European politicians place a lot of hope in public investments despite the fact that such investments only form a negligible part of the GDP and are less effective than private investments. Apart from the project of the bank union, there are no reforms which would open a perspective for increased profitability of investment and job creation in Europe. What will be the benefits of increased infrastructural investments for entrepreneurs in transport and industry if the European Commission does not oppose growing protectionist trends?
Some politicians and economists express the view that state investment should compensate for the weak investment demand on the part of private companies. According to them, increased spending on infrastructure, energy or connection networks will stimulate private investments, which will result in a significant upturn for European economy. Such as scenario is possible, but not very likely, particularly in a macroeconomic scale. Juncker’s project is more likely not to have an impact on the long-term growth rate of European economies. Such a prognosis is supported by some important arguments.
Firstly, public investment cannot substitute an improvement in institutions and regulations, which have an impact on the functioning of the markets. Such improvement is a far less undertaking as far as attracting media attention is concerned, but in the long run it is far more important than, say, whether Poland gets 2 bln or 0.2 bln PLN thanks to Juncker’s initiative.
This argument pertains not only to national economies, but to the single EU market as well. Sadly, despite the announcement of further liberalization of this market by the European Commission, some state take unilateral protectionist action. The most egregious example is the case of minimum wage regulations in Germany, which Berlin wants to impose on drivers employed by companies from other countries. The EC is still investigating whether the regulation is in accordance with EU laws, but this does not stop the French government from announcing similar plans.
One should not expect that at a time of regulative and political uncertainty transport an d logistics companies will be eager to invest. This applies also to companies from Germany and France, for whom such legislation means increased costs of productions and sales – because of transport costs. As a result, the long-term investment spending multiplier (GDP growth caused by increased investments) might be close to zero or even negative if irrelevant projects engage labour and capital resources.
Losses caused by EU regulations (a lower GDP than could be achieved otherwise) will certainly not be compensated for by the European Fund for Strategic Investments (EFIS) which will have a starting capital of 21 bln euro and is intended to provide financing with 315 bln euro (including private capital). The improvement of conditions for entrepreneurship in Europe may also be a factor in investors decision on whether or not to locate funds in the EFIS.
Secondly, public investment do not always have the desired impact on economic growth. If in some cases this impact is significantly higher than zero, it is still much lower compared to project in the private sector. The differences in profitability between public and private investments are widely discussed in economic literature – the decisive argument is the impossibility of an effective socialist economy.
Chart 1. Estimated increase in GDP growth (in percentage points) as a result of an increase of 1 percent GDP in private and public investments respectively, 1960-2005
Source: Own elaboration based on: A. Afonso, M. St. Aubyn, Macroeconomic Rates of Return of Public and Private Investment. Crowding-in and Crowding-out Effects, EBC 2008
According to EBC economists*, a 1 percent of GDP increase in private investment translated to an average of 0.27 percentage points of additional GDP growth in 1960-2005 (based on an unweighted mean for 17 developed economies). In the case of public investment, the average long-term impact was estimated on as little as 0.02 percentage points of additional GDP growth, which is a marginal value.
Officials selecting projects sent by entities from particular countries will have the decisive vote in the EFIS, though the investments will be partially financed by private capital. Thus, a great space for “political bargaining” will be created. This casts serious doubts over the criteria of investment selection, as well as the execution and subsequent monitoring of investments.
Thirdly, there is no consensus among economists as to the direction of the causal relationship between increased public investments and GDP growth. Some use data to argue that it is the growing economy that makes it possible for more public investments to be financed, and not – as EU politicians assume – the public investments are the driving force. This stems for the fact that wealthier states and regions spend a greater part of their GDP on investments and public services and that this spending is higher in times of good economic climate. Social spending are fixed and reducing them is costly in political terms, so when budget income drops, politicians often start spending cuts with public investments.
To sum up: even if 315 bln euro for investments in Europe in indeed gathered, it will not guarantee success. The above sum is only the costs of investments, the results of which are highly uncertain and a thing of the distant future. The expansive policy of EBC, which is artificially lowering interest rates and thus interfering with rational market pricing of long-term investments, is another risk factor.
Damian Olko, expert of the Research and Analysis Centre of Employers of Poland
* A. Afonso, M. St. Aubyn, Macroeconomic Rates of Return of Public and Private Investment. Crowding-in and Crowding-out Effects, Working Paper Series, Nr. 864, EBC 2008