Investing in growth: Europe’s next challenge
Although the decline in Europe’s level of private investment from 2007 to 2011 is rarely highlighted as a feature of the region’s financial crisis, it was unprecedented. In fact, during that period, private investment in the European Union’s 27 member states (the EU-27) plunged by a combined total of €354 billion—20 and 4 times the fall in private consumption and real GDP, respectively.
In the past, private consumption has been the driving force behind most economic recoveries. But high rates of unemployment and personal debt have made consumers cautious about spending. Governments are feeling the weight of large debts and pressure to deleverage, so they cannot fill Europe’s private-investment hole themselves by investing or consuming. And while exports have played a significant role in the recovery thus far, they now face headwinds, not least because Europe is its own biggest export market and its overall growth has been anemic.
In contrast, publicly traded European companies had excess cash holdings of €750 billion in 2011, close to their highest real level in two decades. By removing regulatory barriers, European governments could, at a relatively low cost, unlock short-term private investment that would contribute to growth—and inspire confidence in firms that have hesitated to launch their own dormant investment plans.
Skeptics might argue that governments can make a difference only at the margins of the private sector’s investment decisions. But the largest investment potential for private companies lies in capital-intensive sectors such as energy and transportation, where government policy has a significant impact. MGI’s latest research finds that closing only 10 percent of the current subsector variation between countries in capital stock per worker would involve more than €360 billion in additional investment—more than what was lost during the financial crisis.
Such government intervention has a poor track record. “Picking winners” has too often been ineffective and a drain on public money. Instead, governments should consider a new policy for investment: prioritizing sectors in which it is most likely to help renew GDP growth, identifying barriers in those sectors, executing cost–benefit analyses, and building the skills necessary to implement these new policies effectively.
Regulatory change often involves difficult, time-consuming political trade-offs, so businesses looking to invest shouldn’t rely exclusively on regulatory changes, however great the imperative and opportunity. Companies need to examine their own approaches to investment. That might mean taking a more granular perspective on market opportunities (for example, by focusing on “micromarkets,” at the city rather than country level), engineering a step change in capital productivity, or ensuring that the bitter experience of recent years does not screen out potentially attractive opportunities by creating a bias against risk.