- By Chris Kremidas Courtney
Linda Yueh is Adjunct Professor of Economics at London Business School, and Fellow at St Edmund Hall, Oxford University
The European Fund for Strategic Investments (EFSI), commonly referred to as the Juncker Plan, is off to a good start, stimulating pledges from not only European but also non-EU countries like China.
The plan is to raise a considerable sum of €315bn over three years by working with the European Investment Bank (EIB), which will issue bonds to finance projects that develop energy and other infrastructure projects, as well as improve funding for SMEs. This is indeed the right way to leverage a relatively small sum into an ambitious pool of money. In detail, the EU has itself invested €8bn on top of an existing €8bn budget as well as a further €5bn put in by the EIB. The top AAA-rated EIB can then issue bonds, taking advantage of record-low interest rates, to leverage the initial €21bn into a fund large enough to make a difference in jump-starting European growth.
The EFSI ambitiously seeks to encourage private companies to make the investment, thereby largely reducing the impact of the plan on government fiscal positions. But that means a reliance on public-private partnerships, which have a mixed record when it comes to maintaining long-term infrastructure projects such as railways. Nevertheless, the debate over whether governments should be borrowing so as to invest is a separate one.
The EFSI means a reliance on public-private partnerships, which have a mixed record on long-term infrastructure projects
The focus on investment, with the usual caveats, should be welcome in Europe. After all, it’s well established that rich countries could use a rejuvenation of their infrastructure. During the last recession, it was public investment that was slashed as a part of austerity programmes, bringing large hits to infrastructure. Investment in the eurozone is still around 15% below its pre-crisis level. Yet ratings agency S&P have estimated that a 1%-of-GDP increase in government spending on infrastructure would translate into a bigger bang, increasing the eurozone economy by 1.4%. Their estimate is even bigger for rich countries like Britain, where GDP would expand by 2.5%. The OECD goes further to stress that increases in public investment would boost economic growth and thus cut government debt. So why has it been so difficult to raise investment since the crisis?
The main constraint has been the imposition of fiscal austerity by governments that have been too focused on the budget deficit. It’s only in the very recent past that economic growth has come back into focus. That largely explains the public side, but private investment has also dropped sharply since the recession. German companies, for instance, have doubled their retained cash in the past decade, and others have followed suit. The puzzle as to why these companies don’t invest is key to understanding how one of the pillars of growth hasn’t delivered during the recovery.
Government and consumer spending were hit hard and slow to recover, leaving deficient demand, both public and private, that hasn’t given companies the impetus to invest. The sharpness and the duration of the Great Recession also created uncertainty over whether or not to commit funds for investment stretching well into the future. European economies are now largely back on their feet. And the recent focus on growth not just by the European Commission but also national governments offers more opportunity. The opening up of strategic sectors like energy to private investors could offer stable returns at a time when it’s challenging to put your money to work.
The low returns of the post-crisis environment affected infrastructure investments because there were other, more enticing, places to put your cash. Stocks, for instance, were pushed to sky-high levels by cheap money and zero interest rates across major markets such as Germany’s Dax. But global stock markets are now deflating from their heady heights while interest rates are still rock bottom in Europe, so fixed income investments continue to generate low returns.
Investing in roads or energy doesn’t reward a high return though does tend to be stable
And there’s now an uncertainty from the divergence between the tightening, or normalisation, of rates in America while the European Central Bank continues to inject cheap cash and has even set negative deposit rates for the banking system. This makes an investment with fixed returns, such as in infrastructure, relatively more attractive. Traditionally, investing in roads or energy doesn’t reward a high return though does tend to be stable. Usually set by regulators, yields from infrastructure such as utilities and toll roads range from 3-4%. In the current low-rate environment, that’s not a bad return.
Indeed, BlackRock estimates that insurers are putting 15% of their investment portfolios, double the pre-crisis figure, into infrastructure. And they’re not the only ones. Chinese businesses have also recently invested in European utilities such as water for a predictable long-term return. There are, then, good reasons to have confidence in the Juncker Plan. Aside from China, other countries such as those in the Middle East as well as private companies sitting on cash may well consider putting some of their funds into Europe.
There’s no shortage of projects being proposed by EU member states for investors to choose from. The potential gains from the investment may well outweigh the downsides of public-private partnerships at present. Another upside is how much the European economy could be boosted by greater investment. Growth in the world’s largest economic entity would undoubtedly be welcome to the rest of the world.
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