"Traffic jams are not only exasperating, they also cost dear
in terms of productivity. Bottlenecks and missing links in the
infrastructure fabric; lack of interoperability between modes
and systems; non-communication between too many closed and scattered
telecommunications circuits. Networks are the arteries of the
single market. They are the lifeblood of competitiveness, and
their malfunction is reflected in lost opportunities to create
new markets and hence in a level of job creation that falls short
of our potential.
The establishment of networks of the highest quality [...] is
a priority task. It will require a joint, massive and sustained
effort on the part of the authorities at all levels and of private
operators. The potential to create jobs is substantial, both directly
in the short term by initiating large-scale projects and through
the beneficial effect in the long term on production conditions".
These themes, summarised by Jacques Delors in the White Paper.
Growth, Competitiveness and Employment, are the focus
of the debate between the international experts invited to Milan to discuss the role of infrastructure in spurring
development while respecting environmental compatibility.
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Growth, Investments, Public Deficit and Maastricht
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Thursday 3 October 1996
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The Maastricht conditions and investments in transportation and information systems
There is considerable potential for infrastructure development, largely associated with the high rate of unemployment, which represents a waste of productive resources and causes savings to decline as a result of a lack of income: an increase in the demand for labour - and hence income - would create additional savings to sustain this investment. Some investment could be financed by the government without changing or worsening the budget deficit (if calculated properly, i.e. separating investment from current expenditure). However, monetary policy is keeping interest rates artificially high and the Maastricht treaty forces governments to include investment in current outlays.
It therefore seems that new and feasible opportunities can be created by simply reformulating the concepts of government expenditure and deficits. While the deficit on current expenditure should be subject to very strict limits, no limit should be placed on investment except for a requirement that public and private money generate the same rate of return.
A model of interaction between growth, investments and public and private savings
The driving forces of economic development are investment in physical capital, productivity of capital, investment in human capital and population growth. Investment is determined by national saving, i.e. private savings minus the deficit. Private savings are proportional to income through a coefficient that depends on the growth rate. According to the life-cycle theory of saving, growth depends on investment, but investment in turn depends on growth through individual saving. Growth is therefore a complex function depending on a number of variables, the budget deficit in particular. The latter absorbs part of private savings, directly reducing investment - and therefore the capital stock and future income - and sets in motion a perverse circle: reducing investment reduces growth, which in turn reduces savings and thus indirectly reduces investment.
This effect is primarily linked to the behaviour of the deficit/GDP ratio: when this rises, consumption increases at the expense of investment and consumption by future generations. Such a process is evident in Italy, where an increasing ratio of deficit to debt and GDP has been accompanied by a decline in growth, savings and investment. The Maastricht treaty therefore correctly requires countries that wish to participate in monetary union to reduce their deficits to the standards laid down in the agreements.
Price stickiness, monetary policy and unemployment
The above model assumes full employment, which requires an adequate real quantity of money. In the long run this is guaranteed by monetary policy and the flexibility of wages and prices. However, in the presence of price rigidity, employment also depends on monetary policy. An insufficient money supply produces excessively high interest rates that reduce investment, income and savings. It is argued that the high unemployment in Europe in the eighties and nineties is largely due to the restrictive monetary policy stance of the Bundesbank, which has been imposed on the other countries in the EMS through a policy of fixed exchange rates and free capital movements. When unemployment is caused by an overly tight money supply, budget deficits contribute to sustaining demand and employment.
Criticism of the Maastricht criteria
- The definition of deficit
- treatment of capital account expenditure
- failure to correct for inflation
- Deficits and surpluses linked to cyclical conditions
- Treatment of deficits that are linked to cyclical conditions
Italy would benefit greatly from participation in monetary union, gaining exchange rate stability and a sharp fall in interest rates in particular. Nevertheless, it is unlikely that current Government programmes will enable Italy to satisfy the Maastricht criteria as currently formulated by 1997: the debt, deficit and perhaps even inflation could be higher than the limits set out in the treaty.
There are three possible remedies:
- reduce the deficit to 1% adjusted for inflation, i.e. well below the Maastricht limits and the level in most of the other countries;
- rapidly reduce inflation to zero, which will sharply reduce the deficit by reducing interest rates (this is not a very feasible option given the current conflict over labour policy between the Government and the social partners).
- modify the Maastricht objective, expressing it in terms of the debt/GDP ratio and imposing a reduction in fixed decrements. At the moment, Italy would probably meet such a criterion, since the deficit/GDP ratio has already fallen and should continue to decline gradually (Italy is in fact the only major country to reduce the ratio. In the others it is rising and would continue to rise even if the 3% objective were satisfied).
If none of these alternatives is practicable, the only option will be a further fiscal tightening in 1997, with all the adverse consequences associated with the depressive effect of restrictive fiscal measures in the presence of a weak economy and a high rate of unemployment.
The choice would then be between this extremely painful solution and not participating in monetary union, at least for a few years. It is difficult to say which of the two is worse; we can only conclude that, at the moment, the answer is not obvious.
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