14 February 2017
Investment in the Eurozone has been on something of a rollercoaster ride in recent years. Following strong growth in gross fixed capital formation (GFCF) through the early 2000s, investment levels peaked in Q1 2008 before falling sharply through the initial crisis period and then again during the double-dip recession in 2010. The profile and volatility of investment has differed significantly by member state. In Spain and Ireland, construction played a major role in the initial boom and bust in investment through the 2000s and initial crisis. Volatility continued in Ireland through the past few years but driven by intellectual property investment skewed by strategic patent transfers. Conversely, in France and Germany, GFCF growth was much less volatile than in their peripheral counterparts, reflecting more modest changes in components of investment and relative economic stability (see Chart 6). More broadly, GFCF has been on a gradual recovery path in the Eurozone with 2015 and 2016 showing especially strong growth numbers; the Q3 2016 level of investment is now 8.2% above its 2013 trough. This investment recovery has been supported by accommodative ECB policy which improved credit conditions; the June 2016 European Parliament Monetary Dialogue session reported that if the policy rate was held at 2008 levels, investment would be 5.5ppts lower than it actually is.
Nonetheless, the level of GFCF remains 12% below its historic peak in 2008. The reality is that monetary policy can only solve so many problems; experts at the Monetary Dialogue Session pointed to inadequate fiscal support as a constraining factor on investment growth in the Eurozone, as well as the need for structural reforms to boost potential growth and an improvement in corporate profitability. What chance is there that we will get any or all of these three in the coming year? The last one is the most likely to materialise in the short term to further boost business investment. The increase in inflation this year, thanks in part to the oil effects dropping out, may turn out to be bad news for consumers’ wallets but stands to benefit corporate profitability in terms of nominal cashflows. Strengthening corporate profits can equip firms to then use some of these gains to invest in the future (see Chart 7).
Of course, having the cashflow to invest is only half the battle; firms need to feel confident that the market environment requires and rewards this investment. Eurozone growth for 2016 came in well above potential and 2017 has made a solid start against the backdrop of a broader cyclical upswing taking hold; so, we expect investment growth to continue to strengthen through the year. However, apart from the positive short-term cyclical story, longer-term issues of structural reform and political attitudes to fiscal support show few signs of being resolved anytime soon. With a swathe of elections in France, Germany, the Netherlands and probably Italy over the next year, there is some potential for change at the margins once these have passed; for example, in France, centrist candidates are proposing more business-friendly policies. However, without a significant change of stance on fiscal support from Germany, particularly for public investment to boost growth potential, the burden will fall on still heavily indebted firms to lead the continued Eurozone investment recovery.
Stephanie Kelly, Political Economist