EU Debt and Fiscal Rules No Obstacle to Public Investment

Debt and fiscal rules do not generally lead to countries investing less. This has been shown by an evaluation conducted by researchers at the ifo Institute for EconPol Europe. The European Commission is currently planning to soften the rules of the Stability and Growth Pact. According to the Commission, these rules have a negative impact on government investment. “But our findings show that fiscal rules, such as the EU’s Maastricht criteria, are not a fundamental barrier to public investment,” says Florian Dorn, coauthor of the study.

“The effects of debt and fiscal rules depend on the way these rules are designed. If the rules are too rigid, they do not allow policymakers to cushion the economy in economic crises. This may well then affect public investment. In contrast, flexible rules can have a positive effect on public investment, but depending on how they are designed, this can lead to higher public debt” says study coauthor Sebastian Blesse.

The study’s authors propose a reform of EU fiscal rules which enhances investment incentives but continues to limit public debt. Debt-financed spending should be limited to net investments. All other government spending would have to be covered by corresponding revenues in the government budget. The authors emphasize that it’s important to clearly define what counts as a public investment. This is intended to reduce the risk of EU member states’ circumventing the rules by, say, reinterpreting social or transfer payments as public investment. However, in times of economic crisis, debt-financed support measures should still be possible, even those that do not fall under the umbrella of investment.

In their analysis, the authors evaluate 20 empirical studies that examine the effects of fiscal rules on public investment or its components. It should be noted that this evaluation considers only the effect of fiscal rules on public investment, and not the effects of actual compliance with fiscal rules.

Questions can be directed to: Dr. Florian Dorn, 0049 / 89 / 9224 1292, Dorn@ifo.de and Dr. Sebastian Blesse, 0049 / 911 / 477904-7, Blesse@ifo.de