Monday, November 24, 2014

Can Investment Save Europe?

PARIS – Economic growth in Europe remains disappointing. Virtually all European Union members are expected to post higher output in 2014; but, according to the International Monetary Fund’s latest projections, the average growth rate in the eurozone will barely exceed 1%. And, whereas the British economy is displaying strong momentum, its GDP has only now surpassed the pre-crisis mark. In per capita terms, the EU is still poorer than it was seven years ago.

In this context, a new policy target has emerged: investment. Italian Prime Minister Matteo Renzi, who currently holds the EU’s rotating presidency, has pushed for it, and Jean-Claude Juncker, the president-elect of the European Commission, has called it his “first priority.” His goal for the next three years is to mobilize an additional €100 billion ($134 billion) per year (0.75% of GDP) for public and private investment.

Investment is certainly a politically appealing theme. It can unite Keynesians and supply-side advocates; proponents of public spending and supporters of private business can stand together. And historically low long-term interest rates undoubtedly provide an exceptionally favorable opportunity to finance new ventures.

But 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 time when private income has shrunk, public resources are scarce, and debt burdens are heavy, plans to stimulate investment should be carefully scrutinized.

Even seemingly purposeful projects can seriously backfire: only a few years ago, Europe’s well-intentioned efforts to stimulate renewables resulted in a solar energy bubble of macroeconomic proportions. Whereas 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 essential to determine, prior to any effort to boost investment, whether sluggish growth in Europe reflects abnormally low capital formation. The data suggest that it does: from 2007 to 2013, investment has fallen by 18% in the EU, compared to just 6% in the United States. In Southern Europe, investment has literally collapsed; even in Germany, it will reach pre-crisis levels only this year.

But this is hardly a sufficient observation, because excessive pre-crisis real-estate investment made a sharp downward adjustment inevitable. The reckless construction of condominiums without buyers and airports without passengers had to stop. More generally, investment tends to follow economic growth: companies add new capacity only if there is demand for their products. A recession almost 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, DIW, the German economic institute, reckons that the investment gap is real; for the eurozone, it puts the gap at about 2% of GDP, or €200 billion. That is a significant number, which suggests that there is a case for policy action.

That raises the next issue: what impedes investment, and what can be done to remove such obstacles? Part of the answer concerns regulation. For example, investment in efficient energy production and conservation is being held back by pervasive uncertainty about the future path of climate policies. A European agreement on how to stabilize the price of carbon would help to catalyze private projects. At the national level, well designed, stable schemes to improve domestic heating efficiency would also be helpful. More generally, regulatory clarity and predictability are essential to private investment.

The answer is also partly financial. In Europe, the pre-crisis boom in real-estate investment was fueled by reckless credit flows from Northern to Southern Europe. Credit rationing has followed, as banks reduced their overburdened balance sheets and were discouraged from risk-taking. Moreover, money has flowed back to Northern Europe from the distressed periphery. As a result, credit for, say, a small Spanish 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.

  • Contact us to secure rights


  • Hide Comments Hide Comments Read Comments (11)

    Please login or register to post a comment

    1. Commentedcar Acu

      To paraphrase the old expression, "consumers are from Venus, investors are from Mars."
      So let's express it in a language that both understand:
      Investment tends to work not when it brings profit to investors but when it puts spending money in everyman's pockets that enable the latter to buy consumer goods. Said DEMAND jumpstarts a flagging economy or continues the economic hamster cycle.
      All the invested trillions won't work unless they actually generate jobs and spending cash that goes into consumers' pockets for consumer goods and services, whenever these jobs create DEMAND.
      The current Confessions of an Economic Hit Man "paradigm" puts the bulk of investment money into the pockets of a small, insignificant-as-a-consumer-group, elite. Mass consumption/demand depends on mass distribution of jobs and discretionary income.
      No cash in consumers' pockets, no DEMAND. Result: stagnant economies.
      I will not address the political "fallout" to elites. They have always known the score: educated, non-docile middle-classes who do not believe in autocratic, frozen in place, class-stratified regimes-- while demanding an authentic (not "illusion of participation") voice in democratized resource-sharing decisions. Yes, "a seat at the table."
      Post-Piketty, it's a brave new world...
      Investment in job creation will not only save Europe, it may save Capitalism...from itself.
      Be well.

    2. CommentedMohammed Haris

      Apart from discouraging irrational investment, it is equally important to pay heed on the sources by which they (infrastructure projects) are being financed. ECB Chairman Mario Draghi has termed shadow banking most dangerous for the modern global economy. Not only do irrational investment may backfire, rational investment funding with inappropriate and reliable source may also put an economy into recession mode.

    3. CommentedSantiago Rouco Rodríguez

      JM Keynes made the right diagnose, lack of aggregate demand, and the right solution, public investment. Of course, that could be implemented by a state that rules its own currency (USA, UK), not like EU. And worst for EU periphery countries, that throw all the money of the rescues to the bank black holes (the bankrupt oligarchies of Europe). Investment in infrastructures, energy (good even because geopolitics), health, demographics (Europe needs badly more children), education, new technologies, and so on.

    4. CommentedJonathan Lam

      Would Mr. Juncker give 0.25% to the saving if it were 1.5 Euro to a dollar to save the bank?

    5. CommentedJonathan Lam

      gamesmith94134: Can Investment Save Europe?
      Investment cannot save Europe; EU needs a reform. From the standpoint of the exchange, Euro rose from 0.9 to a dollar to the present 1.34; it was not the investment or cash flow that proven GDP does not apply growth and the present 0.8-1% is not growth by nature, it is the validity of its capacity of Euro. If you are balancing the equity and employment to yield growth, you are reviving the love of white elephants again; or, just another co-incidence that euro was just going with the flow or credit that price escalated without meeting its value. Subsequently, it signaled that inequality was stratified in its social development that its consumer or saving is diminishing in a larger scale; except for money that is docked out on equity. It is way beyond the north and south divisions even for the Luxemburg; and its depreciation was trodden by lesser consumption that the margin of affordability was not efficient to meet a qualified payout in the present economy. Apparently, the shift to devaluation or deflation is inevitable based on the European who is striving to meet their cost of living; even though the EU insisted the inflation was minimal with the exception of equity and energy. then, what else is out there? white elephants or whiteout cost of living. "In per capita terms, the EU is still poorer than it was seven years ago."; GDP might have driven up 10% by its 1.2 to 1.34 to a dollar as in 1% of actually no growth.

      I think Mr. Juncker was right about the TIPP that a round of tax reform must apply; however, if he think of the "vulture fund" off to enhance the private investment to its equity financial or M&A would definitely widen the gaps of inequality. If the employment lingers; then that cost of living will rise significantly after the expansion, further depreciation of Euro will stand indefinitely. If cost of living rise with no accumulated saving to banking, I bet restructuring of Banking is not far ahead.

      At present, I think we should look into the leaner market system like Spain, Portugal and Iceland; their labor market or human capital market is not erupted and stable. why not follow and scrutinize how adaptive they can be, instead, further intensify for another erosion of Euro? I think the human capital is the first priority to strive on its reasonable value that they will survive and grow.
      Another 100 billion euro will be a disaster for the future of EU if the tax reforms are not maturely emerged to its political forum and developed some unity of the European Union.

      In applying a free fall to sustain a leaner monetary and human market system may sound action on The Taming of the Shrew and Mr. Juncker is the merchant of Venice who is much ado about nothing, but at the midsummer night dream, with measure for measure. It is All's well that ends well.
      Life is all in Shakespeare's comedy....we All get a laugh.
      May the Buddha bless you?

    6. CommentedRamon Prat

      Seems oddish, or at least strange, that the choosen actors for managing loans in our modern economies are non-bank companies. Aren't banks the real specialists in loans and credit instruments?

    7. CommentedJoshua Ioji Konov

      Dont like repeating myself, over and over again, but the trickle-down economics so closely followed by the EU, and this article is a perfect example of it, does not work in present day globalization and rising productivity: to expect on private business and investment to revival EU economy under the presently used policies cannot and will not work (look at the last 10_ years), therefor, the "invisible hand" of the governments should invest much more than 100b yearly to have any major effect, however the entire EU policies entails redistribution of wealth from the have not to the have, also without Quantitative Easing the EU will stay in the limbo much longer than the EU government expect,,,. stop mingling and chewing on the same policies that have proved wrong globally: from the US and UK to Japan and China, the History has shown that only active governmental investment works out in the current economic conditions!

    8. CommentedZsolt Hermann

      I do not think the problem is with "investment", "austerity", "stimulus" or any other specific economic, or even political measures.
      There is not even a problem with the basic knowledge or intelligence of the leaders and experts making decisions.
      The problem is they are making their research, measurements and decisions in the wrong paradigm, with the wrong coordinates.

      As now we can clearly see from the latest advances of classical sciences, and from the daily events of the global crisis, contrary to our long held belief humanity is not outside, not independent from the vast natural system we evolved from and still exist in.
      And the natural system is based on strict, unbending natural laws and principles that are fully binding to us all.

      And the principles of the natural system say that the whole system is global and integral, and it is maintaining a very precise and sensitive balance as it operates within natural necessities and available resources.

      Thus in order for a human system, global human society to survive, we have to become equivalent in form, adapt to the system.
      This means integration and mutually complementing cooperation.
      It means living within natural necessities and available resources.

      As soon as we get the paradigm, the coordinates right, all those intelligent, educated people today making desperately wrong decisions and standing helplessly, immediately can start making the right observations and right decisions, guiding humanity towards prosperity and sustainable future.

        CommentedEdward Ponderer

        A Thomas Guide was a great way to find your way around a lateral city drive. With GPS, this has become a much easier, and more updated process. But when you find yourself accelerating down an incline towards a cliff, precise right and left steering instructions to reach your destination are rather futile.

        We require homeostasis to "balance the car," and as in all nature this requires a fractal structure, with mutual concern/guarantee links throughout. This leads to a swarm intelligence-- "wisdom of the crowd" or "crowd-sourcing" in human terms of capability vastly beyond the ken of any oligarchy of lone leaders--even the wisest of the wise.

        What we need to work with is not worn-out first-order economic theories, but a living, breathing, global system of local micro-managers that know that the well-being of their neighbors on outward is the most critical factor in their own security and happiness.

        In short, we need to educate away from competition and into collaboration in conjunction with global integration.

        How long shall we suffer "same old, same old" approaches whose continuing failure, even contribution to the problem, stands as a vast empirical witness to our foolishness. We either follow the grain of nature, or continue to eat our own flesh.

    9. CommentedVal Samonis


      val samonis