Monday, October 11, 2010

Evaluating the returns on investments in street roads

In an earlier post, I had discussed about the large economic multiplier impact of all-weather rural connecting roads. Now a BREAD working paper by Marco Gonzalez-Navarro and Climent Quintana-Domeque comes to similar conclusions about the impact of slum infrastructure up-gradation through the provision of urban pavements.

Interestingly, they convinced the municipal council of Acayucan municipality in Mexico to allocate funds for pavement of all remaining street roads in a manner that would enable a randomized control study of the impact of roads. They divided the 56 pavement project areas (defined as contiguous sets of unpaved city blocks connecting to the city's pavement grid) randomly into two equal groups, and one group of 28 areas were sanctioned with road pavements for the 2005-07 period (the reality that the municipal body did not have funds for pavement of all areas helped). On comparing the treatment and control areas, they found that

"... homes in streets that were paved increased their value between 15 and 17%. Households living in streets that were paved obtained more credit, had higher per capita expenditures, increased motor vehicle ownership and were more likely to have made home improvements. The rate of return to road pavement is estimated to be 2% without considering externalities, but raises to 55% once externalities are accounted for...

Increases in consumption are more strongly correlated with increases in housing value than reductions in transport costs, suggesting that the wealth e ffect generated by the road pavement was a stronger driver of consumption than the reduction in transport costs."

They also write,

"We estimate the private gains to land plots on paved streets to be 109% of construction costs, which can have important implications for urban infrastructure financing."

In simple terms, the overwhelmingly major share of benefits from road pavements are captured by increase in home values and its attendant wealth effect on households. They also found that the increase in land values easily off-set the expenditure incurred in financing the roads, thereby making a strong case for investments in them and increasing their attractiveness to potential investors/financiers.

This study underlines the importance of downstream issues like transparency in land registration and a formalized real estate market. In the absence of either, the beneficial effects of these road pavements and other similar civic infrastructure provisions get dissipated, thereby obscuring their potential economic returns to the stakeholders. Further, the aforementioned deficiencies leave the local bodies without any mechanism to finance these investments by capturing a share of the incremental returns.

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