Why is investment in the euro area continuing to show only weak recovery ?

Since the onset of the global financial crisis, investments in the euro area were cut dramatically and they have not yet returned to their pre-2008 levels. Low levels of investments do not merely depress demand – a highly cyclical component – but also undermine an economy’s long-term growth potential. The article attempts to explain the recent evolution of euro area investment. More specifically, it investigates the factors hindering a capital spending revival and the European policy initiatives that have been taken to remedy the situation. From both an international and a historical perspective – i.e. compared with previous post-crisis periods – we are looking at a highly unusual state of investment’s recovery which drags on. There may possibly be a persistent component to the shortfall, in as much as it is an adjustment to previously excessive spending, particularly by households on residential property. That said, business investment has also yet to stage a major recovery. Focusing on business investment, it is apparent that subdued economic growth has combined with underutilised production resources to clearly reduce the necessity of such investment. But a weak business cycle alone does not explain business investment dynamics : this article draws on the accelerator model to demonstrate that a set of other factors also underlies the weak investment dynamics since 2012, e.g. uncertainty, financing restrictions, ongoing deleveraging and fragmentation of the financial markets. In addition to these short-term factors, a number of structural changes have taken place in the past decades, changes that may have triggered more secular trends. This is a complex theme, however, and it is unclear what the impact on capital spending has been of globalisation and the shift to a service-based society in advanced economies. Demographic trends, and particularly population ageing, are claimed by some to necessitate less investment, but one might equally argue that more capital-intensive production practices should be implemented to offset negative effects on growth. The euro area appears to be stymied in an unfavourable equilibria of slow economic growth and lagging investment. The Investment Plan for Europe attempts to break this adverse loop by increasing funding capacity through an investment fund, and by improving the general investment climate. Also known as the Juncker Plan, its aim was to generate € 315 billion of investment within three years – and a year on it looks more or less on track to achieve this aim. The same drive also saw the launch of the Capital Markets Union initiative, whose aim is to create a fully integrated European capital market in due course and which should make funding easier for SMEs. However, this initiative is still very much on the drawing board.