Squaring the circle - A European Investment Guarantee Scheme (EIGS)14 March 2013
This week’s EU summit is, once again, returning to the question of how best to balance the need for fiscal consolidation with growth and employment. This is a welcome and necessary focus: Europe is facing a severe economic and social crisis, with unacceptable levels of (youth) unemployment. But how can this circle between the need to save and the need to invest be squared?
Public finances are tight across the EU and there is little appetite for (additional) transfers from the better-performing countries to those in need. Long overdue structural reforms in the crisis countries – if they go beyond simply cutting expenditure or raising taxes – will ultimately help to deliver growth, but this will take years. Some of the measures in the Compact for Growth and Jobs and in the Multi-Annual Financial Framework agreement – when fully operational – will help, but their effects are likely to be rather limited in scale as well as time-delayed.
Progress on expanding the EU’s internal and external markets is positive, but will not particularly help countries most in trouble. The devaluation of wages in the EU’s periphery is having some effect, boosting exports and limiting imports, but this is only starting to close some of the huge gaps between crisis and better-performing member states. And the positive effect of internal devaluation is somewhat limited as it also depresses domestic consumption, which is already being hit by cuts in public expenditure.
So, with consumption and government spending depressed and the impact of external trade limited, what remains? The way out of the crisis will, at the end of the day, require higher levels of investment, both domestic and from abroad. Investment would not only have a positive overall long-term effect – boosting a country’s productive capacity – it would also create employment in the short term, for example in the construction sector in the case of physical infrastructure investments.
But with public investment severely cut back in the crisis, can private investment fill the gap to boost lagging economies? There is certainly scope to increase private-sector investment in public infrastructure through the development of EU project bonds, the Connecting Europe Facility and the further development of Public Private Partnerships. But this is not enough and there are limits to the capacity of a country in crisis to use such instruments.
Nevertheless, there are still significant funds available which are seeking attractive investment opportunities. Companies in northern Europe with access to cheap capital and often significant cash assets, wealthy private investors, some emerging economies, and big institutional investors such as pension funds are looking for interesting opportunities, but high levels of uncertainty prevent them from investing their money in Europe’s periphery.
Risks and a lack of confidence undermine readiness to invest in the countries hit worst by the crisis. The majority of investors are not convinced that the crisis countries will be able to generate the economic growth necessary to provide a solid return on their investment. In addition, there are numerous risks associated with investing in countries in Europe’s periphery, including political risks (possible changes in policy direction, for example concerning taxation), the risk of social unrest (including strikes) and financial risks (like the potential inability of public and private customers to pay their bills). There is also the more fundamental fear of a country dropping out of the euro, which would risk destroying the overall value of any investment. While this uncertainty has been somewhat reduced since last summer, any residual long-term ambiguity – easily reignited by political events, as seen in Italy – reduces readiness to invest.
So what can be done to address these barriers? The EU should create a European Investment Guarantee Scheme (EIGS) to provide a form of insurance for excessive risks incurred when investing in crisis countries. To be credible, such a scheme would require some financial underpinnings, but it would only pay out should the downside risks materialise. The EIGS would create investment opportunities and help to boost sustainable growth and employment in Europe’s periphery, addressing the direct consequences of the crisis. It would resemble a tried and tested method of supporting trade and investment: countries such as Germany use similar instruments to provide export credit guarantees for companies dealing with developing economies.
A number of strong arguments speak in favour of establishing a European Investment Guarantee Scheme:
It would demonstrate confidence in the long-term future of the crisis economies;
it would be fairly cheap unless the worst-case scenario is realised;
any potential pay-out would benefit companies in the countries shouldering most of the financial ‘burden’ underpinning the scheme, making it politically easier to accept;
it could help to save viable companies in the crisis countries which might otherwise go bust, despite the positive effects of internal devaluation and structural reforms, for example in the labour market;
it would provide a safe investment route for institutional investors, freeing up the available capital and increasing returns on savings in the economically stronger countries;
investment by pension funds in countries affected by the crisis would help to address the challenges arising from ageing by directing the savings from the ‘baby boomer’ generation into helping Europe grow, ensuring that younger people can get jobs;
it could help reduce capital flight from crisis countries, and;
it would not provide an incentive for governments in the crisis countries to overspend (‘moral hazard’) as no direct support would go to national executives.
Investment in crisis countries would help to realise a key (potential) benefit of a common currency zone – the efficient allocation of resources. Private investment into productive capacity, aiming at long-term and profitable returns – rather than using taxpayers’ money to finance sovereign debt and rescue banks – would be a win-win situation for both the crisis and better-performing countries.
The key question for governments (and parliaments) is whether they are willing to ‘put their money where their mouth is’: how strongly do they believe in the future of the euro zone? If they do, the EIGS would be an effective, cheap and innovative way of providing some much-needed support, which is crucial to make any crisis response economically and politically viable in the long term.
Of course, the EU summit cannot decide to start the EIGS tomorrow. The details of such a scheme would have to be carefully investigated and developed, together with private-sector insurers and investors. But the European Council could, for example, decide to establish a Task Force to work out the details of such a scheme, how it could best be financed and administered, and what excessive risk should be covered. The EIGS Task Force could report in time to allow implementation as early as 2014, potentially backed by EIB (European Investment Bank) assets and/or financing from the (yet to be established) new fiscal capacity (‘solidarity mechanism’).
The EIGS would help to cure Europe’s economy and fight (youth) unemployment from which all countries – in the euro zone and beyond – would benefit. A decision by EU leaders to move the idea forward would send a strong signal of trust in the future of Europe’s economy and common currency.
Fabian Zuleeg is Chief Economist at the European Policy Centre (EPC) in Brussels.
Disclaimer: The views expressed in this Commentary are the sole responsibility of the author.Squaring the circle – A European Investment Guarantee Scheme (EIGS)