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An open and integrated capital market is vital for attracting investment that benefits citizens, businesses and investors among the EU member states. Three key issues were identified recently: – the importance of harmonised rules to reduce costs for businesses and clients; – the need to improve the supervisory architecture, and – better understanding the reasons behind effective solutions to prevent fragmentation in all trading infrastructures.
Increasing productive investment
To meet the EU-wide strategic objectives, the developers and businesses have to get a minimum annual investment of about €750-800 billion; it corresponds to about 4.5 percent of EU GDP annually. The reforms in the EU-wide competitiveness require substantial investment; the issue that has been covered in Draghi report (chapter five).
Note. These are huge amounts and hardly accessible presently: for comparison, investment under the Marshall Plan after WWII (during 1948-51) was equivalent to 1-2% of EU GDP. Delivering this increase would require the EU’s investment share to jump from around 22% of GDP today to around 27%, reversing a multi-decade decline across most large EU economies.
All references to the Draghi report in: https://commission.europa.eu/topics/strengthening-european-competitiveness/eu-competitiveness-looking-ahead_en
Related links: https://commission.europa.eu/topics/strengthening-european-competitiveness_en
Important Draghi’s note is that “productive investment in the EU is not rising to the modern challenges”; thus, since the so-called great financial crisis of 2008-09, a sizeable and persistent gap has opened between private productive investment both in the EU and the US. At the same time, the private investment gap across the two economies has not been offset by higher government investment, which also dropped after the crisis and has been persistently lower in the EU compared to the US as a share of GDP.
For example, the EU households provide ample savings to finance higher investment, but at present these savings are not being channeled efficiently into productive investments. In 2022, EU household savings were €1,390 bn compared with €840 bn in the US. But, despite their higher savings, EU households have considerably lower wealth than their US counterparts, largely because of the lower returns they receive from financial markets on their asset holdings.
Financial literacy
It is important to promote financial literacy and investor education as well as tax incentives to increase retail investor participation in capital markets.
Financial literacy means the knowledge and skills needed to make important financial decisions. Every day, thousands of people are deciding where to open a bank account, which mortgage to choose, where to invest their money and how to save for retirement.
However, according to the OECD/INFE 2020 international survey of adult financial literacy, about half of the EU adult population does not have a good enough understanding of basic financial concepts.
See international survey in: https://web-archive.oecd.org/temp/2022-08-09/555847-launchoftheoecdinfeglobalfinancialliteracysurveyreport.htm
While the overall figures are low, the problem is more acute in some parts of society than others, with the most vulnerable disproportionally affected. Low-income groups, for instance, as well as women, young people and older people, tend to score lower than the rest of the population when it comes to financial knowledge.
Financial literacy also protects individuals from over-indebtedness, excessive risk-taking, fraud, or cyber risks: Commission mentions that “financial education complements consumer protection, but does not replace it”.
More on “financial literacy” in: https://finance.ec.europa.eu/consumer-finance-and-payments/financial-literacy_en
Activating private sector
= First parameter is an activation of the private sector’s finances; the process that evidently needs sufficient public support. For example, the European Commission and the IMF’s Research Department have simulated scenarios of a sustained EU investment push of around 5% of GDP, using their “multi-country models”; e.g. the suggestion was that investment of this magnitude would increase output by around 6% within 15 years. Since supply adjusts more gradually than demand – as the build-up of additional capital takes time – the transition phase implies some inflationary pressures, but these pressures dissipate over time.
Besides, the process of unlocking the investment will be challenging: historically, about four-fifths of productive investment in the EU has been undertaken by the private sector and the remaining one-fifth by the public sector. Delivering private investment of around 4% of GDP through market financing alone would require a reduction in the private cost of capital – by approximately 250 basis points in the European Commission model.
Although improved capital market efficiency (e.g. through the completion of the Capital Markets Union) is expected to reduce private financing costs, the reduction will likely be substantially smaller. Fiscal incentives to unlock private investment therefore appear necessary to finance the investment plan, in addition to direct government investment.
= Second parameter is the issue of required stimulus to private investment to have some impact on public finances, but productivity gains can reduce the fiscal costs. If the investment-related government spending is not compensated by budgetary savings elsewhere, primary fiscal balances may temporarily deteriorate before the investment plan fully exerts its positive impact on output. However, if the necessary reforms are implemented, the investment push should be accompanied by a significant increase in EU total factor productivity, TFP.
A sizable increase in TFP will improve the government budget surplus, significantly reducing the implementation’s transitional costs, provided that the additional revenue is not fully spent on other purposes. For example, a 2% increase in the level of TFP within ten years could already be sufficient to cover up to one third of the required fiscal spending, i.e. investment subsidies and government investment; the 2% TFP increase can be considered modest given the current 20% gap TFP levels between the EU and the US.
Investment efficiency in Europe
A key reason for less efficient financial intermediation in Europe is that capital markets remain fragmented and flows of savings into capital markets are lower. There are three main fault lines, although the Commission has introduced several measures to build a Capital Markets Union, CMU.
= First, the EU lacks a single securities market regulator and a single rulebook for all aspects of trading and there is still high variation in supervisory practices and interpretations of regulations. = Second, the post-trade environment for clearing and settlement in Europe is far less unified than in the US.
= Third, despite the recent progress made on withholding tax, tax and insolvency regimes in the EU member states remain substantially unaligned.
EU capital markets are also undersupplied with long-term capital relative to other major global economies, owing largely to the underdevelopment of pension funds. In 2022, the level of pension assets in the EU was only 32% of GDP while in the US total assets amounted to 142% of GDP and in the UK to 100%.
This difference reflects the fact that most European households’ pension wealth takes the form of claims on public pay-as-you-go social security systems. EU pension assets are highly concentrated in a handful of member states with more developed private pension systems: e.g. the combined share of the Netherlands, Denmark and Sweden in EU pension assets amounts to 62% of the EU total.
Note. Previous publication: E. Letta “Much more than a market: speed, security, solidarity in empowering the Single Market to deliver a sustainable future and prosperity for all EU citizens”, Report to the European Council (April 2024) in: https://www.consilium.europa.eu/media/ny3j24sm/much-more-than-a-market-report-by-enrico-letta.pdf
The Commission has also recently launched a study on “consolidation and reducing fragmentation in trading and post‑trading infrastructures in Europe and on the scaling up of funds investing in innovative and growth firms”; a report will be delivered next year. By breaking down barriers and promoting consolidation, the EU can create a more attractive environment for investment and growth, ultimately benefiting businesses, consumers and the economy as a whole.
More in:
https://finance.ec.europa.eu/news/breaking-down-barriers-market-integration-2024-10-11_en