Europe Needs More than Infrastructure Spending to Thrive

(Bloomberg View) -- For the past two decades, the EU has grappled with a productivity slowdown that has kept wages and economic growth in check. Politicians are increasingly mentioning infrastructure as a possible solution: The hope is that building more roads and better bridges can help companies improve efficiency and re-start growth.

However, while infrastructure may indeed provide a much-needed stimulus to Europe’s economies, it isn’t the reason why the EU has fallen behind the U.S. in terms of productivity growth. Since the mid-1990s, U.S. productivity growth accelerated relative to Europe, even though the gap in public infrastructure investment has shrunk. For Europe to close the transatlantic gap, a building boom won’t be enough; what’s needed is more investment in R&D and ensuring that more innovative companies are allowed to thrive.

Historically, public investment has been a key driver of productivity growth. The economic historian Alexander Field showed that the infrastructure built under the New Deal helped to make the U.S. much more efficient in the late 1930s and early 1940s. In Europe, the post-war reconstruction is also widely credited as one of the reasons behind the economic boom in the 1950s.

Europe Needs More than Infrastructure Spending to Thrive

However, the widening of the productivity gap between the U.S. and the EU since the mid-1990s has little to do with infrastructure. Between 1995 and 2015, the difference between the amount of output produced in an hour of work in the EU and the U.S. rose to 33 percent from 23 percent of EU levels. Yet, the transatlantic gap in public investment has actually narrowed: In 1997, the U.S. administration invested roughly 3.8 per cent of gross domestic product in new capital projects. By 2015, this had fallen to 3.4 per cent. For the EU, the level of public investment has remained at 2.9 per cent.

It is still possible that infrastructure spending was more effective in the EU than it was in the U.S. However, there are indications to the contrary. Recent research by Riccardo Crescenzi, a professor of economic geography at the London School of Economics, has found that between 1995 and 2009 there was no clear link between motorway investment and growth in the EU.

Europe Needs More than Infrastructure Spending to Thrive

One reason is that politicians tend to waste public money on “white elephants” rather than using funds on projects which would actually boost productivity. The emphasis is often on large-scale plans such as the U.K.’s 55.7 billion pound ($72.4 billion) High Speed 2 rail project linking London to Manchester and Leeds, which Britain’s national auditors have shown risks offering limited returns. Other studies have shown that politicians should place more emphasis on smaller projects -- such as fixing potholes -- which can offer better value-money-for-money; but these are often neglected. Digital infrastructure can also be a spur for growth in regions where it lags behind. Europe could do more of this sort of investing. 

But if Europe is serious about closing the productivity gap with the U.S., two other areas should take priority. The first is investment in research and development: A recent study by the European Central Bank shows that while total investment in R&D has risen in the euro area since before the crisis, it remains lower than in the U.S. The gap in the number of high-tech applications remains substantial.

The second area relates to insolvency regimes. Technological revolutions are never done by governments alone. This is why it is essential that the most innovative companies are allowed to thrive. The problem in the EU is that too many productive factors, such as workers and machines, are locked into inefficient companies. This lowers the average level of efficiency, and makes it harder for better firms to expand. One solution is to make more companies go bust. This calls for European banks to hold borrowers to their terms and for better insolvency regimes to allow for more orderly restructurings.

It will take years, if not decades, for Europe to close the productivity gap with the U.S. But the strategic choices should be made now. For all the instincts to build more, the answer to Europe’s productivity problems may well lie elsewhere.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg View. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times. 

To contact the author of this story: Ferdinando Giugliano at fgiugliano@bloomberg.net.

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