Investment recovering only gradually in euro-area countries
Investment is still lagging far behind pre-crisis levels across most of the euro area. According to the Bundesbank's latest Monthly Report, the shortfall is biggest in Greece and Cyprus, at more than 70% and almost 60% respectively, compared with a figure of 30% in Italy, Spain and Portugal, and almost 10% in France. As the report explains, just three euro-area countries, including Germany, have returned to or marginally exceeded their pre-crisis levels.
The Bundesbank's economists note that investment is now broadly recovering on the back of improved financing conditions, reduced uncertainty over future developments and an economy that is now beginning to regain momentum.
"Activity in the euro area has been rebounding since spring 2013, and the same can be said for gross fixed capital formation," they write, adding that investment could be stimulated further still by adopting a policy approach centred around structural reforms to bolster the euro area's long-term growth prospects.
The Bundesbank's economists attribute the investment restraint observed in recent years in the corporate, household and public sectors in part to a deterioration in financing conditions, a high degree of uncertainty and the need to deleverage.
Households and non-financial corporations had amassed huge debt burdens in the pre-crisis era, the authors write, noting that between 1999 and 2007, household debt as a share of gross domestic product (GDP) had climbed by 39 percentage points to 81% in Spain, 34 percentage points to 87% in Portugal, and 50 percentage points to 100% in Ireland.
"The need to deleverage depresses economic activity as a whole and investments in particular," the economists explain. After all, they write, it takes funds to reduce debts – funds which players could then no longer channel into investment.
The authors posit that the macroeconomic and political turmoil witnessed in recent years also had an impact on developments.
"In times of heightened uncertainty, it is only natural to adopt a wait-and-see attitude when decisions have a bearing on the future. Investment decisions by businesses are probably a notable example of this phenomenon," they write. Another point they raise is that the financial and economic crisis had initially been accompanied by a tightening of credit standards in some countries, which might have also crimped investment.
The authors suggest that the above-average investment growth rates seen in some euro-area countries before the crisis go some way towards explaining the post-crisis downturn in euro-area investment.
"Construction investment, in particular, had reached a magnitude in those countries that was not sustainable," they write.
The onset of the financial crisis in 2008 changed everything. Housing construction investment between 2007 and 2014 was down by around 90% in Greece, 70% in Ireland and 50% in Spain on the figures for 1999-2007 and continues to plot a downward trajectory to this very day, the authors explain.
"The decline particularly hit housing construction, but it also took its toll on other areas of construction – that is, commercial and industrial construction and the development of public and private infrastructure." Construction investment makes up a large share of total investment; in 2014, for example, it accounted for just over 50% of aggregate gross fixed capital formation in the euro area. If gross fixed capital formation diminishes, it can have a huge bearing on aggregate investment activity, which also includes investment in machinery and equipment and in intellectual property products.
Investment performs two important economic functions. First, it is a key component of aggregate demand. Second, it contributes to the capital stock, which the Federal Statistical Office defines as comprising all produced assets repeatedly or continuously used in production for more than one year. That makes investment a
"key determinant of aggregate potential output," the authors write, cautioning that a failure to regularly renew the capital stock impedes technological advancements and hinders structural change in the economy as a whole.