European support for economic stimulus through public investment

Governments around Europe, and particularly in the 18 members of the eurozone, are struggling to address the extraordinary weakness of aggregate demand which persists after several years of easy monetary policy and record low interest rates.

Output is static or falling in many countries and the European Central Bank seems powerless to arrange a further monetary stimulus.

When official interest rates hit zero, the conventional options have run out. There has been no spending response to the lower interest rates. Private investment in Europe is weak, down 20% and more from pre-crisis levels, so politicians have been seeking support at European level for a stimulus through public investment.

They found some backing in Strasbourg last week from the European Commission president Jean Claude Juncker, who announced a new fund designed to stimulate public investment across the EU. But the initiative contains some smoke and mirrors.

The Irish Times reported that €21bn would be available from EU resources, while RTÉ announced that €325bn was the figure. Now €21bn would be a pretty small sum (less than the loan losses at Anglo, for example) when spread across the EU’s 28 member states.

The €325bn comes about because the scheme involves the limited EU money being used to leverage a hoped-for €300bn-plus from private investors. The EU funds would take first losses, so the idea is to offer the comfort of limited guarantees against loss in the hope of enticing private money into debt-financed public projects.

The projects themselves have not been identified – a very large red flag.

The purpose of Juncker’s proposal is clear: most governments cannot borrow to fund public investment projects without breaking commitments to cut their budget deficits.

Using EU (and national government) guarantees to the private sector gets any resulting debt off the balance sheet and could permit the projects to go ahead inside EU budget guidelines.

There are two snags with this approach. The first is that hiding debt off the balance sheet does not make the debt go away. If there are national government guarantees, the debt will come back on balance sheet if things go wrong. Irish taxpayers will be familiar with the consequences of off-balance-sheet guarantees.

The second snag is the viability of the projects themselves. Whenever private money is enticed into projects on the basis that the downside risks are the government’s problem, there is the danger that normal commercial prudence goes out the window.

A committee of bureaucrats will vet the projects, and you may take reassurance from this arrangement if you wish. Some sound projects will doubtless be identified, but these would probably have gone ahead anyway with unguaranteed private finance. If there are genuinely new projects with a stimulatory effect, they could turn out to be the ones that nobody would have financed without the guarantees.

Juncker’s initiative should be seen as a weak and dangerous substitute for what the eurozone does not have, namely a coherent overall macroeconomic strategy.

The policy of low official interest rates from the ECB has simply not had the desired effect. Those governments, notably Germany, which could loosen fiscal policy are unwilling to do so while the struggling peripheral economies, as well as France and Italy, have excessive debts and continuing deficits.

If the eurozone was a proper monetary union with centralised macroeconomic policy, it would be pursuing a two-handed strategy right now, with low official interest rates but also a more relaxed budgetary policy. It is Europe’s misfortune that the system is really just a common currency area and not a proper monetary union.

In any event, what is lacking throughout the eurozone is not public investment, although there may be worthwhile projects needlessly deferred, but voluntary investment from the private sector unaided by guarantees or similar gimmicks.

European firms simply do not see strong enough demand and consequent requirements for investment in productive capacity. They will not see this any time soon if the best that Europe can come up with is the Juncker plan.

The situation in Ireland is thankfully a little brighter. The sharp decline in the value of the euro against the dollar and sterling is a big boost for Irish-based firms, much of whose business is with the UK and the US. The decline in oil and gas prices is a further boost to the European economy generally.

There will be a temptation for the Irish political system to seek out whatever crumbs may drop from the EU table as a result of this latest plan, but this is not a rerun of the Structural and Cohesion Funds back in the 1990s. These were grants, not loan guarantees. If there are dodgy projects pushed forward under the new scheme, they will end up as liabilities of the Irish Exchequer.