Euro Watch – Government investment collapse

by: Aline Schuiling

In this publication: During the years 2010-2015, the eurozone went through a period of tough fiscal austerity, which reduced economic growth. During this period government fixed investment fell by more than 15% in the eurozone … and by 50% in some peripheral countries, which tends to hurt economic fundamentals and limit private investment as well. Meanwhile, tax income rose much faster than nominal GDP throughout the eurozone, lifting the tax burden that weighs on the economies … implying that the fiscal policy mix that was chosen during the years of austerity might very well have a downward impact on economic growth in the eurozone in the longer term as well.

Euro-Watch-Government-investment-collapse-21-June-2016.pdf (71 KB)


Following the global financial crisis of 2008-2009, a period of fiscal policy tightening began throughout the eurozone. During the years 2010-2014 all big eurozone countries implemented austerity measures. In 2015, the result was more mixed, with fiscal policy neutral in the eurozone as a whole. Still, the majority of the biggest countries continued to tighten the fiscal policy reigns, so we have included this year in our analysis. According to estimates by the European Commission, 2016 will be the first year when budgetary policy, on average, will be expansionary in the eurozone as a whole. In this research note we take stock of the changes in the main components of the governments’ budgets during the period 2010-2015. We have looked at the eurozone aggregate and the eleven biggest individual countries.


Total government expenditure increased during the period 2010-2015 …

Government spending rose in the eurozone as a whole during the period 2010-2015. Total expenditure increased by 7.5% during the five-year period. Current expenditure rose by 10%. The largest component of current expenditure, social transfers (with a share of 51%) increased by 14%, while the second largest component – compensation of government employees – rose by almost 5%. The only part of current expenditure that actually fell in the eurozone as a whole during the five-year period 2010-2015 is interest expenditure (5% of current expenditure), which declined by almost 4%. The latter seems to be the result of the ECB’s policy measures, which lowered government bond yields, as the level of government debt increased in all countries.

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… whereas government investment declined …

In contrast to current government expenditure, government gross fixed capital formation (GFCF) and other government capital expenditure declined during the years 2010-2015. Fixed investment fell by 16%, while other capital expenditure declined by almost 10%. In Greece, Spain and Portugal, GFCF plummeted by no less than 50%, while in Ireland and Italy it dropped by 30-40%. The drop in government investment during the years of austerity will probably limit GDP growth in the longer-term as well. To begin with, government investment in infrastructure, education and technology improves productivity and the business environment, which stimulates private sector investment and improves a country’s competitiveness. Moreover, government investment tends to have a direct positive spill-over effect on private sector investment as well, for instance via the co-financing of projects or public private partnerships for infrastructure investment.

… and taxes and social security contributions rose

On the other side of the coin, eurozone governments on aggregate received more income from taxes and social security contributions during the period 2010-2015. Social contributions increased by almost 14% – roughly equal to growth in social transfers. Meanwhile, income from taxes on production and imports rose by 20% and income from current taxes on income and wealth increased by 23%. The rise in tax income was higher than the rise in nominal GDP in all countries during the years 2010-2015, implying that the tax burden on the economy has increased. This reflects that governments also hiked taxes as part of their austerity programmes. In general, a higher tax burden tends to weigh on economic activity and GDP growth in the longer-term, by reducing incentives to work and invest although the impact can vary depending on the type of tax and the structure of the economy. That said, several economic studies 1) find that, in general, austerity measures based on cuts in government expenditure tend to have a less negative impact on GDP growth in the longer-term than austerity based on tax hikes.

Growth in the periphery to suffer the most

The most striking differences between government finances during the period 2010-2015 in the periphery and core is that total government expenditure (current expenditure and fixed investment) fell only in the four countries that were in a EU-IMF support programme during the crisis (Greece, Ireland, Portugal and Spain). It grew in the rest of the big-11 countries. Meanwhile, Greece was the only country were current expenditure fell noticeably during these years (-30%), with the rest of the ‘programme countries’ merely cutting government investment. With respect to the longer term consequences of the austerity measures, it seems that the impact on economic growth will be largest in the peripheral countries. We have constructed an austerity drag indicator, which combines the drop in the share of government investment in GDP and the rise in tax income in GDP. It turns out that economic growth in Greece, Spain, and Portugal might suffer the most in the longer term from the policy mix that was chosen during the years of austerity, while GDP growth in Germany, the Netherlands and Belgium will probably be hurt the least.



1) For instance, OECD Journal: Economic Studies “Fiscal multipliers and prospects for consolidation“, NBER Working Paper Series “Large changes in fiscal policy: taxes versus spending“