The governor of the Bank of Italy Ignazio Visco spoke at the 64th Conference on Administrative Studies "Economic development, financial constraints and quality of services", at Villa Monastero in Varenna. Here is the text of his speech, entitled "Public investments for the development of the economy":
In the last decade, the Italian economy has gone through the worst crisis in its history. The double-dip recession, during which gross domestic product fell by around nine percentage points, was followed by a weak and stunted recovery: since 2013 we have recovered less than half of the lost ground. In this context, the opportunity to increase spending on public investments, which can have positive effects on the level of economic activity in the short term and affect its growth potential in the longer term, has been widely supported. The impetus provided by higher spending is usually higher if it is deficit financed. It can be stronger if the investments made are complementary to private capital, marginally increasing its profitability: this would encourage spending on business investments. In the medium to long term, the increase in growth potential derives from opening up new opportunities for economic activity and stimulating innovation; these effects can be achieved with the creation of material infrastructures, especially if with a high technological content, and above all through investments in research and knowledge.
In the short run, the increase in the level of output, measured by the so-called "investment multiplier", can be strong enough to exceed the growth in public debt due to the deficit. But if the longer-term effect on growth potential is not grafted onto this effect, the reduction in the debt-to-product ratio is temporary: while the deficit continues to feed the debt, the product returns to growth at similar rates to those prior to the spending increase. The entity of the multiplier depends on some important variables: speed and efficiency of the interventions and ability to identify those capable of determining an effective qualitative and quantitative increase in public capital are the qualities necessary to maximize the direct impact on the product; the continuation of orderly financial conditions is essential to avoid phenomena of "crowding out" of private investments, which can be discouraged by an increase in interest rates. The careful selection of programs to be financed is also crucial to obtain the longer-term effects on growth potential; it must not penalize the resources available for intangible infrastructures.
The constraints resulting from the high level of debt must be taken into consideration. An unproductive increase in the deficit would end up worsening the prospects for public finances, fueling investor doubts and pushing up the risk premium on government bonds. The public debt-to-output ratio could quickly drift onto an unsustainable trajectory. In the current conditions of public finances and with a low degree of efficiency in administration, recourse to the deficit must be used with caution, ensuring that resources are effectively used to support economic activity, in the short and longer term. Even if an effective investment policy were able to bring the economy onto a higher growth path, it would still be necessary to define a credible strategy in budget objectives and reform lines, such as to determine a reduction in the risk premium on securities of Italian state. In this scenario, the debt-to-product ratio would embark on a trajectory of progressive reduction, the more rapid the smaller the difference between interest charges and nominal growth of the economy and the larger the budget surplus net of interest expenditure .
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Public investments and aggregate demand
It is known that so-called "direct" public spending, such as investment spending, can have a stronger impact on aggregate demand than expenditure with "indirect" effects, such as public transfers, which can be partially allocated to savings by their recipients, to a greater extent as incomes rise. However, the precise assessment of the short-term macroeconomic effects of an increase in public investment is surrounded by high uncertainty. The size of the multiplier (ie the increase in output generated by an increase in deficit-financed spending) depends on many factors: the degree of utilization of productive resources, the stance of monetary policy and the resulting financial conditions; the presence of any delays and inefficiencies in the definition and implementation of investment programs; the assessment of the markets on the prospects for debt sustainability following the increase in spending. Simulations carried out over a short-medium term with the Bank of Italy's quarterly econometric model indicate that in the most favorable scenario the multiplier is greater than unity and the increase in product obtained with the greatest investments determines a reduction in the ratio between public debt and GDP over a five-year period. It is reasonable to hypothesize that if the selection of investments were not accurate, or their implementation was characterized by waste and inefficiencies, the multiplier would be significantly lower, approaching the (lower) one of transfer expenditure. Under these circumstances, the debt-to-GDP ratio would increase.
The same result would occur if the spending plan aroused investor fears: the increase in financing costs (for the public sector and consequently for the private sector) would reduce the stimulus to economic activity provided by higher investments, while the deficit would higher due to both the lower growth of the economy and the progressive increase in interest expenditure. Assessing the potential impact of a higher deficit on the sovereign risk premium is not simple: it is a non-linear and volatile relationship, influenced by many variables, some not immediately quantifiable. If the fiscal expansion were to be accompanied by a deterioration in investor confidence such as the one that occurred between 2011 and 2012, for various reasons, the impact on interest rates could be, as then, particularly high. Estimates based on values recorded in advanced economies under normal financial conditions cannot be applied to such situations. However, it must be remembered that every year the State has to place around 400 billion of public debt on the market. The econometric model does not explicitly take into account the complementarity between public and private capital in the production function of firms. Investments that are able to increase the profitability of private capital, encouraging its accumulation, can translate into higher values of the multiplier.
The empirical literature on this link is extensive but – also due to non-trivial methodological difficulties – it does not arrive at univocal results. However, the estimated effects confirm their relevance. Even the econometric exercises conducted by other institutions, despite the incomplete comparability of the various simulations, underline the decisive role of the context factors that I mentioned previously: the reaction of monetary policy, the ability to select well and to implement without delays or wasteful investments, expectations on the evolution of public finances.
Public investment and growth potential
Economic analysis has long recognized that technical progress and total factor productivity dynamics constitute the effective engine of economic growth for advanced countries, where the initial rapid accumulation of physical capital and growth of the labor force have exhausted their drive. An adequate endowment of public capital can facilitate the adoption of new technologies and the reorganization of production processes, also facilitating the creation of new businesses. It can prove essential in supporting the initial stages of development of particularly innovative technologies. However, it must be recognized that the link between the accumulation of public capital and economic development, however crucial, is essentially elusive. It is evident that public capital does not only include material infrastructures – such as transport networks and those for telecommunications and energy – but also the set of knowledge and skills that an economy can have at its disposal. These two types of capital, tangible and intangible, share some characteristics of public goods and without state intervention they would be available in insufficient quantities. The state supports intangible accumulation both directly, with scientific research in universities and public research centers and with the provision of educational services, and indirectly, through subsidies and tax incentives for private activity. There is evidence that both of these forms of intervention, if well designed, have a positive impact on economic growth. In a context of rapid technological change, promoting the accumulation of human capital and its qualitative improvement appears equally if not more important than investment in physical infrastructure, especially in our country. Public spending on education is around 4 per cent of GDP, much lower than the euro area average. Italy ranks last among developed countries for the skills of its workforce. The gap with respect to other countries is also pronounced with reference to research and development activity, although in this case it is almost entirely due to the private component of the expenditure.
Public expenditure for investments and infrastructure endowment in Italy
Expenditure on gross fixed investments by public administrations has decreased in Italy in recent years and is lower than that recorded in other European countries. In nominal terms it has decreased by 4 per cent a year on average since 2008; a trend towards a reduction in spending is also observed in the rest of the euro area, albeit less pronounced. As a percentage of GDP, spending fell in Italy from 3 per cent in 2008 to 2 per cent in 2017; the reduction was concentrated in local administrations. The European Commission has recently estimated that in our country there is a "deficit" of public investments. It should be kept in mind that the economic significance of the expense items does not always coincide with the accounting classification. Expenditures recorded in the general government account under the item "gross fixed capital formation" are not entirely destined to the formation of material infrastructures, nor do they represent the totality of the financial resources destined for this purpose. About half regards other types of expenditure, such as those for plants, machinery and patents. Investments in material infrastructures are also made by subjects outside the public sector who in any case carry out works of public utility (among these the concessionaires of the railway, road, energy and telecommunications networks).
Only part of these expenses pass from the public budget and are recorded under the item "investment grants", a very heterogeneous item whose composition is affected by national peculiarities in the sectoral classification of the bodies involved (inside or outside the public administrations) and in the methods of regulating public utilities. Measuring a country's infrastructure endowment is a complex exercise. You can use financial indicators based on the resources used or you can do it
use of physical endowment indices (length and density of transport networks, energy and water supply, telecommunications, etc.) which may also reflect differences in the morphology of the territories and in the degree of efficiency with which resources are used. Lastly, there are indices which aim to capture the overall adequacy of the infrastructural networks, taking into account as far as possible the potential demand, the
connections between the different networks, congestion phenomena. If reference is made to indicators based on the so-called permanent inventory method, which aggregates historical data on annual investment expenditure net of
estimated depreciation, the situation of Italy appears substantially in line with that of the major economies of the euro area. Compared to the early 2000s, the gap with France has widened, but there has been an improvement with respect to Germany and Spain.
In 2017, Ferrovie dello Stato made investments of approximately 4,5 billion (4,3 in 2016), almost entirely carried out by the subsidiary RFI Spa, which manages the network. Autostrade's investments for
Italy amounted to about 600 million; another 200 were invested by the second concessionaire in order of importance, the Gavio group. For the telecommunications network, TIM has invested around 3,5 billion. As regards electricity infrastructure, in the two-year period 2016-17 Enel invested over 2,5 billion, Terna over 1,9 billion. For the natural gas network, Snam has made investments of around 2,7 billion in the last three years. Using physical indicators of infrastructural endowment and relating them to appropriate scale variables, different results are obtained. For example, in relation to population (a measure, albeit a very crude one, of potential transport demand), the Italian road and rail network is less extensive than that of France, Germany and Spain. Similarly, if we compare the minimum travel time between two territories, weighted by population, we confirm Italy's disadvantage compared to the European average, suggesting possible effects of congestion.
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Finally, to measure the adequacy of a country's infrastructures as a whole – not just transport infrastructures – subjective assessments are available, the interpretation of which requires particular caution. For example, the World Economic Forum produces a synthetic index for 137 countries in the world; Italy is in 58th place, far behind all major European countries. According to a similar survey (although limited to European countries and municipal infrastructures) conducted by the European Investment Bank in 2017, Italy would have a quality level similar to that of Spain but lower than that of France, Germany and the average of the European Union. Overall, a divergence can be noted between what is suggested by the indicators constructed starting from historical expenditure and what can be deduced from more analytical indicators of network adequacy (a delay of Italy compared to other European countries emerges only from the second group of indicators). It could be assumed that this divergence is also due to a lower "efficiency" in the construction of the works. As I noted earlier, efficiency is a key variable in determining the macroeconomic impact of investment spending, both in the short and long run.
The full text on the Bank of Italy website.
