The Investment Fund by the European Commission cannot be expected to foster jobs and growth up to the end of 2016. An alternative- or a way to bridge the gap- would be to allow member countries to invest into pre-specified drivers of growth outside the limits of the Fiscal Pact, writes Karl Aiginger.
Economic growth is anaemic at best in Europe, with half of the countries at the brink of a recession or deflation or both. Jean-Claude Juncker’s knight in shining armour ? the 315bn € Investment Fund ? has to pass through 28 parliaments, then to persuade the financial markets, and finally sensible projects need to be found. That means that the Fund will at best result in employment and growth towards the end of 2016.
To give up the Fiscal Pact, as demanded by the IMF, some US economists, and some leading journalists in big European newspapers is not a good idea, since the level of sovereign debt is still high in most countries, and reneging on a pact would furthermore undermine credibility. Giving up the goal of a balanced budget also means more staying within old structures i.e. deficit spending for past priorities, without increasing the pressure for structural reforms.
Buying from German’s Golden Rule
Public deficits are different, whether they are spent on administration, or on enhancing future welfare. This idea was used decades ago by Germany, where the public sector was allowed to make deficits if they were spent for public investment (this was called the “Golden Rule”). It was given up formally in 2009, as public investment was considered too large, as infrastructure was in general well-developed, and theoretical and empirical analyses have shown that in rich countries material investment is no longer closely related to growth and employment. The main drivers of growth in industrialized countries are innovation and human capital.
We therefore propose a “Silver Rule”, which exempts specifically important, mainly intangible investments, from the upper limits of expenditure as defined in the Fiscal Pact. This exemption should be temporary. Furthermore, it should be qualitatively connected to structural reforms and supervised by an independent authority.
More specifically, the European Commission should define five categories of public expenditure which (i) are specifically important for growth in the long run (expenditure with investment characteristics) and (ii) which have high multiplier effects in the short run. Such categories could be research and education, early childhood investment, infrastructure maintenance and upgrading, refurbishment of homes and offices, bottlenecks in energy and broadband grids, renewables, and start-up centres, to name but a few.
We propose that increases in public expenditure in these predefined categories of up to 1% of GDP can be done outside the deficit limit defined in the fiscal pact for 2015 and 2016. The countries have to commit to five reform projects in their economy (from labour market reforms to the structure of public expenditure, taxes, pension reforms etc.).
While the categories for intangible investment are decided by the Commission, the adherence is controlled by independent authorities (e.g. the courts of audit of another member).
Relation to alternatives
The proposal is similar to the Golden Rule, but first it refers to the increase in expenditure, and secondly mainly to intangible investment. Some contain a mix of tangible and intangible investment, but all refer to closing bottlenecks and to upgrading structures rather than building up systems from the scratch.
In contrast to the 315bn € Investment Fund, the Silver Rule can be implemented without delay. In the proposed areas projects already exist at the national level and had been curbed due to budget restriction in all countries.
A disadvantage of a proposal focusing on a large share of wages could be that some expenditure makes sense only if they continue beyond 2016 (new teachers, retraining). This should be possible within the limits of the Pact after two years if traditional expenditure has been cut.
Countries can decide on their priorities within the given categories, but all should contribute to European growth in the short as well as in the long run, and should not be micromanaged by “Brussels” or “Berlin” (an argument why “reform contracts” were opposed two years ago).
Bridging the gap to recovery and investment plan
The additional flexibility of the fiscal pact is limited to a 1% corridor for 2015 and 2016. The Fiscal Pact must not to be reneged on; it is made more flexible in a direction Germany had used before (and the “exceptional circumstance clause” allows the extra expenditures without change in the Pact). The intangible investments allowed are closely related to structural reforms. We call the proposal “Silver Rule”, as it is the intelligent brother of the “Golden Rule” for economies in the 21st century. It fits with the EU 2020 strategy for smart, inclusive and sustainable growth. It has synergies with the 315bn € Investment Fund which will become effective only towards the end of 2016.