Infrastructure and Regional Economic Growth

Abstract

This chapter outlines two models for analysing the relationship between infrastructure and regional growth, and discusses relevant empirical examples. The first model adopts a standard spatial equilibrium approach, and shows that the effect of new infrastructure on regional activity depends on its direct impacts on local productivity, local amenities and the price of non-traded goods, especially housing. These impacts are determined, in part, by how existing characteristics of the region complement the specific investment. If infrastructure contributes positively to real amenity-adjusted net wages, the local region increases its attractiveness and the result is an influx of firms and individuals to the region. In turn, this has dynamic effects that may amplify or attenuate the initial growth impetus. It is also possible that an infrastructure project contributes negatively to real amenity-adjusted net wages, thereby imparting a negative influence on equilibrium regional activity. The second model treats a major infrastructure investment as a real option that gives private sector developers the option, but not the obligation, for further development. The value of this option must be included by authorities when assessing benefits of a new infrastructure project. They need to judge the direct private sector responses to an investment plus the indirect equilibrium responses under alternative states of nature. The model shows that for a major infrastructure project, as in the case of other real options, a certainty equivalent approach is generally inadequate for investment analysis since that approach may under-estimate the benefit of a new project when future states are uncertain, learning occurs and decision-making is sequential.