The EU’s cohesion strategy is admirable and smart. Whereas such investment in the past was heavily tilted toward physical infrastructure – particularly transport – the agenda has shifted to a more balanced set of targets, including human capital, employment, the economy’s knowledge and technology base, information technology, low-carbon growth, and governance.
That said, one can ask what the economic and social returns on these investments will be. True, sustaining high growth rates requires sustaining high levels of public investment, which increases the return to (and hence the levels of) private investment, in turn elevating output and employment. But public investment is only one component of successful growth strategies. It will do some good in all scenarios, but its impact will be much larger beyond the short term if other binding constraints are removed.
Three complementary issues seem crucial. One, mainly the province of the European Central Bank, involves price stability and the value of the euro. The second is fiscal, and the third is structural.
Inflation rates, now well below the ECB’s 2% annual target, are in the deflationary danger zone. Because deflation drives up the real burden of sovereign debt and public non-debt liabilities such as pension systems, its emergence would undermine the already fragile state of many countries’ public finances and kill growth.
In a post-crisis environment of aggressive and unconventional monetary policy in other advanced countries, the ECB’s less aggressive policies (owing to its more restrictive mandate) have resulted in an exchange rate that has damaged competitiveness and the growth potential of many eurozone economies’ tradable sectors. This is crucial, because most economies experienced pre-crisis growth patterns characterized by unsustainably high levels of domestic aggregate demand. So rebalancing requires shifting toward the tradable sector and external demand. A weakening euro will help.
The ECB understands this, and, without being explicit about it, is expanding its asset-purchase programs to elevate inflation and bring down the euro. ECB President Mario Draghi has been clear that restoring target inflation and weakening the currency is not a growth strategy. Difficult reforms are needed to put many national economies’ fiscal affairs in order and to increase their structural flexibility. The ECB cannot do it alone.