Friday, 20 July 2012

The effects of an investment stimulus

Rory O'Farrell: The idea of an investment stimulus got a boost this week. Though people may disagree over the extent to which this is 'new money', it shows that at the very least, the government want to be seen to be pro-investment stimulus.

Coincidentally, this week I presented a working paper which uses the HERMIN model (used by the EU to measure the effects of cohesion funding) to assess the effect of an investment stimulus.

Two interesting things stand out about the announced stimulus. First is the involvement of the European Investment Bank (EIB). Not only do they bring money to the table, but perhaps more importantly they bring their expertise in assessing projects and an independent pair of eyes. They won't be funding any vanity projects.

The second is the off-the books nature of the funding. With traditional financing, the net cost to Government of an investment is considerably less than the headline cost, about 57%. This is as multiplier effects lead to increased tax revenue. Then over the medium term, the supply side effects of higher GDP and tax revenue more than offset interest payments on a project. However, as the projects are 'off the books' and the tax revenue is 'on the books' there will be an immediate decrease in the reported Government deficit. Though this is playing with accounting rules, it means that the government will about €400 million more room to manoeuvre and staying within Troika limits.

Overall, we can expect 17,000 jobs to be created per €1bn invested in a year, and there is a multiplier of 1.6. When designing a stimulus, it is important to front load the investment, and then phase it out. This allows the export cavalry enough time to come over the hill and save us from long term unemployment and stagnation.


Paul Hunt said...

It's interesting that we've seen no economic evaluations of the projects that will be funded with this 'stimulus'. I thought we had a new Government Economic and Evaluation Service to do that sort of thing? Or maybe it isn't up and running yet? Though, then again, they mightn't want those of use who might know a little bit about these things poking our noses in. It looks a bit like the usual 'mushroom method'.

And just think how much money would be available for the 'stmulus' if the ESB and BGE networks were re-financed, restructured and sold. Silly me. Would never happen. If it did the ESB wouldn't be able to invest 100s of millions boosting economic activity and adding jobs in Britain.

Eoin Reeves said...


At this stage any efforts at stimulus should be welcome in principle. But "off balance sheet financing" is nothing short of Enron-style accounting trickery. The government will still be on the hook for investment that is initially financed by the private sector when the PPP model of procurement is adopted. It is essential therefore that individual projects are subjected to cost benefit analysis first and then put through a value for money test. The latter is required under the PPP guidelines issued by the Department of Finance. But don't expect that these analyses will be put into the public domain thereby allowing independent scrutiny! The faith in the PPP model that underpins the Stimulus Plan is largely based on faith. Since PPP was first adopted in 1999, just two contracts have been audited by the C&AG. Neither study shed the PPP model in favourable light. In the UK, the PPP/PFI model has been undermined by a recent report by the Treasury and is likely to be reconfigured. It is not clear that any lessons from the past (in Ireland or elsewhere) will be brought to bear in this new Stimulus Plan which appears to assume that the PPP model is works efficiently. How naive?

Rory O'Farrell said...

@ Eoin

I heard someone refer to the set-up as a public (Government)-public (BoI is largely state-owned)-public (the EIB is owned by the various member states) partnership.

Do you think this makes a difference?

Eoin Reeves said...


An interesting question that highlights the uncertainty about what exactly was announced on July 17th. The term PPP is used to cover a wide range of different collaborations. The long term infrastructure PPPs that have been adopted in Ireland over the last 13 years involve private sector responsibility for all or most elements of the project life cycle i.e. design, build, operate and finance. The collaboration you describe obviously doesn't include private sector involvement but the Minister's announcement clearly does envisage the private sector coming on board. However there might not be much in the line of private finance if transfers from the EIB and the exchequer (i.e. proceeds from privatisation) account for a big slice of the €2.25 billion. The mix of public/private sector funding will only become apparent over time. But the fundamental point remains. What's bought now will be paid for later. In the medium to long run, public finances will not be improved by adopting PPP. In fact they are likely to take a greater hit because PPP is very unlikely to deliver value for money over traditional procurement methods (which are by no means perfect either).

Eoin Reeves said...

My apologies to Rory. The previous post should have been directed to Rory (not Robert). ER.