Governments and policymakers often assume that infrastructure development is key to jumpstarting economic growth for citizens, an “If we build it they will come” chain reaction of new jobs, more efficient transportation, and safer streets.

The view among economists, however, has been more cautious. This is partly because the relationship between infrastructure spending and economic growth, if focused only on the United States, has been hard to update. The US Eisenhower Interstate Highway System, after all, was signed into law through the Federal Aid Highway Act in 1956.

So, researchers turn their focus to developing countries, which have undertaken ambitious and dramatic infrastructure projects in recent years. India’s Golden Quadrilateral highway received new sections and major upgrades between 2001 and 2006, when 95 percent of the work was completed. Overall, India invested $71 billion to upgrade, rehabilitate, and widen the country’s major highways to international standards. The GQ, as the fifth-longest highway in the world, links four of India’s largest cities and many districts in between.

"Will finance show up where companies need to be? Or does the availability of finance shape where companies end up locating?"

It is the districts “in between” that comprise a rich laboratory for learning about the relationship between infrastructure spending and economic growth more broadly. A new study examining the GQ network, specifically the highway program above vis-a-vis local financial development in districts all along the route, is the first paper to connect microlevel financial development with infrastructure development.

The paper, Infrastructure and Finance: Evidence from India's GQ Highway Network, is coauthored by HBS professors William Kerr, the Dimitri V. D'Arbeloff - MBA Class of 1955 Professor of Business Administration; Ramana Nanda, Sarofim-Rock Professor of Business Administration; Abhiman Da, of the Indian Institute of Management Ahmedabad; and Arti Grover and Ejaz Ghani, both of the World Bank.

“Overall, at the district level, financing developed alongside the infrastructure. The catch is that almost all of that happened in environments that were already above average in terms of the financial conditions,” Kerr says.

Martha Lagace: How did you come to study roads and financial development?

William Kerr: A starting point is the important role of the infrastructure provision in any economy and how it shapes economic activity. Infrastructure includes everything from roads and airports to trains and broadband communication. We want to understand the impact for how the economy functions for entrepreneurship and for the productivity of incumbents so there can be better investments and so we can learn about broader economic phenomena.

This is particularly true and interesting in developing economies because they are making big investments on a regular basis. The available academic work to help them is not as much as we would like, given the size of the bets they’re making.

The second and academic interest is that we learn much more from a developing country than a developed one. Roads, railroads, and harbors in the United States, for example, were all built before we had detailed datasets. Developing countries are quite interesting for researchers because the changes these countries are making are enormous for the local economy, and it is also a point in time where, in the case of India, there is very good recordkeeping and data.

Even if you wanted to study these questions in the United States, there is no comparable dataset that exists in comprehensiveness and quality. So, add that data advantage with the fact that India is making these big infrastructure investments like the Golden Quadrilateral highway network and you have a very rich environment to study.

Earlier research that I did with some of our coauthors on this paper was connected to the manufacturing sector of India. We studied how the GQ project affected the productivity of incumbent plants and the growth of new entrants. The GQ was very important for the manufacturing development that India experienced. The places where new plants were frequently sprouting up were right along the GQ project, and they were not along other highways that weren’t being developed or were in more rural locations.

With that background, we began talking with Ramana about interesting questions from the finance side that would be nice to layer into this framework and analysis.

Ramana Nanda: One of the debates in the finance literature has been whether finance follows real activity like real investments and companies setting up. Will finance show up where companies need to be? Or does the availability of finance shape where companies end up locating?

In the last several decades, there has been a lot of work showing that finance plays a strong role in shaping where companies will end up locating. In some sense, infrastructure has the potential to overcome constraints. So, if finance did not exist in a place, what if we were to make large infrastructure investments? Would that lead to a lot of economic activity, and would finance flow in there? That would be an interesting narrative because it would mean that policymakers could effectively overcome any lack of financial development—for various historical reasons—by making large infrastructure investments in an area.

Another potential outcome could have been that infrastructure and finance end up being more complementary to each other. This would be in the sense that, while infrastructure is really important, firms would locate in places where finance already existed. In those cases, you might think that the regions that already had some amount of financial sector development would disproportionately benefit from the infrastructure investment.

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Whether finance is a necessary precondition for development is obviously important for developing countries. It’s equally applicable to policymakers elsewhere who are thinking about how they should best make infrastructure investments.

Lagace: How did you carry out this study over a several-thousand-mile highway network?

Nanda: As Bill mentioned, the Indian government collects comprehensive, detailed microdata. One of the great datasets they maintain is in the Reserve Bank of India, the Indian central bank. They collect data on loans to individuals and firms across the entire country by banks also across the entire country. So, they have information on the recipient of the loan, the amount, the location where that loan was made in terms of which district it was made in, and other categories. One of our coauthors, who used to work at the Reserve Bank of India, helped aggregate that information up to the level of district, time, and industry. We put together all loans that were made to private nonfinancial corporations. We do not include the public sector, and we do not include the financial sector itself.

Kerr: This is important because it means that these are not loans that were taken out to pay for the GQ itself. These are loans in the private sector alongside the roads that are developing.

Nanda: This allowed us to understand what was happening to lending around the districts where the GQ highway was being built compared to other districts that looked quite similar before the highway was built but then did not get the infrastructure investments.

Lagace: What did you find?

Kerr: Overall, at the district level, financing developed alongside the infrastructure. The catch is that almost all of that happened in environments that were already above average in terms of the financial conditions. So, if you were starting from no financial backing or no existing infrastructure, then upgrading or building the GQ highway did not encourage the development of new loans.

Nanda: You could think of two stories. One is about catching up. And the other is about divergence. Our results are more consistent with divergence than catching up. The places that were already well developed seemed to benefit even more, while those that had not developed as much were not keeping up with the ones that had already had some amount of financial development.

"Policymakers can’t just rely on the motto of 'If I build it they will come' for the financing side.

Now, these are obviously “on average” statements. A benefit of the approach that we use is it allows us to look at averages across the entire country and across the entire highway network. That does not mean that any individual, specific districts might not have been doing incredibly well even if they were not ones that were above some initial threshold.

Kerr: It’s also important to recognize that this is a study about the bank loans. There still might have been a benefit from the GQ that some districts would have been able to achieve. It just did not come in a way that required the financial sector to support or help it.

Lagace: What should managers and policymakers keep in mind?

Kerr: Policymakers can’t just rely on the motto of “If I build it they will come” for the financing side.

Nanda: While this research is, perhaps, more applicable to policymakers than managers, as a manager, if you are trying to take advantage of infrastructure spending, it always helps to know that you can finance whatever it is you are trying to do. Making sure that financing is available is important.

To the extent that policymakers are interested in stimulating entrepreneurial activity and are thinking about infrastructure spending as one way of doing that, I think the implications of our work are that that would need to go hand in hand with trying to create the environment to have financiers show up.

In India, there is bank branching by the state bank of India that provided capital to farmers, consumers, and small businesses in rural areas, where private sector banks were not going. We have not connected the dots between that activity and which districts had above-average financial development. But, that’s an example of how one might imagine that there are complements between infrastructure spending and making financing available.

About the Author

Martha Lagace is a writer based in the Boston area.

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