As opposed to the general assumption, economic growth in Europe remains disappointing even today. Virtually all Union members are expected to post higher output in the current calendar year but, according to the IMF’s latest projections, the growth rate in the eurozone will barely exceed 1%. In addition, whereas the British economy is displaying strong momentum of growth, its GDP has only now surpassed the pre-crisis mark. In per capita terms, European Union is still poorer than it was seven years ago.
In this framework, a new policy target has emerged INVESTMENT. Italian Prime Minister, who currently holds the Union’s presidency, has pushed for it, and Juncker, president-elect of the European Commission, has called it his first priority. His goal for the next three odd years is to mobilize an additional $134 billion per year, which is approximately 0.75% of GDP for public and private investment.
Investment is certainly a diplomatically appealing melody. It can hitch Keynesians and supply-side advocates; protagonists of public spending and supporters of private business can stand together and archaeologically low interest rates unquestionably provide a favourable opportunity to finance new ventures. However, it does not automatically follow that governments should pour money into public infrastructure projects or foster private investment by adding further incentives amid already auspicious market conditions. At a clock when incomes have shrunk, public resources are scarce, and debt burdens are substantial, plans to stimulate investment should have to be carefully dissected. Even seemingly, purposeful projects can backfire: a few years ago, Europe’s well-intentioned efforts to stimulate renewables resulted in a solar energy bubble of macroeconomic proportions. Although cutting greenhouse-gas emissions is necessary, the current generation of relatively inefficient renewables should not be deployed at the expense of the development of more cost-effective technology.
That is why it is very essential to determine, before any effort to increase investment, whether sluggish growth in Europe reflects abnormally low capital formation. Data suggests that it does: from 2007 to 2013, investment in the European Union has fallen by 18%, compared to just 6% in America. In Southern Europe, investment has plainly collapsed. In Germany, it will reach pre-crisis levels only this year.
Nevertheless, this is scarcely a sufficient observation, because excessive pre-crisis real-estate investment made a sharp downward adjustment inevitable. The thoughtless construction of condos without buyers and airports without travellers had to stop. More so, investment tends to follow economic growth: companies add new capacity only if there is demand for their products. A recession always implies a disproportionate fall in investment.
For these reasons, determining whether low investment is a cause or a consequence of slow growth is not as easy as it may seem. Taking push and pull factors into account, the German economic institute, estimates that the investment gap is real; for the eurozone, it puts the gap at about 2% of GDP. That is a significant number, which suggests that there is a case for policy action.
That raises the next issue: what hinders investment, and what can be done to remove such hindrances?
Part of the answer concerns regulation. For example, investment in efficient energy production and conservation is being held back by persistent uncertainty about the future path of climate policies. A European agreement on how to stabilize the price of carbon would help to catalyse private projects. At the national level, stable schemes to improve domestic heating efficiency would also be helpful. In addition, regulatory clarity and predictability are essential to private investment.
The answer is also financial. In Europe, the pre-crisis boom in real-estate investment was powered by reckless credit flows. Credit rationing has followed, as banks reduced their overburdened balance sheets and were discouraged from risk-taking. As a result, credit for, say, a small company is neither cheap nor abundant.
This calls for immediate action. Packaging existing loan portfolios and offloading them to non-bank investors, as many have proposed, should be encouraged. Beyond short-term fixes, the main priority must be to encourage a resumption of savings flows across Europe, but this time in the form of equity, not bank deposits, and loans. For this, Europe needs an adequate regulatory and tax framework. Official institutions could also be involved in a suitable way. Oddly, the European Investment Bank, the EU’s financial arm, is authorized to provide only loans and guarantees, not equity investment. Substitutes should be found.
There are, finally, a few fields where national governments could act directly. Infrastructure is a case in point, provided that the current interest in investment projects is not used as an excuse to revive Europe’s love for white elephants.
Will it be enough? It is hard to know. The EU faces a delicate balancing act between the need to foster investment and the need to remain cautious, especially with public money. Juncker, for his part, will need to display both firm resolve and sound judgment.
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