wave of infections across the European Union, uncertainty about the pandemic and the economic recovery is running high. Even if governments refrain from imposing too many restrictions, investment is unlikely to pick up.
The corporate sector needs creative measures. Whole industries are affected by the declining cash flows resulting from collapsed demand. Lower sales are depleting firms’ cash reserves and, ultimately, their capital and net worth. Some companies can endure a long period of subdued cash flows, because they have large cash buffers and good business prospects that allow them to borrow. The majority, however, will struggle to keep afloat and to invest to maintain competitiveness (see Chapter 3). Standard guarantee programmes and subsidised loans are only part of the solution for these companies, as they cannot take on more debt. Firms need fresh capital, but it will take time to be generated from retained earnings, if at all. Capital may also not be readily available from private investors either, given the size of the European private equity market. Government intervention, which includes providing equity or quasi-equity investments along with debt restructuring, would help significantly. A multitude of proposals are circulating about the right course to take, while maintaining appropriate incentives and reducing moral hazard (Blanchard, Philippon and Pisani-Ferry, 2020; Boot, et al., 2020).
The lift-off of infrastructure investment is at stake. It took five years of economic expansion for the growth rate in infrastructure investment to turn positive. Investment in 2019 was still well below the level seen in many countries before the global financial crisis.[19] The resurgence was due to increased investment from both the private sector and the government. Sustained high levels of uncertainty, along with mounting government deficits, could derail infrastructure investment, however. Policymakers need to focus on reassuring the private sector so that it will continue investing and implementing the current pipeline of planned infrastructure investment.
While government investment plans remain ambitious, past experience sounds a note of caution. The aggregate EU government deficit in the second quarter of 2020 was -11.4% of GDP. At the same time, government debt increased by 8.4 percentage points of GDP to 87.8% of GDP. The European Commission expects the ratio of government debt to GDP in the European Union to increase by a further 7.3 percentage points in 2020, before shedding 2 percentage points in 2021. While current market conditions, along with large-scale support from the European Central Bank, are conducive to increasing debt, history shows that markets can swing suddenly and may force through a round of fiscal consolidation. In the past, episodes of fiscal consolidation have been very detrimental to government investment. That said, the latest budgetary plans submitted by Member States to the European Commission provide some reassurance that governments are trying to avoid reducing their investments, at least for the time being.
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