27 June 2012

Splashing the cash on infrastructure projects isn't the answer to Europe's economic woes, despite what some politicians may think, says HSBC's Group Chief Economist Stephen King.

By Stephen King
Group Chief Economist

As the European Union's 27 nations gather for their summit -- an event seemingly focused mostly on lunches, dinners and photo-opportunities -- the rest of us may wonder what, precisely, our leaders will be able to conjure up to rescue us from economic oblivion. As this is a European Union event, not one restricted to the 17 members of the eurozone, there will have to be more on offer than common bond issuance, a eurozone banking union and a large bill for the German taxpayer.

The latest "big idea" for generating decent economic growth in Europe is investment in infrastructure, prompted by François Hollande, France's newly elected President, and agreed upon by the eurozone's "Big Four" last week. The idea is to raise about EUR130 billion for investment in technology, transport, renewable energy and any number of other worthy areas. Where, precisely, the money comes from -- we are, after all, living in a period of austerity -- remains an unanswered question.

Nevertheless, there are plenty of people on both left and right who think spending money on big public works, particularly those that might bring better connections between European nations, can only be a good thing.

Why? Extra infrastructure spending, it is claimed, would give a much needed shot in the arm to the European economy and, if done through European institutions using, say, the EU's structural funds, the spending might be seen to benefit all European nations, not just Spain or Greece. The common accusation that infrastructure projects are no more than fiscal transfers through the back door could therefore be neatly sidestepped.

I struggle to get too excited about this idea. One obvious objection is simply that EUR130 billion is a tiny amount, less than 1 per cent of a year's worth of the EU 27's national income and by no means enough to offset the diet of fiscal gruel most European nations are now living off.

Should, then, the number be much bigger? A key argument used by those favouring infrastructure projects is that the cost of borrowing is, for the more creditworthy governments, remarkably low. While Spanish long-term borrowing costs are a long way north of 6 per cent and Italian rates only a smidgin below, the UK can borrow at a mere 1.7 per cent and the Germans at only 1.5 per cent, with the Americans sandwiched in between. So to kick-start Western growth these creditworthy nations should take the lead, borrowing more to invest in their own futures and, at least in Germany's case, in Europe's.

The underlying assumption is that creditors -- the people who lend to the UK, Germany and the US -- know what they're doing. These, however, are the same creditors who, a few years ago, happily lent to Spain, Portugal, Ireland and Greece at ridiculously low interest rates, only to change their minds when the going got tough. By that stage, unfortunately, southern European nations had borrowed more than was good for them, thanks both to their creditors' earlier generosity and to a hopelessly optimistic view of their own future growth prospects. Spain's national income today is about 13 per cent lower than it was expected to be based on economic forecasts made at the beginning of 2007, before the financial crisis.

Yet despite these years of economic disappointment there has been no shortage of infrastructure spending in southern Europe. Athens has a spanking new airport with impressive road and rail connections into the city. Madrid Airport's Terminal 4, opened in 2006 and an architectural dream, is one of the largest in the world, again with wonderful links into the city.

Meanwhile, despite the superb passenger experience that the new terminal offers, those in the know now prefer to travel between Madrid and Barcelona by train, which, thanks to a colossal investment in high-speed rail, now takes a mere 2 hours and 38 minutes. There is, in theory, more to come. By 2020, Spain's ambition is to construct a high-speed rail network of more than 6,000 miles, the densest in the world measured relative to either land mass or population size.

If infrastructure investment equals economic salvation, why have things in southern Europe gone from bad to worse? Why has the Greek economy contracted 16 per cent over the past two years? Why is the youth unemployment rate in both Greece and Spain above 50 per cent? Certainly not through any shortage of infrastructure spending. It has brought neither growth nor higher tax revenues, but instead opened up a yawning chasm in the fiscal accounts. Creditors have taken fright.

In too many cases, large-scale public sector infrastructure projects merely satisfy a politician's need to "do something", whether or not the activity involved ultimately delivers the predicted benefits. Here in Britain we have our own siren precedent. In 1964 Fred Lee, the Minister for Power, told the House of Commons that the proposed construction of advanced gas-cooled nuclear reactors meant that "we have won the jackpot this time -- we have the greatest breakthrough of all times". He believed Britain would lead the world in nuclear power, allowing us to use the white heat of nuclear technology to solve, among other things, our balance of payments problem. Thirteen years later the Central Electricity Generating Board described the subsequent investment as "one of the major blunders of British industrial policy" and the UK economy had become the sick man of Europe.

When money is cheap, investment in infrastructure offers an unending stream of temptations. Clearly, many such projects are worthwhile. Where would London be without its Tube network or Paris without the Métro?

But these projects should be judged on their individual merits, not as a cure-all contribution to some hastily arranged macroeconomic stimulus package. The evidence of failure -- thanks, in no small part, to political whim trumping market discipline -- is simply too great.

Over the past 20 years, Japan ended up building what became known as "bridges to nowhere", pointless schemes that did nothing to boost growth. The West is in danger of making the same mistake.

Stephen King originally wrote this article for The Times newspaper, published on 27 June 2012.

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