The Public Investment That Is Missing from Social Spending

The Public Investment That Is Missing from Social Spending


Since the 2008 crisis, public and private investment have decreased in Europe. If for the private sector the contraction is due to cyclical rather than structural factors, for the public sector the causes may be different. A relevant factor in this trend is attributable, without a doubt, to the austerity policies pursued by governments, which have particularly affected capital expenditure, since it is easier to cut than current spending.

Despite the uncertainties, the economic literature is in agreement that a prolonged contraction of investment can have negative effects on the economy. Over the last few years, numerous studies have been conducted by the main international economic agencies, primarily the IMF and OECD, as well as large consulting firms, to try to quantify the so-called "investment gap", i.e. the difference between the level of actual investment and the level of investment needed for maintaining and developing a country's stock of infrastructure. These studies have focused on the so-called economic infrastructure – roads, ports, water networks, telecommunications, the electricity grid – and have tended, albeit with different methods, to support the argument that the economies of the advanced and developing countries are not investing enough.

On the other hand, social infrastructure, meaning fixed assets in the health, education, and housing sectors, has never been investigated. In these sectors, estimating the "investment gap" is problematic because it implies defining what, in the first place, is the optimal level of investment compared to needs and resources. To do so, it would be necessary to: a) define the level of needs; b) measure how infrastructural investment contributes to the satisfaction of those needs; 3) estimate the level of investment that is necessary.

Given the knowledge and information available, it is not possible to establish objectively the link between infrastructural spending and health indicators or educational outcomes; in fact, the impact of social infrastructure in terms of these outcomes is not yet clearly determined. It is not even possible, due to lack of data, to define an investment demand curve, which is a function of the state of physical assets, stock of equipment, and technology growth. There are also no benchmark standards for optimal levels of capacity utilization, even for simple parameters such as the number of pupils per class.

To bridge this knowledge gap, the European Investment Bank (EIB), through the STAREBEI program, which funds academic research that is relevant to the bank's policies, has supported SDA Bocconi School of Management to define and quantify the potential infrastructure gap in EU health and education expenditure, as well as the possible policy instruments to fill such gap. The research study conducted by SDA Bocconi had also the purpose of contributing further evidence to the debate initiated by the High-Level Task Force on Investing in Social Infrastructure in Europe, chaired by Romano Prodi and Christian Sautter. The task force had already highlighted that in the coming years an investment gap of about €142 billion per year could hobble health and long-term care, education and lifelong learning, and affordable housing.

The research team of SDA Bocconi, coordinated by Veronica Vecchi, and composed of Niccolò Cusumano, Francesca Casalini and Filippo d'Arcangelo, built an econometric model based on the existing literature, which internalizes economic and demographic variables to forecast investment needs in health and education from here to 2040.

The model, presented to the G20 Long-Term Investment working group in Paris, shows that over the next 20 years, according to a business-as-usual scenario that extrapolates the growth trend of the recent past, investment in health care will double in proportion to EU GDP, rising from 0.15% to 0.3%, while in the educational sector the investment/GDP ratio would remain unchanged or even decrease. However, in the latter case, the decrease in school-age population entails that capital intensity per student is likely to increase significantly.

These results represent a trend. However, it is necessary to ask whether these investments will be sustainable from an economic point of view and whether they will be able to meet social needs effectively. The model also allowed the derivation of a second curve, which estimates the investment required to address unmet needs in health care and reduce school dropout rates, as defined by Eurostat. The difference between the two curves yields an investment gap (to 2040) of €477 billion for health care and €507 billion for education. Moreover, an interesting fact is that in health care, by the early years of 2030, the share of private investment seems bound to exceed public investment.

The contribution of the private sector, also through forms of private-public partnership, will therefore become fundamental within health care systems. It is worth pointing out, however, that since this is a one-sector model and rather than a general equilibrium model, such assessments can only be seen as partial. Furthermore, it should also be considered that technological innovation is likely to be progressively introduced and this could enable an improvement in services without necessarily requiring the same trend of investment growth estimated by the model.

The research has also identified recommendations on financing investment outlays, by identifying guidelines to reform forms of partnership with private capital. Among these recommendations, there is internalizing the logic that is behind Social Impact Bonds, and in particular payments linked to results, in models of infrastructure financing. Such logic seems especially applicable to small-scale investment in social sectors, and is currently being studied by the European Commission, in order to identify forms of financial support that are part of the European Fund for Strategic Investments (EFSI).

by Veronica Vecchi and Niccolo' Cusumano, SDA Bocconi School of Management
Translated by Alex Foti

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