Investing in Europe’s physical and knowledge infrastructure
Europe would benefit from extra investment in both its physical and knowledge infrastructure – the two are necessities, not alternatives. But what are the political choices and impediments to an EU investment and growth agenda?
With Europe’s debt crisis receding for the moment and the economic numbers slowly ticking up, heads are beginning to lift up from bare-knuckle crisis management to look at what comes next. Some interesting new ideas are coming onto the table about how to use the current lull in the storm to act to make any recovery sustainable and re-equip Europe’s economy for the future. This essay examines recent proposals to shock Europe out of its torpor by embarking on a massive programme of infrastructure investment, financed by public and private capital. However, the essay argues that a better strategy would be to combine a well-targeted programme of capital spending with greater investment in human and social capital, along with smarter industrial policy to foster hi-tech firms in growth industries.
The attractions of ramping up infrastructure spending in a low-growth situation are obvious. By mobilising dormant private sector resources through public guarantees the European Commission and European Investment Bank (EIB) together could turbo-boost investment spending, which has flagged at both the EU and national level since the crisis. Depending on the sums involved and how well capital is deployed, a major investment programme could have two positive effects. First, the boost to activity would lift growth and employment across the continent. Second, investing in Europe’s creaking infrastructure could eventually pay for itself through raising total factor productivity (TFP).
Policy is already moving tentatively in this direction. Last year, the European Council launched a ‘Compact for Growth and Jobs’ comprising a range of interventionist policies. Economic Commissioner Olli Rehn declared in August that: ‘The current gap in private sector lending has to be bridged by other players.’ He pointed to a €10bn capital increase for the EIB, allowing it to increase lending by 40%, as an example of moves to unlock private capital currently frozen due to economic uncertainty. This will strengthen the EIB’s capital base and it is claimed that it will unlock up to €180bn of additional investment over the three years to 2015. The EIB is also cooperating with the European Commission over its 2020 Project Bond initiative. This will stimulate capital market financing for large-scale infrastructure projects in Trans-European Networks (TENs) in transport, energy and broadband telecoms by publicly underwriting the debt of the project company. However, the amount of seed- envisaged, a mere €230m, is currently pretty un-ambitious (though this is expected to be leveraged to more than €4bn).
The above initiatives are however nowhere near enough to satisfy calls for decisive action. Other groups are now stepping into the debate with their own schemes, behind which political coalitions may build in support.
A new ‘Marshall Plan’
The standard bearer of these is a proposal from the German trade union confederation, the Deutsche Gewerkschaftsbund (DGB), for nothing less than a new ‘Marshall Plan’ involving an: ‘economic stimulus, investment and development programme for Europe’. The DGB’s manifesto is for a ten-year, €260bn a year investment plan for the whole EU which uses private funding backed by public capital and could, it claims, provide a growth impetus of more than 3% of EU GDP (the entire EU budget is currently 1% of GDP).
The DGB identifies a huge pool of private capital - €27 trillion - standing idle for want of a productive outlet. By tapping private capital, the Marshall Plan gets around potential objections that it is suggesting that the answer to too much borrowing is more borrowing. Supply-side bottlenecks would also be tackled by expanding funding for training, R&D and transport. Re-equipping Europe’s households and businesses to meet EU emission reduction targets would absorb €150bn of the annual €260bn total. But the switch to energy efficiency could produce €300bn of savings on energy imports, according to calculations by the German Institute for Economic Research 1. The figures are certainly impressive, but will it work?
The Marshall Plan proposes setting up a ‘European Future Fund’, which would issue ‘New Deal’ bonds to investors. The interest on these bonds would be covered by revenue from the proposed Financial Transactions Tax (FTT) on currency and derivatives trading together with a proposed one-off wealth tax of around 3% on private assets.
The DGB’s plan envisages an annual issue of €180bn of New Deal bonds financed by profit on the investments as well as €75-100bn from the FTT. However some analysts2 dispute those projections, as EU modeling on which the DGB’s analysis rests questionably assumes no loss of growth or tax revenues arising from banks shifting their activities to avoid the FTT.
In July, the London School of Economics hosted a meeting of labour economists under the auspices of the LSE’s ‘New European Trade Unions Forum’. The meeting revealed considerable enthusiasm for the DGB’s scheme, but also some doubts. The elephant in the room in talks of a new ‘Marshall Plan’ is undoubtedly the DGB’s refusal to countenance financing investment spending through Eurobonds, an idea backed by many other European trade unions but emphatically opposed by the German government. This is unfortunate. Mutualising sovereign debt through a ‘tranche transfer’ to be held by the European Central Bank (ECB) as Eurobonds could help solve Europe’s under-investment problems as well as its debt crisis, argue some commentators, so long as these tranches are no longer counted towards the national debt of members states.
If this was combined with an easing of the strictures of the Stability and Growth Pact, so that national co-financing of EIB projects is exempted from debt calculations as well, and if ECB bonds were also permitted to co-finance EIB debt, then this could dramatically increase the amount of EIB funding available for capital spending on the TENs.
Increasing the size of the European Investment Bank
Simply acting to increase the size and leverage of EIB funding could have a similar effect. The Foundation for European Progressive Studies (FEPS), a Brussels-based thinktank, claims even a modest increase in the equity base of the EIB, of say €12bn, could pay huge dividends if leveraged further through the EU stepping in to provide extra risk buffers for EIB lending. Combined with a redirection of unspent Structural funds (€15bn a year), FEPS estimates that its proposal could increase investment in the EU by between 0.25% and 0.33% of GDP, enough to create 1.2m jobs. If this stimulus was combined with national investment plans currently underway in many countries, and if austerity-driven caps on current spending could be relaxed as the immediate fiscal crisis recedes, then Europe could be set for a sizeable Keynesian boost as it emerges from recession.
Betting the house on infrastructure spend?
But just how effective is infrastructure spending at stimulating economic growth? Most of the infrastructure/growth plans assume a fairly large fiscal multiplier. The justification for this optimism is that much of the investment would be targeted towards employment-rich sectors, like construction, with a correspondingly large impact on consumption and tax revenues. Given the extent of under-investment since the onset of the crisis this seems plausible. The academic literature on the macro-economic effects of infrastructure spending mostly shows a positive impact on growth.
However, some recent studies using new econometric techniques show a smaller (although still positive) impact than has previously been assumed3. One OECD paper claimed that approximately 20% of investments in transport, electricity grids and telecoms networks between 1960 and 2005 produced fewer net benefits than the initial spending4. The big conundrum for policymakers is that infrastructure spending is complementary to other types of investment. In the policy’s favor, inadequate infrastructure undoubtedly constrains other investment and stifles competitiveness. But the flipside of this is that excessive spending on infrastructure has no added value, so badly-directed investment imposes an opportunity cost on the rest of economy by starving other areas of funding, constraining growth5.
Warnings abound of Japan’s fruitless efforts to kick-start growth in the 1990s through costly and unproductive infrastructure construction. Of course, thorough cost-benefit analysis by independent experts ought to enable the authorities to sift between productive investments and panic-driven white elephants. But there is, nevertheless, a clear warning here about keeping politics, especially the need to be seen to ‘do something’, out of economic decision-making. The OECD cautions that before investing in new capacity it is important to ensure that best use is made of existing capacity6. Less is often more, in other words.
On the surface there appears to be little danger of this, as promising-looking projects abound. For example, the World Economic Forum estimates that upgrading the fixed and mobile telecoms infrastructure in the EU15 to give near universal access to high speed internet could cost between €250bn €320bn7. Perhaps surprisingly, parts of the rich north are as much in need of investment as the indebted south. The flipside of Germany’s huge current account surpluses has been a paucity of spending at home, with the country’s physical infrastructure being much neglected. Germany’s KfW public investment bank estimates that municipal investment in fixed assets per capita has fallen by 35 % since 1992 8.
Furthermore, Europe already possesses the ideal institutional vehicle to select, fund and project-manage the schemes – the EIB. The EIB has already drawn up an extensive ‘hit list’ of viable infrastructure projects as part of its contribution towards Europe’s 2020 Agenda. Areas earmarked for attention include support for the Knowledge Economy, transport, energy and health9. The EIB has years of hands-on experience, a good track record of delivery and is largely apolitical. But could it be pumped up to become the investment juggernaut envisaged without sacrificing focus? There is an inevitable danger that project quality would be sacrificed for quantity as it attempted to disburse the huge quantities of funding proposed. Among the EIB’s many virtues are its simple decision-making structures. It rigorously assesses projects on an Economic Rate of Return basis, meaning that it will not back anything deemed unlikely to contribute to growth10. But a vast Marshall Plan-type undertaking would entail an infinitely more complex and politicized set of considerations.
PWC, the consultancy firm which advises governments on infrastructure planning, recommends setting up a cross-national ‘economic infrastructure plan’ for large, multi-project investment programmes in place of case by case evaluation11. Drawing up such a plan on an EU-wide scale implies significant political input to address the inevitable tradeoffs. Would the Germans and Dutch be willing to provide yet more subsidies to southern nations to help them to compete with them more effectively? How would the Greeks and Portuguese feel about a ‘rescue plan’ that diverted scarce money to repairing German autobahns? These problems are not insurmountable, but it’s unrealistic to expect the EIB to resolve them on its own.
There are also question marks over the absorption capacity of European countries, with many national investment plans struggling to get off the ground, for example the Regional Growth Fund in the UK. Draw-down of European Structural Funding has been slow since 2007 and up to 25% of Regional Funds are not even allocated, by some estimates.
The case for social investment
A final, nagging doubt remains. What exactly is a front-loaded stimulus in infrastructure supposed to achieve?
It appears to aim at simultaneously tackling a number of problems that are related but not necessarily complementary over the immediate time period. Its broad objective is to kick-start growth in short order through a Keynesian investment boost. But many of its detailed proposals entail initial costs that might boost productivity over the long run, but with little positive short term effect. Investment spending can certainly boost growth, but often with a long time-lag. With Europe’s economies now emerging from recession, the plan could eventually be an expensive solution to a problem (a deficit of demand) that has changed or no longer exists.
At the very least, any infrastructure plan should be combined with a social investment strategy to ensure that improvements in human capital keep pace with assumed jobs growth. The EU’s Lisbon Strategy implicitly assumes this (although its 2020 Agenda is less emphatic), and new economic and fiscal coordination measures designed to tackle the economic crisis have created mechanisms to further employment and social policy coordination as well. The need for action to improve skills and access to jobs is so important as to almost go without saying. But the potential contribution to economic recovery of a strategy to reduce uncertainty and improve social resilience should also not be overlooked12.
Given its scale and ambition, the Marshall Plan also implies a move to an EU-wide industrial policy. In fact, a well-resourced, activist industrial policy, with a focus on training, R&D and targeted help for new growth industries in commercialising new technology, could be a better long-term bet than a splurge on infrastructure spending alone. One of the things keeping policymakers up at night is the fear that Europe’s recovery, when it eventually comes, will involve settling into a low-growth, high unemployment equilibrium as old industries limp on and new ones struggle to be born. Accordingly, many analysts believe Schumpeter, not Keynes, holds the answer to Europe’s growth problem. Rather than pouring money into physical infrastructure, perhaps it is Europe’s knowledge infrastructure that needs supercharging, as a recent Policy Network paper argued’13.
The EU has already committed to foster specialisation in hi-tech industries as part of its Lisbon Agenda and 2020 Strategy and, to be fair, the DGB also calls for substantial extra investment in skills and training to achieve these goals alongside its call for infrastructure spending. However, one key problem with an EU-wide industrial strategy has always been the difficulty of designing policies to suit countries with different industrial bases displaying diverse patterns of comparative advantage. Existing policies therefore tend to be limited to horizontal, sector-neutral interventions to harmonise tax and regulatory environments. In any case, going beyond this is generally derided as ‘picking winners’ and therefore doomed to failure. But many analysts now argue that industrial policy can be effective if targeted at industries that are already innovative and productive but perhaps need some encouragement to refocus onto higher-growth market sectors, so long as these are accompanied by tough competition rules to prevent rent-seeking 14.
European policymakers need to get much more adventurous about providing active support for R&D in knowledge-intensive, future growth sectors, while also investing in building capacities for the transfer of this knowledge to private industry. Support for basic R&D is obviously necessary, but of equal importance is how the knowledge that is produced is disseminated and used. Innovation in modern industry increasingly requires linking technologies that are very different. But companies are only able to do this if they possess reciprocal knowledge of one another, which is difficult if they are geographically dispersed. One suggestion is that the EU could help this along by creating applied technology networks – ‘European Centres of Innovation and Research’ - to house researchers from across European countries and industries15.
Access to finance is also an area where market failures exist that the EU could usefully tackle. Mariana Mazzucato argues that governments need to go far beyond the provision of basic R&D, as the private sector may still be too risk-averse to exploit promising new technologies even when these are handed to them on a plate. Mazzucato claims that, in the USA, government programmes have provided 20–25 per cent of total funding for early stage technology firms. Similar schemes should be set up in Europe, beginning with a large increase in funding for the European Investment Fund, which already has a good track record in supporting start-ups and encouraging innovation.
Getting value for money
Ultimately, Europe will benefit from extra investment in both its physical and knowledge infrastructure – the two are necessities, not alternatives. But, while the former addresses past under-investment, the latter goes even further by ensuring that Europe’s future economic path will be one of sustainable growth and skilled jobs. Focusing on improving TFP through active industrial policy to foster the new generation of highly-innovative companies will take longer to realise, and could be slower to impact the unemployment figures than ramping up infrastructure spending, but it is perhaps a sounder use of scarce money.
Steve Coulter teaches political economy at the European Institute at the London School of Economics, and coordinates the LSE’s New European Trade Union Forum, linking European unions with academia
1 DIW Weekly Report no.25/2012.
2 ‘What would be the economic impact of the proposed Financial Transactions Tax on the EU? Review of the European Commission’s Economic Impact Assessment.’ Oxera Consulting. 2011.
3 Calderón, C., Moral-Benito, E. and Servén, L. (2011) ‘Is Infrastructure Capital Productive? A Dynamic Heterogeneous Approach.’ Policy Research Working Paper 5682, World Bank, Washington, DC.
4 Égert, B., T. Kozluk and D. Sutherland. Infrastructure and Growth: Empirical Evidence. OECD Economics Department Working Papers 685. 2009.
5 Newbery, D. (2005) Infrastructure Pricing and Finance, in HM Treasury ‘Microeconomics Lecture Series, May 2004-June 2005’, pp.22-39.
6 ‘Infrastructure Investment. Links to Growth and the role of Public Policies.’ (2009). OECD Economics Department Working Papers No. 686.
7 ‘The Global Information Technology Report 2013’. World Economic Forum.
8 ‘Investing for the Future.’ KfW Economic Research. No. 21, May 2013.
9 ‘Increasing lending to the Economy: Implementing the EIB Capital Increase and joint-Commission EIB Initiatives.’ Joint Commission-EIB Report to the European Council, 27-28 June 2013.
10 ‘The Economic Appraisal of Investment Projects at the EIB’. European Investment Bank. March 2013.
11 ‘Strategic Infrastructure – steps to Prioritize and Deliver Infrastructure Effectively and Efficiently.’ PWC
12 ‘The EU needs a Social Investment Pact.’ Vandenbroucke et al. (2011). Observatoire Social Européen. Opinion Paper 5/2011.
13 ‘Prospering through Innovation Economics’. Robert D. Atkinson. Policy Network 16th April 2013.
14 ‘Rethinking Industrial Policy.’ Aghion et al. Bruegel Policy brief. 2011/04.
15‘In Support of European Centres of Innovation and Industry.’ European Issues Policy Paper no. 230/2012. Robert Schuman Foundation.