The Debt Question: For mature economies, public investment needs cannot justify large additional deficits.

• Author: Gros, Daniel

Europe's fiscal rules were put in abeyance when the Covid-19 crisis started. Governments had to lock down the economy to slow down the spread of the virus. As a result, the economy tanked (in some countries briefly by more than 10 percent). Government revenues fell and expenditures rose to compensate enterprises and workers for the loss of income. The European economy is now recovering quickly, allowing governments to reduce their deficits. However, many argue that this is not a good time to return to austerity because Europe needs a large investment effort to underpin a green and digital economy.

The question is thus whether more public investment can constitute a case for even higher public debt. An answer requires a careful look at the numbers. Over the lifetime of the euro, the member states of the euro area have accumulated public debt worth over [euro]8,000 billion (despite the seemingly strict fiscal rules). Over the same time span, the total amount spent on public investment has been of a similar order of magnitude, [euro]7,600 billion. One could thus argue that over 90 percent of the deficits incurred over the last twenty years were justified by public investment.

However, this would overlook one key aspect. Most of what is called public infrastructure investment (in official statistics it is called "gross fixed capital formation") represents in reality repairs and maintenance to offset wear and tear on the existing stock. Roads, railways, and bridges need constant repairs as could be seen tragically in Italy when a motorway bridge in the city of Genoa suddenly failed, causing considerable loss of life.

If one deducts maintenance from the overall expenditure, one arrives at what in national accounting is called "net fixed capital formation," that is, the addition to the stock of public capital. This is much smaller than (gross) public sector investment. For the euro area, one finds that about nine-tenths of all public investment consists of repairs and maintenance.

In rough numbers, this implies the following: if a country spends about 3 percent of GDP on gross public investment (roughly the past euro area average), the increase in the capital stock, which is the part which might justify more public debt, would be equivalent to about 0.3 percent of GDP.

If one puts the increase in the public capital stock in relation to the increase in public debt in the euro area, one thus finds that only 12 percent of the total increase in public...