The EU needs supply-side reform
Sadly, many of the projections as to the impact of the Plan are based on optimistic assumptions. For a start, it is far from certain that the Commission will be able to summon the much-repeated sum of €315 billion. This is because the bulk of the funds is expected to come from private investors, with direct contributions from the Commission and the European Investment Bank (EIB) amounting to just €21 billion. In other words, the Commission aims to leverage EU funds on a 15:1 ratio through loans and guarantees that will reduce investment risk and thus encourage private financing that otherwise would not happen.
However, what guarantees that investors will take the bait? As policy-makers have often highlighted, there is an investment shortfall of about €400 billion in the EU compared to pre-crisis levels. But this is due to myriad factors of which the risk associated with investment in particular projects is only one. Others include continued weakness in many European economies, a dearth of bank financing and, notably, equity financing for EU businesses, as well as the simple fact that some investments made before 2007 were spurred by cheap credit and unsustainable construction booms in countries like Spain and Ireland. Thus, reducing risk as the Juncker Plan seeks to do can at best be expected to have a moderate impact on the EU’s investment shortfall.
Now, to the forecast benefits of the Plan. The ILO report looks at a variety of scenarios. To their credit, they include a conservative scenario that acknowledges the difficulty of getting private investors on board. In this scenario, the Investment Plan would amount to €63 billion, that is, the amount of loans that the EIB would be able to make without private contributions. According to the ILO, this scenario would result in 430,000 additional jobs across the EU.
They then go on to project expected job gains given the full amount of the Plan: with €315 billion in public and private financing distributed according to EU countries’ GDP, 1.8 million jobs would be generated. Finally, Scenario 3 looks at the expected employment impact if funds were allocated according to a mixed GDP and unemployment criterion, that is, countries with greater-than-average joblessness would have access to a greater proportion of available funds. It is in this scenario that the headline figure of 2.1 million new jobs comes about.
It is worth pointing out that the predicted job gains as a result of the Investment Plan are a short-term burst rather than a long-term shift upwards in EU employment. Even by the ILO’s own calculations, job growth levels off in 2018 before beginning to converge with the baseline.
At any rate, the trouble with the ILO’s forecasting is that neither GDP nor unemployment are optimal investment criteria. Instead, investors decide where to put their money according to perceived risk, expected profitability, the volume of resources needed, the availability of debt financing, etc. Using GDP or unemployment to decide where to allocate funds is bound to lead to suboptimal investment, and possibly very bad results given that high unemployment suggests adverse economic conditions and therefore increased risk.
Shockingly, the report spends a lot of time highlighting the potential upside in employment and even reduced debt-to-GDP ratios across the EU, but little to none on the downside. One might even be led to believe that the Juncker Plan amounts to a free lunch: all benefits and no costs. But there is no such thing. Aside from the fact that public spending would, at least to some extent, lead to a crowding out of private investment, what happens if some of the projects financed by the Plan fail? Given that all or part of each project would be guaranteed by EU and EIB funds, and given that EU member states fund the EU budget and provide the EIB’s capital in varying proportions, there can be little doubt: European taxpayers will be picking up the tab.
This is also why national governments have been reluctant to promise additional contributions to the Plan, despite strong encouragement by the Commission, which has promised to exclude said contributions from its calculation of national budget deficits. But even if the Commission turns a blind eye to it, any supplemental funding from member states will weigh on their public finances and be subject to potential losses if investment projects turn sour. Moreover, national government involvement would increase the likelihood of member-state meddling in project financing decisions, potentially leading to a repeat of mistakes made during the boom such as with Spain’s infamous ghost airports.
What is the conclusion from all of this? Is it that policy-makers at EU and member-state levels can do nothing to try and spur productive investment across the Union? Not at all. But rather than spending most of their time squabbling over grandiose demand-side schemes that could hurt taxpayers without having a long-term impact on EU unemployment, they should turn their sights to the supply side.
Across-the-board deregulation and liberalisation are much more likely to unlock high levels of private investment across the EU. At member-state level, governments should tear down regulatory barriers that are hampering growth, from the UK’s onerous planning laws to restrictions on cross-border energy trade between Spain and France.
At EU level, policy-makers must reconsider recent legislation that, while well-intentioned, could have severely negative effects on investment finance. This includes financial market regulations such as Solvency II, which will increase capital requirements for insurers and reinsurers from 2016, potentially curtailing their function as fundamental equity providers for European companies. Crucially, the Financial Transactions Tax (FTT) under negotiation by eleven member states must be scrapped, as it will make bank financing harder to come by in an already unfavourable environment.
When it comes to economic policy in Europe, the right hand needs to know what the left hand is doing: supply-side regulations cannot be allowed to contradict the purpose of demand-side initiatives like the Investment Plan, especially when the former are much more likely than the latter to have a long-standing positive impact. To boost investment and jobs, deregulation is the way to go.
This article was originally published by CapX.