The significant decline in public investment in some EU countries since the crisis may risk potential output....ECB

21 March 2016                         ECONOMIC BULLETIN

Public investment in Europe

See full Report Public investment in Europe

Since the crisis, public investment has fallen in a number of European countries, particularly those that came under market pressure.1 Low levels of public investment, if maintained over a prolonged period, may lead to a deterioration of public capital and diminish longer-term output. 

The fall in public investment and the current low interest rate environment have prompted calls to stimulate public investment spending as a way to increase short-term demand and raise potential output. In the European Union (EU), this has led to the adoption of the Investment Plan for Europe (2015). 

The fiscal positions of many EU countries remain precarious, however, and the provisions of the Stability and Growth Pact call for further fiscal consolidation in many of them. Using a model-based analysis, this article considers the circumstances under which additional public investment might best stimulate economic growth and what the impact on public finances would be.

Recent developments in public investment 

Both public and private investment have fallen in the years following the financial and sovereign debt crisis. After being stable at around 3% of GDP for more than a decade, public investment in the euro area started to increase in 2005, reaching 3.6% of GDP in 2009 (see Chart 1). In the years following the crisis, public investment reverted to a ratio below the pre-crisis average of 3% of GDP. For the EU as a whole, the public investment ratio follows a similar pattern, with a less pronounced post-crisis retrenchment. Developments in public investment in Europe mirror developments in the United States, albeit at a lower level. By contrast, the public investment-to-GDP ratio in Japan went into long-term decline followingthe high levels observed in the mid-1990s, although more recently it has started to pick up. 

Private sector investment in Europe declined during and after the crisis, and has not yet recovered, by contrast with developments in the United States and Japan (see Chart 2). While public investment data are subject to various limitations, in particular measurement issues (see Box 2), the recent developments observed in public investment are difficult to attribute to those limitations. For example, although the increased use of public-private partnerships (PPPs) and privatisations has been shifting parts of previously public investment to private investment since the 1970s, the decline in post-crisis public investment in the EU has been accompanied by a fall, not an increase, in private investment (see Charts 1 and 2).

Developments in public investment are very heterogeneous across countries in the EU. 

When comparing pre-crisis public investment, as a percentage of GDP, with the average over the past three years, three distinct groups of countries can be identified (see Chart 3). First, there have been large investment cuts in countries with substantial fiscal consolidation needs. The largest declines in public investment ratios took place in countries with initially high general government investment rates, which were in some cases related to pre-crisis booms, and in countries under market pressure. Most notably, public investment-to-GDP ratios fell in Croatia, Portugal, Greece, Spain, Cyprus and Ireland. Second, in countries with relatively low levels of general government investment in the years leading up to the crisis, public investment has neither declined much nor increased (Belgium, Germany and Austria). Third, public investment has increased in a number of eastern EU countries, in particular those that have benefited from the increasing use of cohesion funds after joining the EU (Latvia, Poland, Romania and Bulgaria).

As a ratio of government expenditure, developments in public investment have been even more heterogeneous across EU countries. 

When measured as a percentage of GDP (see Chart 3), the investment ratio is influenced by thenegative effect of the crisis on output growth. As a share of total public expenditure (see Chart 4), the decline in investment in countries under market pressure reflects the fact that government investment was used more intensively than other expenditure items as a consolidation instrument.

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