic growth with less effort and sacrifice.

Diligence in Capital Spending

What produces the value added is not the ‘expenditure’ made, but the ‘asset created’. Recorded in the national or sectoral statistics is merely the expenditure incurred and not the qualitative and quantitative measures of the accumulation of physical capital. Amounts of rupees or dollars spent on a transport related project, therefore, would not mean much unless such are fully and effectively deployed in creating a productive asset. Any leakages in the process, inefficiencies or over-expenditures, thus, lead to a gap between the expenditure made and the value of output generated. As the creation of future value added depends on the capacity of capital assets generated and not on the expenditure made on them, such gaps will inevitably give rise to poorer implicit investment productivity estimates, or higher ICOR values.

Investment appraisal, a vital exercise undertaken prior to making investment decision, helps ensure productivity of new investment. In the case of investments made by the private sector, a financial viability assessment is imperative in investment decision making, as the purpose of investment would be profits.

Thus, the capital productivity in private sector projects is automatically taken care of. Such a natural compulsion does not exist with regard to State sector projects mainly because the decision-makers are aware that they are not at financial risk of any losses incurred owing to implementing an unviable investment. Therefore, explicit measures and procedures are required to ensure that public sector investment decisions are based on a proper assessment of their socio-economic viability.

Calling for competitive bids for procurement based on pre-determined specifications helps capital efficiency as the procurer would then have the choice of going for the most productive alternative. This opportunity is absent when unsolicited offers are entertained with no competition, and the possibility of over-estimated capital expenditure cannot be ruled out under such circumstances. Extra care is thereby necessary to ensure that the quoted investment figures are reasonable and not excessive.

An increasingly large proportion of projects implemented in the transport sector appear to be from unsolicited offers where only a single proposal is available for appraisal. To that extent, the role of planning becomes more important to ensure capital productivity of new investment.

Bench-marking capital investment could be useful for planners and policy-makers in minimising the possibility of incurring excessive capital expenditure in public sector projects, particularly when competitive bidding procedure is not adopted.

The key is to acquire the required quantum of a capital asset of a pre-determined quality at the lowest possible capital expenditure. Higher than acceptable ICOR levels indicate that this requirement has not been sufficiently met, and that there is scope for improvement in future investment decision-making.

Effective usage of capital assets

Creation of a capital asset with the required efficiency is not a sufficient condition to ensure the generation of the expected growth impetus. Its deployment and effective use in its intended purpose are also imperative. Any asset created through capital expenditure, but not effectively used, amounts to a waste.

There are, unfortunately, a number of such unused or poorly used capital assets in the transportation sector. Kelaniya new railway bridge still unused even after five years of its completion at a cost of Rs. 950 Mn. Nilwala Ganga railway bride, completed in 2007 at a cost of Rs. 320 Mn is suffering the same fate.

It took nearly seven years since completion in 2001 to put the Mattakkuliya road bridge, constructed at a cost of Rs. 240 Mn, into full use. Kelanisiri road bridge, Japansese funded Load Testing Plant at Ratmalana railway workshop and the new facility to rebuild railway carriages at Dematagoda, are among other examples of investment in capital assets which lie idle.

Poor conception of projects, inadequate planning, delays in associated sub-projects, or simple abandonment owing to change in political or administrative leadership are commonly perceived causes. Whichever the case may be, their avoidance would help improve capital productivity in the transport sector, thus enhancing the growth impetus of transport sector investments.

Operational efficiency

Assets so created with capital efficiency, and put into use, need to be properly managed to deliver economic benefits. Efficacy of planning and implementing projects would become futile if they are improperly operated and managed in producing services.

Properly deployed and managed capital assets would generate value to the optimum levels, thus reducing the pressure on infrastructure and other capital assets to expand unnecessarily. Operation of public buses and trains at reasonable load factors, for example, would help transport sector enhance its capital productivity, thus enabling the sector to satisfactorily support economic development process with the smallest possible rolling-stock fleet.

The market today is much more competitive than a few decades ago. It requires a broader spectrum of qualitative parameters, including punctuality, standards, comfort and speed, in addition to traditionally expected connectivity and mobility at affordable costs, to attract customers.

Unlike a few decades ago, the customers have a wider choice open to them, and their affordability levels of costlier alternatives have increased.

Thus, the public transport sector and its operators will have to look beyond the current horizon, and reform themselves to face the evolving demand conditions, if satisfactory patronage of the services they offer is to be expected.

Railway service, for example, would continue to lose its passenger market share unless it is reformed to become more customer oriented, and capitalise on its comparative advantages in providing long distance services of quality with shorter travel times, and commuter services with more capacity, reliability and punctuality. Intercity express operation, if properly planned, pitched and marketed, is likely to fetch demand. Attention of policy-makers should be drawn to explore this possibility as without greater patronage of railway by passengers and freight customers, the transport sector would not only become incapable of supporting economic development, but also will become a retardant of development process through wide-spread generation of negative externalities.

Minimising growth-destructive effects

Managing externalities is another parameter of strategic importance. This is because the negative externalities of transport sector, expected to be generated in much larger proportions owing to the demand-pull growth of transport-related activities, could, in return, become growth destructive. For example, the growth of private vehicle fleet by 40% in 5 years, expected under a high economic growth scenario, would cause severe pollution, congestion, and accidents.

This could undermine the growth and development process through negative social and economic implications. It would be the urban poor who would be exposed and most affected from such externalities.

Fuel consumption would go up in parallel to the vehicle kilometres operated, and a significant proportion of such costs would be borne by the general public to the extent that fuel would be priced below true costs.

Offering road space free for motorists is a social injustice because it would be the rich who would benefit at the cost of welfare of the poor, Furthermore, our motorists do not efficiently utilise the scarce road space provided free of charge for them.

The result would be operational inefficiency, thus calling for structural adjustment within the transport sector in favour of public transportation.

Hence, not only the diligence in capital spending, but also minimising wastages, leakages and over-expenditures, as well as proper planning of capital projects to avoid idling or under-utilisation of assets, become imperative.

It is necessary to maximise operational efficiency and minimise negative externalities. These are essential requirements for the transport sector to better serve as an effective “load bearer” of national economic development in the medium to long run.

Exploiting investment beyond Capital Accumulation

It is the conventional role of investment, namely, the building up of the capital stock, which has largely been played in the transport sector in the recent past. Investment has been made for the purpose of capital accumulation, in view of ensuring future productive capacity in the sector. A bridge or a train or a signalling system has been looked upon merely as a required capital asset to operate trains, and hence to produce transportation benefits. Little appears to have been done to think beyond this traditional horizon.

Yet, the capital expenditure could stimulate another economic spiral through its “demand creation effect”, potentially much wider than what is fuelled by the “asset creation effect”. A capital expenditure made has the potential of multiplying its income generation effects over and over again when such expenditure is ploughed back into the national economy . A marginal propensity to consume of 0.75, for example, provides for a multiplier of 4, meaning the theoretical possibility of securing four times the investment value as economic benefits over the years, in addition to the value generated through usage of the asset.

For this, investment programs need strategic formulation.

Projects have to be developed in such a manner that the domestic economic forces would be used to the maximum possible extent in creating assets so that the value addition, in the process of asset creation, would accrue to the national economy. Projects executed by foreign agencies, for example, would add less value within the local economy, depriving the local enterprise of possible opportunity to earn, grow and further invest in the economy.

Trends observed in the recent past

Let us take the example of railway track construction in Sri Lanka. Historically the job was done locally, by the Sri Lanka Railways, using material inputs from abroad when such could not be sourced locally.

Even for the procurement of material, the competitive bidding procedure was adopted by and large, resulting in cost effectiveness in inputs. The technology unavailable with us was obtained through procurement at competitive prices.

The projects were thus implemented in achieving both benefits, namely (a) construction of the asset (in this case the railway line) to generate value addition in train operation, and (b) creation of linkages to the maximum possible extent within the local economy through which “construction related” value added, and many other multiplied economic value generation spirals, would be stimulated.

The recent pride of Sri Lanka Railways, in this regard, was the reconstruction of over 60 km and damage repair of another 40 km of the Tsunami affected Coastal railway line in 56 days in early 2005, exclusively by local effort, at an estimated cost of Rs 450 Mn.

When the contracts for railway track construction are granted to foreign companies, a greater proportion of value generated in construction would be accrued outside the national economy. Such investment would only be initiating one of the two possible economic growth effects, namely the “asset creation effect”. It would fail to initiate construction demand-related multipliers, thus, depriving the economy and its stakeholders a significant portion of growth potential of capital expenditure incurred. The sub-optimality would be more if the cost of construction by foreign sources becomes much greater than the local estimates.

Execution of projects and the impact on GNP

The Gross National Product (GNP) differs from the commonly used Gross Domestic Product (GDP) by the amount of net factor income from abroad. Factor incomes earned and repatriated by non-national economic agents operating on Sri Lankan soil are excluded from the GDP, and the factor incomes earned by Sri Lankan entities operating abroad and remitted to Sri Lanka are added, in order to compute GNP. Therefore, the evolution of GNP as a ratio of GDP could reflect as to how favourable or adverse the trend of Sri Lanka’s net factor income flow has been.

The GNP/GDP ratio of the Sri Lankan economy, worked out in current market prices, displays a significant downward trend over the past 25 years.

This indicates a growing net repatriation of factor returns as a ratio of GDP. In other words, the inflow of factor earnings from abroad is increasingly becoming insufficient to compensate for the outflows.

This observation is relevant for our discussion because much of this may be largely “investment centred”. Higher the foreign capital borrowed for domestic capital formation, and more the contracts for road, railroad, port or airport construction in Sri Lanka are undertaken by foreign enterprises, greater would be the outflows of factor returns on account of interest, wages and profits. This would lead to deterioration of GNP/GDP ratio unless the inflow of factor returns does not grow at a sufficiently high rate to compensate for the growth of outward remittances.

There exists a notable difference between Foreign Direct Investment and public sector infrastructure investment executed through foreign contractors. In the case of FDI, the company would source capital, bears investment risks, becomes responsible all factor payments, and takes away only a portion of what it would generate as domestic value added. The Government becomes the investor in the case of the latter, and responsible for making outbound interest payments on foreign borrowed capital, irrespective of the project’s viability. The Government would also bear the risk of generating value added on the investment made, but pay in full to the foreign contractor for the project execution. Foreign lenders and foreign contractors would wish to maximise deployment of material, labour and technology of their country of origin.

Thus, the possibility of such undertakings withdraw almost everything they generate as value through their activities, and leave hardly anything for the local economy other than the asset created, cannot be excluded.

Making contractual opportunities for project execution available for local entrepreneurship wherever possible, feasible and capital efficient, therefore, will help reduce the foreign dependence in investment, prevent shrinkage of GNP as against GDP, and enhance domestic capacity building and resource employment.

Foreign enterprises should be employed to execute public investment contracts only when such involvement becomes essential and unavoidable. When employed, the policy-makers should be smart enough to secure maximum possible returns to the local economy by way of strategically managing such foreign loan packages and projects.

The transport sector, including Highways, Ports and Aviation, has made commitments on capital expenditure of nearly USD 6 Bn on infrastructure development through foreign borrowings during the past six years. This trend is likely to continue.

Therefore, the transport sector bears a considerable responsibility to strategically meeting this challenge by making available the investment opportunities arising out of development needs to the local enterprises and organisations with priority and to the maximum possible extent, for the betterment of our national economy.

To be continued