A gaping hole

Europe challenged by inadequate private investment

Worries about government underinvestment in the euro zone may be misplaced. While many of the member states should probably put more money into infrastructure, a new study by Berlin-based economic think tank DIW shows that a protracted dearth in private sector investment threatens the continent's long-term economic potential.

Europe's capital stock, the underpinning of its wealth, is already ageing at a worrying pace. In several European countries - in particular Germany, the Netherlands and Finland - the weakness long predates the financial crisis. Since 1999, the ratio of annual investment expenditure to GDP was 0.5 percentage points lower than the level necessary to keep the capital stock in good nick and to foster future growth, the DIW calculates.

The euro crisis has made things worse. In hard-hit countries like Greece, Ireland, Portugal and Spain the level of private investment has dropped by as much as 40 per cent, with few signs of a substantial recovery. For the entire euro zone, the annual shortfall is euro 180 billion, or two per cent of GDP.

Curing the problem is more difficult than diagnosing it. After all, each private company makes its own investment decisions. If so many of them have been cautious for so long, there must be something structurally unattractive about the euro zone's investment environment.

Governments could help with generous tax breaks for capital expenditure. A temporary, pan-European investment fund funnelling cheap credit to companies would be an even more important initiative. DIW reports that sheer access to credit, not the cost of borrowing, is often the biggest obstacle, in particular for small and medium-sized enterprises.

The problem requires some big thinking from European policymakers - and some big spending. A euro 90 billion investment fund, half of the annual shortfall, looks like a minimum to have any noticeable effect.

Of course, such measures would weigh on governments' budgets. Germanic austerity hawks might be unhappy at the prospect, but the DIW study also has a hard lesson for fans of government spending. Kick-starting private sector spending will do more for the economy than old-school expansionary fiscal policy.