The New 'Growth Package' from the EU
Last week, China's biggest export destination, the European Union, established a new growth package. The desired size of a new investment fund is 315 billion euros, and it will be called the European Fund for Strategic Investments (EFSI). During a period of three years, new investments financed by the fund are expected to lift annual GDP growth in the EU by 0.7 percentage points. The calculations from the EU show that the package can create between 1 million and 1.3 million new jobs. The sectors to invest in are different fields within infrastructure, such as normal infrastructure, but also transmission of electricity and data. Financing for small and medium-sized businesses is also on the agenda again.
The newly elected president of the European Commission, Jean-Claude Juncker, has just one problem: the EU does not have the 315 billion euros. In reality, Juncker has found 16 billion euros in two EU funds, plus a further 5 billion euros in the commonly guaranteed European Investment Bank (EIB). He will use this sum as a foundation for an investment fund with a balance sheet of 315 billion euros. That's leverage of 15 times, which is a lot. It seems though as if the European Commission is fully aware of this issue. But the people working for it are smart, so they will just use their bank, the EIB, which is basically guaranteed by EU member states, to create a first level of leverage in the fund.
It's done this way. The new EFSI becomes an independent unit hosted by the EIB. But the bank actually gets the 21 billion euros paid in and not the EFSI. Backed by this capital, the EIB will participate in the investment fund with 63 billion euros. This amount will act like a sort of paid-in equity that reduces the leverage to five times. In other words, the fund has 20 percent in equity to absorb losses. The leverage of five times still presents an obstacle to attracting investors. But what has been largely discussed so far is the real fiscal, or growth, effect of the investment fund, which is the second challenge for Juncker.
Let's start with the challenge of finding outside investors for the remaining 80 percent of the fund. This will be a challenge since investing in projects that have not already found financing is difficult because investors are cautious in such cases. As Juncker says, these are high-risk investments. Therefore, I argue that these investments have to provide a higher rate of return than normal, which is difficult in a zero-growth economy. The fund might be attractive for outside investors if the investments into the fund are done on a total portfolio basis so the investor does not invest in individual projects. In addition, the EIB must take the first 20 percent as a loss. Even with this arrangement, I remain doubtful over how many investors will line up. One reason is that investments in infrastructure have a tendency to either work or not. In this case, we will know after construction is finalized, but by then it will be too late to change fixed costs very much. Furthermore, most of the obvious projects are already built in developed countries. As Juncker says, it's high risk, and he couldn't be more right.
Let's assume that the investors are found. Will this then kick-start the European economy? Achieving the projected 0.7 percentage increase in GDP growth requires that 80 percent of the capital coming from outside investors would not have been invested in similar projects via other channels. Again this is doubtful because the amount that Juncker is trying to raise will partly come from funds that are aimed at infrastructure investments, unless, of course, the investors come from China and elsewhere.
Some economists have argued that only the 21 billion euros can be seen as the truly positive fiscal effect. I would give the European Commission credit for the 63 billion euros from the second leverage. This would equal 0.2 percentage points in additional GDP growth for the next three years.
The dream is to create 1.3 million new jobs, and to do this the commission is willing to invest 315 billion euros over three years. This is 242,300 euros per job created mainly in Southern Europe. For example, the annual average salary for a Spanish worker is 20,000 euros. Every new job is, of course, very important, but I would say that it is a pretty high price to pay for getting people back to work. The hope is that the invested money is being repaid, but as Juncker has said these are high-risk projects. It is unavoidable that some losses from the investments will occur, and it seems that the commission is willing to risk 63 billion euros. This is 48,400 euros per job over three years, which is close to the accumulated three-year average salary for workers in the targeted areas.
My best guess is that Juncker will not find the investors without some sort of a guarantee for the remaining 80 percent of the capital in the investment fund. If he underwrites the guarantee, then the EFSI starts to be interesting for investors, and the very smart investors can probably get access to cheap funds at the European Central Bank. All-in-all, this can result in a brilliant opportunity for smart investors sponsored by European taxpayers. But the long-term growth effect will be limited.
It's obvious to everybody that EU needs radical and innovative reforms to reduce the 25 million unemployed people and to make the bloc a desired investment destination again. If Juncker is willing to risk 63 billion euros, he should pay out the 48,400 euros as seed capital to 1.3 million start-ups. Some of these will become the new Googles, Apples and Alibabas of the world and each will be worth more than the 315 billion euros he is dreaming of getting back in return.
Peter Lundgreen is the CEO and founder of Lundgreen's Capital, an investment consulting and advisory company
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