Public investment is not a panacea

The European Commission criticized again the high current account surplus in Germany. It suggest increasing public investment as one possible way to tackle the problem. Simulations show however that the effect of public investment on the current account is limited.

In its country specific recommendations the European Commission expressed again criticism regarding the high and persistent level of current account surplus in Germany. As potential way to tackle this macroeconomic imbalance the European Commission suggests to increase public investment and therefore support domestic demand. Public investment as proportion of GDP has remained largely constant and is below the euro area average, criticized the European Commission. Simulations with the Oxford Global Economic Model show that raising public investment from currently 2.1 percent of GDP to the euro area average of 2.6 percent of GDP can reduce the current account surplus by only up to 0.6 percentage points in 2025. The effect on the European trading partners is however limited. The current account deficit of France would decrease by less than 0.1 percentage points, the effect on Spain and Italy is even lower.

Increasing public investment can therefore contribute only to a limited extend to tackling this kind of macroeconomic imbalances. Still, this does not mean that higher government spending for investment projects are redundant. Although it negatively affects the development of public finances, investment at all levels of government stimulate economic activity both in the short and the long term. Infrastructure projects for instance improve location quality for enterprises and increase the total capital stock of the economy. Furthermore, investment boosts economic growth and creates new job opportunities. In the long run, it leads to higher potential output and improves the long term growth perspectives.