Financing Investment in Times of High Public Debt: 2023 European Public Investment Outlook

CERNIGLIA, FLORIANA MARGHERITA (Ed.); Saraceno, Francesco (Ed.); Watt, Andrew (Ed.) Book Financing Investment in Times of High Public Debt: 2023 European Public Investment Outlook Provided in Cooperation with: Open Book Publishers Suggested Citation: CERNIGLIA, FLORIANA MARGHERITA (Ed.); Saraceno, Francesco (Ed.); Watt, Andrew (Ed.) (2023) : Financing Investment in Times of High Public Debt: 2023 European Public Investment Outlook, ISBN 9781805112006, Open Book Publishers, Cambridge, https://doi.org/10.11647/OBP.0386 This Version is available at: https://hdl.handle.net/10419/290586 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc/4.0/ FINANCING INVESTMENT IN TIMES OF HIGH PUBLIC DEBT Financing Investment in Times of High Public Debt 2023 European Public Investment Outlook Edited by Floriana Cerniglia, Francesco Saraceno, and Andrew Watt https://www.openbookpublishers.com ©2023 Floriana Cerniglia, Francesco Saraceno, and Andrew Watt (eds). Copyright of individual chapters is maintained by the chapters’ authors. This work is licensed under a Creative Commons Attribution 4.0 International license (CC BY-NC 4.0). This license allows you to share, copy, distribute and transmit the text; to adapt the text and to make commercial use of the text providing attribution is made to the authors (but not in any way that suggests that they endorse you or your use of the work). Attribution should include the following information: Floriana Cerniglia, Francesco Saraceno, Andrew Watt (eds), Financing Investment in Times of High Public Debt: 2023 European Public Investment Outlook. Cambridge, UK: Open book Publishers, 2023, https://doi.org/10.11647/OBP.0386 Further details about CC BY-NC licenses are available at https://creativecommons.org/licenses/by-nc/4.0/ All external links were active at the time of publication unless otherwise stated and have been archived via the Internet Archive Wayback Machine at https://archive.org/web Any digital material and resources associated with this volume may be available at https://doi.org/10.11647/OBP.0386#resources Every effort has been made to identify and contact copyright holders and any omission or error will be corrected if notification is made to the publisher. ISBN Paperback: 978-1-80511-200-6 ISBN Hardback: 978-1-80511-201-3 ISBN PDF: 978-1-80511-202-0 ISBN ebook (EPUB): 978-1-80511-203-7 ISBN XML: 978-1-80511-204-4 ISBN HTML: 978-1-80511-205-1 DOI: 10.11647/OBP.0386 Cover image: Photo by Mika Baumeister on Unsplash Cover design: Jeevanjot Kaur Nagpal Contents Acknowledgements xi Preface xiii Franco Bassanini, Sebastian Dullien, Alberto Quadrio Curzio, and Xavier Ragot Introduction 1 Floriana Cerniglia, Francesco Saraceno and Andrew Watt References 11 PART I. State of the Art 13 1. Europe 15 Andrea Brasili, Atanas Kolev, Debora Revoltella, Jochen Schanz, and Annamaria Tueske 1.1. Public Investment, Current Dynamics, and Plans 15 1.2 Public Investment in Europe: The Most Recent Data 16 1.3 Projections of Public Investment and Capital Transfers in Member States’ Stability and Convergence Programmes 18 1.3.1 Projections of Public Investment in Member States’ Stability and Convergence Programmes 19 1.3.2 The Role of Capital Transfers and Investment Grants 20 1.4 The Role of the Recovery and Resilience Facility (RRF) 21 1.5 Is the Old Framework ‘Biting’ with Respect to Plans? Will Member States Diminish their Investment Attitude? 24 1.5.1 Interest Expenditures are Projected to Rise Slightly 24 1.5.2 General Government Deficits are Projected to Decline 25 1.5.3 The evolution of fiscal stance: changes in the structural primary balance 25 1.6 Congestions and Bottlenecks in Public Investment in EU 26 1.7 Concluding Remarks 33 References 34 2. Financing Public Investment in France 35 Mathieu Plane and Francesco Saraceno 2.1 The Historical Evolution of Public Investment 35 2.2 The Public-Investment Dynamics since the COVID Crisis 36 vi Financing Investment in Times of High Public Debt 2.3 Net Investment Increases but the Pace of Public-Capital Accumulation is Still Low 38 2.4 General Government Net Wealth: Still Positive but a Strong Decrease Since 2008 39 2.5 Savings and Investment Financing: The Large Gap Between the Central Government and Local Authorities 42 2.6 How is Public Investment Financed in France? 43 2.6.1 Who Does What? 43 2.6.2 Co-financing is Becoming the Norm 44 2.7 Is French Public Debt Sustainable? 45 References 50 3. Germany Lacks Political Will to Finance Needed Public-Investment Boost 51 Katja Rietzler, Andrew Watt, and Ekaterina Juergens 3.1 Situation and Recent Developments 51 3.2 What Does the German Population Expect? Results from an IMK Survey 53 3.3 Financing Government Investment Spending 57 3.3.1 General Overview 57 3.3.2 Fiscal Situation of the Federal Government 59 3.3.3 Fiscal Situation of the Federal States 62 3.3.4 Fiscal Situation of Local Government 63 3.4 What has Been Achieved under the German RRF Plan? 64 3.5 Outlook 66 References 67 4. Italy’s Public Investments. The NRRP and Beyond 69 Giovanni Barbieri, Floriana Cerniglia, Enzo Dia 4.1 Introduction 69 4.2 Italy’s NRRP 71 4.3 Challenges of the NRRP 76 4.4 Italian Public Finance: Public Investment Beyond the NRRP 79 References 82 5. Public Investment, Deficit and Public Debt in Spain, 1995–2022 85 Francisco Pérez and Eva Benages 5.1 Introduction 85 5.2 The Trajectory of Public Investment in Spain, 1995–2022 86 5.3 From Investment to Capital Accumulation 88 5.4 Investment and Public Deficit Financing 90 5.5 Conclusions 95 References 97 vii Contents PART II. Challenges 99 6. Escaping Fragmentation and Secular Stagnation. The EU Policy Mix and Investment Financing 101 Pier Carlo Padoan 6.1 Introduction 101 6.2 Phases of European Growth 102 6.3 Secular Stagnation and the Growth Environment 105 6.4 The NGEU Policy Response 106 6.4.1 Public Investment 107 6.4.2 Structural Reforms 108 6.4.3 Financing Needs and the Role of Private Investment 109 6.5 Summary and Conclusions 110 References 112 7. From Crisis to Crisis, Can Europe Count on National Promotional Banks as Silver Bullets? 113 Laurent Zylberberg 7.1 Introduction 113 7.2 A Particularly Difficult Economic Environment for the European Union 114 7.2.1 Europe has been Facing Increasing Investment Needs for Many Years. 114 7.2.2 These Needs are Part of Successive and Sometimes Simultaneous Crises 116 7.2.3 The European Economic Environment is also Characterised by Other Penalizing Factors 121 7.3 Assets to Meet These Major Challenges 124 7.3.1 A Dense Network of Strong, Robust NPBIs Anchored as Close as Possible to the Ground 124 7.3.2 A Dynamic Started with the Juncker Plan and the Role of the EIB 126 7.3.3 Enabling NPBIs to Make Full Use of their Potential 129 7.4 One Step Beyond… 131 References 134 8. Making Green Public Investments a Reality in the EU Fiscal Framework and the EU Budget 137 Atanas Pekanov and Margit Schratzenstaller 8.1 Introduction 137 8.2 Fiscal Framework 139 8.3 Options to Support GPI in the EU Fiscal Framework 141 xiv Financing Investment in Times of High Public Debt the environmental transition and of the digital transformation is an imperative that cannot be postponed. So, too, are the financing of the public policies needed to deal with the aging population, of the investments in research and technologies required to ensure international technological competitiveness, and of the investments in defence and security made necessary by the worsening of international relations. Rather than merely returning to restrictive fiscal policies, it is necessary to explore and develop more sophisticated solutions and tools, which this book begins to outline. The challenge concerns Europe in a special way. Champion in the production of rules (and often of good rules), the European Union must now equip itself with the necessary tools to face the enhanced need to produce essential European public goods (EPGs). The pandemic has served as a stark reminder of the significance of robust and cooperative health systems that transcend national boundaries. Simultaneously, global events such as the Ukraine crisis and the Middle-East conflict have emphasized the urgent need for the development of a unified EU defence policy. In a world characterized by growing interconnectivity, heightened vulnerability, and the prevalence of externalities and spillover effects, there is an escalating demand for EPGs, extending beyond traditional domains like security to encompass research and development, climate-change mitigation, digital infrastructure, the supply of critical raw materials and components, and more. While the demand for EPGs is evident, their supply and financing continue to be a complex issue. With Next Generation EU and SURE, the European Union has opened, albeit temporarily and exceptionally, the path to financing EPGs through common resources raised on the financial markets through the issuance of European sovereign bonds. However, political resistance to providing the European Union with permanent financing instruments remains strong. But the succession of crises and emergencies cannot fail to produce a weakening of this resistance. Sooner or later (and it would obviously be better sooner than later), the need to face increasingly challenging and dramatic crises, which European states are not able to overcome with national resources, will require a change in the European policy mix with the strengthening of European central fiscal capacity and with new fiscal rules aimed at underpinning investment and the sustainability of national public finances. Introduction Floriana Cerniglia, Francesco Saraceno and Andrew Watt When the first European Public Investment Outlook (Cerniglia and Saraceno 2020) was published, in the summer of 2020, the world economy was in the middle of an unprecedented health and ensuing economic crisis. The policy response to the crisis was bold in all EU countries and involved a significant fiscal effort. Central banks accommodated this effort, in EU countries as well as in the USA, with massive purchases of bonds: the EU’s 1.8-trillion-euro Pandemic Emergency Purchase Programme (PEPP) ran from 2020 to the spring of 2022. This allowed interest rates to be kept low and shielded EU governments from possible market pressures in the face of a large increase in public debt (see Figure 0.1). The macroeconomic environment changed drastically in the Summer of 2021, not only with respect to the pandemic, but also with respect to the previous decade. The economy rebounded virtually everywhere, and the disarticulation of the supply side led to inflationary pressures, most notably in the energy and food sectors. This pressure was later compounded by geopolitical tensions and by the invasion of Ukraine. As inflation picked up, the attitude of central banks changed, and the policy stance turned restrictive. Both the US Federal Reserve and the ECB engaged in a long series of rate increases (the end of which is not yet certain at the time of writing in November 2023) and started shrinking their balance sheets. In this new macroeconomic environment — as sovereign interest rates increase, while economic growth slows and the risk of an economic downturn increases — the issue of public-debt sustainability has come to the fore. © 2023 F. Cerniglia, F. Saraceno & A. Watt, CC BY-NC 4.0 https://doi.org/10.11647/OBP.0386.00 2 Financing Investment in Times of High Public Debt Fig. 0.1 Government Interest Payment and Debt. Source: European Commission–Ameco. In the meantime, the legacy of the many crises of the past fifteen years is one of a renewed attention to the role of government. The ‘New Consensus’ paradigm (Saraceno 2022a) that had dominated since the 1980s was challenged by the Global Financial Crisis of 2007–2009, prompting a wide-ranging process of ‘Rethinking macroeconomics’ (to cite the title of a series of conferences held at the IMF in the early 2010s and organised by the then Chief economist Olivier Blanchard; see, for example, Blanchard 2016). This process of rethinking is still in progress, and it is quite unclear what will emerge as a new consensus in economics, if one will emerge at all. Nevertheless, whatever the result 0.0 1.0 2.0 3.0 4.0 5.0 Interest as % of GDP 1999-2008 2009-2014 2015-2019 2020-2022 2023-2024 (F) Source European Commission -Ameco 0 50 100 150 Debt as % of GDP 1999-2008 2009-2014 2015-2019 2020-2022 2023-2024 (F) Source European Commission -Ameco 3 Introduction of the current debate will be, it is highly unlikely that we will return to the pre-2008 consensus of a limited role for public policies in regulating and shaping the economy. The multiple crises that hit the world economy in the past fifteen years were due to a mix of endogenous (the financial crisis), self-inflicted and policy-induced (the sovereigndebt crisis), and exogenous (the pandemic) causes. All highlighted the need for a renewed role of the government in the economy and for a reassessment of the policy mix. Whether that mix calls for a classic Keynesian business-cycle stabilization, as in 2008, for public investment and industrial policies to favour and steer the ecological and digital transitions, for the provision of global public goods such as health and education, or for a coordinated approach by fiscal and monetary policies to fight inflation (or, indeed, secular stagnation) is secondary: few economists today would argue, as many would have done before 2008, that we should constrain public policies and let markets tackle the contingent and structural challenges that our societies repeatedly confront. Thus, advanced economies face a dilemma: how to reconcile the now widely accepted need to finance the public policies that are necessary to manage an increasingly complex environment in which structural, contingent, and geopolitical factors are inextricably linked, with the objective of public-debt sustainability? After the pandemic, it seemed that policy makers in most European countries had decided on a clear priority in this dilemma: rethink fiscal policies to guarantee the fiscal space necessary to pursue all the pressing policy objectives, while guaranteeing the sustainability of public finances. In other words, sustainability was a constraint on the objective of granting policy-makers the tools to implement proactive policies. The return of inflation in 2021–2022, though, marked a partial revival of the pre-2008 emphasis on limiting the role of government. This was reflected in the return of longdiscredited monetarist ideas (Saraceno 2023) but has also resulted in a shift of focus in the debate on policy and sustainability. At least in Europe, against the background of higher interest rates, the main preoccupation in many policy quarters is returning to the question of how to curb public debt. Sustainability, instead of being a constraint in the attempt to create fiscal space, has returned to being the main objective of policy-makers. This shift of narrative and of priorities can be seen clearly in the discussion on the reform of EU fiscal rules. In November 2022, the European Commission (2022) issued a Communication on the reform of the Stability Pact. This centred around a medium-term perspective in assessing sustainability and on setting out countryspecific trajectories that granted some policy space while ensuring that the policies implemented would not threaten sustainable public finances. Most notably, it enabled Member States to argue for fiscal space for specific public investment projects that could convincingly show a positive longer-run impact on debt-servicing capacity. In the few months that passed between the Communication and the actual proposal, that was put on the table in April 2023 (European Commission 2023), the approach changed substantially. Curbing debt was reinstated as a primary objective of the fiscal 4 Financing Investment in Times of High Public Debt rules: the amendment to the old Stability Pact originally proposed by the Commission was meant to avoid excessively curbing governments and to limit, at least to some extent, pro-cyclical fiscal policies. The issue of creating the fiscal space, which the current Stability Pact does not provide for, has been downgraded in the latest proposal and is now ancillary with respect to the debt-reduction objective. This is the background against which this European Public Investment Outlook, the fourth of a series, tackles the issue of financing public expenditure and, particularly, public investment in European countries. The authors who contributed to this Outlook may differ somewhat on aspects of fiscal policy and on the fiscal rules that the EU should adopt to replace the Stability Pact. Yet, they all share the conviction that, in the coming years, public investment should be not only protected but expanded and deployed, together with other instruments, to facilitate and steer the ecological and digital transition. We hope that this volume of the European Public Investment Outlook will contribute to rebalancing the debate on sustainability and fiscal space. Fiscal sustainability can never be overlooked when designing public policies for the simple reason that the effectiveness of such policies would be hampered if they were to lead to the loss of confidence in the government’s credibility and to turbulence in sovereign debt markets. This is especially true in a complex institutional environment like the eurozone, which requires member countries to coordinate twenty fiscal policies among themselves and with the common monetary policy. Yet, we believe that the issue of sustainability should not be dramatized in the current situation and that it should not overshadow the more important issue of how to ensure that fiscal space is created to respond to the challenges of the time. There are, in fact, several reasons why we believe that debt reduction is given too much emphasis in current European debate. First, although monetary tightening and inflation have caused interest rates to go up quite substantially and caused spreads to reopen between sovereign-debt yields, nominal growth has also increased, because of inflation. The fact that current real interest rates are actually lower than before does not mean much going forward (nominal interest rates will likely not decrease much as inflation returns to normal). Nevertheless, most countries took advantage of low rates in the past few years to increase the average maturity of their debt, and interest payments, as a percentage of GDP, are forecast by the Commission to barely move in the short run, even for more problematic countries like Italy (see Figure 0.1 and Chapter 1). In most of the Eurozone, then, the interest bill will remain smaller, as a percentage of GDP, than had been the case in earlier years and also than in the USA. Second, while the European Central Bank (ECB) is currently focused on its core business of fighting inflation, it is unlikely to revert to its former non-interventionist attitude regarding spreads and sovereign debt-market instability. Since the ‘whatever it takes’ speech by then-ECB President Mario Draghi in 2012 and the subsequent launch of the Outright Monetary Transactions (OMT) program, the ECB has 5 Introduction implicitly targeted spreads, de facto acting as a lender of last resort. In mid-2022, the Transmission Protection Instrument (TPI) was launched explicitly to permit — in principle, unlimited — purchases of bonds from countries experiencing a deterioration in financing conditions not warranted by country-specific fundamentals. Because turbulent times are (unfortunately) bound to continue, it is inconceivable that the ECB will readopt a non-interventionist stance. Of course, this cannot be taken as a green light to embark on irresponsible fiscal policies: first, the OMT comes with heavy conditionality; second, the TPI, with its caveat about country-specific fundamentals, sends the clear message that only countries with sound fiscal policies can be protected. With these instruments, however, Euro-area member states can now count on a Lender of Last Resort, even if this function is more conditional than in countries such as Japan and the USA. With it in place, they are less likely to face speculative attacks and much better equipped to fight them if they do occur. Last but not least, high interest rates may not be here to stay, as many currently believe. The forces behind the secular downward trend of neutral interest rates (demographics, inequality, high debt and the ensuing increase in the propensity to save, etc.) have been temporarily muted by the sudden inflation burst that began in 2021. When the certainly-persistent-but-still-temporary drivers of inflation subside, there are reasons to believe that secular stagnation and a chronic tendency to excess savings may start to haunt monetary authorities again (Blanchard 2023; Saraceno 2022b). In any case, the restrictive impact on activity of the interest rate hikes already implemented are still feeding through the economy. A slowing economy will constrain the ability of both price- and wage-setters to seek higher nominal incomes, and policy rates will be cut again. Previous instalments of this series (Cerniglia et al. 2021; Cerniglia and Saraceno 2020, 2022) highlighted the deterioration of the public capital stock of EU countries, even the richer ones. Many of the dozens of authors involved in the chapters of the previous Outlooks emphasized the need, in today’s world, to steer away from a purely accounting definition of public investment in favour of a notion encompassing both tangible and intangible capital, such as social capital. These themes emerge in the current Outlook as well, in chapters written by academics, policy makers, economists at think tanks and at international organisations, and practitioners. This installment has a specific focus on the issue of financing. Unfortunately, the currently predominant sentiment of EU policy-makers on debt and interest rates is quite unaligned with our assessment: it is likely that debt-reduction will remain one of their primary preoccupations in the near future. How to finance public policies, most notably investment, in an environment of tight budget-constraints, therefore, will be central in the next few years. This question is addressed in the chapters of the first part of this Outlook that take into account selected countries’ particular challenges and options. The chapters of the second part, taken together, evoke multiple sources of financing of public investment, including the mobilizing of national public resources but also public investment banks, European 6 Financing Investment in Times of High Public Debt agencies, monetary policies, financial markets, the EU budget, and so on. It is vital that the European policy and institutional framework both permit and encourage nationallevel public investment and make adequate provisions for financing European public goods at EU level. Decisive for the former is an investment-friendly reform of the fiscal rules. At the European level, a robust, substantial, and permanent investment facility is needed in view of the urgent challenges relating to decarbonization and of the imminent end to the Next Generation EU’s Recovery and Resilience Facility (RRF; Watt 2022). Financing Investment in Times of High Public Debt, like its predecessors, is divided in two parts. Part I offers an analysis of the state of the art of public investment in Europe (Chapter 1) followed by individual country reports on the European Union’s four largest economies: France in Chapter 2, Germany in Chapter 3, Italy in Chapter 4, and Spain in Chapter 5. These chapters share a common focus on comprehending the scope for maintaining and expanding public investment in the coming years while considering the difficulty of financing it at a time when debt-to-GDP ratios are increasing in some countries due to higher interest rates and low growth, and, in some cases, the foreseeable end of finance through the RRF. As in the preceding Outlook reports, the country-specific chapters, when relevant, update the information presented in earlier instalments. Additionally, some chapters discuss impact and policy responses related to the economic-recovery plans deployed to address challenges stemming from the COVID-19 pandemic and further compounded by geopolitical tensions, low growth, high inflation, and high interest rates. Chapter 1, by A. Brasili, A. Kolev, D. Revoltella, J. Schanz, and A. Tueske, assesses the role of public investment within the EU’s response to both short-term and longterm challenges such as managing inflation, ensuring financial stability, effecting fiscal consolidation, coping with energy- and food-price shocks, and transitioning towards climate neutrality while maintaining energy security. It provides a comprehensive depiction of the dynamics of public investment in Europe in 2022, encompassing planned investment for the current fiscal year and the ongoing implementation efforts of the RRF along with the associated emerging challenges and hurdles. The analysis draws on data from a multitude of sources, including Eurostat, the Stability and Convergence Programmes of Member States, the implementation progress of the RRF, and data from the TED-procurement database.1 In Chapter 2, M. Plane and F. Saraceno provide a historical overview and describe the different phases, from the 1940s until today, of public investment in France. An assessment is made of the pace of public-capital accumulation since the COVID-19 pandemic (it is increasing slowly). Two main findings emerge from an analysis of stocks 1 TED (Tenders Electronic Daily) is the online version of the ‘Supplement to the Official Journal of the EU’, dedicated to European public procurement. 7 Introduction and flows: first, public investment and the stock of capital have been largely affected by the macroeconomic cycle; second, the capital stock is still significant (and larger than in other countries). General government net wealth remains positive, although it has decreased significantly since 2008. A large gap exists between the central government and local authorities in terms of savings and investment financing. The authors also discuss how public investment is financed in France and whether the current level of public debt is sustainable. Chapter 3, by K. Rietzler, A. Watt, and E. Juergens, assesses public investment in Germany. After more than a decade of weak public investment, Germany has accumulated a significant backlog. The additional public investment required over the next decade is estimated to be in the range of €600–800bn, equivalent to 1.6–2.1% of GDP. The current fiscal situation had appeared as relatively favourable from a financing perspective. However the ruling by the constitutional court, just as the publication was going to press, that government plans to finance investment through borrowing, evading the debt brake, are unconstitutional has cast this into serious doubt. There is a serious risk that policy, far from expanding investment, will begin to tighten as early as 2024. Germany lacks the political will to remedy the situation which the debt brake and the court ruling have created and provide the needed boost in public investment, whether through higher borrowing or by raising taxes. Chapter 4, by G. Barbieri, F. Cerniglia, and E. Dia, provides the country report on Italy with an analysis of the role of the Italian National Recovery and Resilience Plan (NRRP) in boosting public investment up to and beyond 2026. Italy’s NRRP, with more than €235bn available for investments and reforms makes it one of the most remarkable modernization initiatives in the last seventy years. The impact of the NRRP is assessed and specific implementation challenges are highlighted, some of which have been caused by factors such as fragmented governance, a lack of effective monitoring, and compliance issues. Overcoming these difficulties is crucial for continuing to receive disbursements from the Commission. The effectiveness of its governance is also examined. Moreover, the authors note that the question remains of how to ensure a positive capital spending trajectory (especially after 2026) in compliance with the new rules set out in the Stability and Growth Pact; only by increasing public investment can the debt-to-GDP ratio decrease at a faster pace. Chapter 5, by F. Pérez and E. Benages, looks into public investment, the deficit and public debt in Spain from 1995 to 2022. Spain’s public investment during that time has had a very erratic trajectory, with some years seeing large capital accumulation and others with negative net investment The sustainability of the pace of investment has been challenged by expenditure policies that are procyclical rather than having a stabilizing effect. 8 Financing Investment in Times of High Public Debt These and other lessons learned should be incorporated into the revision of the EU’s economic governance framework to improve the compatibility between the fiscal rules and the increased investment envisaged by the Recovery and Resilience Facility. Part II of the 2023 European Public Investment Outlook covers several themes that together address the European Union’s available policy options and the toolkit of resources and instruments at its disposal to raise its game as regards public investment. EU policies and investment financing are analysed from the perspective of fragmentation and secular stagnation (Chapter 6), tools to help foster stability, like national promotional banks (Chapter 7), upgrading EU public goods by also introducing a permanent central fiscal capacity (Chapter 11), and options for a permanent EU sovereign fund (Chapter 12). Three chapters have a green focus, acting as natural bridges to the 2022 instalment of The European Public Investment Outlook — Greening Europe. These chapters focus on including green public expenditures in the EU budget and fiscal framework (Chapter 8), the role of monetary and financial policies in financing climate investments in the EU (Chapter 9), and a set of measures to deal with the crisis of climate change and restore fiscal progressivity (Chapter 10). In Chapter 6, P. C. Padoan makes the case that the EU has been impacted by multiple crises due to economic and geopolitical factors. The crises have left scarring effects and may lead to fragmentation with serious and permanent consequences. The author analyses the EU’s primary response strategy: Next Generation EU and the associated Recovery and Resilience Facility. This recovery instrument, based on public investment and structural reforms, can be an effective policy tool, provided it combines public investment and structural reforms and allows for adequate time to complete the reform cycle. Its efficacy must be evaluated in the context of a new policy mix designed to solve the multiple crises plaguing the EU’s institutional structure. The role of National Promotional Banks and Institutions (NPBIs) is addressed in Chapter 7, by L. Zylberberg, who specifically studies their impact within the EU context. NPBIs experienced a paradigm shift with the great financial crisis of 2008– 2009, which was further reinforced by the COVID-19 pandemic and the Ukraine crisis. The Juncker Plan shed light on the existing investment gaps across Europe and demonstrated that a dynamic European policy was possible. Thanks to the InvestEU programme, European actors such as the EIB Group or national actors via NPBIs and Financial Institutions have thrived in their specific role of fostering essential long-term investments. The author underlines the necessity of developing practical accounting rules that integrate both positive and negative externalities. A. Pekanov and M. Schratzenstaller, in Chapter 8, discuss two paths to foster increased green public investment in the EU: through possible amendments to the current EU fiscal framework and through funding from the EU budget. Since the Commission’s proposal (November 2022) regarding orientations for a reform of the 9 Introduction EU governance framework widens the leeway for debt-financed public investment but does not sufficiently consider existing green public investment needs, several options are considered to ensure a level of green public investment which—together with private resources—could close the existing gaps in green investment. To this end, the EU budget needs to be reoriented towards measures that are effective in achieving decarbonisation and which cannot sensibly be performed at national level, such as the Connecting Europe Facility. Chapter 9, by Y. Dafermos and M. Nikolaidi, delves into the unprecedented transformation of the EU fiscal, industrial, trade, and regulatory policy frameworks that are necessary to address the climate crisis. The authors advocate that this transformation requires the alignment of EU monetary and financial policies with environmentally sustainable practices. A set of tools are presented that central banks, financial regulators, and financial supervisors can employ to advance the EU decarbonisation and climate-resilience targets. Fiscal reform is the focus of Chapter 10, by D. Guzzardi, E. Palagi, T. Faccio, and A. Roventini, who probe how to formulate an adequate policy response to restore fiscal progressivity, which is seen as fundamental in addressing the current climate challenge. They advocate closing the tax-rate gaps between income levels to ensure that the green transition, which demands significant financial resources, occurs in a more equitable manner. The authors thus propose a mix of EU fiscal policies, from which the resulting additional resources can be used to promote climate mitigation and adaptation policies. This approach will lower inequality and help move EU economies toward inclusive and sustainable growth. The importance of including European Public Goods (EPGs) in the ongoing debate on EU reforms is emphasized in Chapter 11, written by M. Buti, A. Coloccia, and M. Messori. They argue that EPGs are a promising step toward a more effective economic union, which needs a permanent fiscal capacity. The discussion of EPGs, they believe, should take into account a number of factors, including the convergence of economic, institutional, and political coherence on the green, digital, and social transition. It should also address the supply of critical raw materials, health, security, and defence. Another tool that can be used to address the climate challenge and promote economic stability is proposed in Chapter 12. P. Heimberger and A. Lichtenberger argue in favour of a new, permanent EU fiscal capacity using the Recovery and Resilience Fund (RRF) as an operational blueprint. They suggest that, overall, the current tools available to the EU as well as the new ones proposed fall short of providing a realistic vision of financing the required public investment. Overall, the contributions in Financing Investment in Times of High Public Debt focus, from different angles, on the urgent need for a coherent EU framework and fiscal 16 Financing Investment in Times of High Public Debt European countries, with a large role played by the RRF. The second section looks at the dynamics of planned investment from the perspective of the available fiscal space. Until 2026, the reinstatement of fiscal rules (after the deactivation of the General Escape Clause) would not necessarily lead to a decline in public investment thanks to the financial resources provided by the RRF, but what will happen in the long run is less clear. The third section describes the ongoing RRF implementation efforts one and a half years after the start of the implementation period and its emerging challenges and difficulties. Small, but rising gaps are observable between planned and realised implementation of the RRF measures as well as between planned and actual disbursements, pointing to capacity constraints and implementation bottlenecks. These findings are corroborated by evidence from the publication of procurement notices as well. Finally, the concluding remarks add a broader context to the above-mentioned sections as well as an outlook regarding the main challenges facing public investment. 1.2 Public Investment in Europe: The Most Recent Data In 2022, government investment rates in the EU remained high, despite a small decline relative to 2021 (see Figure 1.1). Aggregate investment of the general government in the EU was 3.2% of GDP. This is practically equal to its historical average and somewhat higher than the average since the end of the global financial crisis. Investment rates in Southern Europe are still below their historical average, despite significant progress over the past 4 years. In the rest of the EU, investment rates were mostly above historical averages. The observed modest decline is a consequence of slower growth in nominal investment, compared to nominal GDP (see Table 1.1). Fig. 1.1 Gross Fixed Capital Formation of the General Government (% GDP). Source: Authors’ calculations based on AMECO. 0 1 2 3 4 5 6 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 EU Western and Northern Southern Central and Eastern 0 50 100 150 200 250 300 350 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 2015 2016 2017 2018 2019 2021 EU Western and Northern Southern Central and Eastern 0.0 1.0 2.0 3.0 4.0 5.0 6.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 % of GDP NW South CEE European Union 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 Index 2000=100 Western and Northern Southern Central and Eastern European Union 0 1 2 3 4 5 6 7 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF in 2023-2026 Average GFCG financed through RRF in 2023-2026 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF financed through RRF in 2023-2026 0 0.5 1 1.5 2 2.5 Greece Croatia Spain Portugal Italy Estonia Cyprus Austria Romania Germany Finland Hungary France Luxembo… Poland Malta Belgium Lithuania Netherlan… Bulgaria Czechia Denmark Sweden Ireland Slovenia Slovakia Latvia % of GDP Average Capital Transfer financed through RRF in 2023-2026 Average Capital Transfer in 2023-2026 17 1. Europe Government investment grew faster than total government expenditure in the EU. Total expenditures of the general government in the European Union grew by 4.8% in 2022, relative to 2021. This was 3 p.p. slower than expenditure on gross fixed capital formation and shows that EU governments have continued to prioritise investment. Total expenditure grew even slower in Western and Northern EU in 2022, by 3.8%. Only in Central and Eastern Europe did the growth rate of total expenditures exceed the growth rate of investment: by about 1 p.p. The rate of growth of government investment exceeded the increase of government debt by 3.5 p.p. in the EU on aggregate. In Q1 2023, nominal gross fixed capital formation grew by 7.4% YoY, keeping pace with the previous year. Table 1.1 Investment and GDP (annual % change) European Union Western and Northern Southern Central and Eastern Investment 7.1 7.3 4.1 10.5 GDP 9.3 8.3 9.0 16.0 Source: Authors’ calculations based on AMECO Real government investment remained broadly stable in 2022 (see Figure 1.2). Despite the high growth of nominal investment, real government investment did not change much. The high rate of inflation in 2022 meant that real government investment remained just below its 2021 levels. Real investment in Northern and Western Europe was practically unchanged, while in Southern Europe it was about 1% lower. In Central and Eastern Europe real government investment was about 2% lower than in 2021. Fig. 1.2 Real Gross Fixed Capital Formation of the General Government (index 2000=100). Source: Authors’ calculations based on AMECO. 0 1 2 3 4 5 6 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 EU Western and Northern Southern Central and Eastern 0 50 100 150 200 250 300 350 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 2015 2016 2017 2018 2019 2021 EU Western and Northern Southern Central and Eastern 0.0 1.0 2.0 3.0 4.0 5.0 6.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 % of GDP NW South CEE European Union 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 Index 2000=100 Western and Northern Southern Central and Eastern European Union 0 1 2 3 4 5 6 7 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF in 2023-2026 Average GFCG financed through RRF in 2023-2026 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF financed through RRF in 2023-2026 0 0.5 1 1.5 2 2.5 Greece Croatia Spain Portugal Italy Estonia Cyprus Austria Romania Germany Finland Hungary France Luxembo… Poland Malta Belgium Lithuania Netherlan… Bulgaria Czechia Denmark Sweden Ireland Slovenia Slovakia Latvia % of GDP Average Capital Transfer financed through RRF in 2023-2026 Average Capital Transfer in 2023-2026 18 Financing Investment in Times of High Public Debt Real investment of local governments was more resilient than that of central and regional governments. Overall in the EU, real investment of local governments increased by 1.3% in 2022 relative to 2021. The highest increase was in Southern Europe, where real investment grew by 3.1%, followed by an increase of 2.7% in Central and Eastern Europe. This growth was offset by declines in central and regional government real investment. Real investment of the central government in the EU declined by 1.4%, while regional government investment declined by 4.4%. EU nominal spending on investment grants and other capital transfers in the EU increased by 14% in 2022. The highest increase in such expenditure was in Western and Northern Europe, where it grew by 22%. In Southern Europe, investment grants and other capital transfers increased by 13%, while they grew 7% in Central and Eastern Europe. 1.3 Projections of Public Investment and Capital Transfers in Member States’ Stability and Convergence Programmes At the end of April 2023, European Union (EU) Member States released their Stability and Convergence Programmes and delivered them to the European Commission (EC). According to the Fiscal Framework Revision proposal, these documents will be merged with the National Reform Plans starting from the European semester of 2024. In this way, a joint assessment can be made of each country’s adherence to the fiscal trajectory and to the planned structural reforms and investments. As usual, the plans include multi-years’ budgetary evolution according to the envisaged fiscal plans and macroeconomic projections. It must be considered that at the time these plans were released, the European Central Bank (ECB) had already raised interest rates six times in a row (there was a total increase of 350 basis points from July 2022 to March 2023), and market expectations were suggesting a further 75 basis-point increase in the policy rate (with a final rate of 3.75% for the deposit rate and 4.25% for the refinancing rate). At the same time, in the Economic Policy Recommendations, the EC highlighted that ‘in the medium term, fiscal policies should ensure fiscal sustainability and prioritise investment to support the twin transition and social and economic resilience’. An emphasis on keeping the bar high on public investment was clear in all the preparatory work and in the proposal of the EU fiscal framework reform (see below and other chapters of this Outlook). The salient motivation behind it is the acknowledgement of the increased role of public actions in fields like energy security, the climate transition, digital transition, and the consequent increased opportunity and needs of providing European Public Goods. An important reference on this topic is Fuest and Pisani-Ferry (2019), which highlights the need for the EU to specifically target the production of public goods that are more efficiently provided at EU than at national level. Buti, et al. put this issue in a different perspective in various contributions (see Chapter 11 in this Outlook), highlighting the opportunity of supplying European Public Goods as 19 1. Europe the most palatable way of creating a Central Fiscal Capacity. According to the Stability and Convergence Programmes released in late April, Member States followed the suggestions of the EC and kept the rising trend in the ratio of public investment/GDP intact for the next years. 1.3.1 Projections of Public Investment in Member States’ Stability and Convergence Programmes The Stability and Convergence Programmes that were released in April indicate that the Member States complied with the European Commission’s plea for continued high standards for public investment, keeping intact the upward trend in the public investment-to-GDP ratio. The graph below (Figure 1.3) projects the planned evolution of public investment as a ratio of GDP for the whole European Union and for the macro-regions.2 This graph shows a continuation of the recent upward trend at the EU level. The public investment-to-GDP ratio is projected to go from 3.2% in 2022 to a peak of 3.6% in 2024– 2025 and is expected to fall only slightly, to 3.5%, in 2026. This would be significantly higher than the average over the decade after the GFC (2011–2020) that was 2.8% but also with respect to the average in the decade before the GFC (3.3%), in line with the above-mentioned idea of an increased role for public investment. This movement is a mix of slightly different macro regional evolutions. According to the projections, there will be a sharp increase in the ratio for Southern EU countries. Southern EU (SE) countries are expected to reach the EU average of 3.6% in 2024 (while they have been well below the EU average throughout the period from 2012 to 2022). Public investments in Central and Eastern European (CE) countries are estimated to stabilize at a high level (at 4.6% of GDP) for the period of 2024 to 2026 after reaching an earlier peak (relative to the EU) of 4.8% in 2023. In the Northern and Western European (NW) countries, the ratio will move less than in other areas: it will reach 3.4% in 2025–2026 a marginally higher level than the long-term average (at 3.3%). 2 Data for EU and for macro-regions are obtained aggregating the numbers suggested by each Member States in their multi-year plans. 20 Financing Investment in Times of High Public Debt Fig. 1.3 Gross Fixed Capital Formation, as a Ratio of GDP. Source: Authors’ calculations based on AMECO data (2000–2022) and on Member States’ Stability and Convergence Programmes. 1.3.2 The Role of Capital Transfers and Investment Grants Public investments’ main motivation is always creating or improving the framework conditions in which private investment may find a more fertile territory to flourish. However, public investment is not the only option to facilitate private investment, capital transfers and, in particular, investment grants can also be used for this purpose. While capital transfers are sketched in the Stability and Convergence Programmes,3 investment grants (that are a portion of capital transfers) are not. Figure 1.4 shows the massive use of capital transfers during and after the Great Financial Crisis (to support the financial sector) and during the COVID-19 crisis (to support the non-financial business sector). Excluding these two episodes, the ratio of investment grants to total capital transfers has been almost stable at an average of 0.65% (that is, investment grants represented on average 65% of capital transfers). It is useful to refer to the whole aggregate for two reasons. Firstly, because investment grants are not reported in plans; secondly, it may represent a useful policy tool (outside of crises episodes when the public sector might respond to specific needs by buying into the equity of private companies). 3 But not for example in the EC forecasts nor in AMECO. 0 1 2 3 4 5 6 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 EU Western and Northern Southern Central and Eastern 0 50 100 150 200 250 300 350 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 2015 2016 2017 2018 2019 2021 EU Western and Northern Southern Central and Eastern 0.0 1.0 2.0 3.0 4.0 5.0 6.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 % of GDP NW South CEE European Union 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 Index 2000=100 Western and Northern Southern Central and Eastern European Union 0 1 2 3 4 5 6 7 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF in 2023-2026 Average GFCG financed through RRF in 2023-2026 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF financed through RRF in 2023-2026 0 0.5 1 1.5 2 2.5 Greece Croatia Spain Portugal Italy Estonia Cyprus Austria Romania Germany Finland Hungary France Luxembo… Poland Malta Belgium Lithuania Netherlan… Bulgaria Czechia Denmark Sweden Ireland Slovenia Slovakia Latvia % of GDP Average Capital Transfer financed through RRF in 2023-2026 Average Capital Transfer in 2023-2026 21 1. Europe Fig. 1.4 Capital Transfers Before, During, and After Recent Crises. Source: Authors’ calculations based on AMECO data (2000–2022) and on Member States’ Stability and Convergence Programmes. Figure 1.4 also shows that the last period may have structural implications. Countries in NW Europe project a use of capital transfers proportionally larger than that of CE and SE countries. This may reflect a conscious choice: as noted above, the weight of investment grants increased notably in NW countries already in 2021–2022. Capital transfers for NW European countries are projected to represent about 1.6% of GDP from 2023 to 2026 (compared to an average of 1.2% from 2011 to 2019). 1.4 The Role of the Recovery and Resilience Facility (RRF) This year, the Convergence and Stability programmes mandatorily include a table that shows the role of the RRF on both the revenues and on the expenditures side. On the expenditures side, RRF resources are split into current and capital expenditures. In turn, capital expenditures are split in capital transfers and public investment. In addition, we also include what is reported in the summary RRF table by some countries as ‘financial transactions’. This is because the category includes planned participations in start-ups or similar initiatives by some of the Member States, which can be considered as having a similar role as capital transfer. The countries that are making use of these expenditures are Greece, Croatia, Portugal, and Romania. However, current expenditures financed through RRF grants or loans are excluded. Figure 1.5 shows the contribution of the RRF to support public investment. The average weight of the RRF relative to GDP (shown by dark blue bars) is quite high in the following CE countries: Bulgaria, Croatia, Hungary, and Romania. It is also quite high in the following SE countries: Greece, Italy, and Portugal. Figure 1.6 provides 0 1 2 3 4 5 6 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 EU Western and Northern Southern Central and Eastern 0 50 100 150 200 250 300 350 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 2015 2016 2017 2018 2019 2021 EU Western and Northern Southern Central and Eastern 0.0 1.0 2.0 3.0 4.0 5.0 6.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 % of GDP NW South CEE European Union 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 Index 2000=100 Western and Northern Southern Central and Eastern European Union 0 1 2 3 4 5 6 7 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF in 2023-2026 Average GFCG financed through RRF in 2023-2026 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF financed through RRF in 2023-2026 0 0.5 1 1.5 2 2.5 Greece Croatia Spain Portugal Italy Estonia Cyprus Austria Romania Germany Finland Hungary France Luxembo… Poland Malta Belgium Lithuania Netherlan… Bulgaria Czechia Denmark Sweden Ireland Slovenia Slovakia Latvia % of GDP Average Capital Transfer financed through RRF in 2023-2026 Average Capital Transfer in 2023-2026 22 Financing Investment in Times of High Public Debt more information about the dynamics and shows the contribution of the RRF to the change in government gross fixed capital formation (GFCF) in the period 2023–2026 compared to their level (as a ratio of GDP) in 2011–2019. For many countries, RRF allows for the acceleration of capital spending in the period considered. The dark and light blue bars almost coincide for Italy, Croatia, Latvia, and Czechia; RRF is a bit lower but gives a very large contribution for Romania and Greece, and it is larger than the acceleration in public investments for Bulgaria, Lithuania, Slovakia, and France. Estonia, Cyprus, Poland, and, particularly, Hungary project a lower level of public investment in the period 2023–2026 than the one they experienced in 2011–2019, but the difference would be much higher without the RRF contribution. The RRF’s role is also large when it comes to capital transfers. Figure 1.7 illustrates the average planned capital transfer as a ratio to GDP for the period 2023–2026 and the average of the expenses that are financed through RRF funds as a ratio to GDP for the same period. It is very clear from this figure that the use of capital transfers is more concentrated in a few countries (in Estonia, Greece, Croatia, Italy, Cyprus, and Portugal). Fig. 1.5 The Role of RRF in Supporting Public Investment, 2023–2026. Source: Authors’ calculations based on Member States’ Stability and Convergence Programmes. 0 1 2 3 4 5 6 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 EU Western and Northern Southern Central and Eastern 0 50 100 150 200 250 300 350 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 2015 2016 2017 2018 2019 2021 EU Western and Northern Southern Central and Eastern 0.0 1.0 2.0 3.0 4.0 5.0 6.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 % of GDP NW South CEE European Union 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 Index 2000=100 Western and Northern Southern Central and Eastern European Union 0 1 2 3 4 5 6 7 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF in 2023-2026 Average GFCG financed through RRF in 2023-2026 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF financed through RRF in 2023-2026 0 0.5 1 1.5 2 2.5 Greece Croatia Spain Portugal Italy Estonia Cyprus Austria Romania Germany Finland Hungary France Luxembo… Poland Malta Belgium Lithuania Netherlan… Bulgaria Czechia Denmark Sweden Ireland Slovenia Slovakia Latvia % of GDP Average Capital Transfer financed through RRF in 2023-2026 Average Capital Transfer in 2023-2026 23 1. Europe Fig. 1.6 The Role of RRF in Supporting the Acceleration of Public Investment, 2023–2026. Difference in GFCF between 2011–2019 and 2023–2026 Source: Authors’ calculations based on Member States’ Stability and Convergence Programmes. Fig. 1.7 The Role of RRF in Supporting Capital Transfers, 2023–2026. Note: Spain’s average RRF is based on the 2021–2024 period. Greece’s average includes financial transactions, that are sizeable. Financial transactions are also included for Croatia, Portugal and Romania. For France, the Stability Programme (SP) does not distinguish between capital transfers and gross fixed capital formation. Both are described as capital expenditures. These capital expenditures are included here as gross fixed capital formation. As for Italy, the latest plan includes only the sum for the period 2020–2026 (for both GFCF and capital transfers), while the SP for 2022 detailed RRF-funded expenditures by year. These amounts have been divided by the total number of years so that the 2022 target profile has been maintained as much as possible. Source: Authors’ calculations based on Member States’ Stability and Convergence Programmes. -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF financed through RRF in 2023-2026 Difference in GFCF between 2011-2019 and 2023-2026 0 1 2 3 4 5 6 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 EU Western and Northern Southern Central and Eastern 0 50 100 150 200 250 300 350 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 2015 2016 2017 2018 2019 2021 EU Western and Northern Southern Central and Eastern 0.0 1.0 2.0 3.0 4.0 5.0 6.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 % of GDP NW South CEE European Union 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 Index 2000=100 Western and Northern Southern Central and Eastern European Union 0 1 2 3 4 5 6 7 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF in 2023-2026 Average GFCG financed through RRF in 2023-2026 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 Romania Italy Greece Hungary Croatia Bulgaria Portugal Slovenia Latvia Poland Slovakia Cyprus Malta Lithuania Czechia France Estonia Spain Austria Sweden Belgium Denmark Germany Ireland Luxembourg Netherlands Finland % of GDP Average GFCF financed through RRF in 2023-2026 0 0.5 1 1.5 2 2.5 Greece Croatia Spain Portugal Italy Estonia Cyprus Austria Romania Germany Finland Hungary France Luxembo… Poland Malta Belgium Lithuania Netherlan… Bulgaria Czechia Denmark Sweden Ireland Slovenia Slovakia Latvia % of GDP Average Capital Transfer financed through RRF in 2023-2026 Average Capital Transfer in 2023-2026 24 Financing Investment in Times of High Public Debt In summary: first, Member States have endorsed the EC recommendation to keep the bar high for public investment in their fiscal plans; second, the RRF contributes significantly to this effort, especially in the SE and CE countries. 1.5 Is the Old Framework ‘Biting’ with Respect to Plans? Will Member States Diminish their Investment Attitude? As discussed above, the Stability and Convergence Programmes were drafted in a situation where the General Escape Clause was still valid (even though its deactivation had already been decided for 2024), debates around the proposal for a new fiscal framework were also ongoing, and the ECB had not yet completed its tightening cycle. The ambition of this section is to show how these elements combine to shape Member States’ policy choices on investment. The EU Commission assessed the evolution of fiscal stance in Member States according to the reference indicator that was proposed in the new fiscal framework (under discussion). In particular, the ‘Fiscal Statistical Tables providing background data relevant for the assessment of the 2023 Stability or Convergence Programmes’ make reference to the fact that fiscal stance should be judged net of the expenditures financed by RRF grants. This suggestion is also taken into account here. 1.5.1 Interest Expenditures are Projected to Rise Slightly In their plans, Member States projected that interest expenditures will gradually increase from the current 1.62 to 2.03 as a percentage of GDP. Table 1.2 shows the disaggregation in EU macro regions. While there is a large gap in levels of interest expenditures that is explained by the dimension of the debt (that is much larger for SE countries than for the other areas), the projected increase over the projection horizon is not particularly different. This is likely due to the longer maturity of the underlying portfolios of highly indebted countries. Table 1.2 Interest Expenditures/GDP Source: Authors’ calculations based on Member States’ Stability and Convergence Programmes. 2022 2023 2024 2025 2026 EU 1.62 1.59 1.80 1.86 2.03 NW 1.02 1.02 1.22 1.28 1.45 SE 3.39 3.08 3.38 3.47 3.68 CEESE 1.38 1.75 1.87 1.82 1.88 25 1. Europe The dynamics of interest rates (after the draft of the Stability and Convergence Programmes) can cause some further increase in interest expenditures, but this should not alter this picture dramatically.4 1.5.2 General Government Deficits are Projected to Decline Regarding the deficit, the gradual phasing out of the measures that were introduced to support households and businesses after the Russian invasion of Ukraine, and an improving economic cycle from 2024 on, should favour a decline in deficit. Table 1.3 shows the deficit declining from above 3% in the EU and in all macro regions in 2023 to below that threshold, although by not a huge margin, by 2026. Table 1.3 General Government Net Lending Source: Authors’ calculations based on Member States’ Stability and Convergence Programmes. It is important to understand that in case of any slippage in public accounts, public investment, an easy-to-cut item from a (national) politics point of view, may come under pressure. 1.5.3 The evolution of fiscal stance: changes in the structural primary balance Having a look at the change in structural primary balance can be useful as a way to assess the change in fiscal stance, particularly as the old framework included the assessment of the path and speed of movements towards the Medium-Term Objective. It is important to understand the effect of worsening public finances on public investment. Therefore, it is useful to look at changes in the structural primary balance to determine changes in fiscal policy. Table 1.4 clearly shows that fiscal policy becomes more restrictive after 2023 and that there is a marked decline in the deficit. This decline in the deficit is also clearly smaller after 2024. 4 At the moment of finalizing this chapter, while short-term rates are slightly higher with respect to market expectations back in late April, long term rates have declined more than previously thought partially compensating the first effect. 2022 2023 2024 2025 2026 EU -3.4 -3.7 -2.6 -2.0 -1.7 NW -2.4 -3.5 -2.3 -1.6 -1.4 SE -6.0 -3.8 -3.0 -2.5 -2.2 CEESE -3.9 -4.3 -3.2 -2.8 -2.7 32 Financing Investment in Times of High Public Debt tenders and the signature of contracts appears somewhat larger for RRF-co-funded procurement than for nationally or EU-co-financed investment, at least for procurement related to construction (see Figure 1.11).6 This might capture the delays related to infrastructure projects that can be picked up from Member States’ monitoring of RRF projects (see above). However, the difference in the signature delays is small, and, given that the publication of procurement notices for RRF-co-funded projects only started to take off in 2021, the estimates of signature delays beyond 500 days become quite uncertain for RRF-related notices. Fig. 1.11 Delay between Tender-Submission Deadline and Contract Signature. Source: Authors’ calculations. In summary, evidence from the publication of procurement notices corroborates the findings from Member States’ monitoring of the implementation of their Recovery and Resolution Plans: that bottlenecks have so far been small but may increase as the implementation of the planned investments gathers steam. 6 In the corresponding bivariate Cox regression, the hazard ratio is 15% lower for EU (excl. RRF)- co-funded investments than for nationally funded investments, and 35% lower for RRF-co-funded investments. Both estimates are statistically significant in that regression at the 1% level (50,000 contract awards, robust SEs). The share of contracts signed typically hits a ceiling at about 75% of contracts tendered in this dataset, including at longer horizons. This may reflect that some tendered contracts are never signed or gaps in the reporting of contract awards. 0.00 0.25 0.50 0.75 1.00 Share of contracts signed 0 200 400 600 800 Days to contract signature National EU-cofin. excl. RRF RRF-cofinanced Construction and maintenance. By source of funding, Southern and Eastern Europe Delay between tender submission and contract signature 33 1. Europe 1.7 Concluding Remarks The end of the pandemic and the outbreak of the Ukraine war added three new pairs of conflicting objectives to the EU’s economic policy: to lower inflation while preserving financial stability, to preserve energy security while accelerating the transition to climate neutrality, and to consolidate fiscal budgets while softening the effect of the energy- and food-price shocks. On balance, monetary policy tightened rapidly, and public spending accelerated, especially for public infrastructure related to the green transition. The European Commission has introduced new tools like the Next Generation EU fund and the RePowerEU plan. It has also proposed adaptations to the fiscal framework that make it easier for Member States to undertake longer-term investment programmes without hitting the limits of the framework. In addition, in the guidelines for fiscal policy, it pushed for the expansion of public-investment plans. The Next Generation EU fund and the Recovery and Resilience Facility are already providing resources to the EU economy through 2026. However, it is still uncertain how the need to sustain high levels of public investment will interact with the new fiscal framework. Some pressures may well re-emerge after 2026, once the RRF expires. Now, it is high time to implement the planned efforts. As delays start to pile up in specific areas, it is worthwhile to have a closer look at their nature and specificities. As expected, there have been some delays in implementing the Recovery Fund. This is due, in part, to abrupt price increases that have drastically altered the costs of infrastructure and construction projects. Other delays relate to the diffuse nature of the projects, which involve multiple levels of local government. Improving implementation capacity is key for the success of the existing plans. Preserving space for future investments is crucial for Europe to maintain a leading role in the needed digital, green, and energy transitions. 34 Financing Investment in Times of High Public Debt References Fuest, C. and J. Pisani-Ferry (2019) ‘A Primer on Developing European Public Goods’ EconPol Policy Report. vol. 3, November European Commission (2022) Recommendation for a COUNCIL RECOMMENDATION on the economic policy of the euro area COM (2022), 782 final European Commission (2023) European Semester: National Reform Programmes and Stability/Convergence Programmes European Commission. ‘Recovery and Resilience Scoreboard’, https://ec.europa.eu/economy_ finance/recovery-and-resilience-scoreboard/index.html European Commission (2023) Report from the Commission to the European Parliament and the Council on the implementation of the Recovery and Resilience Facility: Moving Forward. 25 September. 545 final/2 TED database, https://ted.europa.eu/TED/main/HomePage.do 2. Financing Public Investment in France Mathieu Plane and Francesco Saraceno The chapter first deals with the historical evolution of public investment and capital in France. While still high in comparison with other EU countries, it was significantly reduced since the early 1990s. A reversal of the trend, prior to COVID-19, was mostly due to local governments. After COVID-19, a rebound was followed by flat growth; investment in 2023 is barely at 2019 levels. The result of these trends is a significant drop in net public wealth (mostly of the central government) since 2008. Funding exhibits a growing diversity. Investment spending is increasingly characterised by co-financing involving multiple actors, reducing the central-government share. The chapter concludes with an assessment of the sustainability of France’s public finances. The critical gap (g-r) remains positive for France even in the current environment of high inflation and increasing interest rates. We conclude, with some caution, that there is no real cause, in the medium run, for concern regarding sustainability. 2.1 The Historical Evolution of Public Investment From the end of the 1940s until today, public investment in France has passed through different phases. After a long period of sustained growth during the 1960s (5% of GDP on average; see Figure 2.1), public investment remained at a relatively high level during the 1970s and 1980s (4.4% of GDP on average). The first break took place during the 1990s, a period during which priority was given to reducing the public deficit to meet the Maastricht criteria and join the euro. This resulted in an adjustment to public investment that, on average, fell below 4% of GDP from the mid-1990s to the beginning of the 2010s, when a second shock occurred. Following the sovereign-debt crisis, the fiscal stance changed, and a substantial part of the fiscal adjustment was achieved by reducing capital expenditure. Indeed, the reduction of public investment during that period has contributed to almost a third of fiscal consolidation even though investment represented only 6% of public expenditure. The share of public investment-to-GDP from 2014 to 2022 fell to 3.5 % on average and, during the period 2015–2018, reached its lowest level since 1952. A recovery in public investment began in the two years before the COVID-19 crisis, with an increase of nearly 14% between the end of 2017 and the © 2023 M. Plane & F. Saraceno, CC BY-NC 4.0 https://doi.org/10.11647/OBP.0386.02 36 Financing Investment in Times of High Public Debt end of 2019. This shift was linked to the electoral cycle of municipal elections and the government’s desire to preserve investment within the framework of the targeted budget contract with local communities. Fig. 2.1 Public Investment by Administrative Category, in % of GDP. Source: Authors’ elaboration based on data from INSEE. 2.2 The Public-Investment Dynamics since the COVID Crisis Because of the political cycle, a partial reversal in public investment was to be expected after the municipal elections of 2017. Nevertheless, the drop observed in 2020 is out of proportion with that observed in previous cycles and is a result of the pandemic. Indeed, the COVID-19 crisis (and the first lockdown) led to a drop of 15% in public investment in the first half of 2020. By comparison, the three strongest half-yearly decreases observed for the previous seventy years were between 5% and 6%. From the second semester of 2020, however, public investment nearly returned to the pre-COVID-19 level (-3 % at the end of the year 2020 with respect to the end of 2019), despite the second lockdown in November and December 2020 (Figure 2.2). In addition, the government voted in September 2020 for a hundred-billion-euro recovery plan (‘Le Plan de Relance’, see Plane and Saraceno 2021), partially financed (40bn euros) with funding from Next Generation EU. The ‘Plan de Relance’ includes a section on public infrastructure, with particular emphasis on the thermal renovation 37 2. Financing Public Investment in France of public buildings, with increased planned investment from the beginning of 2021. Moreover, a new investment plan, ‘Build the France of 2030’, was announced in October 2021. This latter plan is intended to meet long-term challenges, particularly ecological ones, through massive investment to help the technological champions of tomorrow to emerge and to support the transitions of French sectors of excellence: energy, automotive, aeronautics and even space. These plans, presented by President Macron, identify public investment as central to the revival and strengthening of the economy as well as to the meeting of major future challenges, first and foremost that of ecological transition. Despite these major announcements, public investment has remained surprisingly flat. In fact, it was, at the midpoint of 2023, almost at the same level as at the end of 2020. Public investment, therefore, had not returned to its pre-crisis level (-1%), yet GDP is 1.7% above its pre-COVID level (Figure 2.2). Fig. 2.2 Public Investment and GDP. Note: 0 = 2019q4, in %, volume. Source: Authors’ elaboration based on data from INSEE. It is also important to note that, while public investment remains mainly the responsibility of local authorities (carrying out 58% in 2022), the post-COVID dynamic is more on the side of the central government. Today, its investment is at a higher level than 2019, while local authorities and Social Security, have not returned to their precrisis investment levels (see Figure 2.1). Indeed, part of the investment programmes resulting from the Recovery Plan or ‘France 2030’ are implemented by the central government, and not by local authorities. -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 Q4 2019 Q1 2020 Q2 2020 Q3 2020 Q4 2020 Q1 2021 Q2 2021 Q3 2021 Q4 2021 Q1 2022 Q2 2022 Q3 2022 Q4 2022 Q1 2023 Q2 2023 GDP Public investment -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Civil engineering works Non residential buildings Housing Machines and equipments Intellectual property rights Weapon Sytems -180 -160 -140 -120 -100 -80 -60 -40 -20 0 20 40 60 80 100 120 Gross financial debt Net financial debt Non financial assets Net wealth Maastricht public debt -400 -350 -300 -250 -200 -150 -100 -50 0 50 100 150 200 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Total public administration State Local authorities -15 0 15 30 45 60 75 90 105 120 135 -2 0 2 4 6 8 10 12 14 16 18 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Gross public debt in % of GDP (right scale) Apparent interest rate Ten yeears interest rate Interest payment as %of GDP Crise des subprime Crise Covid -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Critical Rate (g-r, right scale) Nominal growth rate of GDP Ten year interest rate 38 Financing Investment in Times of High Public Debt 2.3 Net Investment Increases but the Pace of Public-Capital Accumulation is Still Low The assessment of gross investment needs to be complemented by the analysis of the net flow of fixed assets (net investment) to assess the dynamics of the capital stock (abstracting from the effects of revaluation of the existing stock). Thus, if gross investment is larger (smaller) than the depreciation of capital (consumption of fixed capital, CFC, in national-accounts nomenclature), then net investment increases (decreases), and the stock of capital increases (decreases). From the late 1970s to the first half of the 1990s, France’s general government net investment was strong, averaging more than 1% of GDP per year (Figure 2.3). It even experienced a strong boom over the period 1987–1992, averaging above 1.4% of GDP per year. From 1993 to 1998, general government net investment declined sharply, reaching 0.5% of GDP in 1998, which amounted to a decrease of 1% of GDP over the space of six years. This, as was the case in other European countries, was mostly due to the effort to meet the Maastricht criteria in the run-up to the adoption of the euro: the cyclically adjusted deficit for France decreased from 4.6% of GDP in 1993 to 1.8% in 1998, and investment was the main adjustment variable. Net investment recovered in the next phase, then fluctuated between 0.7% and 0.9% of GDP over the 2000–2010 period, without ever returning to the level observed during the 1980s and the first half of the 1990s. Since 2011 and the Global Financial Crisis, net investment has been at its lowest level since the late 1970s, when wealth accounts were introduced. Fig. 2.3 Net General Government Investment by Component as a % of GDP. Source: Authors’ elaboration based on data from INSEE. -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 Q4 2019 Q1 2020 Q2 2020 Q3 2020 Q4 2020 Q1 2021 Q2 2021 Q3 2021 Q4 2021 Q1 2022 Q2 2022 Q3 2022 Q4 2022 Q1 2023 Q2 2023 GDP Public investment -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Civil engineering works Non residential buildings Housing Machines and equipments Intellectual property rights Weapon Sytems -180 -160 -140 -120 -100 -80 -60 -40 -20 0 20 40 60 80 100 120 Gross financial debt Net financial debt Non financial assets Net wealth Maastricht public debt -400 -350 -300 -250 -200 -150 -100 -50 0 50 100 150 200 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Total public administration State Local authorities -15 0 15 30 45 60 75 90 105 120 135 -2 0 2 4 6 8 10 12 14 16 18 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Gross public debt in % of GDP (right scale) Apparent interest rate Ten yeears interest rate Interest payment as %of GDP Crise des subprime Crise Covid -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Critical Rate (g-r, right scale) Nominal growth rate of GDP Ten year interest rate 39 2. Financing Public Investment in France Thus, during the period 2014–2018, France spent about 0.7 percentage points (p.p.) of GDP (about €18bn per year in 2022 euros) less on net investment than it did during the period 2000–2010, and 1.4 p.p. (approximately €37bn per year in 2022 euros) less than during the period 1990–1992. The picture that emerges from the analysis of stocks and flows is rather consistent and gives two main messages. The first is that, in France, public investment and the stock of capital have been largely affected by the macroeconomic cycle. In the two significant phases of fiscal consolidation―the run-up to adopting the euro in the 1990s and the aftermath of the sovereign debt crisis―investment was strongly reduced. Especially in the latter case, net investment turned negative to zero for all levels of government, thus reducing the stock of capital that, before the pandemic, was already at an all-time low. The second message that emerges, specifically from the analysis of stocks, is that, despite these trends in investment, the capital stock in France is still significant (and larger than in other countries). One might ask, then, if the effort of consolidation and the disproportionate burden that it has laid on public investment led, at least, to more sustainable public finances. A comparison of the evolution over the last twenty years of non-financial assets’ net flows in relation to primary net financial flow (financial assets — financial liabilities — interest expenses), which we consider here as a proxy of the net worth, clearly reveals the emergence of two sub-periods. The first, which runs from 1996 to 2008, can be seen as a period in which the additional public net financial debt (excluding interest expense) was more than offset by the net accumulation of non-financial assets, leading to a positive net value. This means that the general government stock of wealth increased in value over this period, even abstracting from price effects. The second period, which runs from 2009 to 2022, displays a new pattern in which the net debt increase is no longer offset by an increase in public non-financial capital, generating a sharp deterioration in the government’s net worth. The economic and financial crisis has led to a sharp increase in public debt, and fiscal consolidation began to be implemented in 2011. On one hand, it partly reduced new financial commitments; on the other, it has been more than offset by a reduction in the net accumulation of nonfinancial assets. This is yet-further proof that the burden of fiscal consolidation was disproportionately laid on the shoulders of public investment. The sharp reduction in net worth, therefore, casts doubt on the effectiveness of fiscal consolidation in strengthening the public-finances outlook for France. 2.4 General Government Net Wealth: Still Positive but a Strong Decrease Since 2008 What is referred to as ‘public capital’ covers a wide variety of assets, such as land, residential buildings, ports, dams, and roads. It also includes intellectual property rights. It is necessary to break down the ‘wealth of the State’ into these different 40 Financing Investment in Times of High Public Debt components to understand its dynamics, considering that price (most notably land price) and volume effects may play a significant role in explaining the evolution of the different components and of aggregate figures. We use public data from the INSEE national accounts; our analysis covers the period 1978–2021. INSEE reports the consolidated level (general government) and its components, distinguishing between the central government, local governments, social-security administrations, and other government agencies. In 2022, the consolidated public sector had a positive net wealth, despite the negative impact of the COVID-19 crisis (Table 2.1). Total assets held represented 167% of GDP, of which 103% was for non-financial assets. Financial liabilities totalled 134% of GDP. The net worth in 2022 was, therefore, 33% of GDP, around €12,700 per capita. Table 2.1 Decomposition of General Government Net Wealth As a % of GDP In euros per head 1978 2007 2022 2022 Non-financial assets 60.8 90.4 102.9 39,920 Financial assets 27.6 52.6 64.0 24,820 Financial liabilities 33.7 84.9 134.2 52,040 Net worth 54.7 58.1 32.8 12,700 Source: INSEE and authors’ calculations. After reaching a record level in 2007 (58% of GDP), it has lost 25 points of GDP in the space of fifteen years. The reasons for this sharp drop are to be found on the net financial liabilities (debt) side, which increased substantially while non-financial assets increased slightly (see Figure 2.4). This net worth is unevenly distributed among different levels of government. Indeed, it is very positive for local administrations (72% of GDP in 2022), very negative for the Central Government (-57% of GDP in 2022), and slightly positive for socialsecurity administrations and other government agencies (8% and 10%, respectively). Broadly speaking, the central government―which runs recurrent public deficits ― has accumulated public debt; low-debt local governments hold non-financial assets, be they land, buildings, or civil-engineering works. With the economic and financial crisis from 2008 onwards, the net worth of the central government deteriorated considerably as public deficits and debt increased. On the other hand, the net worth of local governments remained high and relatively stable over the same period due to a stable value of non-financial assets and their debt. 41 2. Financing Public Investment in France Fig. 2.4 Evolution of General Government Net Wealth as a % of GDP. Source: Authors’ creation based on data from INSEE. -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 Q4 2019 Q1 2020 Q2 2020 Q3 2020 Q4 2020 Q1 2021 Q2 2021 Q3 2021 Q4 2021 Q1 2022 Q2 2022 Q3 2022 Q4 2022 Q1 2023 Q2 2023 GDP Public investment -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Civil engineering works Non residential buildings Housing Machines and equipments Intellectual property rights Weapon Sytems -180 -160 -140 -120 -100 -80 -60 -40 -20 0 20 40 60 80 100 120 Gross financial debt Net financial debt Non financial assets Net wealth Maastricht public debt -400 -350 -300 -250 -200 -150 -100 -50 0 50 100 150 200 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Total public administration State Local authorities -15 0 15 30 45 60 75 90 105 120 135 -2 0 2 4 6 8 10 12 14 16 18 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Gross public debt in % of GDP (right scale) Apparent interest rate Ten yeears interest rate Interest payment as %of GDP Crise des subprime Crise Covid -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Critical Rate (g-r, right scale) Nominal growth rate of GDP Ten year interest rate 48 Financing Investment in Times of High Public Debt short-to-medium run, that is, until 2030.3 Furthermore, managing the transition (and ensuring a fair distribution of its costs) will likely involve higher energy prices―again, in the next decade or so―and higher public debt (in the order of 10 additional points from now to 2030, and of 25 points at the 2050 horizon). All this will lead to higher and possibly more volatile inflation in the next decade. While the factors just mentioned may lead to think that secular stagnation is past us, almost all the reasons for the compression of consumption and investment that led Gordon (2016) and Summers (2016) to revive the concept of secular stagnation are still having an effect. It is even possible that these will play a larger-than-ever role in the future. Demographic factors and persisting high inequality will continue to push up savings. More flexible and precarious labour markets and an increasing debt burden (both public and private) will also likely have an influence on the savings rate. Last but not least, macroeconomic and geopolitical uncertainty will reduce the propensity to invest (especially in long-term projects) and feed precautionary savings. It is true, on the other hand, that geopolitical uncertainty could lead to a greater propensity to hold safe assets (thus pushing up demand for government bonds) and to make new public investment in previously neglected sectors, such as defence, thus contrasting the tendency towards secular stagnation. While it is not possible to forecast which of these forces will prevail, it seems unlikely that the huge investments needed to set our economies on the path of ecological and digital transition will be sufficient to compensate for secular structural trends such as aging, rising inequality, uncertainty, and geopolitical instability. It is, therefore, reasonable to think that these forces will again dominate in the medium term and that policy makers will return in a few years to struggle with secular stagnation and deflationary pressures. This is a point also made by Blanchard (2023) and by the already-quoted WEO chapter (IMF 2023). The latter argues that, once the inflationary episode is over, we will return to an era of low interest rates; advanced countries will continue to suffer from reduced productivity growth and population aging, and emerging countries will see a similar situation as the dynamics of their economies catch up and converge with those of richer countries. This has, of course, strong implications for debt sustainability―globally and for France. If interest rates are bound to remain sufficiently low, then fiscal space will be enhanced even with modest growth rates. In fact, by looking at the past, the growthinterest differential remained positive for most of the past decade (see Figure 2.7). 3 The ecological transition will require mostly capital substitution with the objective not of increasing productivity but of greening production. 49 2. Financing Public Investment in France Fig. 2.7 The Critical Gap (g-r) for France. Source: Authors’ creation based on data from INSEE. If this keeps being the case in the medium-term future, sustained investment may be compatible with a stabilization or even with a moderate reduction of public debt. -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 Q4 2019 Q1 2020 Q2 2020 Q3 2020 Q4 2020 Q1 2021 Q2 2021 Q3 2021 Q4 2021 Q1 2022 Q2 2022 Q3 2022 Q4 2022 Q1 2023 Q2 2023 GDP Public investment -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Civil engineering works Non residential buildings Housing Machines and equipments Intellectual property rights Weapon Sytems -180 -160 -140 -120 -100 -80 -60 -40 -20 0 20 40 60 80 100 120 Gross financial debt Net financial debt Non financial assets Net wealth Maastricht public debt -400 -350 -300 -250 -200 -150 -100 -50 0 50 100 150 200 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Total public administration State Local authorities -15 0 15 30 45 60 75 90 105 120 135 -2 0 2 4 6 8 10 12 14 16 18 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Gross public debt in % of GDP (right scale) Apparent interest rate Ten yeears interest rate Interest payment as %of GDP Crise des subprime Crise Covid -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Critical Rate (g-r, right scale) Nominal growth rate of GDP Ten year interest rate 50 Financing Investment in Times of High Public Debt References Blanchard, O. J. (2023) ‘Secular Stagnation Is Not Over’, PIIE Realtime Economics Blog January 24, https://www.piie.com/blogs/realtime-economics/secular-stagnation-not-over Corsello, F., M. Gomellini, and D. Pellegrino (2023) ‘Inflation and Energy Price Shocks: Lessons from the 1970s’, Banca d’Italia Occasional Paper. 709 (July) Draghi, M. (2012) ‘Speech at the Global Investment Conference in London’, ECB (26 July) Gordon, R. J. (2016) The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War. The Princeton Economic History of the Western World. Princeton University Press IMF (2023) ‘The Natural Rate of Interest: Drivers and Implications for Policy’, chapter 2 of World Economic Outlook. A Rocky Recovery. pp. 45–68. Washington DC : International Monetary Fund Ministère de l’économie et des finances (2023) ‘Évaluation Des Grands Projets d’investissements Publics’, Annèxe Au Projet de Loi de Finances Pour 2023 Pisani-Ferry, J. and S. Mahfouz (2023) ‘Les Incidences Économiques de l’action Pour Le Climat’, France Strategie, Rapport à La Première Ministre (Mai) Plane, M. and F. Saraceno (2021) ‘From Fiscal Consolidation to the Plan de Relance’, in F. Cerniglia et al. (eds), The Great Reset―2021 European Public Investment Outlook. Cambridge, UK: Open Book Publishers, https://doi.org/10.11647/OBP.0280 Platzer, J. and M. Peruffo (2022) ‘Secular Drivers of the Natural Rate of Interest in the United States: A Quantitative Evaluation’, IMF Working Papers 2022 (030) Summers, L. H. (2016) ‘The Age of Secular Stagnation. What It Is and What to Do About It’, Foreign Policy (March/April), https://www.foreignaffairs.com/articles/ united-states/2016-02-15/age-secular-stagnation 3. Germany Lacks Political Will to Finance Needed Public-Investment Boost Katja Rietzler, Andrew Watt, and Ekaterina Juergens After more than a decade of weak public investment, Germany has accumulated a substantial public-investment backlog. The requirements for additional public investment in the next decade are in the range of €600 to 800bn, implying a further commitment of 1.6 to 2.1% of GDP each year. The federal government had made provisions for much smaller programmes, evading the debt brake. After the federal constitutional court ruled that shifting € 60 bn to an off-budget fund is unconstitutional, even this is now under threat. The court ruling casts doubt over similar operations at the federal and state levels, and comes when fiscal policy was already tightening under the pressure of the reapplied debt brake and rising interest rates. As this publication goes to press Germany is engaged in a fierce debate how to resolve the budget crisis. 3.1 Situation and Recent Developments After more than a decade of weak public investment, Germany has accumulated a substantial public-investment backlog, particularly at the local-government level. Investment needs, which range from roads and school buildings to the digitalisation of public administration, were already estimated in 2019 at €457bn over a ten-year horizon (Bardt et al. 2020). With the recently enhanced climate goals of the EU and the German government, additional investment needs in the health sector, as well as higher prices, the requirements for additional public investment and investment promotion in the next decade are more likely in the range of €600 to 800bn, which would imply a further annual commitment of 1.6 to 2.1% of GDP (Dullien et al. 2022; Rietzler and Watt 2022).1 Whereas infrastructure investment should be raised substantially and smoothed—to avoid the problem of intermittency and procyclicality—over the 1 The estimate was based on 2022 GDP. © 2023 K. Rietzler, A, Watt & E. Juergens, CC BY-NC 4.0 https://doi.org/10.11647/OBP.0386.03 52 Financing Investment in Times of High Public Debt long-term, investment to reduce greenhouse-gas emissions needs to be frontloaded, as the remaining carbon budget is shrinking rapidly. Investment to decarbonise the economy is mainly required in the private sector (in particular, production, transport, and heating), but the government plays a vital part in providing incentives for the private sector via investment grants in addition to carbon pricing and regulation. Furthermore, the government sector must decarbonise its own facilities, which amount to about 176.000 units at the local-government level alone (BMWi 2018). The current federal government is well aware of the requirements, having promised ‘a decade of investment’ in its coalition agreement (Rietzler and Watt 2022). Thus, one would expect a sustained and sizable increase in investment spending. Fig. 3.1 Government Investment (GGFCF and its Components) and Investment Grants. Note: in €bn, price adjusted, reference year 2015. Source: Destatis, calculations of the IMK. So far, the required massive additional public investment is nowhere to be seen in the data. Figure 3.1 shows that, after a strong increase in 2020 that was partly induced by the pandemic response, real government gross fixed-capital formation (GGFCF) declined again in the following two years. Investment in machinery and equipment, in construction, and in other products all dwindled. In early 2023, these trends showed little sign of reversing. In the first half of 2023, overall government investment declined by 2.7% compared to the second half of 2022, masking a strong decline of investment in machinery and equipment but somewhat stronger investment in construction compared to the previous half year; this was mainly at the municipal and state level, 0 10 20 30 40 50 60 70 80 90 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Total government gross fixed capital formation (GGFCF) GGFCF - of which: Construction GGFCF - of which: Machinery and equipment GGFCF - of which: investment in other products Investment grants (not included in GGFCF) 53 3. Germany Lacks Political Will to Finance Needed Public-Investment Boost while federal-construction investment declined strongly even in nominal terms. Thus, part of the catch-up process since 2015 has been reversed. Particularly in construction, double-digit price increases prevented nominal growth rates of a magnitude not seen since the German-reunification boom from translating into higher investment in real terms. In 2022, both nominal government construction investment and the respective deflator increased by 16%, leading to mere stagnation in real terms. In the first half of 2023, price increases for governmentconstruction investment slowed somewhat. Municipalities, which accounted for 59% of the overall public-construction investment (almost three times the amount spent by the federal level), still report that their actual investment spending—85% of which is construction (cf. Figure 3.2)—regularly remains below what they had planned to spend. Municipalities face staff shortages in their administration and complain about capacity constraints in the construction industry (Raffer and Scheller 2023), both of which delay the roll-out of projects. Unlike public investment itself, government investment grants to the private sector have increased massively since 2019 both in nominal and in real terms.2 Here too, the expansion in real terms has recently been slowed by strong price increases. 3.2 What Does the German Population Expect? Results from an IMK Survey Against the background of the accumulated-investment gaps, the adequacy of infrastructure has become a major barrier to economic activity in Germany—and Europe more generally—as firms report in surveys (European Investment Bank 2023, p. 69). Two other main barriers to private investment being voiced by managers are high energy costs and perceived uncertainty about the future (ibid.). These latter concerns could be at least partly alleviated, however, by improving the investment activity of the state. For instance, a more extensive public-goods provision in the renewable energy sector and the greater reliability of government investment spending could reduce uncertainty for private enterprises. 2 The deflator of private gross fixed-capital formation is used for price adjustment. 54 Financing Investment in Times of High Public Debt Fig. 3.2 Nominal Gross Fixed Capital Formation of Government Subsectors in 2022, on Federal, State, and Local Levels, in €bn. Source: Destatis, excluding social security, which accounted for only €0.9bn or 0.8% of the GGFCF. 8.674 12.108 9.121 5.822 11.111 13.608 5.093 33.440 0.926 Federal gvt.: machinery and equipment Federal gvt.: construction Federal gvt.: other products States: machinery and equipment States: construction States: other products Local gvt.: machinery and equipment Local gvt.: construction Local gvt.: other products 55 3. Germany Lacks Political Will to Finance Needed Public-Investment Boost It is not only business leaders, however, who are concerned. A recent nationwide survey shows that German citizens and residents—whose votes ultimately determine the funding available for public-investment and spending priorities—are also discontented with the deterioration of public infrastructure and would prefer stronger public investment activity (Behringer et al. 2021; Henze et al. 2022). The survey examined public satisfaction with public infrastructure in various categories (see Figure 3.3) and attitudes towards government-investment activity in the run-up to the 2021 German federal election. The data was collected as a computer-assisted online survey, and the total dataset encompassed 8,483 individuals aged between 18 and 75, selected representatively according to main sociodemographic and geographic characteristics, such as gender, age, income, and federal state. The results of the survey reveal that, across all investment categories, the overall satisfaction with infrastructure is rather low and the desire for more government investment is strong in Germany. Fig. 3.3 Satisfaction with Public Infrastructure and Desire for More Investment, in % of Total Respondents. Note: Respondents shown were ‘somewhat satisfied’ or ‘very much satisfied’ with public infrastructure, and their desire was that investment would ‘increase somewhat’ or ‘increase substantially’. Source: Henze et al. (2022). As Figure 3.3 shows, satisfaction with the state of public infrastructure is low on average, being lowest for categories such as climate protection (31%) as well as education and health (34%). Accordingly, about 68% of surveyed individuals are generally in favour of an increase in government investment. The respondents see the greatest need for investment by far in the areas of health (87%) and education (79%), which is consistent with their dissatisfaction with the state of infrastructure. Since the survey was conducted during the COVID-19 crisis, these responses reflect the detrimental consequences of curbing investment in the health-care system that was 30 40 50 60 70 80 90 Public transport Roads Walk and bike paths Mobile and internet Education Health Environment protection Public security Satisfied with infrastructure Increase investment 56 Financing Investment in Times of High Public Debt vividly exposed by the pandemic. In addition, environmental protection is seen as an important area by more than two thirds of those surveyed. Notably, the majority of respondents prefer an increase in public investment in almost all German federal states. In some of these, more than 70% see a need for additional investment (North Rhine-Westphalia, Schleswig-Holstein, Rhineland- Palatinate, and Berlin). Some significant differences in responses from urban and rural areas as well as from East and West Germany, however, are worth mentioning. Firstly, residents of cities report a much higher satisfaction with public transport (48%) than those of rural areas (31%). Analogously, the urban population is much more content with internet and mobile networks (52% versus 44%). The quality of infrastructure in these categories is, of course, much higher in metropolitan areas than in the countryside. It is nevertheless striking that a relatively low satisfaction in rural areas does not translate into a proportionally higher demand for investment in public transport and digital infrastructure. This stands in stark contrast to, for example, health care, which shows an expected correlation between lower satisfaction and higherinvestment desire in the countryside. This interpretation does not imply that public-transport and digital-infrastructure issues are negligible in rural areas: there, a broad majority is in favour of more investment, too. However, while rural respondents seem to be more willing to accept cutbacks in public transportation, they report a higher interest in increased infrastructure investment benefitting private vehicles, such as roads and bridges (60% in the rural areas versus 56% in the cities. The difference is statistically significant). These patterns suggest self-selection between urban and rural areas and ‘lock-in effects’. Residents of smaller towns must rely largely on cars for transportation. Since they don’t use public transport, they do not express such an interest in investing in a better network, perpetuating the current situation, even though they are dissatisfied with it. The same phenomenon can be noticed in the case of bicycle infrastructure. Only 53% of all respondents expressed their preference for higher investment in this category, mirroring a still very low volume of traffic by bicycle in Germany. Accordingly, the need for the state to take an active role in providing alternatives becomes even more relevant: the green transition does not emerge by itself but builds on the systems already in place, and existing infrastructure shapes not only the current behaviour but also people’s expectations of possible solutions and their plans. Secondly, the biggest difference between East and West Germany is in the desire for more investment in environmental protection. While 73% of surveyed individuals voiced their preference for more investment in climate protection in West Germany, only 60% of respondents—still a majority—shared these demands in the East. The difference in responses of residents of East and West Germany does not reflect a lower objective need for environmental protection in the East. Rather, these are differences in the perceived urgency of climate issues in comparison to other economic and social concerns between the two groups. 57 3. Germany Lacks Political Will to Finance Needed Public-Investment Boost Importantly, the respondents were asked how the additional public investment should be financed. This is necessary in order to elicit comprehensive preferences on public finance. Upon being confronted with the question of how to pay for the increase in public investment, about 6% of all survey participants who voiced a preference for this increase withdrew their request, and a further 7% of respondents could not answer the question. On the other hand, 17% specified that they would prefer the investment to be debt-financed; 62% (the majority) indicated that they would prefer other expenditures to be reduced; last but not least, 8% of the respondents were in favour of a tax increase to finance the additional public investment. 3.3 Financing Government Investment Spending 3.3.1 General Overview Germany faces various challenges in overcoming its huge investment backlog and implementing the necessary investments for the economic transformation. Until the surprise constitutional court ruling on 15 November 2023, funding did not seem to be the critical issue. Staff shortages, both in relevant economic sectors and in public-sector administration, play a prominent role; and spending often remains substantially below plan (Raffer and Scheller 2023; Rietzler and Watt 2022). According to extrapolated survey data from the Research Institute of the Federal Employment Agency (IAB 2023), there were almost 1.7 million vacancies in the second quarter of 2023. This is an exceptionally high number by historical standards despite a decline compared to the fourth quarter of 2022. The ratio of registered unemployed persons to the estimated total vacancies was 1:1.5. In the second quarter of 2022, vacancies in construction were estimated to be above 162,000 and in public administration (including social insurance) nearly 30,000. Despite two major crises, massive fiscal stimulus, and high deficits in some years; German public finances are in relatively good shape. The debt-to-GDP ratio of 66.1% at the end of 2022 is substantially below the euro-area average and has risen by much less than in the financial crisis. Employment is at a record level, and most forecasters, including the IMK (Dullien et al. 2023), expect declining deficits as the energy crisis is overcome and the spending on the ‘electricity-price brake’ and the ‘gas-price brake’ remains far below plan as gas prices have returned to pre-war levels (Figure 3.4). 64 Financing Investment in Times of High Public Debt distribution mechanism for the VAT share of the local communities, which currently favours economically strong communities, should be changed. However, such improvements for the municipalities would increase the fiscal pressure for the federal level. Helping overindebted municipalities also remains on the agenda, as SPD, Greens and Liberals promised a solution in their coalition agreement but have yet to deliver. After several states (Hesse, Saarland and Rhineland Palatinate) started their own debtrelief programmes, North Rhine Westphalia, the most populous state, has announced its own programme (Landesregierung Nordrhein-Westfalen 2023). While such state debt-relief programmes receive much praise, it must be noted that the municipalities still bear a large share of the debt service burden under these programmes. This is particularly true in the case of North Rhine Westphalia, where the state hardly injects any funds of its own. 3.4 What has Been Achieved under the German RRF Plan? As was noted in last year’s chapter on Germany (Rietzler and Watt 2022), funding from the Recovery and Resilience Facility (RRF) is currently playing and will continue to play a minor role in financing public investment, in contrast to some other Member States. Originally, the German national plan to implement the RRF (DARP: Deutsche Aufbau- und Resilienzplan) foresaw €25.6bn in grants to be made available for projects from 2021–2026. Germany did not avail itself of the option to draw on RRF loans, because the interest rate on such loans was slightly higher than that which Germany, with its safe-haven status, enjoys on international bond markets. At the start of 2023, an additional €2.4bn were made available to Germany based on a recalculation of the RRF allocations to Member States, thus adding firepower of just under 10%. In addition, the REPowerEU programme, which was designed to help Member States to wean themselves off Russian energy as quickly as possible, made available to Germany an additional €2.1 for energy-related investment, specifically. Despite these welcome top-ups, Rietzler and Watt’s 2022 finding that EU programmes are of only secondary importance in Germany continues to hold true. This is the case because the substantial redistributional element in the original RRF targeted Member States severely affected by the COVID-19 crisis and those with GDP per capita below the EU average (Watt and Watzka 2020). The end of 2023 marks the mid-point of the RRF programme. Assessing the progress made by the roll-out of RRF projects in Germany is not easy. At the time of writing (October 2023), Germany has only received the pre-financing which was paid out, unconditionally, in 2021. None of the envisaged five tranches, each of which requires detailed national reporting and approval by the EU Commission, has been disbursed, 65 3. Germany Lacks Political Will to Finance Needed Public-Investment Boost although a request for payment of just under €4bn was submitted in mid-September.9 Correspondingly, the EU Commission RRF Scoreboard reports that Germany, to date, has not been officially assessed as having achieved any of the envisaged milestones and targets. To a considerable extent, however, this situation reflects a processing delay that stems from the conceptualisation of the RRF facility. Only a 100% achievement score of milestone and targets triggers a full payment. Therefore, Member States shy away from submitting payment requests to receive their funding if all milestones and targets due for that tranche have not yet been achieved fully, so as to avoid receiving only partial payments, creating additional bureaucracy. An answer to a recent parliamentary question by the German Finance Ministry (8 June) indicated that the German government had, as of 30 April, itself designated 58 of the total 129 milestones and targets set out in the DARP as completed (Deutscher Bundestag 2023a: 36). Most milestones have been reached in the first two pillars of the DARP: decarbonisation (21) and digitalisation (11). Milestones in the other four pillars are in single figures: education (8), social inclusion (6), health (5), and public administration (7). In many cases, the inception-stage milestones achieved so far have been of a preparatory legal nature: passing/publishing legislation or administrative decisions enabling private-sector actors to claim various forms of support or bid for public contracts. In some cases, though, programmes have already been implemented with concrete and quantified outcomes; examples include support for electrical-vehicle purchases, tablets for teaching purposes, and the digitalisation and modernisation of hospitals. Changed circumstances led to the revision of 2 milestones, and the finance ministry is currently preparing to submit the first funding application, which will cover 36 milestones/targets. Even if the RRF makes a relatively minor contribution to public investment in the German case, its expiration in 2026 will see this source of financing dry up. Unless EU resources are expanded, Member States including Germany will, moreover, be jointly responsible for servicing the loans taken out to finance the RRF. Discussions are ongoing about whether a successor facility, one likely to be differently structured and possibly permanent, will be put in place. To judge by the most recent EU Commission proposal (the Strategic Technologies for Europe Platform (STEP), June 2023), however, there does not seem to be much appetite for a centrally-funded facility of anything like the required order of magnitude. 9 Germany is not alone in this: a number of other Member States have, to date, not yet received funding by regular tranches. 66 Financing Investment in Times of High Public Debt 3.5 Outlook Germany’s huge public-investment needs are widely recognized. Despite the pledge to initiate a decade of investment that the governing coalition made when it took office at the end of 2021, too little has been achieved. Understandably, recent focus has been on supporting households in the energy and inflationary crisis sparked by the Russian invasion of Ukraine (Watt 2022). As energy prices have declined from their peaks in 2022, the government is concentrating on its exit from the crisis mode. Already before the constitutional court ruling, the key objective was clearly the consolidation of public finances, not the raising of investment, however. The finance minister, from the liberal FDP, aimed to solve the trade-off between budget consolidation and additional investment via cuts in social and consumption spending (BMF 2023a). While this is politically popular insofar as it avoids the need for tax increases or higher borrowing, it proves difficult in practice to achieve spending cuts by orders of magnitude that would free up substantial additional resources. Most spending is on the basis of legal entitlements that are difficult to change substantially in the short run. The government is still not prioritising public investment in the modernisation of Germany and its transformation to a low-carbon economy. It is not sufficiently understood that digital and ecological transformation are a once-in-a-generation challenge, like German reunification, which—among other instruments—was financed via a mixture of public debt and tax increases. Similarly, the modernisation and transformation of the economy should be financed using a mix of instruments. To the extent that future economic activity and, consequently, tax revenues are increased via public investment, debt finance in line with the golden rule is economically justified. Already politically difficult thanks to the debt brake, the constitutional court ruling has now seemingly ruled out deficit financing of a substantial proportion of the planned additional investment and accompanying support measures for business and households. Given this, and the fact that climate protection and adaptation will not, in all cases, contribute to future growth and additional revenues it would make sense to finance some of the investment via additional tax revenues and also cut back ecologically damaging tax breaks. At the moment, however, there is a political majority for neither tax increases nor for a substantial reform of the German debt brake. Germany is also opposing reforms of the European fiscal rules which could increase the scope for public investment. It was already likely that public investment in Germany, even if there are increases in certain areas, would remain substantially below what is necessary. After the constitutional court ruling there is heightened uncertainty as to the path forward and a real risk of a substantial scaling back of the level of ambition. 67 3. Germany Lacks Political Will to Finance Needed Public-Investment Boost References Bardt, H., S. Dullien, M. Hüther, K. Rietzler (2020). ‘For a Sound Fiscal Policy: Enabling Public Investment’. IMK Report, 152e, https://www.imk-boeckler.de/fpdf/HBS-007619/p_imk_ report_152e_2020.pdf Behringer, J., S. Dullien, C. Paetz (2021). ‘Überwältigende Mehrheit der Deutschen will kräftige Investitionsausweitung’. IMK Policy Brief, 112, https://www.imk-boeckler.de/fpdf/ HBS-008181/p_imk_pb_112_2021.pdf Bundesministerium der Finanzen, BMF (2023a). ‘Bundesfinanzminister Christian Lindner im Interview mit der Süddeutschen Zeitung’. 17 June, https://www.bundesfinanzministerium. de/Content/DE/Interviews/2023/2023-06-17-sueddeutsche-zeitung.html —— (2023b). ‘Schieflage der Bund-Länder-Finanzbeziehungen’, in BMF-Monatsbericht. March: 8–13, https://www.bundesfinanzministerium.de/Monatsberichte/2023/03/ monatsbericht-03-2023.html Bundesministerium für Wirtschaft und Energie, BMWi (2018). ‘Energieeffizienz in Kommunen. Energetisch modernisieren und Kosten sparen: Wir fördern das’. BMWi, Berlin, https://www.foerderdatenbank.de/FDB/Content/DE/Download/Publikation/ Energie/energieeffizienz-in-kommunen-broschuere.pdf?__blob=publicationFile&v=2 Bundesrechnungshof (2023a). ‘Bericht nach § 88 Absatz 2 BHO an den Haushaltsausschuss des Deutschen Bundestages Umsetzung des Onlinezugangsgesetzes Steuerung und Koordinierung’. 29 March, Bonn, https://www.bundesrechnungshof.de/ SharedDocs/Downloads/DE/Berichte/2023/onlinezugangsgesetz-volltext. pdf?__blob=publicationFile&v=2 —— (2023b). ‘Bericht nach § 88 Absatz 2 BHO an das Bundesministerium der Finanzen über die Sondervermögen des Bundes und die damit verbundenen Auswirkungen auf die Haushaltstransparenz sowie die Funktionsfähigkeit der Schuldenregel’. 25 August, Bonn, https://www.bundesrechnungshof.de/SharedDocs/Downloads/DE/Berichte/2023/ sondervermoegen-volltext.pdf?__blob=publicationFile&v=6 Deutsche Bundesbank (2021). ‘Federal Debt: Allocate Premia on Accruals Basis in Budgetary Interest Expenditure’. Monthly Report. June 2021: 47–51 https://www.bundesbank.de/en/ publications/reports/monthly-reports/monthly-report-june-2021-868086 —— (2022). ‘State Government Finances in 2021: Surplus and Additional Reserves from Emergency Borrowing’. Monthly Report. October: 13–28 https://www.bundesbank.de/en/ publications/reports/monthly-reports/monthly-report-october-2022-898764 Deutscher Bundestag (2023a) ‘Schriftliche Fragen mit den in der Woche vom 5. Juni 2023 eingegangenen Antworten der Bundesregierung’, Drucksache, 20/7918, 9 June 2023 https:// dserver.bundestag.de/btd/20/071/2007148.pdf —— (2023b). Entwurf eines Gesetzes über die Feststellung des Bundeshaushaltsplans für das Haushaltsjahr 2024 (Haushaltsgesetz 2024–HG 2024), Bundestagsdrucksache, 20/7800, 18 August, https://dip.bundestag.de/vorgang/gesetz-%C3%BCber-die-feststellung-des- bundeshaushaltsplans-f%C3%BCr-das-haushaltsjahr-2024/302729 Dullien, S., A. Herzog-Stein, P. Hohlfeld, K. Rietzler, S. Stephan, T. Theobald, S. Tober, and S. Watzka (2023). ‘Stark restriktive Geldpolitik verschärft Wirtschaftsflaute’. Prognose der wirtschaftlichen Entwicklung 2023/2024. IMK Report, 184. https://www.boeckler.de/fpdf/ HBS-008701/p_imk_report_184_2023.pdf 68 Financing Investment in Times of High Public Debt ——, K. Rietzler, and A. Truger (2022). ‘Die Corona-Krise und die sozial-ökologische Transformation: Herausforderungen für die Finanzpolitik’. WSI-Mitteilungen, 75(4): 277–85 https://doi.org/10.5771/0342-300X-2022-4-277 European Investment Bank (2023). ‘Resilience and Renewal in Europe’. European Investment Bank Annual Report 2022/2023, https://doi.org/10.2867/307689 Gechert, S., K. Rietzler, S. Schreiber, and U. Stein (2019). ‘Wirtschaftliche Instrumente für eine klima- und sozialverträgliche CO2-Bepreisung: Gutachten im Auftrag des Bundesministeriums für Umwelt, Naturschutz und nukleare Sicherheit’. IMK Study, 65, https://www.boeckler.de/pdf/p_imk_study_65_2019.pdf Henze, L. T., E. Jürgens, and C. Paetz (2022). ‘Einstellungen zur öffentlichen Infrastruktur und zum Investitionsbedarf im Regionalvergleich’. IMK Policy Brief, 129, https://www.imkboeckler.de/de/faust-detail.htm?sync_id=HBS-008383 Institut für Arbeitsmarkt- und Berufsforschung, IAB (2023). IAB-Stellenerhebung: Offene Stellen, https://iab.de/das-iab/befragungen/iab-stellenerhebung/aktuelle-ergebnisse/ Kultusministerkonferenz, KMK (2023). ‘Abfrage der geflüchteten Kinder/Jugendlichen aus der Ukraine’. 38. und 39. Kalenderwoche (18 September – 1 October 2023), https://www.kmk. org/fileadmin/Dateien/pdf/Statistik/Ukraine/2023/AW_Ukraine_KW_39.pdf Landesregierung NRW (2023). ‘Landesregierung Nordrhein-Westfalen geht mit Programm für kommunale Altschulden in Vorleistung—zudem 6-Milliarden- Investitionsprogramm für kommunale Infrastruktur mit Fokus auf Klimaschutz und Klimaanpassung’. Press release. 19 June, https://www.land.nrw/pressemitteilung/ landesregierung-nordrhein-westfalen-geht-mit-programm-fuer-kommunale-altschulden Rietzler, K., A. Watt (2022). ‘Public Investment in Germany: Squaring the Circle’, in Cerniglia, F. and Saraceno, F. (eds). Greening Europe—2022 European Public Investment Outlook, Cambridge, UK: Open Book Publishers: 41–53, https://doi.org/10.11647/OBP.0328 Raffer, C., H. Scheller, (2023). KfW Kommunalpanel 2023. Kreditanstalt für Wiederaufbau, Frankfurt am Main, https://www.kfw.de/PDF/Download-Center/Konzernthemen/ Research/PDF-Dokumente-KfW-Kommunalpanel/KfW-Kommunalpanel-2022.pdf Unabhängiger Beirat des Stabilitätsrats (2023). 20. Stellungnahme zur Einhaltung der Obergrenze für das strukturelle gesamtstaatliche Finanzierungsdefizit nach § 51 Absatz 2 HGrG zur Sitzung des Stabilitätsrats am 2. Mai, https://www. stabilitaetsrat.de/SharedDocs/Downloads/DE/Beirat/2023/Stellungnahme/20230502_ Stellungnahme_Beirat.pdf;jsessionid=FBA712DC9B95B9572EF0BE64FE9657AE. intranet632?__blob=publicationFile Watt, A. (2022). ‘Inflation and Counter-Inflationary Policy Measures: The Case of Germany’, IMK Study, 183–10, https://www.imk-boeckler.de/de/faust-detail. htm?sync_id=HBS-008504 —— and S. Watzka (2020). ‘The Macroeconomic Effects of the EU Recovery and Resilience Facility’, IMK Policy Brief 98, https://www.imk-boeckler.de/de/faust-detail. htm?sync_id=9110 4. Italy’s Public Investments. The NRRP and Beyond Giovanni Barbieri, Floriana Cerniglia, Enzo Dia This chapter provides the country report on Italy with an analysis of the role the Italian National Recovery and Resilience Plan in boosting public investment up to and beyond 2026. Italy’s NRRP has 235 billion euros available for investments and reforms, making it one of the most remarkable modernization initiatives in the last seventy years. The impact of the NRRP is assessed and specific implementation challenges are highlighted, some of which have been caused by factors such as fragmented governance, a lack of effective monitoring, and compliance issues. Overcoming these difficulties is crucial for continuing to receive disbursements from the European Commission. The effectiveness of its governance is examined. An open question is how to ensure a positive capitalspending trajectory in Italy (especially after 2026) in compliance with the new rules set out in the Stability and Growth Pact. 4.1 Introduction Italy’s National Recovery and Resilience Plan (NRRP) is worth €235bn: €191.5bn come from the Recovery and Resilience Facility (RRF), €13.5bn from React-EU, and €30.6bn from direct Italian government funding through its Complimentary Fund.1 Thus, over two hundred billion euros have been devoted to investments and reforms for Italy; it is one of the most impressive modernization plans of the past seventy years. If fully implemented, it could potentially generate one additional point of growth over the next decade. While this is a considerable amount, it is de facto equivalent to what was lost in the decade from 1 See Barbieri, G., Cerniglia, F., Gori, G. F., Lattarulo, P., (2022), ‘NRRP—Italy’s strategic Reform and Investment Programme’, in F. Cerniglia and F. Saraceno (eds), Greening Europe—2022 European Public Investment Outlook. Cambridge, UK: Open Book Publishers: 55-70, https://www.openbookpublishers. com/books/10.11647/obp.0328; and Barbieri, G., F. Cerniglia, (2021), ‘Relaunching Public Investment in Italy’, in F. Cerniglia, F. Saraceno, A. Watt (eds), The Great Reset—2021 European Public Investment Outlook, Cambridge, UK: Open Book Publishers: 63-78, https://doi.org/10.11647/OBP.0280 © 2023 G. Barbieri, F. Cerniglia & E. Dia, CC BY-NC 4.0 https://doi.org/10.11647/OBP.0386.04 70 Financing Investment in Times of High Public Debt 2009–2019 due to the economic and financial crisis of 2008–2009 and the austerity measures that followed to curb public spending that mainly impacted capital investments.2 Moreover, to truly tackle the existing North-South disparities in Italy, even greater resources are required than those currently available. While 40% of the NRRP funds are to be dedicated to the Mezzogiorno region and the reduction of the North-South gap is one of the Plan’s transversal objectives, projections suggest that the resources from the NRRP will only decrease but not eliminate the gap. For example, the GDP per capita in the Mezzogiorno is currently 55% of that in central and northern Italy; in 2026 it should rise to 59%. In addition, the NRRP is currently facing a series of implementation challenges. There is concern over the planning and spending capabilities of certain local governments, which are expected to receive a substantial portion of the allocated resources. There is also concern over the recent surge in raw material costs which act like a sword of Damocles, as the Plan was originally designed with lower infrastructure-expenditure commitments. In fact, the Italian government have negotiated with the European Commission to amend the Plan in order to facilitate the feasibility of the projects and coordination with the REPowerEU programme. Public-investment flows over the coming year will be fuelled in Italy not only by the NRRP’s resources but also by cohesion policies primarily focused on the Mezzogiorno region. The overarching goal of these is the reduction of territorial gaps. Here, again, much depends on the spending-planning capacity of local governments especially in the Mezzogiorno. Furthermore, there are growing concerns that the constraints imposed by the new European fiscal regulations, set to take effect (potentially) in 2024, may not ensure a consistent trajectory of public investment in Italy beyond 2026. Yet, a comprehensive programme, aimed at recuperating a decade of declining public investments and addressing the significant funding needs resources required posed by the digital and green transitions, call for a timeline and resources that go well beyond 2026. The progress of Italy’s NRRP and the constraints that could hinder the path towards sustained growth of public investments beyond 2026 are outlined in this chapter. An update on the current state of advancement is also provided. We evaluate whether the resources allocated by the Plan genuinely contribute to enhancing investment and assess whether Next Generation EU (NGEU) can be deemed successful, including as an experiment for a shared European-debt framework in funding critical public investments crucial for growth and EU convergence. 2 This progression has been extensively documented in the chapter on Italy of the previous Outlook instalments. 71 4. Italy’s Public Investments. The NRRP and Beyond 4.2 Italy’s NRRP The total resources available in Italy’s NRRP from the Recovery and Resilience Facility are €191.5bn (which is 26.5% of the entire RRF), of which €68.9bn are grants and €122.6bn are loans. It is aligned with the strategic guidelines outlined within the NGEU and is divided into six missions: 1. Digitization, innovation, competitiveness, culture and tourism; 2. Green revolution and ecological transition; 3. Infrastructure for sustainable mobility; 4. Education and research; 5. Inclusion and cohesion; and 6. Health. The €191.5bn budget is allocated in the plan as follows: 21% for Mission 1; 31% for Mission 2; 13.3% for Mission 3; 16.1% for Mission 4; 10.4% for Mission 5; and 8.2% for Mission 6. Italy’s NRRP is designed as a performance-driven strategy rather than a mere expenditure programme. It is structured around reforms and investments, carefully timed through the achievement of milestones (a total of 213) and targets (a total of 314) by the set deadline: 2026. As a result, all measures within the NRRP are accompanied by a clear implementation schedule and a list of expected outcomes that must be fulfilled in order to receive the planned allocation of financial contributions or loans. Each reform and investment are associated with a comprehensive description of the measure’s objectives and with indicators that reflect the aims. The indicators serve as benchmarks for evaluating3 progress and elaborate: a) milestones, that is, critical stages of implementation (both in terms of tangible progress and procedural steps), including the adoption of specific regulations, the full functionality of information systems, or the successful completion of projects; and b) targets, that is, measurable indicators that gauge the outcomes of public interventions (such as kilometres of constructed railways) or the impact of public policies (like reducing the incidence of informal employment). Table 4.1 shows, for each deadline, the number of milestones and targets corresponding to the total funds received, divided into grants and loans. 3 In accordance with Regulation UE 2020/852 (‘framework to facilitate sustainable investment’) and with the European Green Deal’s objectives, the RRP’s measures must comply with the principle of Do-No-Significant-Harm (DNSH) to provide a substantial contribution to protecting the ecosystem without significantly damaging the environment. See De Vincenti, C. (2022), ‘Green Investments: Two Possible Interpretations of the “Do No Significant Harm” Principle’, in Cerniglia, F., Saraceno, F. (eds), Greening Europe—2022 European Public Investment Outlook, Cambridge, UK: Open book Publishers, 2022:177–85, https://doi.org/10.11647/OBP.0328 72 Financing Investment in Times of High Public Debt Table 4.1 Grants and Loans Timeframe Milestones and Targets Gross amount (€bn) Disburse-ments (€bn) Deadline Grants Loans Total 13/08/2021 24.9 31/12/2021 51 11.5 12.6 24.1 21 30/06/2022 45 11.5 12.6 24.1 21 31/12/2022 55 11.5 10.3 21.8 19 30/06/2023 27 2.3 16.1 18.4 16 31/12/2023 69 8.1 12.6 20.7 18 30/06/2024 31 2.3 10.3 12.6 11 31/12/2024 58 6.3 15 21.3 18.5 30/06/2025 20 2.3 10.3 12.6 11 31/12/2025 51 4.6 10.3 14.9 13 30/06/2026 120 8.5 12.3 20.8 18.1 527 68.9 122.6 191.5 191.5 Source: italiadomani.gov The disbursed instalments to date include: • 13 August 2021: pre-financing instalment of €24.9bn (of which €8.957bn in grants and €15.937bn in loans), which represents 13% of the total amount allocated to Italy in grants and loans under the Recovery and Resilience Facility. • 13 April 2022: first six-month instalment of €21bn (€10bn in grants and €11bn in loans), following the positive assessment of the NRRP targets that Italy had to reach by 31 December 2021. • 8 November 2022: second semi-annual instalment of €21bn (€10bn in grants and €11bn in loans) following the positive assessment on the achievement of 45 targets and objectives. Some of the targets and objectives covered include reforms in public administration, public procurement, tax administration, and territorial health care. In addition, investments were made in key strategic sectors, including ultrawideband and 5G, research and innovation, tourism and culture, hydrogen development, urban redevelopment, the digitalisation of schools, and reducing the backlog of court cases. • 28 July 2023: third six-month instalment of €18.5bn was approved by the Commission after accepting the Italian government’s proposed revisions to the NRRP (see details in section 4.3 below). The European Commission did not approve the disbursement of the full instalment of €19bn (€10bn in grants and €9bn in loans); €500 million were deducted because the government had not reached a required objective on implementing measures to ensure 73 4. Italy’s Public Investments. The NRRP and Beyond more student accommodations (beds), which was one of the milestones that needed to be reached by 31 December 2022.4 • 22 September 2023: The request for payment of the fourth instalment was forwarded by the Government to the European Commission. The next milestones and targets will need to be reached by the Italian government to obtain the disbursement of the fourth instalment (renegotiated with the Commission) so as to obtain by end 2023 the total €35bn planned for the year.5 As mentioned above, in addition to investments, the NRRP commits Italy to a major reform programme aimed at improving regulatory and legal conditions in order to steadily increase the country’s equity, efficiency, and competitiveness.6 Figure 4.1 shows the number of investments and implemented reforms by Mission. Fig. 4.1 Number of Investments and Reforms by Mission. Source: Calculations of structure of NRRP Missions based on ReGiS data. 4 The initial target of assigning 7,500 beds by 31 December 2022—a target that the EU Commission assessed with exceptional precision—is now being transformed into a qualitative milestone (of reaching the larger objective of 60,000 beds by 2026). This adjustment is being proposed alongside ten previously submitted changes in order to receive the fourth instalment of the NRRP. 5 The EU Council adopted on 19 September 2023 the decision approving the amendments to Italy’s RRP relating to certain goals and objectives to be achieved by 30 June 2023 for obtaining the fourth instalment of 16.5 bn euros. 6 The NRRP contains three main types of reforms: 1) horizontal or contextual reforms, that crosscut across all the NRRP’s Missions. These consist of structural innovations to the system, aimed at improving equity, efficiency, and competitiveness, thus contributing to the overall economic climate of the country (for example reforms within the public administration and the justice system); 2) enabling reforms, these reforms constitute a subset of contextual reforms and are directly aimed at ensuring the implementation of the NNRP and, in general, and removing administrative, regulatory, and procedural barriers that influence economic activities and the quality of services provided (for examples reforms related to public contracts, simplification of regulations and procedures, boosting competition, and the reduction of payment delays by public administrations; 3) sectoral reforms, included within each individual Missions that consist of legislative innovations for specific areas of intervention or economic activities aimed at introducing more efficient regulatory and procedural frameworks within their respective sectoral domains (for example, reforms related to the labour market and education). 30 43 11 24 16 8 22 13 10 11 5 2 0 10 20 30 40 50 60 M1 M2 M3 M4 M5 M6 Investments Reforms 11.5 11.5 11.5 2.3 8.1 2.3 6.3 2.3 4.6 8.5 12.6 12.6 10.3 16.1 12.6 10.3 15 10.3 10.3 12.3 24.1 24.1 21.8 18.4 20.7 12.6 21.3 12.6 14.9 20.8 0 10 20 30 40 50 60 2021 2022 2022 2023 2023 2024 2024 2025 2025 2026 VALUES IN €BN Grants Loans Total 80 Financing Investment in Times of High Public Debt and Resilience Facility (RRF) — accounted for 0.2% of Italy’s GDP in 2022; they are expected to peak at 1.8% in 2025 (if all the funds received are actually spent), less than half of the investment forecasted for that year. In essence, the data show that Italy’s positive trend in public investments, mostly driven by the NRRP, will end in 2026. Hence, it is more important than ever that Italian budgetary policy support a positive public-investment trend beyond 2026. Unfortunately, the phase before us (already from this year) is one of great uncertainty. Fiscal policy must now reckon with lower internal economic growth prospects, and low growth in countries with which Italy has strong interdependencies. Italy’s macroeconomic dynamics are also conditioned by the geopolitical turmoil triggered by the war in Ukraine, inflation, and restrictive monetary policies implemented by Central Banks, which have begun to drain liquidity from the economic system. Key Italian macro- and public-finance data for the upcoming years, as provided in the DEF, are here reviewed.17 The GDP growth trend in real terms is 0.9% for 2023, 1.4% for 2024, 1.3% for 2025 and 1.1% for 2026.18 It should be noted that the highest growth (expected in 2024) should occur thanks to the large amounts of public investment over the period here considered. The new European fiscal rules — which will most likely put Italy on a path of deficit and debt reduction — will introduce enormous constraints, given the country’s high public debt. Fom 2024, the so-called ‘general escape clause’, activated by the Commission in 2020 in response to the economic consequences of the COVID-19 pandemic, will cease to apply. As is well known, the European Commission had begun a discussion on reforming the Stability and Growth Pact’s rules and the economic governance of the European Union before the effects of the COVID-19 pandemic became apparent. This discussion was last raised in November 2022 with the presentation of a series of guidelines.19 The Italian government, while supporting the main tenets of the European Commission’s proposal, pointed out critical aspects on several occasions. Concerns were raised about the division of Member States into three categories, according to a debt sustainability analysis conducted by the European Commission and recommended greater involvement by the 17 Submitted by the Government to Parliament on 13 April 2023, to be followed by Update to the Economic and Finance Document (DEF) (by September 2023) and the Budget Law (December 2023) for 2024 and beyond. The DEF contains trends, forecasts, and real economic data. 18 NADEF updates (September 2023) are as follows: 0.8% in 2023, 1.2% in 2024 and 1.4% in 2025. As noted by the Parliamentary Budget Office, the projections presented in the DEF are subject to a notable degree of uncertainty regarding the execution of the NRRP. This uncertainty is further accentuated by the lack of tables in the DEF on annual expenditure forecasts. The DEF’s forecasting methodology, encompassing both trend and programme-based projections, is premised on the assumption that expenditure will be fully implemented by 2026. See Testimony of the President of the Parliamentary Budget Committee during the hearing on the 2023 Economic and Finance Document, Rome 2023, https://www.upbilancio.it/audizione-nellambito-dellesame-del-def-2023/#:~:text=20%20April%20 2023%207C%20The%20President,e%20finance%20(DEF)%202023 19 https://eur-lex.europa.eu/legal-content/IT/TXT/PDF/?uri=CELEX:52022DC0583 by conducting a series of hearings and formulating final documents—see https://www.senato.it/service/PDF/ PDFServer/BGT/1372239.pdf and https://www.camera.it/leg19/824?tipo=A&anno=2023&mese=0 3&giorno=08&view=&commissione=05 81 4. Italy’s Public Investments. The NRRP and Beyond Member States in the process. They also linked the review of economic governance to the ongoing discussions on the reform of state-aid rules and (re)designing industrial policies. A crucial aspect not yet addressed is how to show preference for public investment aimed at combatting climate change and promoting digital transition—two pillars of the NRRP—and supporting international commitments undertaken in defence spending. In the 2023 DEF, the Italian government outlined its intention to gradually, but systematically, reduce its deficit and debt of GDP over three years (4.5% of GDP in 2023, 3.7% in 2024, and 3% in 2025). In 2026, however, the deficit target has been set at 2.5% of GDP. With reference to the debt-to-GDP ratio: it is expected to be 144.4% in 2022, 142.1% in 2023, 141.4% in 2024, 140.9% in 2025, and 140.4% in 2026.20 Obviously, higher interest expenditure in relation to GDP than in previous years and higher average costs when issuing new debt will have a major impact on the expected decrease of (merely) four points. The Parliamentary Budget Office has also developed some scenarios to consider the debt-to-GDP ratio, up to 2024, in the context of the new framework elaborated and proposed by the European Commission. These show that a decreasing debt trend is only possible with economic growth; furthermore, from 2033, the ratio could rise due to the progressive increase of Italy’s aging population. Moreover, the NADEF 2023, adopted in September 2023, confirms the Government’s desire to fully implement the NRRP. The new growth forecasts, in fact, continue to incorporate the full implementation of the NRRP. The Government continues to move forward with its planned expenditure but spending flows have been slightly revised downwards for 2023, to a lesser extent for 2024, and revised upwards for 2025 and 2026. The Parliamentary Budget Office, in a letter validating the macroeconomic framework trend for 2023–24, has highlighted the risks of these continuous slippages in terms of supply bottlenecks, also in reference to the expertise necessary to manage and start the works.21 It follows that overall investments—although supported by the NRRP—will be less dynamic in the short term than forecasted in the DEF (-11.7%). To conclude, only by increasing public investment—even beyond 2026—can the debt-to-GDP ratio decrease at a faster pace, and, above all in times like these, allow the EU in primis to try to build a new framework capable of withstanding the new world powers. A massive public-investment programme funded by European fiscal capacity could enable the (re)construction of a European model that combines democracy, growth, cohesion, and welfare. It is likewise abundantly clear that major emergencies (like climate change) render public intervention hollow if limited to a single state or even groups of states, for example, if the EU alone were to act globally on green transition. 20 NADEF updates for deficit are: 5.3% in 2023, 4.3% in 2024, 3.6% in 2025. With reference to the debt-to- GDP ratio: 140.2% in 2023, 140.1% in 2024, 139.9% in 2025, and 139.6% in 2026. 21 See https://www.upbilancio.it/wp-content/uploads/2023/10/Audizione-NADEF-2023.pdf 82 Financing Investment in Times of High Public Debt References Barbieri, G., F. Cerniglia, G. F. Gori, P. Lattarulo, (2022), ‘NRRP—Italy’s strategic Reform and Investment Program’, in F. Cerniglia and F. Saraceno (eds), Greening Europe—2022 European Public Investment Outlook, Cambridge, UK: Open Book Publishers: 55–70, https://doi. org/10.11647/OBP.0328 Barbieri, G., F. Cerniglia, (2021), ‘Relaunching Public Investment in Italy’, in F. Cerniglia, F. Saraceno, and A. Watt (eds), The Great Reset—2021 European Public Investment Outlook, Cambridge, UK: Open Book Publishers: 63–78, https://doi.org/10.11647/OBP.0280 Bordignon, M. (2022), ‘Europa: ecco le nuove regole fiscali’, Lavoce, November, https://lavoce. info/archives/98748/europa-ecco-le-nuove-regole-fiscali/ —— and L. Ciotti (2023), ‘La transizione verso le nuove regole fiscali europee’, Osservatorio CPI, 24 March, https://osservatoriocpi.unicatt.it/ ocpi-pubblicazioni-la-transizione-verso-le-nuove-regole-fiscali-europee —— (2023), ‘Nuove regole fiscali europee: è pur sempre una riforma’, Lavoce, 16 May, https:// lavoce.info/archives/101126/nuove-regole-fiscali-europee-e-pur-sempre-una-riforma/ —— and F. Neri (2023), ‘Le regole fiscali europee per il 2024’, Osservatorio CPI, 7 June, https://osservatoriocpi.unicatt.it/ocpi-pubblicazioni-le-regole-fiscali-europee-per-il-2024 Camera dei Deputati (2023), ‘I profili finanziari del Piano Nazionale di Ripresa e Resilienza (PNRR)’, Documentazione di finanza pubblica, 4, November, https://documenti.camera.it/ leg19/dossier/pdf/DFP004.pdf?_1667911550919 —— (2023), ‘V Commissione Permanente—Documento finale sulla comunicazione della commissione al parlamento europeo, al consiglio, alla banca centrale europea, al comitato economico e sociale europeo e al comitato delle regioni—comunicazione sugli orientamenti per una riforma del quadro di governance economica dell’UE, COM(2022) 583 definitivo’, 8 March, https://documenti.camera.it/leg19/resoconti/commissioni/bollettini/ pdf/2023/03/08/leg.19.bol0075.data20230308.com05.pdf Caputo, G. O. and G. Viesti (2022), ‘Il PNRR e le disuguaglianze italiane: potenzialità e criticità’, Il Mulino, Autonomie locali e servizi sociali, 2, August: 199–220 https://doi. org/10.1447/105081 Commissione Europea (2022), ‘Comunicazione sugli orientamenti per una riforma del quadro di governance economica dell’UE’, COM(2022) 583 final, https://eur-lex.europa.eu/ legal-content/IT/TXT/PDF/?uri=CELEX:52022DC0583 Corte dei Conti, (2023), ‘Relazione sullo stato di attuazione del Piano Nazionale di Ripresa e Resilienza (PNRR)’, March, https://www.corteconti.it/ Download?id=bbd19bb6-f688-4cb4-ae21-ff1ac2b56466 De Vincenti, C. (2022), ‘Green Investments: Two Possible Interpretations of the ‘Do Not Significant Harm’ Principle’, in F. Cerniglia, F. Saraceno (eds), Greening Europe—2022 European Public Investment Outlook, Cambridge, UK: Open Book Publishers: 177–86, https:// doi.org/10.11647/OBP.0328:177–85 Fabbrini, F. (2023), ‘La revisione del PNRR: problemi sui tempi e sulla strategia’, commento, Centro Studi sul Federalismo, 31 July, https://www.csfederalismo.it/it/pubblicazioni/ commenti/la-revisione-del-pnrr-problemi-sui-tempi-e-sulla-strategia Ministero dell’Economia e delle finanze (2023), Documento di Economia e Finanza 2023, https://www.mef.gov.it/focus/Il-Documento-di-Economia-e-finanza-2023-DEF/ 83 4. Italy’s Public Investments. The NRRP and Beyond —— (2023), Documento di Economia e Finanza 2023— Nota di aggiornamento, https://www.mef.gov.it/focus/ La-Nota-di-aggiornamento-del-documento-di-economia-e-finanza-del-2023-NADEF/ Presidenza del Consiglio dei Ministri (2023), ‘Terza relazione sullo stato di attuazione del PNRR’. 31 May, https://documenti.camera.it/_dati/leg19/lavori/documentiparlamentari/ IndiceETesti/013/001/INTERO.pdf Rizzo, L., R. Secomandi, A. Zanardi (2023), ‘Criticità del PNRR tra rimodulazione e restituzione dei fondi’, Lavoce, 16 June, https://lavoce.info/archives/101391/ criticita-del-pnrr-tra-rimodulazione-e-restituzione-dei-fondi/ Senato della Repubblica (2023), ‘Risoluzione della 5° Commissione Permanente sulla comunicazione della commissione al parlamento europeo, al consiglio, alla banca centrale europea, al comitato economico e sociale europeo e al comitato delle regioni— comunicazione sugli orientamenti per una riforma del quadro di governance economica dell’ue (com(2022) 583 definitivo)’, doc XVIII, no. 1, https://www.senato.it/service/PDF/ PDFServer/BGT/1372239.pdf Servizio Studi della Camera dei Deputati (2023), ‘Terza relazione sullo stato di attuazione del PNRR—I traguardi e gli obiettivi da conseguire entro il 30 giugno 2023’, 14 July, https:// documenti.camera.it/leg19/dossier/pdf/DFP28f.pdf?_1683021396554 —— (2023), ‘La terza relazione sullo stato di attuazione del PNRR—Focus sui profili di riprogrammazione del piano’, 20 June, https://documenti.camera.it/leg19/dossier/pdf/ DFP28_R.pdf?_1693483680910 —— (2023), ‘Monitoraggio dell’attuazione del Piano Nazionale di Ripresa e Resilienza—Le proposte del governo per la revisione del PNRR e il capitolo RePowerEU’, 31 July, https:// documenti.camera.it/leg19/dossier/pdf/DFP28_Ra.pdf Servizio Studi del Senato, (2023), ‘Il bilancio dello Stato 2023–2025. Una analisi delle spese per missioni e programmi’, Servizio del bilancio del Senato, March, https://www.senato.it/ service/PDF/PDFServer/BGT/01372851.pdf Svimez (2023), ‘Dalla ripartenza coesa alle scelte per rafforzare equità e crescita: PNRR, Fondi di Coesione, politiche industriali e diritti di cittadinanza’, in Anticipazioni del Rapporto SVIMEZ 2023: L’economia e la società del Mezzogiorno, July, Rome. —— (2022), ‘Le politiche di coesione: il contributo alla ripresa e alla resilienza’, in Rapporto Svimez: l’economia e la società del Mezzogiorno, Rome: 413–47 Ufficio Parlamentare di Bilancio (2023), ‘Rapporto sulla politica di bilancio’, June, https:// www.upbilancio.it/wp-content/uploads/2023/06/Rapporto_2023_pol_bil_per-sito.pdf —— (2023), ‘Audizione della Presidente dell’Ufficio parlamentare di bilancio nell’ambito delle audizioni preliminari all’esame del Doc. LVII, n. 1 (Documento di economia e finanza per il 2023)’, 20 April, https://www.upbilancio.it/wp-content/uploads/2023/04/Audizione-UPB- DEF-2023.pdf —— (2023), ‘Audizione della Presidente dell’Ufficio parlamentare di bilancio nell’ambito dell’attività conoscitiva preliminare all’esame della Nota di aggiornamento del Documento di economia e finanza 2023’, https://www.upbilancio.it/wp-content/uploads/2023/10/ Audizione-NADEF-2023.pdf Viesti, G. (2021), ‘Il PNRR e il Mezzogiorno. 80 miliardi, un totale in cerca di addendi’, in Quaderni di Rassegna Sindacale, 2: 53–62 —— (2022), ‘Un piano per rilanciare l’Italia?’, in Il Mulino, 2: 23–38 84 Financing Investment in Times of High Public Debt —— (2022b), ‘Il PNRR, gli asili nido e l’uguaglianza delle opportunità’, in Menabò di Etica ed Economia, 3 July, https://eticaeconomia.it/1307-2/ —— (2022c), ‘The Territorial Dimension of the Italian NRRP’, in A. Caloffi, M. De Castris, G. Perucca (eds), The Regional Challenges in the Post-Covid Era, Milan, FrancoAngeli: 201–18 —— (2023), Riuscirà il PNRR a rilanciare l’Italia?, Rome, Donzelli Editore: 53–62 ——, C. Chiapperini, E. Montenegro (2022), Le città italiane e il PNRR, WP Urban@it, https:// www.urbanit.it/wp-content/uploads/2022/06/20220701-citta-e-pnrr-viesti-chiapperini- montenegro-1-1.pdf 5. Public Investment, Deficit and Public Debt in Spain, 1995–2022 Francisco Pérez and Eva Benages Over the past three decades, public investment in Spain has followed an extremely irregular trajectory, with periods of significant capital accumulation and others in which net investment has been negative. The sustainability of the pace of investment has been challenged by expenditure policies that are procyclical instead of stabilizing, in addition to fiscal regulations that have not been able to improve public-productive capital by following the golden rule. The revision of the EU’s economic-governance framework should take into account this and other experiences to enhance the compatibility between fiscal rules and the expanded investment envisaged by the Recovery and Resilience Mechanism. 5.1 Introduction Since the Maastricht Treaty came into force in 1993, Spain’s public investment has gone through very different stages. The causes for these shifts are many. They include the changing overall conditions experienced by the Spanish economy, the scant attention given by spending policies to stabilization and sustainability objectives, the challenges of public-sector financing since the Great Recession, and the fiscal framework established by the Stability and Growth Pact (SGP) in 1997 and its subsequent revisions. Member States have presented objections to the SGP. The first concerns its design, which gives prominence to the output gap, even though this variable is not observable and is subject to debate due to its dependence on the estimation criteria. The second objection concerns Member States’ limited compliance with fiscal rules and the lack of consequences for non-compliance, leading to a decline in the Pact’s credibility. The third relates to the framework’s complexity, which raises questions about both its political acceptability and the European Commission’s discretionary application of its rules (2022). Warnings concerning the poor de facto safeguards for public investment in the EU fiscal-policy framework have increased since 2019 (European Fiscal Board 2019; Darvas and Anderson 2020), despite the loosening of deficit restrictions for that purpose. In October 2021, the European Commission relaunched the public debate © 2023 Francisco Pérez and Eva Benages, CC BY-NC 4.0 https://doi.org/10.11647/OBP.0386.05 86 Financing Investment in Times of High Public Debt on the review of the EU’s economic-governance framework, and, in December 2022, it presented a communication about its reform (European Commission 2022) to the European Parliament, the European Central Bank (ECB), the European Economic and Social Committee, and the Committee of the Regions. This communication proposed a framework to address the financing of a green and digital transition towards a climateneutral economy and to solve the issue of the high public debt-to-GDP ratios reached in the first decades of the twenty-first century. Both challenges require fiscal regulations that enable strategic investments and also protect the viability of fiscal policy. This reformed approach requires closer attention to the trajectory of public investment than in the past because, while capital formation in the EU as a whole has not suffered significantly over the last three decades, some countries, such as Spain, have seen an important reduction in net investment since 2010. As a result, the publiccapital growth rate has been cut in half. These circumstances raise the question of whether the criteria for calculating the deficit that can be financed with debt should expressly contemplate a golden rule that protects net investment, given that the European Recovery and Resilience Strategy is committed to strengthening investments for the ecological transition; the digital transformation; smart, sustainable, and inclusive growth; social and territorial cohesion; social and institutional health and resilience; and policies for the next generation, children, and youth. It is a strategy that also contemplates investment needs for both tangible and intangible assets. This chapter argues for an approach to deficit policy in line with the criteria of the golden rule by examining the trajectory of investment and of public-capital stock in Spain between 1995 and 2022. It also reviews the challenges of financing public investment in the context of high fiscal deficits since the onset of the Great Recession. 5.2 The Trajectory of Public Investment in Spain, 1995–2022 After becoming a member of the EU in 1986, Spain implemented a rigorous public investment strategy that was supported, in large part, by European structural funds. Much of this strategy coincided with the Spanish economic expansion between 1995 and 2008; it was fuelled by a powerful real-estate bubble. Figure 5.1 shows that, up until the onset of the financial crisis, public investment doubled in real terms, growing more than GDP. It also shows a sharp fall thereafter. 87 5. Public Investment, Deficit and Public Debt in Spain, 1995–2022 a) €m 2015 b) Real Evolution of GDP and Public Investment, 1995=100 Fig. 5.1 Public Investment in Spain, 1995–2022. Note: Public investment includes investments made by external agents in infrastructures for public use (ADIF, AENA, State Ports, etc.). Source: BBVA Foundation-Ivie (2023), INE (CNE), and authors’ elaboration. The pronounced procyclicality of the trajectory of gross-public capital formation shows that these expenditures have not been sustainable and have in no way contributed to stability. Instead, they have reinforced growth throughout the expansionary phase and accentuated the recession in the most difficult period of the crisis. Despite the recovery experienced in the last five years, gross public investment in Spain remains at lower real levels than in the initial years of the series, being 6% lower in 2022 that in 1995. The investment effort of the initial long expansionary phase is mostly concentrated in productive infrastructures, mainly transport-related (particularly high-speed railroads). Gross public-capital formation in social infrastructures (educational, health, cultural, social services, administrative, etc.) is also highly important (Figure 5.2). Investment increased by two between 1995 and 2009 in both aggregates, but when the crisis struck, the decline in transport infrastructure was greater and more severe. The recent recovery has focused mainly on social infrastructure, which has returned to its 1995 levels, while productive or transport infrastructure is still 20% below its 1995 level. Figure 1. Public investment in Spain, 1995-2002 a) Millions of euros of 2015 b) Real evolution of GDP and public investment, 1995=100 Note: Public investment includes investments made by external agents in infrastructures for public use (ADIF, AENA, State Ports, etc.). Source: BBVA Foundation-Ivie (2023), INE (CNE) and own elaboration Figure 2. Public investment in productive and social infrastructures. Spain, 1995-2020 (millions of euros 2015) Note: Public investment includes investments made by external agents in infrastructures for public use (ADIF, AENA, State Ports, etc.). Source: BBVA Foundation-Ivie (2023) and own elaboration 0 10,000 20,000 30,000 40,000 50,000 60,000 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 0 50 100 150 200 250 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 Investment GDP 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Productive infrastructures Social infrastructures 88 Financing Investment in Times of High Public Debt Fig. 5.2 Public Investment in Productive and Social Infrastructures in Spain, 1995–2020, in €m 2015. Note: Public investment includes investments made by external agents in infrastructures for public use (ADIF, AENA, State Ports, etc.). Source: BBVA Foundation-Ivie (2023) and authors’ elaboration. 5.3 From Investment to Capital Accumulation The data on the trajectory of the public fixed capital stock allows us to determine how much of gross investment is absorbed to cover the depreciation of existing public capital and what part of net investment produces changes in capital stock.1 The rapid investment pace between 1995 and 2012 implies an increase in stock of 87%, largely concentrated in productive infrastructure (mainly transport2), which grew by 93%. Although public investment increased during the first two years of the Great Recession, from 2010 onwards it does not even cover the depreciation of the existing stock, which decreased by 5% since then (Figure 5.3). The part of gross investment that is absorbed by capital accumulation amortizations is always significant (Figure 5.4). In the period of greatest investment effort, consumption of fixed capital represents around 50% of gross investment and the other half represents net investment, that is, that which constitutes stock growth. However, when gross investment fell sharply with the onset of the crisis, consumption of fixed 1 The analysis that follows is based on information from the database that has been developed by the BBVA Foundation and the Ivie for over twenty-five years, which corresponds to the information for Spain that is used in different international databases, such as EU KLEMS, funded by the European Commission’s 6th and 7th Framework Program, as well as its successor, the EUKLEMS & INTANProd project, funded by the European Commission’s Directorate General for Economic and Financial Affairs (DG_ECFIN) (EU KLEMS 2011, 2012). The database is available at BBVA Foundation-Ivie (2023). In addition, a report that accompanies the database is published annually. Furter details can be found in Pérez and Mas (Dirs.) (2020). 2 The latest data broken down by type of infrastructure (productive or social) corresponds to 2020. Figure 1. Public investment in Spain, 1995-2002 a) Millions of euros of 2015 b) Real evolution of GDP and public investment, 1995=100 Note: Public investment includes investments made by external agents in infrastructures for public use (ADIF, AENA, State Ports, etc.). Source: BBVA Foundation-Ivie (2023), INE (CNE) and own elaboration Figure 2. Public investment in productive and social infrastructures. Spain, 1995-2020 (millions of euros 2015) Note: Public investment includes investments made by external agents in infrastructures for public use (ADIF, AENA, State Ports, etc.). Source: BBVA Foundation-Ivie (2023) and own elaboration 0 10,000 20,000 30,000 40,000 50,000 60,000 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 0 50 100 150 200 250 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 Investment GDP 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Productive infrastructures Social infrastructures 89 5. Public Investment, Deficit and Public Debt in Spain, 1995–2022 capital represented more than 100%, making net investment negative from 2013 onwards and reducing the stock of public capital. Fig. 5.3 Evolution of Public Capital Stock in Spain, 1995–2022, in €m 2015. Note: Public capital includes privately owned infrastructures for public use (ADIF, AENA, State Ports, etc.). Source: BBVA Foundation-Ivie (2023), INE (CNE), and authors’ elaboration. Fig. 5.4 Gross Public Investment, Net Investment, and Consumption of Fixed Capital in Spain, 1995–2022, in €m 2015. Note: Public investment includes investments made by external agents in infrastructures for public use (ADIF, AENA, State Ports, etc.). Source: BBVA Foundation-Ivie (2023) and authors’ elaboration. 0 100,000 200,000 300,000 400,000 500,000 600,000 700,000 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Total Productive infrastructures Social infrastructures -20,000 -10,000 0 10,000 20,000 30,000 40,000 50,000 60,000 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 Gross investment Net investment CFC 96 Financing Investment in Times of High Public Debt not imply an increase in the capacity to produce goods and services in order to grow. Rather, it suggests the maintenance of the flow of services from public assets. The third unfavorable aspect is that fiscal rules have not been operating as stabilizing mechanisms for demand and activity. However, they accentuate the cyclical profiles, especially (but not only) through procyclical adjustments to investment during expansionary and recessionary phases. The European Commission’s proposed review of the EU’s fiscal governance should consider how to address these undesirable features observed in the implementation of fiscal regulations established during periods of high indebtedness in different countries, particularly in Spain. The review of the EU’s economic governance framework should consider this and other experiences, in order to reinforce the compatibility between fiscal regulations and the investment targets set forth by the Recovery and Resilience Mechanism. If they are not protected, it will be increasingly challenging to improve the endowments of both tangible and intangible assets that contribute to the generation of European public goods with capacity to benefit future generations (Giavazzi et al. 2021). 97 5. Public Investment, Deficit and Public Debt in Spain, 1995–2022 References Bank of Spain (2023). ‘Statistical Bulletin’. Madrid, https://www.bde.es/webbe/en/estadisticas/otras-clasificaciones/publicaciones/boletinestadistico/boletin-estadistico.html BBVA Foundation and Ivie (The Valencian Institute of Economic Research) (2023). ‘El stock y los servicios del capital en España y su distribución territorial y sectorial’. València, March, https://www.fbbva.es/bd/el-stock-y-los-servicios-del-capital-en-espana/ Blanchard, O. J. and F. Giavazzi (2004). ‘Improving the SPG through a Proper Accounting of Public Investment’. CEPR Discussion Papers, no. 4220. Washington D. C.: Center for Economic and Policy Research, https://cepr.org/publications/dp4220 Darvas, Z. and J. Anderson (2020). ‘New Life for an Old Framework: Redesigning the European Union’s Expenditure and Golden Fiscal Rules’. Brussels: European Parliament, https://www.europarl.europa.eu/thinktank/en/document/IPOL_STU%282020%29645733 EU KLEMS (2009). Growth and Productivity Accounts: November 2009 Release, updated March 2011, http://www.euklems.net/euk09ii.shtml —— (2012). Growth and Productivity Accounts: Data in the ISIC Rev. 4 industry classification, http://www.euklems.net/eukISIC4.shtml European Commission (2022). ‘Communication on Orientations for a Reform of the EU Economic Governance Framework. Brussels (COM(2022) 583 final’, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52022DC0583 European Fiscal Board (2019). ‘Assessment of EU Fiscal Rules with Focus on the Six and Two- Pack Legislation’. Bussels: European Commission, https://commission.europa.eu/system/ files/2019-09/2019-09-10-assessment-of-eu-fiscal-rules_en.pdf Giavazzi, F., V. Guerrieri, G. Lorenzoni, and C. Weymuller (2021). ‘Revising the European Fiscal Framework’, https://www.governo.it/sites/governo.it/files/documenti/documenti/ Notizie-allegati/Reform_SGP.pdf IGAE (Intervención General de la Administración del Estado). Contabilidad Nacional. Operaciones no financieras. Serie anual. Madrid: Ministerio de Hacienda, https:// www.igae.pap.hacienda.gob.es/sitios/igae/es-ES/Contabilidad/ContabilidadNacional/ Publicaciones/Paginas/ianofinancierasTotal.aspx —— Contabilidad Nacional. Clasificación funcional del gasto de las Administraciones Públicas. Madrid: Ministerio de Hacienda, https://www.igae.pap.hacienda.gob.es/sitios/ igae/es-ES/Contabilidad/ContabilidadNacional/Publicaciones/Paginas/iacogofseries.aspx INE (Instituto Nacional de Estadística). Contabilidad Nacional anual de España (CNE). Revisión Estadística 2019. Madrid, https://www.ine.es/dyngs/INEbase/es/operacion.htm? c=Estadistica_C&cid=1254736177057&menu=resultados&idp=1254735576581 Luiss Lab of European Economics (2023). EUKLEMS & INTANProd-Release 2023. Roma: Luiss University, https://euklems-intanprod-llee.luiss.it/ Mintz, J. M. and M. Smart (2006). ‘Incentives for Public Investment Under Fiscal Rules’. Policy Research Working Papers, Washington D. C.: World Bank, https://doi.org/10.1596/1813-9450-3860 98 Financing Investment in Times of High Public Debt Pérez, F. and M. Mas (Dirs.), E. Benages, J.C. Robledo, and I. Vicente (2020). ‘El stock de capital en España y sus comunidades autónomas. Ajuste de la inversión pública y reducción del déficit’. Working Papers, no. 1/2020. Bilbao: BBVA Foundation, https://www.fbbva.es/wp-content/uploads/2020/01/DE_2020_DT_1_2020_Stock_de_ capital_196-2017_Ivie_prot.pdf PART II. CHALLENGES 6. Escaping Fragmentation and Secular Stagnation. The EU Policy Mix and Investment Financing Pier Carlo Padoan1 The EU has be en impacted by multiple crises due to economic and geopolitical drivers. These crises have left scarring effects and may lead to fragmentation with serious permanent consequences. This takes place against the background of secular stagnation which makes the policy response more difficult. The main response strategy is the NGEU mechanism, based on public investment and structural reforms. It should deliver sustainable growth and structural change that allows to exit the multiple crises―pandemic, geopolitical, energy, inflationary―and puts the European Union on path of twin transformation (digital and green), reverting the drift towards secular stagnation. NGEU is an effective policy tool, provided it acts through policy packages of public investment and structural reforms and allows for time to complete the reform cycle. Its effectiveness must be seen in the context of a new policy mix fit to address the multiple-crises framework. 6.1 Introduction The COVID crisis has prompted a joint response by EU Member States and by the European Commission. In the short-term, temporary measures such as the suspension of the Stability and Growth Pact and the temporary framework on state aid have minimized the immediate costs of the COVID shock. In the medium to long term, policymakers will have to address the challenges of the twin transition towards digital and green activities and to reinforce the EU-growth model. What will make this more 1 UniCredit is not to be held responsible for the contents of this paper. I thank Franco Bassanini, Marco Buti, Lilia Cavallari, Paolo Costa, Luis De Mello, Claudio De Vincenti, Daniel Gros, Paolo Guerrieri, Fiorella Kostoris, Marcello Messori, Alessandro Paladini, Debora Revoltella, Francesco Saraceno, and the participants of the Astrid seminar on european economic policy for useful comments. I also thank Roberto Fratter for excellent support in drafting the text. © 2023 Pier Carlo Padoan, CC BY-NC 4.0 https://doi.org/10.11647/OBP.0386.06 102 Financing Investment in Times of High Public Debt difficult are the consequences of the energy crisis and the inflation acceleration which impacts the dynamic of economic growth. Policymakers will also have to face the challenge of fragmentation generated by geopolitical tensions against the background of persistent secular stagnation. To deal with the Covid crisis, the EU Commission has launched the Next Generation EU (NGEU) programme and activated its operational arm, the Recovery and Resilience Facility which is translated into National Plans of Recovery and Resilience (NPRR). The mission of the temporary instrument is to revamp EU growth in quantitative (how much growth) and qualitative (what kind of growth) terms. It does so by supporting public investment and structural reforms through substantial financing. €750bn in financing is provided by the EU budget and funded by the issuance of dedicated European bonds. 6.2 Phases of European Growth In what follows, I consider the underlying logic of NGEU, linking the specific measures to the EU growth model to evaluate if and to what extent NGEU will be able to deliver growth and transform the EU economy towards its green and digital targets. I also look at the role of investment, both public and private, and the possible financing strategies, given the very large amounts of investment needed to complete the twin transition. Post-war EU growth can be viewed as a sequence of subperiods characterised by growth-acceleration episodes (Hausmann, Pritchet, and Rodrik 2004). One way to identify subperiods is to mirror them with the evolution of the global economic and monetary system. From the Bretton Woods days to the present, the different subperiods exhibit characteristics that can be described as follows, with a specific focus on growth drivers. 1) Free Trade Area and Custom Union. This phase replicates the extension of the Bretton Woods (BW) system at the global level. The Bretton Woods regime was based on a domestic, demand-driven USA economy and an export-driven EU economy. The currency arrangement included a peg to the dollar backed by gold reserves. The main growth drivers in the EU were integration and trade openness. This structure generated a large positive supply shock for the EU, and the opening to international trade led to a significant reallocation of resources within countries. Resources were shifted from non-tradable to tradable sectors. There was no international capital mobility. Most EU countries ran a current-account surplus that reflected an excess of savings (savings > investments). 2) After the BW collapse in 1971, the dollar standard, and the two oil shocks, the EU struggled to converge. Sluggish growth highlights the fragmentation in the EU economy and the persistent risk of divergence between Northern and Southern members. Many EU countries adopted flexible exchange rates in reaction to dollar 103 6. Escaping Fragmentation and Secular Stagnation flexibility. Northern members of the EU, however, established fixed exchange rates among themselves (giving birth to the ‘D mark zone’ in the first part of the 1970s) to enhance stability. Southern members’ currencies devalued as oil prices raised inflation. Inflation differentials widened. Risks of divergence within the EU increased. Stagflation loomed. 3) In spite (or because) of the economic fragmentation in the global system, the EU’s move from a custom union towards deeper forms of integration drove growth. Stability-growth tradeoffs in an inflationary environment are the key features of the macroeconomic system. Initially, flexible exchange rates were effective in absorbing shocks, but inflation in the EU accelerated at different speeds, which generated divergence in relative competitive positions. Excessive currency flexibility and volatility were seen as a challenge to the custom union. The European Monetary System (EMS) was established in 1979 as an attempt to provide stability and convergence in a stagflation environment. The move towards fixed exchange rates, with German monetary policy as an anchor, was seen as a way to enforce discipline and to restore integration. However, the EMS collapsed after a decade, when fixed exchange rates, full capital mobility, and national macroeconomic policies proved to be incompatible. 4) The Single European act. As monetary stability was reestablished, the EU single market and exogenous Total Factor Productivity (TFP) emerged as the drivers of growth. Evidence shows that economic and institutional complexity (such as the one associated with intra-industry trade and ‘social capital’) supports growth. Complexity as a feature of social and economic institutions that affects growth is more pronounced in northern EU members. However, not all TFP is exogenous. An endogenous component is driven by investment in innovation, research and development, and human capital. In spite of a self-sustained growth dynamics, an underlying tendency towards secular stagnation emerged, driven by demographics, inequality, and decreasing productivity. Growth below potential and, in some cases, declines in potential output characterised EU members and the Euro Zone, especially during the euro crisis (see 7, below). The sequence of EU enlargements in the 1980s also mark the start of acceleration episodes. 5) Growth gaps to potential output emerge in the Euro area. In a number of EU countries, structural impediments to growth (including the low quality of institutions) persisted in spite of efforts to complete the single market. This is particularly visible in the lack of a single market for services, which holds back productivity and innovation. Large output gaps also emerged in the USA. Globally, trade regionalism developed as a factor determining the nature of competition and conflict. Strategic trade policy became a policy option in support of national interests. Despite an increasing tendency towards regionalism, the global financial system remained dollar-based. 6) After the crisis of the European Monetary System, a ‘corner-solution dilemma’ emerged regarding the choice of exchange-rate arrangements (was it preferable to have fully flexible rates or a single currency?). The euro was introduced, but not all EU members joined the single currency. Initially, the introduction of the euro brought 104 Financing Investment in Times of High Public Debt convergence: the narrowing of spreads among members of the Euro was seen as a move towards a zero-risk or free-capital-mobility environment. A debt financed growth model also emerged, that is, one in which countries finance their growth through borrowing. This pattern generated imbalances that led to capital flows from excesssaving to excess-investment countries. Investment was directed, especially, towards low-productivity, non-tradable sectors. The lack of exchange-rate flexibility generated a deflationary pressure on deficit economies as surplus countries refused to reflate in order to allow for relative prices to adjust. The overall policy stance was restrictive, and the undervaluation of surplus countries’ currencies was persistent. Integration did not progress. 7) Convergence turned into divergence, and risks of fragmentation increased significantly. In spite of large capital flows, or, rather, because of these, the eurozone proved to be unsustainable, an ‘impossible trinity’. This ‘euro crisis’ and the bank sovereign doom loop prompted euro reform (most notably, the creation of a banking union). This policy response avoided the collapse of the monetary union. However, it shows the fragility of the collective agreement on which the euro was based. The reform was only partly successful, as a conflict between national and EU perspectives (risk mitigation versus risk sharing) persisted and the tendency towards divergence renewed. 8) Global imbalances and the global financial crisis. To accelerate recovery after COVID, the NGEU was launched. Its long-term structural orientation has been seen as the opportunity to reverse secular decline, replace external demand with internal demand, and change the composition of production and consumption in the twin transformation towards green and digital. However, these shifts require investment (both public and private), structural change, and an availability of non-tradable goods (services) to enhance TFP growth. 9) The current state of the EU (and global economy). The latest phase of the EU and global economy shows fragmentation both in financial markets and in trade relations. However, this fragmentation is not affecting Europe as much as other regions―an inversion of the case during the sovereign crisis. What is exceptional about this phase is the coincidence and interaction of multiple crises: geopolitical instability, the return of inflation, global fragmentation, and secular stagnation. This ‘perfect storm’ is reflected in an increase in global risk, monetary-policy dilemmas (inflation-financial fragility tradeoffs), and structural components of inflation. Tensions will not subside soon, and global instability may rise. However, fragmentation will probably increase pressure on countries to join regional agreements or form agglomerations as a strategy to increase protection. A push for Member States’ further integration may be proposed. Such a dynamic would likely be driven by geopolitical factors where Europe may play a leading role in shaping a reform of global governance, that is, a global-policy regime necessary to prevent further fragmentation. In this context, it is important to recall the conditions that enable cooperation and 105 6. Escaping Fragmentation and Secular Stagnation regime-building with multiple actors: a few key players must be identified, there must be repeated interactions between them so as to build mutual trust, adjustments must be available to accommodate differing preferences, and, finally, agreements are to be encouraged as a strategy to aggregate preferences among likeminded countries. The impact of the geopolitical factor can be larger than the one activated by fragmentation. As we are in a framework of multiple crises, further crisis factors can play a role. An analysis of ‘scarring’ can shed some light on these effects. S. Nujin and Yu Shi (IMF 2022) show that different types of crises, including those related to geopolitical factors, can produce scarring effects (that is, permanent negative consequences) that differ at the aggregate and sectoral levels because of the different transmission channels at work in each. The largest impact of the recent crises is seen in service sectors. As supply-side channels of transmission have been interrupted or weakened, so too have capital and research-and-development investment, human capital, and other factors that impact TFP. The ‘scarring’, in this case, is the cumulative reinforcement of the negative medium-term impacts. 6.3 Secular Stagnation and the Growth Environment The multiple-crisis mechanism evolves against a background of secular stagnation which is present both within the EU and globally as reflected in the declining real interest rate. The real interest rate is connected to the ‘natural interest rate’, r*, which is not observed and needs to be estimated. Estimates point to a decreasing natural interest rate for the Euro Zone over the past two decades. With all these caveats in mind, r* can provide useful evidence on the long-run policy environment and information to policymakers as they form their views on policy decisions. Last but not least, the decline of r* also reflects excess savings over investment, that is, growing savings and declining investment lead to lower r* and shrinking policy space. The negative trend is also related to TFP dynamics. More generally, declining r* and TFP reflect a weak effort in innovation, research and development, human and intangible capital accumulation, and demographic factors. As already mentioned, in advanced economies, TFP is partially endogenous, that is, determined by investment in innovation and partly determined by policy which impacts on innovation activities. Evidence confirms the negative impact of TFP and demographic as well as the countervailing impact of fiscal policy on r*. The fall in TFP is generalized in advanced economies but significantly present in the EU. Such a dynamic carries important policy implications. According to a view of the policy process in the long term (which is the one of interest here), a declining r* compresses the space for monetary policy since r* is the upper boundary of the policy rate. However, if r* increases, it compresses fiscal space to the extent that r* is related to the market rate. For a given growth rate, a negative difference with respect to the policy rate makes debt unsustainable. Policy can raise r* in the medium to long run through 112 Financing Investment in Times of High Public Debt f) Incentives that can spark off private-sector investment and structural reforms but also minimize the misallocation of such investment; g) Public-investment financing through the issuance of new European debt, provided such debt can deliver sustained growth. Private investment can be financed through financial markets as climate- and digital-related investment meet the interest of investors and households; h) The increase in potential output generated by NGEU must, in the long term, be matched by an increase in demand from EU institutions; i) The policy mix must include plans to reconstruct international-cooperation regimes to push back fragmentation. The conditions for cooperation with multiple actors are: few key players, repeated interaction to create mutual trust, the ability to adjust preferences. Finally, club-format agreements must be encouraged as a strategy to aggregate preferences among likeminded countries and, consequently, reverse stagnation pressures. To conclude, Europe’s exit from the multiple crises requires a new policy mix. Monetary policy will continue to provide price stability, while taking into account the impact on financial stability. NGEU should be the main driver of growth. Fiscal policy should be reinforced by establishing a central fiscal capacity. On a broader level, action is needed to reinforce the global-policy regime with a cooperative approach to fight fragmentation and escape stagnation. Europe should play a major role to support global cooperation. References Aghion, Philippe et al. (2022). ‘Financial Markets and Green Innovation’, ECB Working Paper, 2686, July, https://doi.org/10.2139/ssrn.4590501 Baker, Mark, Mark Egan, and Suproteem Sarkar (2022). ‘How do Investors Value ESG?’, NBER Working Paper, 30708, December, https://doi.org/10.2139/ssrn.4293621 Bańkowski, Krzysztof et al. (2022), ‘The Economic Impact of NGEU: A Euro Area Perspective’, ECB Occasional Paper, 291, April, https://doi.org/10.2139/ssrn.4095550 Hausmann, Ricardo, Lant Pritchett, and Dani Rodrik (2004), ‘Growth Accelerations’, NBER Working Paper, 10566, June, https://doi.org/10.3386/w10566 Jones, Charles (2021), ‘The Past and Future of Economic Growth: a Semi-Endogenous Perspective’, NBER Working Paper, 29126, August, https://doi.org/10.3386/w29126 Nujin, Suphaphiphat and Yu Shi (2022), ‘Economic Scarring’, IMF Working Paper, 22/248, December, https://doi.org/10.5089/9798400227257.001 7. From Crisis to Crisis, Can Europe Count on National Promotional Banks as Silver Bullets? Laurent Zylberberg The great financial crisis of 2008–2009 was a game changer for National Promotional Banks and financial Institutions (NPBIs) in Europe, with the COVID-19 pandemic and the Ukraine crisis reinforcing this shift. The ‘Juncker Plan’ shed a light on the investment gap and demonstrated that a dynamic European policy was possible. Thanks to the InvestEU programme, actors at the European level, such as the European Investment Bank (EIB), and the national level (via NPBIs and Financial Institutions) thrived in their specific role of fostering essential long-term investment throughout our continent. With this in mind, we need to have a different look at certain tools within practical accounting rules by integrating both positive and negative externalities. 7.1 Introduction For many years, Europe has been experiencing a succession of crises that are sometimes limited to the continent or that reflect global developments. Many economists, including Schumpeter and Kondratiev, have explained that these crises can result from the conjunction of cycles and, thus, from evolutions of the economic model (Portier 2015). However, the instruments for responding to these crises are not indifferent to existing economic and societal models. At comparable economic levels, European countries will not provide the same response as those in Asia. Without erasing the differences in the processes of the legitimization of states and their instruments (Badie 1982), the dynamics generated by the construction of Europe had converging effects in the countries that compose it. One of these effects, the rise of National Promotional Banks and financial Institutions (NPBIs) as investment actors, has become increasingly prominent as the European Union implements investment policies aimed at reducing the gap with other parts of the world. These players, who occupy a specific place in the European economic model, have many differentiating elements but, overall, © 2023 Laurent Zylberberg, CC BY-NC 4.0 https://doi.org/10.11647/OBP.0386.07 114 Financing Investment in Times of High Public Debt have enough strong common characteristics to gradually become one of the driving forces behind the implementation of European policies. This European specificity is a particularly important asset at a time when public actors and, in a comprehensive way, public action regain legitimacy. The COVID-19 crisis has drawn attention to the role of NPBIs as a ‘shock absorber’ for individuals and businesses, even as they also provide essential countercyclical elements. These actors in the European economy cannot act, however, if they are not differentiated from their respective Governments; they must maintain a public status and serve the general interest. Moreover, NPBIs shall also not be likened to private actors while acting in a competitive framework. Several key developments are still needed to give them the means to make full use of their capacities (Zylberberg 2020). 7.2 A Particularly Difficult Economic Environment for the European Union 7.2.1 Europe has been Facing Increasing Investment Needs for Many Years. As the economist Pierre Jaillet has pointed out, long-term investors are essential ‘to find a path of growth that is equivalent to or little less than that of the pre-crisis and to keep public debt on a sustainable trajectory’ (2012: 169), but what type of investments are we speaking about? Whether we speak about productive investments, like the ones related to the renewal of the production tool—its modernization to achieve productivity gains and investments related to environmental adaptation (such as security and research and development or pure financial investments like primary and secondary debt, bond, and equity markets)—there is still the risk of missing out on many investments which can be described as social or the economic purpose of which is indirectly linked to the production apparatus. For example, social infrastructures that includes investments in health, education, and affordable housing are in a relative blind spot. Others not directly linked to investment in economic apparatus are altogether left out from the categorization seen above. This investment vision, therefore, can be misleading as demonstrated in the report by the former European Commission Chair, Romano Prodi and the former French Economy Secretary of State, Christian Sautter (Prodi 2018). When simplified, the background noise indicates that private investment will naturally be directed towards profitable productive investment or financial investment, whereas public investment should be confined to social investment without the use of a viable economic model. This distinction misses the numerous interactions between the different types of investment. It neglects the study of externalities, whether positive or negative, and ultimately leads to a rigid and time-bound categorization of economic actors. The temporality factor, which distinguishes between short-term and long-term 115 7. From Crisis to Crisis investment, however, is essential for understanding and guiding the behaviour of investors, whether they are public or private. Against this background, the European Investment Bank (EIB) makes the same observation every year: how Europe is lacking investment compared to the USA. This differential is even more striking if we focus on productive investments, whereby the gap is nearly 4 points! (Figure 7.1). Fig. 7.1 Rest of Productive Investment in the European Union Compared to the United States since the Global Financial Crisis. Note: Non-construction investment includes investment in machinery, equipment, and weapon systems, intellectual-property products, and cultivated biological assets. Source: Eurostat and OECD national accounts statistics. The financial crisis of 2008–2009 marks a clear separation of this trend. Investment in the USA reached its pre-crisis level in 2011, while, in Europe, it was necessary to wait ten more years for a return to the same level. In 2014, the European Union, faced with the acuteness of the problem, launched the ‘European Fund for Strategic Investments’ (EFSI). Unofficially known as the ‘Juncker Plan’, its objective was for the European Union to catch up with the same investment trend as it had experienced during the recovery that followed the previous crises of 1993–1997 (Le Moigne 2015). In this regard, the Juncker Plan marks not only an economic but also an ideological turning point in the way the European Union looks at the role of public actors in investment. European actors are beginning to turn their backs on a system in which competition rules and the monitoring of public aid are the alpha and omega. By focusing on the ability of public investment to leverage, the Juncker Plan highlights the strength of public investors (including EIB and NPBIs). 116 Financing Investment in Times of High Public Debt 7.2.2 These Needs are Part of Successive and Sometimes Simultaneous Crises The 2008–2009 financial crisis resulted in a GDP with severe constraints on investment. But what stood out in this crisis was the difference in the recovery between the USA and the European Union, as shown in Figure 7.2. Fig. 7.2 Real GDP Per Capita: European Union versus United States (index 2007=100). Source: World Bank. This differential in GDP per capita has resulted in a corresponding weakening of investment. How can one explain such a difference between Europe and the USA? The crisis of 2008–2009 was triggered in the USA by the real-estate boom of previous years. In Europe, if the real-estate boom was somehow mastered, the crisis was firstly a banking one and had long-lasting effects on the whole financial system (Jamet 2008; Figure 7.3). 80 85 90 95 100 105 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Real GDP per capita: European Union versus USA (index 2007=100) constant US Dollar 2015 Source World Bank United States European Union 117 7. From Crisis to Crisis Fig. 7.3 Real Gross Fixed Capital Formation (EU 28, in 2013 prices, €bn). Source: European Commission 2021. This difference between geographical areas was alarming (Buti 2014), particularly in the way this lack of investment would induce long-term effects on the economy. Again, it is important to note that, while the USA was starting to raise its level of investment in 2011 (the lowest point having been reached in 2010), it was not the case in Europe. Lack of investment continued there until 2013, with a further significant decrease in 2011. This temporal disparity is largely due to differences in the financing of the economy between the two continents. We must remember that ‘Banks are clearly the largest source of finance in the Eurozone (51%), unlike the United States, where bank credit would account for less than a fifth of the total financing of the economy’ (CEPII 2015). 2416 2527 2543 2528 2567 2640 2717 2869 3039 3021 2657 2659 2714 2647 2606 2300 2400 2500 2600 2700 2800 2900 3000 3100 1998 2000 2002 2004 2006 2008 2010 2012 2014 Real Growth fixed Capital Formation (EU 28, in 2013 prices, €bn) Source European Commission, 2021 118 Financing Investment in Times of High Public Debt Fig. 7.4 Bank Lending versus Corporate Bonds (Corporate Bonds as a % of Corporate Borrowing in the USA, EU27, UK, France, and Germany). Source: Panagiotis, A., H. Eivind Friis, and W. Wright (2022). As financing schemes clearly diverge between USA and Europe, measures taken after the 2008–2009 crisis produced differing impacts. One response was the strengthening of banking constraints to avoid falling back into the mistakes of the past. These new rules have increased the robustness of the European-banking model. To sum it up in one sentence: considering the causes of the 2008–2009 crisis, the remedies have had adverse effects on the recovery of the European economy. While these new mechanisms were being put in place to boost growth in Europe, the COVID-19 health crisis occurred, which was unprecedented in all respects in recent global-economic history. Although we have experienced major economic crises or global epidemics in the past, we have not, in recent times, experienced both simultaneously. The impact on GDP was immediate, as shown in Figure 7.5. Beyond the direct economic effects of the COVID crisis, what has had a lasting impact on economies is a return to the forefront of economic-sovereignty issues. While the globalisation of manufacturing chains was taken for granted, the COVID-19 crisis highlighted sovereignty issues that had been being largely ignored. Even worse, issues arose in unexpected areas (such as surgical masks or aspirin) that were never identified as key components prior to this pandemic. 26 26 53 53 79 75 64 64 87 84 74 74 47 47 21 25 36 36 13 16 0 10 20 30 40 50 60 70 80 90 100 Bank lending versus corporate bonds (Corporate bonds as a % of corporate borrowing in the USA, EU27, UK, France, and Germany) Corporate bonds Bank lendings 119 7. From Crisis to Crisis Fig. 7.5 Quarterly Real GDP Growth in % quarterly. Source: OECD. -25.0 -20.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 Q1-2019 Q2-2019 Q3-2019 Q4-2019 Q1-2020 Q2-2020 Q3-2020 Q4-2020 Q1-2021 Q2-2021 Q3-2021 Q4-2021 Quaterly Real GDP Growth in % quarterly (source OECD) Mexico United Kingdom United States Euro area (20 countries) China (People's Republic of) 120 Financing Investment in Times of High Public Debt As the COVID-19 crisis came to an end, a new geopolitical crisis was breaking out in Europe that highlighted other, particularly energy-related, dependencies. One significant result of this compounding of crises is that NPBIs became the instruments of national sovereignty that were mobilised to act in various areas (ELTI 2023). Indeed, the invasion of Ukraine has had numerous, protean effects on European economies. We can mention a few of them: scarcity of energy sources, the economic impact of the sanctions put in place for companies working with Russia and Belarus, the hosting of refugees, etc. To cope with this economic shock, NPBIs were mobilised both in their traditional functions and, often, beyond their usual remits. They supported national economies through loans, some of which were subsidized; provided suitable financing for undertakings directly affected by the conflict, either via their commercial outlets or their own supplies; and launched emergency-housing programmes in neighbouring countries. They also undertook other actions to support Ukraine in budgets and in various donations. In addition to these essential measures aimed at those most directly affected by the conflict, NPBIs provided help to other economies as they adapted to the new situation. Their interventions in the energy sector are a good example of their ability to respond quickly to immense needs. Europe’s largest NPBIs, not to mention the EIB (or the ‘European Climate Bank’ as it likes to be called), were already heavily involved in the energy sector; they were at the heart of financing the energy transition, notably by funding renewable energies. The war in Ukraine posed new challenges that required focus on immediate needs. While maintaining their commitments to participate in the energy transition, NPBIs were asked to participate in the financing of very short-term solutions to address the end of the energy supply from Russia. Thus, the German NPBI (KFW) became the financier of the three new ports for Liquified Natural Gas (LNG) terminals in Germany, whilst the Italian National Promotional Bank (CDP) and its subsidiaries participated in the financing of a new terminal. In a country like France, where nuclear power plays a major role, Caisse des Dépôts (CDC) were tasked to examine the possibilities of financing the renewal of the nuclear-power plants. Beyond energy, the entire scope of national and European sovereign financing was impacted by the Ukrainian crisis. Because NPBIs have both very large resources and the capacity to rapidly redirect these funds, they have been called upon to meet these new demands. Environmental transition requires significant funding over a long period of time. On one hand, there is a need to change our production methods to achieve greenhousegas-emission neutrality by 2050 and, on the other hand, to adapt our economies to climate change. Although it is difficult to determine the precise requirements, with variations being quite large depending on the methods of calculation (Meltzer 2016; Li 2023), the order of magnitude amounts to tens of billions of dollars per year per European country. Two elements are clearly established. The first issue is linked to the temporality of the return on investment. Green investments need to mobilise actors 121 7. From Crisis to Crisis coming from different parts of the economic spectrum. The co-ordination between them is quite difficult as, in terms of temporality, the expected return on investment differs from one actor to another. Secondly, the public sector alone does not have the means to meet the needs, but the private sector will not mobilise for profitability that seems either too low or too uncertain. A combination of the two is necessary, therefore, to achieve the required funding. Indeed, beyond the amounts, the problem in the search for funding is the time differential between immediately identifiable needs and returns, which are sometimes hypothetical but always deferred. Moreover, Pisani-Ferry et al. (2023) have recently pointed out that a large part of these investments will not increase growth potential since most will be used to finance fossil-fuel reductions without increasing production capacity. Another challenge to the environmental transition is that efforts must be made in three directions: the substitution of capital for fossil fuels, the reorientation of technical progress, and, finally, in sobriety. The first of these will command the lion’s share of investment efforts with, according to the authors mentioned above, 85% of the total amount. Sobriety in using energy for daily life will contribute for a mere 15% to 20% of the energy use. Households and companies have to adapt their behaviour in order to reduce the global use of energy. 7.2.3 The European Economic Environment is also Characterised by Other Penalizing Factors A multitude of factors led to an increase in the financing requirements for the European economies. This situation is more shocking since two penalizing factors play a disabling role. The first of these factors is the return of inflation in Europe (Figure 7.6). After many years without increasing prices, we have now entered a new cycle, which may be limited in time, but, in any case, will have medium-term effects on the European economies (De La Rosière 2023). This is especially true for households wherein current expenditure is increasingly constrained (Cusset 2023). This change in inflation has had a direct effect on interest rates. Of course, this allows long-term investments to regain attractiveness by differentiating themselves from short-term investments, and in time, will recover their value. Conversely, inflation- and interest-rate rises will have a delaying effect on borrowers who may fear that their debts will rapidly increase. It is also this logic that encourages precautionary savings (BPCE 2023). In general, one of the main drivers of inflation is energy-price growth. There is a strong correlation between the price of energy, in its form of final consumption, and inflation (Pisani-Ferry et al. 2023). It is certainly possible to envisage a differential increase in the price of energy, since fossil-fuel sources would be used less as renewableenergy sources become more readily available. There will be complex mechanisms to manage if market mechanisms are left alone to decide the price of energy. Indeed, the fall in demand for carbon-based energy could lead to a fall in prices, or a smaller 128 Financing Investment in Times of High Public Debt • The presence of an NPBI in a country is a formidable asset in directing investments towards projects strategic for Member States. • Some sectors have benefitted greatly from these investments, particularly Small and Medium Enterprises (SMEs) and Mid-Caps, research and development, and the energy sector. • Europe was able to set up this mechanism in a timely manner, going against the principles heralded in previous years—like State aid or competition rules—that led to the construction of a market in which immediate economic interventions were slowed. Beyond the figures, the Juncker Plan has also brought significant changes to public financial actors. The EIB Group has been led to think beyond traditional lending and to transform its approach. Through the Juncker Plan, the EIB has recognized the logic of using long-term investments as well as of taking more risks than before (Griffith-Jones 2020). In addition to this change of approach, which has been beneficial to the European economy, the EIB and other NPBIs have strongly developed their cooperation in this new framework. Their complementarity quickly emerged as a guarantee of the success of the Juncker Plan. EIB had the financial tools provided by the European Union but did not have the capillary network close to the ground that characterises most NPBIs. Conversely, even the most powerful NPBIs only had a limited European approach and, above all, did not have this access to European financial instruments. This complementarity did not erase the competition that might exist on certain projects or divergent modes of operation, however. In the end, the essential question was who would carry the final risk in a project involving all of these actors. Overall, the Juncker Plan has been successful, but some elements could have been better developed. Firstly, some sectors have generally been missed out by EFSI. Social infrastructure or transport have only marginally benefitted from the Juncker Plan. Social infrastructures are long-term investments by nature with limited returns whose positive externalities are undeniable; thus, they could have legitimately been fully part of the Juncker Plan dynamic. In the end, they represent only 6% of the financing (Prodi 2018). The situation for transport is different because these investments, with variable returns, often require direct or indirect subsidies. As EFSI did not offer this type of financing, another tool was adapted. The Connecting Europe Facility, which was built on the work of NPBIs since 2020 rendered those institutions responsible for identifying the projects to benefit from a European grant as well as investment from the local NPBI. Here, the leverage effect will be important and will make it possible to find funding in line with the projects. The Juncker Plan also has a relatively greater impact on the EIB Group’s risk model than on its products. The European Investment Bank is primarily a lending 129 7. From Crisis to Crisis bank, unlike several European NPBIs, such as the Caisse des Dépôts in France and the Cassa Depositi e Prestiti in Italy. The European economy needs equity financing which is significantly harder to mobilise than loans. EFSI had the ambition to respond to this lack on certain projects—such as the financing of the Marguerite 2 infrastructure fund—but this part of the dynamic remains marginal. We cannot say that EFSI produced a structural shift of the EIB balance sheet in favour of equity, but it is true to say that EIB Group took more risks under EFSI via dedicated projects. Finally, small projects (those under €50m) remain difficult to finance. They incur fixed costs of the same order of magnitude as larger projects, but their risks are more difficult to assess. To monitor such projects is costly in staff and other terms. Therefore, there is a natural tendency to finance larger projects. Furthermore, smaller projects are more difficult to identify. Developing thematic platforms would surely help to tackle this issue. By bundling different projects together, it becomes easier to reach the minimum critical amount and to propose a financing model. The risk profile of such a bundle is not easy to assess, however. Yet, this is where the detailed, local knowledge held by the NPBIs is a very important asset. To implement these field-based platforms, it would have been necessary for the EIB to establish a large-scale delegation capable of working with NPBIs, but this was difficult since EFSI was directly on the balance sheet of EIB. Otherwise, NPBIs should have been granted direct access to EFSI, but this case was not foreseen. To summarise: while small-scale projects have received a little more support than in the past, the Juncker Plan has not succeeded in making them a major focus of its deployment. 7.3.3 Enabling NPBIs to Make Full Use of their Potential After the Juncker Plan in 2021, the European Union put in place new tools to allow a more direct involvement of NPBIs while keeping EIB as the main implementing partner. Having national and European actors working together covers both political and financial issues. One of the regular complaints about EFSI was that it was a little bit far from the ground. Because of the multiple intermediaries, the final beneficiary was often not aware that the loan benefitting them had resulted from the Juncker Plan. It was especially true for SMEs and Mid-Caps with the mechanism of guarantee for lenders. Including NPBIs directly in the loop was a major and positive change as they have a capillary network on the ground and a long history of cooperation for the implementation of European policies in territories (Zylberberg 2018). After the Juncker Plan, the European Union launched the InvestEU programme in 2021 with the ambition of simplifying the multitude of existing programmes while facilitating access to actors other than EIB Group. Originally conceived in a context of growth, it also had to be adapted to the very significant recession resulting from the global economic shutdown due to the COVID-19 crisis. InvestEU differs from previous programmes in three major ways (European Commission 2021). 130 Financing Investment in Times of High Public Debt The first is that it brings together 14 previously dispersed specific programmes, each with different rules, under one single mechanism. This simplification facilitates the diversity of actors involved in their implementation and makes the overall investment policy of the European Union more visible. The second change is about priority-setting. Under EFSI, there was a single envelope of funds for all projects, and the primary objective was to recover investment without setting sectorial priorities. Under InvestEU, four windows have been established, and each has a dedicated financial envelope. The four sectors are (1) sustainable infrastructure; (2) research, innovation, and digitalisation; (3) SMEs and mediumsized enterprises; and (4) social investment and skills. Finally, InvestEU is a programme in which institutions other than the EIB may participate once they have satisfied the evaluation process—known as ‘pillar assessments’. Entities eligible to become implementing partners include international organisations or their agencies; public institutions, including organisations of Member States; and, finally, private law organisations provided that they are entrusted with public-service tasks and that they provide adequate financial guarantees. This openness to NPBIs, as well as to institutions such as the EBRD or the Bank of the Council of Europe, is a major development insofar as it enlarges the potential partner pool for the European Commission. InvestEU recognises that European investment policies require complementarity between the European level and national levels: it is essential to have implementation partners who are closer to the ground and to the projects themselves. Against this background, there is an increasing cooperation among NPBIs with an exchange of best practices and through joint positions without forgetting the establishment of the Marguerite 3 Investment Fund. Marguerite is a leading European infrastructure investor having managed three funds since 2010. It was created at the initiative of the European Investment Bank and five National Promotional Banks from Italy, France, Germany, Poland, and Spain, it has evolved into a fund manager with private investors and the support of EFSI and InvestEU. The rise of the European Association of Long-Term Investors (ELTI) reflects this collective dynamic. This association brings together over thirty members of various sizes and balance sheets. It is important to underline that those new annual commitments of ELTI members increased by nearly 30% between 2018 and 2021, reflecting a particularly dynamic period of activity. Most of the amounts committed are in the form of loans, but some NPBIs do not refrain from intervening in the form of equity, which exerts a much greater leverage effect. Large groups are also emerging at national level. The Caisse des Dépôts, which includes entities such as BPI France and La Poste Group with Banque Postale, represents an aggregate balance sheet of more than €1,300bn. Regional cooperation can be seen in the ‘3 Seas Initiative‘, also known as the ‘Baltic, Adriatic, Black Sea Initiative’ (BABS). Further evidence of a move towards financial partnership is political scheme that has transformed into an investment fund 131 7. From Crisis to Crisis with nine first-level sponsors. The main funder is BGK in Poland, but other NPBI partners in the scheme are Altum (Latvia), SID (Slovenia), BDB (Bulgaria), HBOR (Croatia), and VIPA (Lithuania). These public financial institutions work alongside the Estonian Ministry of Finance, banks, and guarantee agencies (such as EximBank in Romania and Hungary). 7.4 One Step Beyond… With its large and widespread network of NPBIs, Europe already has the necessary tools to act. However, over many years, public finance has had to face headwinds from two directions: some proponents of the market economies regard the institutions as intruders in the economic game, and some actors in the public sphere consider NPBIs as potentially illegitimate actors that would be at the service of the public interest without necessarily being dependent on governments (Attali 2022). Today, things seem to have evolved. NPBIs are recognised as essential, but do they have the means to act as efficiently as they could? From time to time, NPBIs must apply supervisory rules primarily intended for other, mainly commercial banks. They also have to abide by accounting norms wherein longterm funding is regarded as irrelevant; however, a long-term approach that includes positive externalities in investment calculations is a necessity to overcome short-term challenges. A financial actor is, above all, a structure that will attract liquidity in order to transform it before it is returned, that is, before it has seen a loss or profit. This financialintermediation mechanism varies according to the types of actors, yet the supervisory rules minimize these differences for legitimate reasons. This transformation impacts both the level of risk and maturity. Thus, liquid or short-term liabilities will become long-term assets. This change is made possible by appropriate management strategies and by the existence of sufficient capital to cope with the eventual materialisation of the residual risks. During crises, any prudential requirements, which define the riskmanagement framework and the level of capital needed to address identified risk, have gradually been reinforced with the aim of strengthening the resilience of actors and the system. As we have already seen, these requirements may have reduced the ability to take risks. Even worse, we contemplate the emergence of what is called ‘the overcompliance’ in different domains. Applying prudential rules to different actors is not a simple task. The trivial thing is to distinguish the actors based on their playing field (banks, insurance companies, etc.) but this essentialist approach does not take into consideration some specificities. From a practical standpoint, this tends to ignore long-term investors like NPBIs. Their specificity as countercyclical agents is ignored as prudential rules lead to pro-cyclical behaviour. Nevertheless, it is also true that supervisory rules are aimed at making financial actors robust and resilient to prevent 132 Financing Investment in Times of High Public Debt the recurrence of crises from the past. They are not tools of economic policy, although they can heavily influence it. Prudential rules are structural elements of the strength of intermediaries and are therefore essential to enable patient investment. The risk-management system must therefore be based on an assessment of long-term risks and returns adapted to the specific characteristics of the players. Since some actors, like NPBIs, have objectives other than short-term financial profitability, these tools lead to a distortion between the indicators used and the purposes of the institutions. Faithful to their core business, regulators give absolute priority to financial ratios alone without considering the positive externalities sought by NPBIs. Climate risk is a good example of this distortion, and it is worth noting that attempts are made to integrate it into risk assessment. Other elements could also be considered, such as the protection offered by a diversified, long-term investment portfolio. The same is true for the reference horizons of indicators which are often short term. If a prudential framework is considered essential to the stability of the financing system and, thus, to the continuous functioning of the economy, some measures could promote a better orientation of savings towards long-term investment while maintaining a secure framework. In other words, there is a penalisation of equity investment which makes the key function of NPBIs—transforming liquidity into long term investment—more difficult at the very time it is the most needed. The long term remains the poor cousin of accounting standards despite recurring alerts on this subject (Demaria 2016). It is worth pointing out that both accounting standards and prudential rules have, for the most part, pro-cyclical effects. Accounting standards lead to gregarious behaviour and leave little room for long-term strategies. Asset valuation is based on the concept of ‘fair value’, which is, in fact, increasingly akin to market value. Quarterly reports have short-term consequences for investor behaviour. International Financing Reporting Standard (IFRS) 9, introduced in 2018, further reinforced this trend. The increasing volatility of valuations are making it more difficult for financial players to devise long-term strategies. To avoid the perception of valuations as artificial or even misleading, asset-valuation mechanisms must be carried out continuously based on the concept of ‘fair value’. As the market is a beauty contest at a given moment (Keynes 1936: 156), it can hardly apply to any long-term perspective. Rather, it fosters an appreciation which, without doubt, is close to the consensus at a given moment, but does not consider the future. This ‘fair value’ valuation, therefore, appears not only to be unsuitable for the management of long-term investments, but also acts as an effective deterrent of them. In this context, it is becoming more important than ever to think about building a long-term accounting framework to avoid using a ten-decimetre ruler to measure the length of a highway! The quality of information is crucial for making informed investment choices, but it is not enough. In a modelling-resistant environment where externalities are 133 7. From Crisis to Crisis numerous, the need to be prioritized. It is up to the public authority, which alone has the necessary legitimacy, to shed this indispensable light. Putting priorities into perspective is part of an effort aimed at investors and, especially, savers. Sometimes, what makes products unattractive is a lack of financial education; however, more often, it is the lack of legible priorities that drives behaviour in these groups. The hierarchy of externalities, whether positive or negative, is key for establishing incentives. They are often put forward progressively without being placed in a global perspective. Clarifying political choices by establishing a hierarchy of externalities can only be done by politicians at the global level, thus proving that the European model makes sense. By establishing a venue for arbitration that bring together experts, politicians, and civil-society representatives at European level, an analysis grid could be proposed to characterise long-term investments. This grid could then be included as a governance instrument for European financial instruments. It could also serve as a basis for characterising long-term investments at national or European level. The NPBIs have shown in recent times, marked by all these challenges, that they are in a position not only to play their full role as countercyclical actors but also to shape, in part, a new restructuring of our economies. In today’s progression of the world economy, Europe has demonstrated its strong assets with these public institutions as well as highlighting their strong legitimacy. 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Therefore, we discuss several options to enable the flexibility of national budgets to ensure a level of green public investment which—together with private resources—is sufficient to close the existing green investment gaps. In addition, the use of the lever the EU budget theoretically offers to contribute to green public investment in the EU needs to be intensified. At about 1% of EU GNI (1.7% of EU GNI including NGEU) the overall volume of the EU budget is limited. The more important are steps to strengthen spending in policies that create EU value added, inter alia green public investment. 8.1 Introduction The European Green Deal (EGD), the EU’s ‘new growth strategy’ that was adopted in 2019 with the aim of making the EU climate neutral by 2050, requires massive investment in the decarbonisation of the economies of the EU.1 Geopolitical developments with the Russian invasion in Ukraine highlight the need to speed up the clean-energy transition and the strengthening of Europe’s energy independence. The ‘Fit for 55’ Package launched by the European Commission in mid-2021 aims at 1 We are indebted to Cornelia Schobert for careful research assistance. © 2023 A. Pekanov & M. Schratzenstaller, CC BY-NC 4.0 https://doi.org/10.11647/OBP.0386.08