When the European Council next meets, it should look at private investment as a means to kick-start Europe’s stagnant economy. With the usual drivers of GDP growth constrained across Europe, the one economic sector able to spend is the non-financial corporate sector.
Indeed, publicly traded European companies had excess cash holdings of 750 billion euros (US$1 trillion) in 2011, close to a 20-year high. Unlocking that cash would give Europe a much larger stimulus package than any government can provide. For example, in 2011 private investment in Europe totaled more than 2 trillion euros, compared with government investment of less than 300 billion euros.
And yet, while trends among European economies have varied, private investment was, overall, the hardest-hit component of GDP during the crisis, plunging by more than 350 billion euros — 10 times greater than the fall in private consumption and four times more than the decline in real GDP — between 2007 and 2011. The magnitude of the private-investment downturn was, in fact, unprecedented — and lies at the heart of Europe’s economic malaise.
Likewise, by historical standards, the private-investment recovery is running late. In more than 40 past episodes in which GDP fell and private investment declined by 10 percent, recovery took an average of five years. Europe is four years removed from the onset of recession, but private investment in 2011 was still lower than its 2007 level in 26 of the EU’s 27 member states.
To be sure, that companies are holding on to their cash, rather than paying it out in dividends, signals that they expect investment opportunities to return — a far more positive situation than in Japan, for example, where companies lack cash to invest. However, European companies remain hesitant, despite low interest rates, keeping private investment well below its previous peak.
Governments can help to persuade companies to let go of their cash by removing regulatory barriers such as zoning regulations in retail and a plethora of requirements in the construction sector concerning everything from the height of ceilings to the size of staircase areas. They should also address the lack of uniform standards across Europe’s internal borders; for example, there are 11 separate signaling systems for rail freight in the EU-15.
After Sweden eased planning laws in its retail sector during the 1990s, the country posted the strongest retail productivity growth in Europe (and outstripped that of the US) between 1995 and 2005. Standardization and liberalization in European telecoms underpinned 9 percent growth in value added and productivity in this period, compared to 6 percent growth in the US.
The largest scope for renewed private investment is in capital-intensive sectors in which government has a major presence as regulator. Even if European countries were to close only 10 percent of the variation in capital stock per worker at the sub-sector level, the impact could be more than 360 billion euros in additional investment — offsetting the 354 billion euros difference in private investment between 2007 and 2011.
Many projects, from airports to university campuses, benefit from returns over decades, which implies that weak demand in the short term will have only a limited impact on their overall viability. Even among more near-term projects, some — for example, retrofitting buildings with more energy-efficient features — could become viable with action from policymakers. Some degree of investment will add to demand, which may persuade others to invest — a virtuous circle.