Appraising public investment efficiency

Techniques such as shadow pricing in project appraisal and policy reforms which liberalize imports, decontrol prices and reduce subsidies, and thus narrow the gap between financial and economic returns, can help to overcome the discrepancy between financial and economic evaluation.
Since public sector investment accounts for such a high proportion of total domestic investment in developing countries, efficiency in the public sector is crucial. However, governments tend to neglect to distinguish between financial and economic returns when appraising public sector investment. Public enterprise investment may thus appear to be financially profitable only because it is protected by tariffs and regulations or because it receives government subsidies through low-interest loans or cash transfers. The project may actually be unprofitable in economic terms and contribute little or nothing to the country's growth. This helps to explain why the rapid growth of public investment in many developing countries during the 1970s was followed later by debt-servicing difficulties. Although part of the foreign borrowings were used to maintain consumption when commodity prices fell, most went to finance large public investments which tended to contribute little to economic growth or to generating foreign exchange to service the debt.
The problem of inadequate appraisal is particularly severe in Africa and is common in most developing countries. Investment in social, economic and political infrastructure, in industry and in service sectors is clearly necessary but projects too often fail to generate significant increase in output. Genuine mistakes and misfortunes can only account for limited number of these, failure is due more often to projects being selected on the basis of political prestige or of inadequate regard for their probable economic and financial rate of return. Even in East Asia, where public money is invested relatively efficiently, greater care and prudence could be used in making economic appraisals.
Efficiency of investment in the public sector is crucial because public sector investment accounts for a high proportion of total domestic investment in developing countries. Merely to raise the rate of growth of investment will not improve efficiency, which in fact, in the developing world, tended to decline in the 1980s. Governments need to take steps which lead not only to a restructuring of output, but also to reform of investment procedures within central government ministries, improved criteria for investment decisions in public sector enterprises and price reforms designed to channel private investment in more socially optimal directions. State-owned enterprises, in particular, may serve only limited interests, be inefficient and often operate at a loss, constituting a drain on development resources for development. Whether or not such enterprises are retained in the public sector, they should be forced to become more competitive through their exposure to market forces.
Type Classification:
D: Detailed strategies