In the first part of this interview we looked at the progress, challenges, and risks of the Capital Markets Union (CMU). In this issue, we dig a little deeper and explore the underlying motivation for its current prominence: Europe’s massive investment needs. This summer Finance Watch published an influential report concluding that private capital alone will not be able to cover the cost of Europe’s investment needs. This finding has since been echoed in places as prominent as the Draghi report. So, where do we go from here and how can we tackle these financial challenges? We continued our conversation with Finance Watch’s chief economist, Thierry Philipponnat, on possible ways out of Europe’s investment crisis.

AK EUROPA: The Capital Markets Union is often presented as a crucial step for the EU’s financial future. Yet, your report suggests that even its full implementation may fall short of expectations. Could you elaborate on your findings?

Philipponnat: It all started because we heard so many high-level EU leaders say that, as we generally have sufficient investment capital in the EU, we only needed to complete the Capital Markets Union, and if we did that, the job would be done. The basic assumption for our report was that the Capital Markets Union would be successfully completed, which we know we are very far away from. Does that mean that we have solved the problem, that we have found all the money that we need? The conclusion of our report is that in the best-case scenario, only a third of the money needed can come from capital markets for one very simple reason: private money will only come if the return is high enough to cover the risk assessed when the investment is made. No adequate return, no private money.

AK EUROPA: Assuming we face a significant shortfall in total investment, what consequences might this have for the EU?

PHILIPPONNAT: We need the money to build the indispensable infrastructure we need to adapt to climate change, for instance, to adapt to rising ocean levels. The European Environment Agency estimates that rising sea levels will cost the EU economy 1 trillion euros per annum, that's 6% of EU GDP. The impact of climate change on GDP will be huge. We need to invest in infrastructure to protect the EU economy from this risk. These investments, as essential as they are, will not be profitable because they will not generate cash flows. So, private money won’t come. The alternative would be that in 20 or 30 years’ time, the EU’s GDP would be 6% lower just because of rising sea levels. A year ago, we published a report called Finance in a hot house world, which estimated that the negative economic impact of climate change could be between 30% and 50% by 2070. This is a nightmare, not only from a human and social standpoint, but also in terms of public revenues. We need to invest, and the CMU can be part of the solution, but we need to find the remaining two-thirds of the money we need from the public purse.

AK EUROPA: You mention public funding as essential. How can we mobilise these public funds?

PHILIPPONNAT: Our rules governing public money are not adequate today. In our report we suggest three possible technical solutions. We have to push and say, hey, we don't have a choice. We have to adapt to this world that is changing so dramatically and so quickly. The first technical solution is to change the rules of the Stability and Growth Pact, the SGP rules. We know it's a very difficult debate, but these rules are absurd. There's no science behind them, it’s just a snapshot of the state of EU finances 35 years ago. At that time, the EU average in terms of debt was 56%, so they went for a 60% limit. France was running a public deficit of 2.6%, so they opted for 3% to give themselves some latitude. If we continue to apply those rules, we will hit a brick wall. The second possible solution, and we're very pleased to see that the Draghi report mentions this, is the possibility to issue debt at EU level. This is also highly political. Three hours after the Draghi report was presented, Germany, Mr Lindner, made a statement saying that there’s no way we're going to borrow money at the EU level. The third technical possibility is monetary financing. We know that’s a big taboo today.

AK EUROPA: Why does monetary financing remain such a controversial topic in economic discussions?

PHILIPPONNAT: No one, certainly not us, is saying that monetary financing is always good under all circumstances. But the way monetary financing is completely banned in the treaties today makes no sense. First, monetary financing is nothing new. A century ago, when the UK was a superpower, it used monetary financing enormously. The United States have been using monetary financing systematically, especially during the war times. Even Germany used monetary financing in the 1980s. Second, it is not true that monetary financing is necessarily inflationary. Money creation by central banks has been enormous over the past 35 years to support financial markets. But the inflation we've seen for the last 3-4 years is not a monetary phenomenon but a supply shock that came from Russia’s war on Ukraine, which has affected food and energy prices. The third thing is that we assume that we have competent central bankers that can be trusted with powerful financial tools.

We have to grow up, we're the only jurisdiction in the world where monetary financing is prohibited by law. Because of the prohibition of monetary financing of public deficits by central banks in the EU, we have what is called QE, quantitative easing. Private banks buy the debt on the primary market and then resell it to the European Central Bank on the secondary market. Effectively, this is “monetary financing” with extra steps. This practice creates enormous reserves for private banks and these reserves are remunerated. In 2023, the remuneration in the EU amounted to 140 billion euros or 1% of EU GDP. So, if we are going to create money, we might as well do it directly for the public budgets.

AK EUROPA: How realistic is it to promote these ideas to finance the massive investment needs in the face of often-proposed austerity and frugality measures?

PHILIPPONNAT: The frugal ones are not those who think they are. I think we are the frugal ones who realise that if we don't invest today, we will lose more tomorrow. If we do nothing, our deficits will get even worse. On adaptation to climate change, there are some fascinating studies that show that the return on investment for adaptation is about one to ten. If you invest one euro today, you will save 10 euros tomorrow. So, who's the frugal one? The one who doesn't want to invest a euro today, or the one who says, I want to save 10 euros for tomorrow?

The opinions and views expressed in this interview are those of Finance Watch and do not reflect the positions of AK. This article is the second part of a two-part interview. The first part of the interview covered the Capital Markets Union.

Further information
AK EUROPA: The EU has an enormous need for investment. How is it to be financed?
Finance Watch: Report - Europe’s coming investment crisis
AK EUROPA: The Draghi Report. Competitiveness at the centre of EU policy
Finance Watch: Finance Watch Challenges Draghi Report on Funding and Financial Stability
EEA: European Climate Risk Assessment