Public investments or fiscal consolidation after the COVID-19 pandemic in the recovery plans

The beginning of the Covid 19 pandemic brings upfront the debate over the questions regarding fiscal policy and the opportunities to stimulate growth via deficits. Through the unprecedented mechanism for Recovery and Resilience, the EU creates opportunities for all member countries to prepare their National Plans for Recovery and Resilience (NRRP) for which they will receive billions of euros in funding. In this way, the instrument allows each country to perform public investments, which if done without the help of the instrument, would’ve led to higher deficits and the need to increase national debt. Nevertheless, the overall aim is not only increasing public expenditure and thus stimulating growth, but also supporting structural transformation of the economies after the pandemic.

European countries may have similar levels of economic development, however they do not always begin from the same starting point. The Center for European policy studies (CEPS) has prepared a comparative analysis (published here) of two “extreme” cases in the faces of Italy and Germany, and their approaches on choosing how to distribute the resources in the national plans. Using the conclusions made by the investigation of CESP, we will also try to describe the Bulgarian approach. 

What does the comparative analysis for the plans in Germany and Italy show?

Italy and Germany have different approaches and priorities, regarding how the resources for their plans should be invested in shorter and longer terms. For the last decade (at least) Italy has been exposed to exceptionally high national debt, while Germany did not experience difficulties with its fiscal stability. Germany’s prudent approach and the years of balanced budgets, allow them to face the crisis without significant disturbances. And while for Italy, it is vital to implement structural reforms and realize an investment plan which would ultimately increase growth potential, for Germany fiscal consolidation is the highest priority. 

If we ignore the differences between the volume of funds which the two countries receive through the NRRP mechanism, Italy’s plan is over seven times higher than Germany’s in terms of financing magnitude. The main differences are in the following directions:

• First of all, Italy invests 84% of the provided funds for capital expenditures, while Germany projects only 57% for such expenditure in their plan.
• While in Germany half of the spending has been done by the end of 2021, in Italy only 17% have been accomplished in this year. Italy focuses first on the completion of structural reforms, thus almost all reforms (over 80%) are planned for the period 2021-2022, while the investments are concentrated primarily for 2025 and 2026. On the other hand, Germany plans to perform both the reforms and investments during the first half of the period. 
• There are differences in the types of projects the two countries decided to invest in. Italy uses the EU funds to finance additional expenditures- around 71% of the entire funding is for projects which have not been included in the national budget. On the German side, the country prefers to include projects which have been working since 2020. This is one of the reasons why the Italian plan is pushed further into the future, compared to the German one.
• A well known issue with Italy’s capacity to absorb EU funds effectively and transparently, is also addressed within the Recovery plan. In late July, 2021 Italy had absorbed 51% of its structural funds from the Multiannual Financial Framework of the EU for the period 2014-2020. The public administration and judicial system of the country suffer from unqualified and insufficient personnel. The procedures and rules are complicated, thus Italy experiences difficulties not only with the planning of public investments, but also in attracting private ones. Due to such circumstances, Italy announces primarily ‘horizontal’ and ‘enabling’ reforms in the plan for 2021 and 2022. The State defines ‘horizontal’ reforms as structural innovations in the judicial system and public administration. The ‘enabling’ measures are described as functional interventions, which guarantee the implementation of the plan and the removal of administrative, regulatory and procedural obstacles that impact economic activities and the quality of services provided.
• In contrast with Italy, German reforms are sectoral- specific innovations in sectors which aim to  introduce more efficient regulatory and procedural regimes.

What are the possibilities for Bulgaria?

Although the plan has still not been approved by the European Commission, the Bulgarian approach in preparing the NRRP resembles the Italian methods rather than those of  Germany. Similarly to Italy, Bulgaria is also well known for its inefficiencies in absorbing EU funds, thus reforms are needed to bolster the preparation and implementation of investment projects , as well as the effective functioning of public institutions. A large proportion of the expenditures would have to be in investments- in the Bulgarian plan they are 82% ( more information could be found in the IME analysis “ A look at the Recovery and Resilience Plan: priorities, investments, expected results” published here). The lack of capacity to fund existing projects and implement them in the plan (even though this is permitted by the regulation) also shows similarities with the Italian approach. Drawing investments further in time, is another commonality between the two states.

The biggest problem for Bulgaria remains binding reforms with productive investments instead of simply absorbing financial resources. The Plan’s delay and a continuing uncertainty about its content and projects, do not create an impression that the authorities know what and how they want to achieve. And when it comes to reforms,  there is no room for time wasting. 

*This document is funded by Active Citizens Fund Bulgaria through the Financial Mechanism of the European Economic Area and Norwegian Financial Mechanism. All its contents are the sole responsibility of Institute for Market Economics and do not represent in any way the views of the Financial Mechanism of the European Economic Area and Norwegian Financial Mechanism and Active Citizens Fund Bulgaria. (www.activecitizensfund.bg)