According to Christine Lagarde, the managing director of the International Monetary Fund, investment in the G20 is 20 percent lower than projected on the basis of its pre-crisis trend. This is significantly more than for G20 output – 8 per cent – and it is certainly enough for the global investment shortfall to become a major topic for international policy discussion.
The data confirm Lagarde’s concern. Whereas, thanks to the launch of major infrastructure and construction projects, the investment-to-GDP ratio has risen in China in comparison to its pre-crisis level, the opposite is true for advanced countries and many emerging countries. In the United States, in Europe and in non-emerging Asia, investment accounts for a lower share of a diminished GDP. Furthermore, a recent survey by Standard & Poor’s finds that after the 2011-2012 rebound, investment by global companies decreased slightly in 2013. Companies from emerging markets especially lack a strong appetite for investment. No recovery is expected for 2014.
These are disturbing facts. The global rebound is still fragile and lacks momentum. Growth acceleration crucially depends on the investment recovery. This is especially true in the weakest countries, where unemployment is at record-high level and politics threaten turning sour.
Remarkably strong profits should lead companies to invest more, and ultra-low interest rates should lead governments and households to invest more. But they do not. As a consequence, soft capital expenditures contribute to keeping the recovery relatively weak. The question is why.
The overreaction of investment to the Great Recession is not a surprise. Along a given growth path, a country’s capital stock must increase in line with potential GDP growth if production capacity is to be adequate. When GDP growth collapses, the capital stock continues to increase thanks to built-in stock inertia, even if investment adjusts. So investment must over-adjust to help bring the capital stock in line with potential output. In the meantime, its contribution to growth is bound to be feeble at best.
There is, however, some evidence of investment weakness over and above what is justified by economic conditions. The German DIW Institute reckons that Europe suffers from both underinvestment and an inherited misallocation of investment.
There are several possible reasons for this situation. First, growth expectations are subdued in the advanced countries, especially in Europe. Companies are not keen to taking the risk of having invested too much. For this reason, there is a risk of self-fulfilling stagnation expectations.
Second, inherited debt weighs on investment behavior. Indebted companies and household prefer to use their income to pay back their debts, rather than to venture into building up potentially useless capacities. As economists Reinhart and Rogoff have pointed out, recovery from debt crises tends to be subdued.
Third, profitable investment opportunities may be scarce. Some scholars are, for example, pointing out that the return on investment in microchips or pharmaceuticals has decreased massively. Of the three explanations, this is the most worrying, because unlike the other two, it does not suggest the healing process will eventually be completed spontaneously.
So what is to be done? Governments do not have a magic bullet, but there are a few things they can do, or avoid doing.
First, do not miss opportunities to create a favorable investment climate. Regulatory clarity and predictability will help. For example, investment in energy production and energy savings is being held back by pervasive uncertainty as regards the future path of climate policies. A global agreement at the Paris conference in 2015 and a European agreement on how to stabilize the price of carbon would help trigger private investment projects.
Second, repair monetary policy transmission wherever needed. In Europe, the credit channel is still partly impaired because of persistent fragmentation and the still-unhealthy state of some banks. The sooner this is addressed in full, the more companies will be able to invest.
Third, revive public investment projects whose social return is high enough to warrant realization. Public investment and private investment are largely complementary to each other. In some countries – emerging as well as advanced – public infrastructure is so inadequate it is holding back private investment. Ultra-low interest rates provide an opportunity to rebuild the public capital stock.
Fourth, promote cross-border investment. The global distribution of savings surpluses has changed significantly with the sharp reduction of the Chinese surplus and the disappearance of the Southern European deficits. Yet some countries – among which the major oil producers and Germany – exhibit significant and recurrent surpluses. These should be invested abroad. A better global framework for investment protection and the definition of legitimate strategic interests would certainly help foster international investment.
Europe is the testing ground for this new approach. After years during which the focus has almost exclusively been on financial stabilization, budgetary adjustment and economic reforms, it is waking up to the investment and growth issue. It does not lack the means to act – after all the European Investment Bank, its development arm, has the largest balance sheet of any development bank – but its stance is still uncertain. Obstacles have to do with the bank’s preference for safe investments (infrastructure in Germany rather than financing small and medium-sized enterprises in Greece), the fiscal rules that limit public investment, and the traditional obsession with the direct national benefits of any European Union initiative. They can be overcome, but this requires resolve and a pinch of boldness. This is a good test for the incoming European Commission.
*Jean Pisani-Ferry teaches at the Hertie School of Governance in Berlin and serves as commissioner-general for Policy Planning in Paris. He is a former director of Bruegel, the Brussels-based economic think tank.