The Press Takes Notice of a Small Problem
We have previously discussed the plans announced by EU commission president JC Juncker to “rescue” the euro area economy by means of € 300 billion of state-directed spending (see “Juncker’s Solution” for details). Now the mainstream press is also beginning to wonder where the money for this ambitious spending plan is supposed to be coming from.
A report by Reuters contains a few points worth commenting on:
“New European Commission President Jean-Claude Juncker is preparing a 300 billion euro ($375 billion) investment plan he will present as a cornerstone of efforts to revive an ailing economy. But history suggests the program risks becoming an exercise in financial engineering rather than a conduit for the new money the region needs to help boost output and create jobs.
A flagship project of the new European Union executive, the investment scheme is due to be unveiled before Christmas. It is still being finalized and few details have been made public. If all the money it promises is raised and spent, it could provide the 28-nation EU with roughly an additional 0.7 percent of GDP in investment per year over three years.
“It is significant,” said Carsten Brzeski, economist at ING bank in Frankfurt. “You would expect some kind of a multiplier effect from investment on jobs and purchasing power and it would increase the growth potential. The downside is that public investment can take years before it gets started.”
But even more than “when?”, the big question hanging over the plan is “how much?”. The 300 billion euros is an overall target for both the public and private money that the Commission hopes to mobilize. The Commission itself does not have any money and is funded through annual EU budgets that must be balanced. Of the region’s 28 governments, only Germany seems to have public finances strong enough to significantly increase investment. But in its drive to have a balanced budget, Berlin is not keen to spend more.
So the Commission plans to use what little public money is available to lure bigger private funds into projects that would otherwise seem too risky or with too low a rate of return.
“Our aim is to ‘crowd in’ private money for big infrastructure projects in the energy sector, transport, broadband or research and development. The private sector cannot take all the risks,” Commission Vice President Jyrki Katainen told Reuters.
First of all, the money can evidently not be raised by EU governments if they try to fulfill the obligations of the fiscal compact. To this we would note that the compact, if anything, suffers from still not being truly enforceable when it comes to larger member nations such as France and Italy. From our perspective, the attempt to impose some sort of fiscal discipline is praiseworthy in principle, but the actual approach to “austerity” and economic reform leaves a lot to be desired, to put it mildly.
Unfortunately the compact does not contain a specific clause with respect to spending – it merely refers to debt and deficits as a percentage of GDP. As a first measure, several countries have taken steps to artificially boost their GDP statistics by adding what seem highly subjective estimates of the value added by drug dealing, prostitution and other “black market” activities to the data. Worse though is that wherever possible, governments have avoided shrinking the State, and have instead imposed new burdens on the private sector, in many cases coupled with draconian enforcement. The additional taxes harm the economy, while the more drastic enforcement is obviously detrimental to liberty and peace, as it requires additional invasions of privacy, encourages snitching, and so forth.
EU government deficits (annual) as a percentage of GDP – click to enlarge.
A Plan that Will Consume Scarce Capital
Secondly, the belief in a “multiplier effect” once again runs into the problem that capital is both heterogeneous and scarce. If it is employed in state-directed investment projects, it must be removed from other employments. It is an apodictic certainty that in the vast majority of cases, it would be better employed in undertakings to which market participants have allocated it voluntarily. It seems obvious that investment projects planned by bureaucracies lack an important ingredient, namely the profit motive. They have therefore no reason to compare input costs to expected returns and to decide whether to undertake certain projects on that basis – and yet, the real capital to pursue these projects will have to be freed up elsewhere.
In the article excerpted above it is in fact admitted that the planned investment projects wouldn’t be touched by the private sector because they do not promise an adequate return. It really takes some doing for long-range investment projects to be so wasteful that they are seemingly not even able to produce a large enough illusory profit when the central bank’s administered interest rate stands almost at zero. Obviously, the private sector could and would gladly “take the risks” associated with these projects if they promised to produce profits in excess of the returns available in other investments. The fact that higher returns are available elsewhere is the market’s way of telling entrepreneurs that there are consumers wants the satisfaction of which is more urgent.
The lack of returns proves ipso facto that the proposed projects are destined to waste scarce capital. The so-called “multiplier effect” is an illusion – it is certainly possible for capital consumption to masquerade as “growth” for a while, but its true nature will eventually always be revealed.
As Mises noted to this:
“Today the majority of the citizens look upon government as an agency dispensing benefits. The wage earners and the farmers expect to receive from the treasury more than they contribute to its revenues. The state is in their eyes a spender, not a taker. These popular tenets were rationalized and elevated to the rank of a quasi-economic doctrine by Lord Keynes and his disciples. Spending and unbalanced budgets are merely synonyms for capital consumption.”
In reality, these spending programs are simply slightly more elaborate and sophisticated versions of Keynesian ditch digging. They make precisely as much sense. If European politicians really want to help to spur economic growth, they must bid adieu to the notion that economies can be “jump-started” by spending on undertakings that are mainly characterized by their inability to produce a return. What is instead needed is a repeal of the ubiquitous red tape hampering entrepreneurs, lower taxes and less government involvement in the market economy.
Top-down investment decrees are bound to do more harm than good in the end. The urge of local governments in Spain to build a new airport in every two-bit town during the boom has left the landscape dotted with a number of large mute witnesses attesting to this.
JC Juncker: trying to spend money he doesn’t have on projects that everybody knows already won’t produce a return. It is not exactly the most brilliant plan ever conceived.
(Photo via Reuters)
Charts by: Euro-Stat
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