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INFRASTRUCTURE AND ITS LINKAGE EFFECTS -ADITI RANASARIA SONALI MAHTANI TANAY NANGALIA YASHVARDHAN KANOI

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INFRASTRUCTUREAND ITS

LINKAGE EFFECTS

-ADITI RANASARIA SONALI MAHTANI TANAY NANGALIA YASHVARDHAN KANOI

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What is Infrastructure?Infrastructure is the prerequisite for the development of any economy. It is synonymous with development, and the lack of infrastructure services signals barriers to growth and overall development. Infrastructure plays a crucial role in society and economy by providing services to households and industry. It includes:• Education, health and family welfare • Water and sanitation• Transport (roads, railways, ports and civil aviation), power and

irrigation• Communications and informatics

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Linkage EffectsThe linkage between infrastructure and economic growth is multiple and complex. Infrastructure creates many direct and indirect externalities, and involves large flows of expenditure thereby creating additional employment.

Infrastructure affects output in two ways:-

One is the direct channel where infrastructure increases the output by reducing the cost of intermediate goods. The other channel is through externality effect. This channel works through higher human capital returns due to education, good quality health.

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The following flow chart gives the various linkages of infrastructural development which finally leads to economic growth:-

Source: Journal of Business Management and Social Sciences Research (JBM&SSR)

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MODELOBJECTIVE:

To show macroeconomic impact of infrastructure development on the output of a nation. We shall be showing the impact through the AD-AS model with unemployment.This unemployment arises due to wage indexation and not due to the effective demand problem.

1. There are two types of capital stock in the economy i.e. Kp(private capital stock) and Kg(public capital stock) 2. There are two types of Investment, Ip(private investment) and Ig(public investment).

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Aggregate supply side of the economy:

3. Production Function

Y = Y (L,Kp, Kg) where, L = Labour Kp = Private Capital Stock

Kg = Public Capital Stock

(Infrastructure)4. Private Investment Function  Ip = Ip(r, Ig) where, r = interest rate Ig = Public Investment Private function is not only a function of interest rate (inverse relationship) but also is positively related to Public Investment. There is complementarity between public and private investment in India.

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Aggregate Demand side of the economy: 

5. Commodity market Y = C(Y-T) +Ip( r, Ig ) + Ig + G

where, G = Government Consumption Expenditure

C = Private Consumption Expenditure

6. Money Market M/P = L (Y, r) ; and

where, M/P = Supply of real balanceL(Y,r) = Demand for money

ASSUMPTION:

Price is flexible and wage is indexed to price level.

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We shall use the concept of Wage Indexation to show the impact of an increase in public investment. We note that unemployment that arises due to wage indexation and is not attributable to the effective demand problem.

W = A.Pα where, W = Nominal wageA = constant, say W0P = Priceα = Indexation parameter

The above expression can also be written as:  = A* From the profit maximising behaviour of the firm we have, = = A*  ( L, , ) = A* dL = (α—1)* A* dP=> dL/dP = according as (α—1) or α 

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The following two cases shall be considered: Case 1: 0<α<1

Here, we get a positively sloped AS curve and a negatively sloped AD curve to obtain the equilibrium price and quantity as P* and Y* respectively.

YY*

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Now, we see what happens to the equilibrium price and output when Ig is raised.In the short run, we assume that an increase in public investment does not change the public stock of capital i.e. Kg remains constant.

As there is no change in Kg, there is no change in the AS curve.

However as Ig rises, it has an indirect impact on private investment and hence Ip rises. Thus, the AD curve shifts to the right. In the short run, equilibrium is attained at a greater price and output.

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Overtime, Kg also rises. This leads to a rightward shift in the MPL curve and as a result, L and then supply of Y rises.

The supply side expansion of output will moderate the price level. It will increase, decrease or remain unchanged depending on the proportion of shift in the AS curve.

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Case 2: α =1

In this case,dL/dP = 0 and thus,dY/dP = 0. Hence, the AS curve is vertical.

As there is no change in Kg, there is no change in the AS curve. It remains vertical. However as Ig rises, the AD curve shifts to the right. In the short run, equilibrium is attained at a greater price while output remains unchanged.

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Overtime, Kg also rises. This leads to a rightward shift in the MPL curve and as a result, L and then supply of Y rises. However, change in price level depends on the shift in the AS curve.

Hence, we see that an increase in public investment has a dual effect. It increases not only public capital, but also provides a stimulus to private investment. Thus there is an unambiguous increase in output.

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Empirical Evidence

SOURCE: Central Statistical Organisation(CSO), RBI and Dun and Bradstreet, India.

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Trend of public and private investment during the 10th year plan of the Indian Government.

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Illustrative Relationship between Infrastructure and Development in South Asia

SOURCE: IDI scores were taken from Kumar and De (2008), and PCI scores were sourced from World Bank. NOTE: PCI stands for Per Capita Income and IDI stands for Infrastructure Development Index.

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ConclusionADB studies suggest that meeting the requirements for infrastructure development to maintain the current growth level until 2020 requires a total investment of $8 trillion. This is a huge amount. Infrastructure Development demands active public sector involvement.

Empirical studies help us understand the complex relationship between infrastructure and economic performance, which is measured in terms of economic growth. Infrastructure achieves this by creating additional jobs and economic activities, reducing production costs through improvements in transport and connectivity, etc.