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Clean energy investment could be a key driver of economic recovery in Europe

by Laszlo Varro, Chief Economist, International Energy Agency

The IEA Chief Economist on energy investment in the COVID-19 recovery:

The economy is in a deep recession. Weak demand and excess capacity weigh down corporate investment; skyrocketing unemployment cuts consumption and threatens social stability. Policymakers respond by debt-funded public investment into clean energy projects that not only successfully stimulates the economy but furthers long-term strategic objectives for an energy transition. The year is not 2020 but 1935, the clean energy projects are the large hydro plants in the Tennessee Valley and the French Alps, and the energy transition is moving the countryside from the petroleum lamp to electric light.

It is interesting to note in the context of the discussions on a Green New Deal that are unfolding in several countries today, that the most iconic achievements of the original New Deal era were actually clean energy projects. This was decades before the emergence of climate concerns, but the energy sector can absorb capital investment rapidly and trigger spillovers into both construction and manufacturing, two sectors that were both hard hit then and today.

Europe has a chance to repeat this historic progress with the implementation of the recently-announced increase in climate ambition. Previous policies under implementation and technology change already put Europe on a declining CO2 emissions path. However, the recently enhanced target of “at least 55% reduction by 2030” represents a step change in ambition. Compared to the trajectory determined by previously-stated policies and national emission plans, the new ambition that puts Europe on track for full decarbonisation requires an additional over 400 million tons emission reduction. In a single decade, Europe will need to eliminate the equivalent of the combined fossil fuel use of France and Belgium, on top of the already meaningful clean energy policies under implementation.

The pandemic reduced emissions, but mostly for the wrong reason, of depressing economic activity. The social and behaviour changes it brought have only a minor energy impact: some people work from home instead of commuting, others drive instead of using public transport. Faster and larger emission reductions will require an unprecedented investment effort. But, the potential rewards are sizeable: as the recent IEA Special Report on a Sustainable Recovery pointed out, a three-year focused clean energy investment push at a global level can lead to 4.5% higher GDP level and create an additional 9 million jobs by the end of the investment drive. This would represent a substantial contribution to the post virus recovery. Europe would represent around 10% of the global green job creation with around 900 thousand additional jobs. Due to labour costs and technology characteristics, clean energy development in Europe tends to be capital intensive and relies on skilled, well compensated jobs. There are significant differences in the labour intensity of various low carbon options, with building retrofits and rooftop solar having a higher than average employment effect. It is appropriate to integrate considerations on labour market impacts into clean energy investment policy design.

For a timely deep decarbonisation, investment in the energy system does not simply need to recover to the 2019 level, as that investment was insufficient for the energy transition objective, but to go significantly beyond. In the IEA Sustainable Development Scenario which is broadly consistent with the new, stringent climate ambition, average energy investment in the 2020s in the European energy system will have to more than double. The increase – from the current depressed level – is around 1% of EU GDP. One reason why this could have a measurable positive macroeconomic impact is that Europe is a very large oil and gas importer. In a high carbon trajectory the oil and gas industry would invest over 60 billion USD annually into projects outside Europe that serve European demand. If this is replaced by wind turbines or building retrofit projects domestically, Europe will need to move to a structurally higher energy investment/GDP ratio.

Investment would have to be transformative. It is not possible to have a “copy–paste” replacement of fossil fuels. A credible decarbonisation pathway will have to involve a step change improving energy efficiency, into renewable energies and investment for new infrastructures. The efficiency ambition is equivalent to retrofitting a Berlin in every three months.

Moreover, as the most successful clean energy technologies like wind and solar generate electricity, massive investments are needed to electrify transport and other energy use. This includes households spending to buy electric cars as well as utility and public investment in charging infrastructures. This will need to be managed carefully: Europe is a powerhouse of internal combustion engine manufacturing but there is currently no European company among the top 5 battery manufacturers. Overall benefits would improve further if a viable and competitive battery manufacturing value chain can be developed in Europe.

For renewables to reach the required volumes, investment in the most mature and scaleable wind and solar will have to increase by 60%, but other technologies like bioenergy and nuclear power will also need to play a role. While there will be imported solar panels, Europe has strong industrial capabilities in most clean energy technologies. Recent technological progress allow renewables to provide energy on a larger scale and they are more technology intensive. They require specialized technical skills Europe can provide, especially in the case of wind turbines and modern grid solutions, Europe is a significant exporter. Retrofitting buildings also require better skills to be efficient, and can be a sizeable source of emission reductions.

The current macro financial environment is a major opportunity for both private and public investment. Most low carbon technologies like wind turbines or electric cars demand a significant initial investment but are then cheaper or even free to operate and save fuel costs. As a result, the ultralow interest rate environment improves their competitiveness. IEA analysis suggests the majority of the investment can be mobilized from the private sector. A wind park with a credible long-term contract is to a certain extent a financial substitute of a long-term bond and is made attractive by negative bond yields. Direct government investment could complement, investing in new infrastructure like hydrogen pipelines and technologies with unusual risk profiles like nuclear. The EU Recovery Fund and national budget funding can thereby appropriately complement private investment.

However to reap the full benefits of the macro-economic environment, non-market barriers to clean energy investment need to be lifted. Despite improving technology and falling costs, the growth of clean energy in Europe flattened in recent years below its historical peak. Complicated and lengthy licencing procedures are a constant complaint from investors. Scale and speed matters. In the Sustainable Development Scenario trajectory, by 2030 Europe will have to build 140 GW more renewable capacity than what the current renewable policies would deliver. This is 20000 wind turbines and the equivalent of a 100000 football fields covered by solar panels. As the current electricity network is not suited to integrate this new energy inflow, and additional 400 billion euros of network investment will be needed over the decade, both to a physical backbone and also into digitalization to the grid. The experience with priority interconnection projects is that even if the money is in the bank, it is not easy to spend it on the electricity network. What is needed is a bottom-up effort to streamline and accelerate such investment regulatory framework.

During the Great Depression, Keynes famously recommended for governments to pay people to dig holes and pay other people to fill them up. We can do even better, by paying people to put the foundations of wind turbines and electric car chargers into those holes. In order to put the energy system on a low-carbon trajectory consistent with the scientific consensus, clean energy investment has to scale up. With an appropriate policy design, this can lead to substantial positive macroeconomic spillovers, helping the recovery of the European economy. The time is now.

Further reading: Global Energy Review 2020: The impacts of the Covid-19 crisis on global energy demand and CO2 emissions




Improving the quality of business investment in Turkey

by Rauf Gonenc, Head of the Turkey Desk, OECD Economics Department

Turkey’s business sector exhibits one of the highest investment rates among OECD countries. However, the 2018 Economic Survey of Turkey (OECD, 2018) suggests that the quality of investment could be enhanced by overcoming the fragmentation of the business sector and by improving the current business environment. A comprehensive micro dataset allowed to distinguish four types of firms whose investment dynamics and challenges differ: i) small businesses with a high degree of informality, ii) medium-sized family firms, iii) large listed corporations, and iv) skilled young start-ups. There is room for increasing the share of knowledge-based and long-term investments – notably innovation, training, digitalisation and R&D investments – in all these types of firms at lower and internationally competitive investment costs.

The small informal businesses – which employ the largest share of Turkey’s labour force – have very  limited access to bank credits and no access to external equity capital as of today. Their ability to fund long-term knowledge-based assets is highly restricted. Medium-sized family firms which have played a central role in Turkey’s strong growth over the past decade are better endowed, and keener, to invest in long-term assets, but are over-leveraged vis-à-vis domestic banks, which restricts their additional investment capacity. Domestic bank loans are also typically of short maturity and entail roll-over risks for the financing of long-term investments. Even so, the majority of family firms refrain from reaching out to securities markets and to external shareholders. Large, listed firms have, in contrast, a good access to national and international debt and equity securities markets, but Turkey’s high risk premia increase their cost of financing above international competitors’. The last group of young skilled start-ups is backed by myriad government incentives at their phase of emergence, but need more risk-sharing and long-term private capital to continue to expand.

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Cultivating Turkey’s equity eco-system would help these different types of firms to develop their long-term, knowledge-based, productivity-enhancing investments. Some obstacles include limited financial transparency of firms, incompatibilities between local and international governance standards, complex and frequently changing tax and subsidy systems, and too restrictive labour market rules which reduce the flexibility of firms and amplify investment risks in the formal sector. The modernisation of the business environment in all these domains would accelerate the emergence of more equity-specialised financial intermediaries, accounting experts, legal and financial advisors, research analysts and market makers. The development of this eco-system is essential for improving mutual confidence between all types of enterprises and potential investors from their local, national and international environments.

The modernisation of the business environment has been ranking high on the government’s agenda for some time. Domestic and regional geo-political circumstances have so far limited progress, and even led to setbacks in some areas such as the rule of law, judiciary independence or the fight against corruption. With the tempering of political uncertainties after the June 2018 elections, a window of opportunity opens for resuming the reform process. The OECD Survey suggests that a three-fold modernisation strategy emphasising i) the formalisation of informal and semi-formal businesses, ii) the introduction of more state-of-the-art management and digital skills in all types of firms, and iii) the rebalancing of financing structures from debt to equity would help the entire business fabric to upgrade the quality of capital formation. Progress would not only contribute to the rebalancing of growth through a more productive and internationally competitive business sector, but also to social inclusion and cohesion through the creation of high-quality formal sector jobs in the entire country.

Find out more:

OECD (2016), OECD Economic Surveys: Turkey 2016, OECD Publishing, Paris.

OECD (2018), OECD Economic Surveys: Turkey 2018, OECD Publishing, Paris.




Getting stronger, but tensions are rising

By Álvaro Pereira, OECD Acting Chief Economist

The global economic expansion is strengthening. Global growth is projected to increase from 3.7% in 2017 to around 4% in 2018 and 2019 in our latest Interim Economic Outlook. In many advanced and emerging G-20 economies, the growth prospects for the next two years have improved. Global trade and investment are growing faster, accompanied by robust job creation. Fiscal stimulus in the United States and Germany will further boost short-term growth. Commodity exporting emerging market economies are recovering on the back of stronger commodity prices and firmer global demand. Inflation remains low, but is likely to rise slowly as labour markets tighten.

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This is welcome news. However,  there are also new tensions and new policy challenges. As the expansion progresses, monetary policy support will be reduced gradually, albeit at different speeds across major advanced economies. The likelihood of faster hikes in US policy rates has already been reflected in slightly tighter short- and long-term financing conditions. Such policy normalisation is desirable, but could expose financial vulnerabilities from accumulated debt and high asset prices. Rising interest rates could create particular challenges for emerging market economies if capital flows and exchange rates were to become more volatile.

Against the positive background, an escalation of trade tensions is a serious risk. US steel and aluminium tariffs will raise costs and harm consumers, while not solving the global overcapacity problem. Escalation of trade tensions would hurt the recovery. Safeguarding the rules-based international trading system is key.

Policymakers need to make the right choices to sustain medium-term prosperity and ensure the benefits are fairly shared by workers and households. Fiscal policy, while it remains supportive, should not excessively stimulate demand. Focusing on changes in the tax mix and spending structure holds significant potential to make growth more sustained and more inclusive in the medium term.

Keeping an eye on medium-term goals also means stepping up reform efforts to boost productivity, employment and inclusion. Some countries – Italy, France, Japan, India and Argentina  – have implemented significant reforms. However, our forthcoming Going for Growth report (to be released on 19 March) shows that in both advanced and emerging economies overall, the pace of structural reform is once again slowing, particularly on the tax and skills policies that are so important to achieving inclusive growth. Political support for reform can dwindle in good times. Yet, good times do provide an opportunity to implement ambitious policies to develop workers’ skills, promote competition, and improve the functioning and inclusiveness of labour markets so that living standards rise durably and widely across society.

Reference

OECD Interim Economic Outlook, March 2018.




Investment, an engine of global growth that has yet to fire up

By Théodore Renault and Dorothée Rouzet, OECD Economics Department

Global growth has strengthened, but policymakers face the challenge of lifting their economies’ long-term potential to ensure it remains robust and more inclusive. Private sector investment has slowed substantially in the past decade. Even though they have started to recover in most advanced economies, net investment rates remain well below pre-crisis levels and are projected to rise only modestly for the next two years (Figure 1) – see our latest Economic Outlook. The capital stock has been eroded by the double whammy of declining gross investment rates and faster depreciation – in part due to the shorter lifespan of technology investments. As a result, stronger investment than in the past is needed to maintain, grow or upgrade the capital stock, and to turn the opportunities offered by new technologies into sustained productivity growth.

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Investment rates have declined even as corporate debt has soared in the post-crisis period, as highlighted in the OECD Economic Outlook special chapter on “Resilience in a Time of High Debt”. This raises questions about what the funds are used for. If borrowing is well used, rising corporate indebtedness can contribute to economic growth by raising productive capacity or improving productivity. This has by and large not been the case: corporate debt has for long risen faster than the productive capital stock in major economies, such as the United States or the euro area (Figure 2). A number of studies suggest that a substantial share of new debt has been used to return funds to shareholders through share buybacks and dividends, rather than financing investment (OECD, 2016). The gap between the cost of equity and debt may have also been a motivation to shift towards debt financing.

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The divergence between investment and corporate debt raises concerns that too much debt may signal inefficient capital allocation. High levels of debt can hamper the ability of corporations to undertake new borrowing to finance productive investment. Over-indebted firms tend to lose dynamism, often even failing to keep up with the required investment to remain competitive, and thus can become “zombie” firms, not only impairing their own prospects but also holding back the performance of competing firms (Adalet McGowan et al., 2017).

Broad structural policy packages are needed to catalyse business investment towards stronger long-term growth prospects. Policy action to make product markets more competitive would raise the prospective rate of return on new investments and encourage innovation, leading to higher productivity growth and ultimately supporting wage and income growth. Reducing the tax bias towards debt and improving the design of insolvency regimes would help the financial system to be more resilient to shocks, thereby minimising the risks of sub-par growth in the medium term.

References

OECD (2017), OECD Economic Outlook, Volume 2017 Issue 2, OECD Publishing, Paris.

OECD Economic Resilience website

Adalet McGowan, M., D. Andrews and V. Millot (2017), “Insolvency Regimes, Technology Diffusion and Productivity Growth: Evidence from Firms in OECD Countries”, OECD Economics Department Working Papers, No. 1425, OECD Publishing, Paris. http://dx.doi.org/10.1787/36600267-en

Caldera Sánchez, A., et al. (2017), “Strengthening Economic Resilience: Insights from the Post-1970 Record of Severe Recessions and Financial Crisis”, OECD Economic Policy Papers, No. 20, OECD Publishing, Paris. http://dx.doi.org/10.1787/6b748a4b-en

OECD (2016), OECD Business and Finance Outlook 2016, OECD Publishing, Paris.
http://dx.doi.org/10.1787/9789264257573-en




Global Economic Outlook: Better, but not good enough

By Catherine L. Mann, OECD Chief Economist and Head of Economics Department

Global growth is projected to rise modestly from 3% in 2016 to just over 3½ per cent by 2018 in our latest Economic Outlook. The mood in the global economy has brightened during the past year, with confidence indicators and industrial production increasing, and investment and trade picking up from low levels. Growth is broad-based, including among major commodity producers.

There are now upside risks from investment to improve the quality of capital with more advanced technology, with rapid rises in demand for high-tech products since the second half of 2016. If this is sustained, it would improve cyclical conditions and support a revival of investment-intensive global value chains, boosting domestic demand and productivity.

The projected pick-up in growth is welcome as the global economy has been stuck in a low-growth trap, but would still leave global growth below the historical average of 4% for the two decades prior to the crisis. In addition, when viewed in per capita terms, GDP growth for the OECD is even further from past norms and income inequality continues to rise. And while business and consumer confidence have generally picked up, these “soft” indicators have become less reliable in predicting “hard” activity, particularly for emerging economies.

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Employment growth has recovered relatively well and headline unemployment rates have decreased in most countries. However, along some dimensions, such as hours worked and part-time working, job quality is more precarious and underemployment remains high. Real wage growth is sluggish and has stagnated for most firms, and is associated with widening productivity gaps to frontier firms, so there are weak foundations for robust consumption growth and widespread improvements in well-being.

Financial stability risks persist and could derail the modest recovery. Policy and political uncertainties are high. Geopolitical shocks and trade protectionism could catalyse snap-backs in asset prices and realise downside risks. High and rising private credit growth for emerging economies, particularly China, is a concern. Rapid increases in house prices in some advanced economies could lead to financial vulnerabilities. Solving non-performing loans in Europe would help to hasten the recovery.

Inflation in advanced economies is generally below central bank targets. After the global interest-rate cycle turned in mid-2016, monetary policy is appropriately moving toward a more neutral stance in the United States, and Europe and Japan are using forward guidance. However, current market expectations imply a rising divergence in short-term interest rates between the major advanced economies in the coming years. This creates risk of sharp exchange rate movements, or other instabilities in financial markets.

In this environment, policy needs to promote inclusive growth and manage financial risks. Countries should implement fiscal policy initiatives that mitigate inequalities and provide long-run benefits, such as boosting education, child care, training and mobility. “High-multiplier” public investments in research and infrastructure would catalyse business activity to strengthen growth. An effective fiscal mix also improves the fiscal position and future output to boost debt sustainability in the longer term.

Each country has its own policy priorities to boost productivity, jobs and inclusiveness as set out in our Going for Growth report. Worryingly, the pace of reform has slowed in recent years and much more can be done to boost competition, skills and innovation. The benefits for inclusive growth can be strengthened through coherent policy packages which maximise synergies if implemented together, such as how active labour market policies do more to raise employment and share gains widely if pursued jointly with greater competition between firms.

The global cyclical upturn is not yet assured: the higher productivity and greater inclusiveness needed to improve well-being for all remain elusive. Policymakers cannot be complacent.

References

OECD Economic Outlook, June 2017.




Portugal needs stronger investment to maintain growth and improve living standards

By Jens Arnold, Portugal Desk, OECD Economics Department

Portugal’s economy has successfully recovered from the strong recession that lasted until 2014. Nonetheless, the economy’s still low investment, which has declined far more than in other Euro area countries, remains a source of concern (Figure 1). Since 2012, investment has hardly exceeded the depreciation of the existing capital stock, meaning that growth of the productive capital stock has almost stalled. This is one reason behind the low potential growth of the Portuguese economy, which the OECD currently puts below 0.5%. Without stronger investment, growth performance is bound to decline to such low levels over the next years.

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Raising investment also matters for wage and productivity developments. Low investment limits the growth of labour productivity, which represents the wage increases that Portuguese workers can pocket without deteriorating the competitiveness of their companies.

More investment is also needed to support the substantial structural change that the Portuguese economy is undergoing. After many years of credit-fuelled expansion of the non-tradable sector, there have been encouraging signs of a reversal towards tradable sectors in recent years, as illustrated by the significant increase in exports. But building on this progress will not be possible without stronger investment in tradable sectors.

Start-ups and young firms are playing a crucial role in this restructuring process. A remarkable 16% of goods exports originated from young exporters in 2014 (Bank of Portugal, 2016). Young firms are also important for productivity: firm level analysis from a census of Portuguese firms suggests that new market entrants have stronger productivity growth than more mature firms, both with respect to labour productivity and multi-factor productivity (Figure 2). They also create three times more jobs than other firms, accounting for almost half the jobs created (Criscuolo et al, 2014).

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But for young firms to prosper, it is important that they get access to finance for their investment needs and that the overall framework conditions are conducive to their entry and growth. Indeed, there is some evidence that the rise of new firms among exporters is losing momentum (Bank of Portugal, 2016). This underlines the need for further improvements in policies.

For example, cleaning up large amounts of non-performing legacy loans on the balance sheets of Portuguese banks is crucial for freeing up funds that stronger firms require to finance investment. In a recent survey by the European Central Bank on SME financing, Portuguese respondents had the second highest incidence of mentioning access to finance as an obstacle, higher than the EU average. Dealing with non-performing loans will require much more decisive policy action than in the past, both with respect to bank supervision and the development of secondary markets for distressed debt.

Given that a large share of Portugal’s distressed assets are loans to corporate borrowers, well-working insolvency frameworks are crucial to restructure companies that are still viable and to allow a speedy recovery of non-viable companies’ assets before they lose value. Portugal has taken important steps to overhaul its corporate insolvency and restructuring framework. However, differences between the rules and their actual implementation persist.

Access to finance is not the only obstacle to higher investment. Even where firms could finance an investment project, they may prefer to hold off because the expected returns are not sufficiently attractive. Weak demand has been a drag on investment in recent years. That’s why it is important to pursue prudent macro-economic policies so as not to jeopardise the recovery of the economy. But further supply-side measures are also crucial. Structural reforms that reduce the cost of doing business in Portugal could make more potential investment projects worthwhile.

Reforms in areas such as regulation, the judicial system, services sectors including utilities and the labour market have led to impressive improvements in historical comparison. However, as discussed in the recently released OECD Economic Survey of Portugal, the reform momentum has slowed down visibly since the end of the external assistance programme, and reform implementation has fallen short of initial ambitions in several key areas. In some areas, much has changed, for example in labour markets, although more could be done. In other areas, such as product market reforms and the regulation of non-tradable sectors, there is scope for further progress, particularly with respect to implementation. Some of Portugal’s rules and institutional features can act as implicit barriers to firm entry and post-entry growth, and should be subjected to a critical review in light of the loss of momentum in the rise of new firms.

References

Bank of Portugal (2016), “Portuguese international traders: some facts about age, prices and markets”,  Economic Bulletin, October 2016, Lisbon.

Criscuolo, C, P N Gal, and C Menon (2014), “The dynamics of employment growth: new evidence from 18 countries”, OECD Science, Technology and Industry Policy Papers, OECD Publishing, Paris.

OECD (2017), OECD Economic Surveys: Portugal 2017, OECD Publishing, Paris. http://dx.doi.org/10.1787/eco_surveys-prt-2017-en




Deploy effective fiscal initiatives and promote inclusive trade policies to escape from the low-growth trap

by Catherine L Mann, OECD Chief Economist and Head of OECD Economics Department

For the last five years the global economy has been in a low-growth trap, with growth disappointingly low and stuck at around 3 per cent per year. Persistent growth shortfalls have weighed on future output expectations and thereby reduced current spending and potential output gains. Around the world, private investment has been weak, public investment has slowed, and global trade growth has collapsed, all of which have limited the improvements in employment, labour productivity and wages needed to support sustainable gains in living standards. Overall, a slowdown in structural policy ambition and policy incoherence have slowed business dynamism, trapped resources in unproductive firms, weakened financial institutions and undermined productivity growth. In the face of these limited prospects, the OECD has argued in previous Economic Outlooks that fiscal, monetary and structural policies need to be deployed comprehensively and collectively for economies to grow sufficiently to make good on promises to their citizens.

The projections in this Economic Outlook offer the prospect that fiscal initiatives could catalyse private economic activity and push the global economy to the modestly higher growth rate of around 3½ per cent by 2018. Durable exit from the low-growth tap depends on policy choices beyond those of the monetary authorities – that is, of fiscal and structural, including trade policies – as well as on concerted and effective implementation. Collective fiscal action undertaken by all countries, including a more expansionary stance than planned in many countries in Europe, would support domestic and global growth even for those economies, who by virtue of specific circumstances, need to consolidate their fiscal positions or pursue a more neutral stance.

Some might argue that there is no space for such fiscal initiatives, given the heavy public debt burden in many economies. In fact, following five years of intense fiscal consolidation, debt-to-GDP ratios in most advanced countries have flattened. It is past time to focus on expanding the denominator – GDP growth. This Economic Outlook argues that the current conjuncture of extraordinarily accommodative monetary policy with very low interest rates opens a window of opportunity to deploy fiscal initiatives. Fiscal space has been created by lower interest payments on rolled-over debt, which also increases gauges of market access and of debt sustainability. On average, OECD economies could deploy deficit financed fiscal initiatives for three to four years, while still leaving debt-to-GDP ratios unchanged in the long term. A front-loaded effort could allow deficit finance to taper sooner and put the debt-to-GDP ratio sustainably on a downward path.

The key is to deploy the right kind of fiscal initiatives that support demand in the short run and supply in the long run and address not just growth challenges but also inequality concerns. These include soft investments in education and R&D along with hard investment in public infrastructures. Such fiscal initiatives would improve outcomes for demand and supply potential even more for economies suffering from long-term unemployment, when undertaken collectively, and when fiscal initiatives are complemented by country-specific structural policies put together in a coherent package. The mix is different for different countries, as developed in Chapter 2, with further details in the Country Notes in Chapter 3 of this Economic Outlook.

Against this backdrop of fiscal initiatives, reviving trade growth through better policies would help to push the global economy out of the low-growth trap, as well as support revived productivity growth. In this Economic Outlook trade growth is projected to increase from a dismal ratio of global trade-to-GDP growth of around 0.8 to be about on par with global output growth – remaining much less than the multiple of 2 enjoyed over the last few decades. This sluggish trade growth compared to historical experience shaves some 0.2 percentage point from total factor productivity growth – which may seem minor – but is meaningful given the slow productivity growth of some 0.5% per year during the postcrisis period.

Some argue that slowing globalization would temper the brunt of adjustments to workers and firms. This Economic Outlook suggests that protectionism and inevitable trade retaliation would offset much of the effects of the fiscal initiatives on domestic and global growth, raise prices, harm living standards, and leave countries in a worsened fiscal position. Trade protectionism shelters some jobs, but worsens prospects and lowers wellbeing for many others. In many OECD countries, more than 25% of jobs depend on foreign demand. Instead, policymakers need to implement the structural policy packages that create more job opportunities, increase business dynamism, promote successful reallocation and enhance policies to ensure that gains from trade are better shared. Fortunately, the country-specific policy packages that make fiscal initiatives more effective in promoting demand growth and supply potential also help to make growth more inclusive.

The transition path to a more balanced policy set and higher sustainable growth involves financial risks. But so too does the status quo dependence on extraordinary monetary policy. Pricing distortions in financial markets abound. Yield curves are still fairly flat, with negative interest rates. Pricing of credit risk has narrowed even as issuance of riskier bonds has increased. Real estate prices continue to advance in many markets, even in the face of attempted tempering by macro-prudential measures. Expectations in currency markets are on edge as evidenced by high measures of currency volatility. These financial distortions and risks expose vulnerable balance sheets of firms in emerging markets, and challenge bank profitability and the long-term stability of pension schemes in advanced economies.

The fiscal initiatives in conjunction with trade and structural policies, as outlined in the scenarios in this Economic Outlook, should revive expectations for faster and more inclusive growth, thus allowing monetary policy to move toward a more neutral stance in the United States at least, and possibly other countries as well. The risk of a growing divergence in monetary policy stances in the major economies over the next two years could be a new source of financial market tensions even as growth picks up, thus putting a premium on collective action by countries to revive growth in tandem.

In sum, policymakers should closely examine fiscal space; low interest rates enable many countries to boost hard and soft infrastructure and other growth-enhancing initiatives. Avoiding trade pitfalls, coupled with social measures to better share the gains from globalization and technological change, are key policy priorities. Using the window of opportunity created by monetary policy and following through on fiscal and structural measures should raise growth expectations and create the necessary momentum for the global economy to escape the low-growth trap.

Further reading:

OECD Economic Outlook

Using the fiscal levers to escape the low-growth trap

The effect of the size and mix of public spending on growth and inequality




The contribution of weak investment to the productivity slowdown

by Yvan Guillemette, OECD Economics Department

Concerns around weak productivity growth are everywhere these days. As the latest OECD Economic Outlook notes, since the mid-2000s, productivity growth has been markedly lower than at any other time since the 1950s. In response, the OECD has just launched the Global Forum on Productivity, an initiative to foster international co-operation between public bodies who promote productivity-enhancing policies. The goal is clear: to kick productivity growth out of the doldrums. In the long run, it drives all gains in living standards. Without it, many countries may not be able to keep the promises embedded in their social programs.

But if we are to boost productivity growth, it would help to understand why it has slowed. Recent OECD work disentangles two overlapping developments (Ollivaud, Guillemette and Turner, 2016). The first is a secular slowdown in total factor productivity growth (the efficiency with which labour and capital inputs are combined in production), which predates the crisis. This trend has continued since, but the reasons behind it are not yet well understood. The second is an abrupt slowdown in investment following the crisis. On average across the OECD and the euro area, trend productivity growth slowed by 0.4 pp per annum between 2007 and 2015, all of which is explained by slower growth in capital per worker. The same is true of most individual OECD countries (see figure).

Change in trend productivity growth between 2007 and 2015

Percentage points per year

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Note: Because the decomposition uses an approximation, a small discrepancy sometimes occurs between the total and the sum of the two contributions.

Why has investment slowed down? A large part of the explanation is simply that weak demand and excess capacity give firms little incentive to invest. Falling investment reduces the amount of capital that workers have to work with, depressing their own productivity and the overall productive capacity of the economy, so-called potential output. The authors calculate that the demand shock associated with the financial crisis may have reduced the aggregate OECD capital stock by about 3¼ per cent and the level of potential output by more than 1% by 2015. The implied reduction in the average growth rate of the capital stock explains about half of the 0.4 pp decline in the contribution from capital deepening to trend productivity growth mentioned above for the OECD area.

Further to the demand effect, capital misallocation during the pre-crisis expansion explains why investment weakness is particularly acute in the countries that saw the biggest investment booms. In addition, many governments have cut public investment in response to deteriorating public finances. Uncertainty, lack of visibility and volatility have added to this unsavoury mix. And to cap it all, the pace of productivity-boosting structural reform has slowed.

High inertia in the capital stock means that the negative effects of the crisis on productivity could last for a while. This realisation adds to the urgency of using all available fiscal space to help stretched monetary policies boost demand, and to redouble efforts on structural reforms.

References:

Ollivaud, P., Y. Guillemette and D. Turner (2016), “Links between weak Investment and the slowdown in productivity and potential output growth across the OECD”, OECD Economics Department Working Papers, No. 1304.

OECD Economic Outlook, June 2016.

 




What is the scope for public investment to lift long-term growth ?

by  Annabelle Mourougane, Jarmila Botev, Jean-Marc Fournier, Nigel Pain and Elena Rusticelli, OECD Economics Department

Long-term rates are low in OECD countries, particularly in Japan, France and Germany. This opens up fiscal space and can justify any public investment projects with a positive rate of return. At the same time, infrastructure needs are sizeable, especially as fiscal consolidation in recent years has pushed down public capital spending to very low levels in many countries. In such a situation, additional public investment is likely to benefit from high rates of return (Fournier, forthcoming).

New estimates in the June OECD Economic Outlook show long-term output gains of a budget neutral sustained investment stimulus of 0.5% of GDP could amount to between 0.5% and 2% (figure below).

Collective action among the major advanced economies to raise good-quality public investment is estimated to bring additional GDP gains. This would represent a gain of around one-half on average after the first year compared to a scenario where countries acts individually in the large advanced economies but Japan, where the gains are uncertain (Auerbach and Gorodnichenko, 2014). Amongst the major advanced economies, Germany would benefit the most from collective action to boost public investment.
What factors affect the gains to such a stimulus (see table below)? OECD analysis points to the following country-specific factors:

  • the initial level of public capital stock and the rate of returns of these investments: Lowering returns to public capital by one standard deviation could significantly reduce the long-term effect on output, by cutting it by around 3/4. Amongst the large advanced economies, the effect on output would be above average in Germany and the United Kingdom, while the output gains can be negative for Japan.
  • the country’s initial position in the economic cycle and the extent of labour-market rigidities, which determine how far persistent demand weakness undermines the productive capacity of the economy (“hysteresis”). In Italy and France, where this hysteresis effect is stronger, the effect of public investment stimulus is stronger.
  • the additional gains structural reforms can bring to the economy: Reforms targeted at frictions that hold back demand for investment, such as increasing product market competition, can lower the opportunity costs of investing, and hence raise the catalytic impact of public investment on private capital spending. Lowering product market regulations by the average improvement over two years in a typical OECD country could add around 0.1-0.3 percentage point to the growth impact after the first year. Such gains would be sizeable in France, Italy and Canada.

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Investment1

References

Auerbach, A.J. and Y.Gorodnichenko (2014), “Fiscal Multiplier in Japan”, NBER Working Papers, No. 19911.

Botev, J. and A. Mourougane (forthcoming), “Fiscal Consolidation: What are the Breakeven Fiscal Multipliers?”, OECD Economics Department Working paper, OECD Publishing, Paris.

Fall, F. and J.M. Fournier  (2015), “Macroeconomic Uncertainties, Prudent Debt Targets and Fiscal Rules”,OECD Economics Department Working Papers, No. 1230, OECD Publishing, Paris.

Fournier, J.M. (forthcoming), “The Positive Effect of Public Investment on Potential Growth”, OECD Economics Department Working Paper, OECD Publishing, Paris.

Mourougane, A., J. Botev, J.M. Fournier, N. Pain and E. Rusticelli (forthcoming), “Can an Increase in Public Investment Sustainably Lift Growth?”, OECD Economics Department Working Papers, OECD Publishing, Paris.




Improving local infrastructure investments in Poland

by Antoine Goujard, Economist, Poland Desk,
OECD Economics Department

Over the last decade, Poland has significantly upgraded its infrastructure network, and public investment has risen rapidly (Panel A). However, bottlenecks still weigh on productivity growth and environmental and health outcomes, and the perceived quality of transport and energy infrastructure remains lower than in most OECD countries (Panels B and C). The EU 2014-20 programming period is an opportunity to improve the management of investment, as structural and cohesion funds that assist in the financing of numerous infrastructure projects are set to reach nearly 3% of 2013 GDP per year (Panel D).

Public investment and EU funds

poland2

1. Gross general government fixed capital formation.
2. Index from the lowest perceived quality (0) to the highest (7).
Source: OECD (2015), National Accounts Database; World Economic Forum (2015), The Global Competitiveness Report 2014-15; European Commission (2014), Summary of the Partnership Agreement for Poland, 2014-20.

Sub-central governments were responsible for about half of total public investment in 2014, above the OECD average and most other Central and Eastern European countries. As in other OECD countries, municipalities design legally binding local land-use plans. However, the quality of land administration appears relatively low (World Bank, 2015), and around 70% of the municipal territory lacks local spatial plans. Local governments have far-reaching responsibilities in transport and energy policies, but the quality of investment outcomes still needs to improve (OECD, 2015 and 2016).

The decentralisation of the allocation of EU funds over 2014-20 will give an even more prominent role to local governments, and there is a need to increase their administrative capacity, accountability and resources. The OECD (2016) analysis highlights three main areas of reforms:

  1. Strengthening national and local planning.

The authorities have done much to adopt general investment strategies across all levels of governments. However, they are relatively recent and will need regular updates. At the metropolitan level, administrative fragmentation has partly obstructed effective land use planning and transport investments, thereby increasing urban-sprawl and congestion, and reducing a city’s attractiveness for individuals and businesses. A welcome recent law foresees the creation of metropolitan governance associations in 2016, notably for transport and spatial planning, but these will remain voluntary. New mechanisms under the 2014-20 EU perspective would also strengthen coordination in infrastructure delivery. In addition, before the recent elections, a draft law was intended to reduce barriers for municipalities to develop local land use plans, and this reform needs to be resumed swiftly.

  1. Developing effective collaboration across levels of governments and improving public procurement practices.

As many local governments lack in-house capacity, and sometimes the financial resources, to conduct procedures and hire external advisors, relying more on central government assistance for project management would improve infrastructure delivery. Creating a central public-private partnership (PPP) agency, as currently discussed, and developing joint purchasing offices and integrated e-procurement procedures would also be good moves, as local governments have been responsible for most PPP projects and procurement procedures combining several public buyers have been relatively infrequent.

  1. Ensuring long-term infrastructure financing.

Funding of local infrastructure management agencies is provided through central-government transfers fixed annually in the budget process, without reliable long-term commitments. The authorities should pursue reforms of public infrastructure pricing to ensure that long-term costs, including environmental and health externalities, are fully recovered. Road pricing could be expanded to ensure effective competition between transport modes and encourage green investments. In particular, the current legislative framework prevents local authorities from setting congestion fees or urban tolls, while such measures may be especially suitable for addressing congestion and local environmental impacts.

Find out more:

OECD (2015), OECD Environmental Performance Reviews: Poland 2015, OECD Publishing.

OECD (2016), OECD Economic Surveys: Poland 2016, OECD Publishing, Paris.

World Bank (2015), Doing Business 2016: Measuring Regulatory Quality and Efficiency, The World Bank.