Under-investment across Europe: soon to be history?

This year has seen a degree of consolidation of economic recovery in the EU, with most of its member states returning to growth. But recovery is very sluggish, and by the end of last year, as many as a dozen EU countries had still not recovered the nominal GDP levels they achieved in 2007. More worrying still, Europe’s long-term growth potential is in decline, and for many member states it is already at extremely low levels. For two decades, investment has been too weak, and much of it arguably went to the wrong sectors. This has undermined productivity, hampering growth and putting Europe’s competitiveness at risk. The Investment Plan for Europe championed by Jean-Claude Juncker’s Commission, and the crucial role to be played by the European Investment Bank (EIB), will be critical in the long-term effort to turn this around.

Gross fixed capital formation in the EU remains weak in relation to GDP levels. Low levels of investment in housing and infrastructure still weighs heavily on overall investment figures, and public investment, particularly in the more vulnerable member states and cohesion countries continues to fall. Since 2011, investment has been held back by weak demand, the lack of investor confidence and a climate of uncertainty. Europe’s banks appear reluctant to expand their lending to the real economy, and public investment has become pro-cyclical since the sovereign debt crisis, with both public investment and infrastructure investment hit by many governments’ fiscal consolidation.

This depressed investment scenario is not only a consequence of the crisis. Investment in productive fixed capital has been consistently lower than in, say, the U.S. or Japan. And Europe is also far from meeting its R&D investment targets, lagging well behind its main competitors. At the same time, there are critical shortcomings in Europe’s infrastructure, especially in energy, transport and digital networks.

It’s worth comparing Europe’s investment levels with estimates of what’s needed to meet the EU’s own targets. The following figures give an indication of the scale of the investment challenge:

• • €130bn is needed to reach the EU target for R&D expenditure as a percentage of GDP;

• • €100bn will be the cost of upgrading Europe’s energy networks for renewables, energy efficiency and security of supply;

• • €50bn is needed to upgrade transport networks to reduce congestion costs and trade bottlenecks;

• • €55bn is the price tag for reaching the EU’s Digital Agenda standards in broadband and data centre capacity;

• • €100bn would be the cost of attaining U.S. standards for education facilities, mostly in higher education;

• • €90bn to modernise European industries and allow them to exploit the benefits of innovation;

• • €90bn to rehabilitate environmental services and ensure water security in the face of climate change.

On top of this €600bn-plus investment shortfall, the European economy also suffers from its relative inefficiency in the reallocation of financial and human resources to growth opportunities, including to innovative start-ups and SMEs with high productivity and growth potential. These market failures include a lack of equity-based financing such as venture capital adapted to the needs of innovative start-ups and growth-stage smaller companies, as well as less flexible institutions. On top of that, the EU’s fragmented internal market, including its labour markets, that makes it harder for fast-growing companies to get the high-skilled labour they need.

Creating a dynamic economy is critical if Europe is to compete in the increasingly open world marketplace. We need innovation to be at the technological frontier and investment to integrate innovations and so create an economy that responds rapidly to growth opportunities. Public intervention can create the right environment for investment and innovation: it should promote a dynamic process of renewal, with sector-level policy targeting innovation spin-offs and synergies without distorting the market.

Juncker’s Investment Plan for Europe is a key EU-level policy tool, designed to give a firm push to competitiveness-enhancing strategic investment. It complements the stimulus already coming from lower oil prices and the euro’s weaker exchange rate following the ECB’s quantitative easing. Like all EIB operations, projects will be selected on merit rather than with regard to any national interests, so it is more than a short-term stimulus to demand. It complements the wider European structural reform process and should have a positive impact on private sector investment levels.

The role of the EIB as one of the European institutions is to create incentives that can encourage partners to commit to crucial investment projects in the EU. By leveraging its AAA status, the EIB raises funds on the international capital market and is able to pass on favourable borrowing conditions to clients. It supports projects that promote growth and jobs focusing particularly on priority areas like innovation, finance for smaller businesses, climate action and strategic infrastructure. Last year, the EIB’s lending volume of €70bn contributed to projects for which total investment amounted to €241bn.

The vehicle for the “Juncker Plan” is the new European Fund for Strategic Investments (EFSI), which aims to mobilise €315bn over three years. The EFSI will enhance the EIB’s capacity and it is funded with €16bn in guarantees from the EU budget and €5bn from the EIB’s own funds. The plan is that these additional resources will allow the EIB and the European Investment Fund (EIF) both to expand their lending activities and attract substantial external co-financing.

Back in 2012, the EU’s member states agreed to increase the EIB’s paid-in capital by €10bn, and the EIB committed to increase its lending by €60bn over three years and thus mobilise total investments of €180bn as a response to the economic crisis. The EIB has in fact met that target ahead of schedule, and estimate the investments that can now be supported by the EFSI, a conservative ratio of 15 has been used. In other words, €21bn will enable around €315bn of investment in the coming years.

The important thing is that the new fund will target sectors of structural importance for Europe’s competitiveness and long-term growth. That means strategic digital projects, and transport and energy sector investments. It also includes investments in education and training, research and innovation. The EFSI will help generate investment of around €100bn each year, or an additional 12% of ongoing investment in those areas.

The EFSI will at the same time avoid the tendency of some public interventions to try to “pick winners”. It will instead provide vertical support to key sectors in ways that enhance competition and create innovation and productivity incentives. All projects will have to pass a rigid test that they are commercially sound, economically and technically viable, and have a clear added value for the EU. They will be assessed, too, for their capacity to bring in private investors, including National Promotional Banks.

The EFSI will complement the EIB group’s existing activities by taking on part of the risks of investment and helping to increase the incentives for project promoters to invest. Because there is abundant liquidity in the market, the projects supported in this way will be able to attract substantial additional funding. What is important from a political perspective is that the EFSI can be seen as a way of using EU funds better; instead of giving out grants and subsidies, it will provide guarantees and loans to leverage private investment.

Much has been written and said about the Investment Plan, and it’s now widely seen as being of critical importance. It puts competitiveness-enhancing investments at the top of the agenda and gives new impetus for structural reforms at the European level to deepen the integration of the single market, especially in the areas of financial and energy markets. It will give a significant push to projects at the national level following years of under-investment across Europe.