Thursday, 7 August 2014

Draghi's duplicity on the relative importance of structural reform and demand for investment

Mario Draghi once again cited the importance of structural reform at yesterday's ECB press conference, suggesting weaknesses in structural reform (his examples had to do with the ease of opening businesses) explained weak investment. of the components of the low GDP figure for Italy is the significantly low level of private investment, while one would observe a rebound in private consumption. As far as private investment is concerned, one observes a very low figure, especially low figure of private investment. This isn’t unique in the euro area. The levels of private investment for the euro area as a whole is low, and certainly much lower than it is in other parts of the world, like in the United States. 
Then we ask ourselves why this is so. Now, certainly it’s not the cost of capital, because interest rates, nominal and real interest rates, have been low. And in some parts of the euro area they are negative, and have been negative for quite a long time.
So the answers are: one has to do with expected demand. But the second answer has to do with the reforms, uncertainty, the general uncertainty the lack of structural reforms produces a very powerful factor that discourages investment. 
There are stories of investors who would like to create, to build plants and equipment and create jobs, but it takes them months to get an authorisation to do so. There are stories of young people who tried to open their business, and it takes 8 to 9 months before they can do so. That has nothing to do with monetary policy. 
So it’s mostly the lack of structural reforms. I keep on saying the same thing, really – reforms in the labour market, in the product markets, in the competition, in the judiciary and so on and so forth. These would be the reforms which actually have and have shown to have a short-term benefit.
Ok, so here's a very simple test of that claim. If low investment mostly has to do with the lack of structural reform, rather than demand, we ought to see no significant variation in investment levels during periods of high versus low demand.  

Source: Eurostat, defining investment loosely as gross capital formation
To say low post-crisis investment is explained "mostly [by] the lack of structural reforms," is, not to put too fine a point on it, to lie. That arranging investment is harder than it should be is bad. But it's blatantly obvious that these difficulties were compatible with much higher levels of investment in the recent past.

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