Investment-led growth: a solution to the European crisis

A major plank for both recovery of the European economy and for its structural transformation is a significant increase in investment, particularly if linked to innovation. Higher investment can accelerate recovery in the short-term, by contributing to expand aggregate demand, but is as-or more important for increasing the future output and structural transformation. In this paper, we argue that for a significant increase in European Investment to occur, it is necessary to have a two pronged approach. One is to use regional and national development banks and national development banks to help catalyse investment. The other is to reduce the pace of fiscal consolidation, so that public investment does not continue to fall. Using the Cambridge Alphametric Model (CAM) we compare and contrast an austerity scenario, which project current austerity trends in Europe till 2025, with an ‘investment-focused’ scenario where investment rates are increases further in the context of an expansion in lending by both the European Investment Bank (EIB) and national development banks, and at the same time governments pursue more expansionary fiscal policies in order to stimulate investment and economic growth further. Our analysis gives a strong illustration of the positive role that development banks can and do play in helping economic recovery after crisis and in achieving structural transformation