The recovery of the European economy is progressing slowly, slower than many expected. Here is why the Next Generation EU money is frantically awaited. However, the impact of the national Recovery and Resilience Plans (RRP) on the economy remains nebulous, especially on the Italian economy. The econometric model used by the Italian government, as we shall see, is based on questionable assumptions: if on the one hand it underestimates the direct effect of public spending, on the other hand it assigns an enormous role to "reforms". This is the real “main course” of what was initially intended to be a major European fiscal response.
Let's start with some comparisons. Not all countries have made the same choices: some like France, Germany and Spain will use only grants, others (like Italy and Portugal) both grants and loans. In terms of volume, the largest Recovery Plan is that of Italy (€191.5 billion in loans and grants, €13 billion from the ReactEU fund and €30.6 billion from a complementary national fund). This is followed, in our sample, by Spain (€69.5 billion), France (€41 billion) and Germany (€27.9 billion) and Portugal (€16.6 billion)
As for the destination of funds, on which a certain amount of discretion remains, at least 37% must be allocated to the green economy and 20% to digitalization. France has the greenest plan (50.6% of its RRP compared with 40% in Italy), Germany the most "digital" (52.4% of funds compared with 27% in Italy). As for the "free" part of the plans, Portugal will allocate as much as 40% of the funds, followed by Italy (33%), Spain (29.6%), France (24.3%) and Germany (7.3%).
But what will be the impact of the RRPs? Their structure is heterogeneous, making comparison difficult, but we will try to do so for the major beneficiaries: Italy, Spain and France.
Let's start from Paris. The additional effect of the Plan on growth will be around 1% in the first two years, dropping below 1 between 2023 and 2025. In this assessment, the characteristics of investments (focused on "supporting demand") come into play, but the models used for estimates also count. In France's, "the productivity of the public capital stock is not taken into account." In other words, the model does not capture the positive effect of public investment on the supply side. A hypothesis that is, to say the least, objectionable.
Turning to the Italian government's forecasts, they consider all available resources (including own resources from the Complementary National Fund) and seek to incorporate the positive repercussions of similar programs in other EU countries. Three alternative scenarios are evaluated. In the "low" scenario, it is assumed that the investments chosen are those with the lowest impact on GDP, while in the "medium" one, the financed expenditures are attributed a slightly higher effectiveness. However, the scenario taken as the main reference is the "high" scenario, in which it is assumed that "the public investments financed are those with greater efficiency". In this scenario, the RRP has an additional impact on GDP equal on average to 2% and increasing over time: from +0.5% in 2021 to +3.6% in 2026. It is legitimate, however, to have some doubts.
The real impact of the Italian plan, however, is after 2023. Let's try to understand why. In the first years, the expected effect of the Recovery is similar - and rather weak - in all three scenarios (low, medium and high). As the document explains, "in the short term, the demand effect prevails", due to the so-called "multiplier" of higher public spending. In the medium term, however, things change: "Greater investment increases the stock of public capital with persistent positive effects on potential and actual GDP". In this way, assuming that public investment has a high efficiency (high scenario), between 2024 and 2026 GDP should be about 3% higher on average than in the base scenario. A substantial gap, explained by the efficiency of public spending. According to Carlo Altomonte, professor at Bocconi and member of the task force for the RRP, this will be possible "thanks to the reform of the P.A. and procurement: for this reason, in the planned reforms, that of the Public Administration is in first place".
In the RRP it is read in fact that "the relevant scenario for the simulation depends (...) not only on the type of investments selected, but also (if not more) on the context in which they will be carried out". The reforms, precisely: that of the P.A. should increase general productivity, reduce costs related to bureaucracy and improve human capital.
Several commentators are not convinced that the intentions of the government are enough to the result, not to say that it will take time for the reforms to go into effect: after decades of neglect of the state machine will be difficult to have immediate results. The same doubts, combined with the fact that the intentions of Draghi & co. have not yet been translated into a text of law, have been had by the watchful controllers of Brussels, a distrust that has lengthened the negotiations in recent weeks. In any case, the government’s optimism about the effect of the reforms could lead to overestimating the impact of the Recovery Plan.
It must be said, however, that the techniques and assumptions used in the forecasts could even have the opposite effect, underestimating its contribution to growth. In fact, the RRP explicitly excludes a key variable: the leverage effect of public investment on private investment. A risk inherent in the choice of the simulation model (QUEST), in which "an increase in public spending leads to an immediate, marked and permanent drop in real consumption", as explained by Francesco Zezza, researcher at Sapienza University, Rome. It is thus clear why the RRP is expected to have a depressive effect on consumption for the first three years. The same government has made estimates based on another model (MACGEM-IT) obtaining in fact rosier forecasts. How is this possible? Simple: in this case demand has a greater role in influencing GDP.
The impact of the RRP therefore remains highly uncertain. To see things more clearly, it is necessary to resort to other evaluations, to different models: some scholars are already doing this (for example, Canelli, Fontana, Realfonzo and Veronese Passarella in the Review of Political Economy, a work that is now being updated), but above all it will be necessary to understand what will really become reality of the RRP with the muddled path designed by the EU.
This article has been originally published in Italian on “Il Fatto Quotidiano” on 10th May 2021. Here it is republished with slight modifications.