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The writer is a former president of the European Central Bank and was prime minister of Italy, 2021-22. He is the author of a recent report on the future of European competitiveness
The EU has committed to achieving carbon neutrality by 2050; investing at least 2 per cent of GDP per year in defence for all Nato members; raising public and private innovation spending to 3 per cent of GDP; upgrading its digital infrastructure to state of the art levels; and investing in climate mitigation and prevention. It also has broader goals, such as preserving its social model.
Many of these aims are set down in EU and national legislation. But the cumulative investment needs they entail are massive. Conservative estimates by the European Commission and the European Central Bank put the figures at €750bn-800bn per year. Meeting these needs would require investment to rise to 27 per cent of EU GDP, from 22 per cent today.
Historically, around 80 per cent of investment in Europe has been financed by the private sector and 20 per cent by the public sector. This implies governments will need to spend more than €1tn over the next seven years.
Many EU governments are confronting this investment challenge from a starting point of high legacy debts and structural deficits. But analysis by the ECB suggests that there is scope for public investment to expand significantly if governments take full advantage of the EU’s new fiscal rules.
The ECB estimates that the new rules — which allow countries to extend fiscal consolidation for up to seven years in order to carry out investments and reforms — could in principle unlock up to €700bn. And once the consolidation phase is over, countries are allowed to keep structural deficits at 1.5 per cent of GDP.
Compared with the previous rules, this margin could create about 1 percentage point more fiscal space for investment. An additional €400bn will also come from existing EU resources.
How can Europe ensure that this fiscal space is both used and used well? The Budget adopted this week by the UK government offers some interesting ideas in this specific regard.
The UK government has chosen to significantly raise public investment over the next five years and has adopted precise rules to ensure that borrowing is used only to fund this investment.
Moreover, in order to ensure the quality of spending, transactions will be validated by independent authorities. This increases the likelihood that public investment has a positive net present value and so supports fiscal sustainability.
EU countries are now in the process of submitting their first budgetary plans under Europe’s new fiscal rules. The early evidence suggests two important differences in their approach from the UK’s.
First, most countries that have fiscal space and are not confronted with a serious deterioration in the macroeconomic outlook are opting for a shorter consolidation path of four years rather than seven. It looks unlikely that these governments will use the margins to raise investment that the new rules provide.
Second, for those countries that do intend to make use of the seven-year extension, the safeguard that money will be spent well lies with the Commission. This requires that it be a demanding negotiating partner, rigorously enforcing investment targets and evaluating the quality of investment and whether it addresses “the common priorities of the Union”.
Until now, public goods like climate mitigation and prevention, energy interconnections, research and defence have been underfunded. It is an open question whether this gap will persist in the future.
At the country level, debt trajectories appear to have been devised only to satisfy debt sustainability analyses. And at the EU level, there has so far been no common assessment of whether the individual plans of countries meet the collective needs of the bloc.
Certainly, the lion’s share of investment will still need to be financed by the private sector. But private finance will not respond without a co-ordinated reform agenda.
A more efficient use of Europe’s high private savings rates requires integrating its capital markets. To redirect private investment from mature industries to more advanced sectors will hinge on completing the single market.
Without this, innovative firms in fast-growing sectors such as digital services will not be able to scale up and attract capital. And, as a result, investment will remain locked in old technologies.
The EU may have a stated preference to be a climate leader, a digital innovator and a geopolitical player. But for now, the revealed preference of its members is different. Without using its fiscal space and reforming its markets, it is hard to see how Europe will achieve its ambitions.