How does infrastructure spending result in economic growth?

Answer by Balaji Viswanathan:

Infrastructure projects – electricity, roads, airports, water systems and telecommunications are the foundations of modern economies. They have a huge multiplier effect (a dollar spent on infrastructure leads to an outcome of greater than two dollars [1]).

When you put up a power plant, you not only generate employment directly through construction and operations at the power plant, but also create an industrial base around the plant who would want to tap the power. These industries would get more entrepreneurs and employ more labor. These workers would purchase more goods from the markets, creating a virtuous cycle.

When you put a road through a backward area, you bring them close to employment options, markets and better healthcare. Infrastructure is the key to wiping poverty.

China and India are on extreme ends when it comes to infrastructure spending. While China's spending on roads and power exploded since late 1990s, India's stagnated (look at the dotted worm below). We haven't only spent less, but we were also quite inefficient.

Unsurprisingly, this increased spending in infrastructure turbocharged the Chinese economy since that period and built up a sizable lead over India.

1. Highway Grants: Roads to Prosperity?

How does infrastructure spending result in economic growth?

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