Letter IEDI n. 1043–The role of public investment to reactivate the post-COVID-19 economy
Today's Letter IEDI summarizes the main aspects of the study prepared by IMF researchers entitled “Public Investment for the Recovery,” recently published in the Oct/20 Fiscal Monitor report.
The document highlights the importance of public investment to stimulate private demand and boost economic recovery after the COVID-19 pandemic.
The IMF maintains that, from a macroeconomic point of view, the arguments in favor of public investment are more vigorous in advanced economies and emerging economies with expected nominal interest rates and inflation at historic lows. This is because these economies have fewer restrictions to finance the necessary expansion of public investment via debt.
It should be noted, however, that this is not about all kinds of investment, but about high-quality projects that bring social benefits, competitiveness and productivity to countries. That is, for the IMF, in a context of low and/or negative real interests, obtaining loans to finance investments is desirable, provided that policy makers ensure that the amounts and quality of investment do not worsen excessively the dynamics of debt. Such a warning is considered crucial for countries that do not issue key currencies in the international financial system.
However, even for low-income developing countries and some advanced and emerging economies that face financial constraints, the IMF considers that expanding public investment could result in positive short and long-term multipliers.
For this to happen, nonetheless, a gradual pace is essential. That is, it would be necessary to carry out a gradual increase in public investment financed by loans in order not to pressure interest rates and, at the same time, prioritize quality investment projects that maximize socioeconomic return.
Thus, given the severity of the COVID-19 crisis, unlike other occasions, the IMF suggests that balanced public accounts should not be pursued immediately after the crisis, avoiding the negative effects of premature austerity policies like those adopted by advanced economies in the wake of the 2008–09 international financial crisis.
The study highlights that investment needs were significant even before the pandemic hit and have increased even more since then. Public and private capital stocks as a proportion of GDP have been declining since the 1990s.
Although public investments in education and economic infrastructure have been relatively preserved —by the way, at an insufficient level in view of demand, according to the Fund— rates have fallen in the sectors of health, housing and environmental protection. This movement is pointed out as a reason for the weakening of countries' resilience to the COVID-19 crisis.
The IMF suggests that governments act immediately, observing the following steps: (1) focus on maintaining existing infrastructure and preventing COVID-19, (2) review and prioritize active projects, (3) create and maintain a project pipeline that can be delivered in a few years, and (4) start planning for new development priorities arising from the crisis.
For the Fund, in order to be timely and efficient, any increase in public investment must meet the following conditions:
• Priority should be given to spending on tackling the health crisis and maintaining the existing infrastructure.
• Governments must identify and create a portfolio of projects carefully evaluated and ready for implementation within the next 24 months. This portfolio should include more complex investment projects that promote digitalization and/or reduce the likelihood and impact of future crises (including those arising from pandemics, climate change, etc.).
• The selection and bidding procedures for public investment projects must be strengthened immediately to curb corruption, delays and rising costs.
As a basis for its arguments, the document presents the results of an empirical exercise to measure the impact of government investment shocks on output, employment and private investment, in periods of low and high uncertainty, carried out for a sample of 72 advanced economies and emerging markets.
In this exercise, researchers at the Fund found that, in periods of high uncertainty such as the current crisis, an increase in public investment equivalent to 1 percent of GDP in advanced economies and emerging markets could raise output by 2 percent over a two-year horizon.
In the medium and long term, it is estimated that the fiscal multiplier in the current context is higher than in normal times and well above 1.0. The magnitude of the fiscal multipliers would, however, depend on the quality of projects and institutional efficiency in countries.
With regard to impacts on employment, the results indicate that in periods of high uncertainty employment grows between 0.9 and 1.5 percent over two years in response to a public investment increase equivalent to 1 percent of GDP. In advanced and emerging market economies, the investment shock would result in the creation of 20 to 33 million jobs, directly and indirectly.
Estimates also showed that public investment has a powerful attraction for private investment, because it signals the government's commitment to growth and stability. In other words, public and private investment have a complementary character (crowding-in).
A significant increase in public investment tends to raise private investment even among companies with liquidity restrictions. The impact is, however, greater for firms less financially constrained and with low leverage. Hence the importance of companies getting to the end of the COVID-19 crisis with low levels of debt.
The study also investigated, for a sample of 400 thousand companies in eight sectors of activity, which types of public investment and sectors are most efficient in stimulating private investment.
The results indicate that public investments in health and other social services have a strong impact on private investments in the time horizon of one year. The crowding-in effect is also more significant in areas that are critical for either solving the health crisis, such as communication and transportation, or boosting the economic recovery, such as construction and manufacturing.