5. Public Investment and Structural Transformation in Spain

The fall in public investment from 2010 onwards was notable both for productive infrastructures (transport, energy, and urban infrastructures) and for social infrastructures (education, health, or social services). They fell sharply from 2010 to 2014 and stagnated considerably in subsequent years (Fig. 5.3).

Moreover, starting in 2010, Spain entered a period in which the public sector’s net fixed capital formation—that is, investment once capital consumption has been subtracted—was negative for a whole decade and did not even cover public capital’s depreciation (Fig. 5.4).

The turning point in this anaemic evolution of Spanish public investment is not linked to the recovery of economic growth. In fact, the economy returned to solid growth between 2015 and 2019, and yet public investment remained stagnated as national authorities tried to rapidly reduce the public deficit by adjusting public investment downward.

This evolution of the public capital stock after the Great Recession has led to a “lost decade” in Spain in terms of new infrastructure development. As shown in Figure 5.6, Spain’s public capital stock per capita moved away from the Eurozone average after the Great Recession due to the aforementioned short-circuit in public investment. In fact, between 2010 and 2019, the scarce investment flows have not been sufficient to maintain existing infrastructure in good condition, with the consequent loss of public capital and the aging of these infrastructures.

Looking at the evolution of public capital stock by asset types, we can observe a remarkable growth in all kinds of infrastructures up until the financial crisis (Fig. 5.7). Between 1995 and 2010, the share of transport infrastructure, particularly roads and railways, increased. Although on a smaller scale, the growth of airport infrastructure was also notable in Spain during these years. From 2010 onwards, however, hydraulic infrastructure and airports were particularly affected by the impossibility of covering the depreciation of their value.

A consequence of the slow investment pace and depreciation of the public capital stock during 2010–2019 has been the progressive aging of assets. In 2007, the average age of Spanish infrastructure was very low compared to neighbouring countries. However, after a decade of not covering capital depreciation, this age increased sharply: assets older than twenty years represented 11% of total public infrastructure in 2007, having risen to 22.5% in 2016 (Fundación BBVA-IVIE 2019). If this slow pace of investment had been maintained, the percentage of infrastructure over twenty years old in 2030 would exceed 50% in the case of road (51%), rail (52.5%), and water (71%) infrastructure.

The inability of the Spanish economy to ensure the renewal of the capital stock during the decade following the financial crisis constitutes a very worrying dynamic, given that it could undermine the medium-term evolution of productivity and future growth. But at the same time, the Spanish experience should make us reconsider the need to thoroughly assess the costs and returns of certain inefficient infrastructure investments, such as some regional or local airports or certain road infrastructures. In the wake of this experience, there is a clear consensus on the need to prioritize those investments that are capable of driving the structural transformations that the country needs: for example, investments that lead the energy transition and allow Spain to change its competitiveness model from one based on low wages to another (more promising) one based on attracting industry thanks to clean, safe, and cheap energy.

5.4 Recovery, Transformation, and Resilience Plan: Impact in Spain

It is very unusual for the same generation to experience two major economic crises in a short period and thus be able to compare them. Nevertheless, this happened precisely with the Global Financial Crisis of 2008–2013 and the COVID-19 pandemic, when completely different economic policy measures were applied. Moreover, public investment is one of the areas where we can best see this change in economic policy strategy.

The response to the 2007 Global Financial Crisis was fiscal austerity, with significant cuts in public spending and investment. However, the response to the COVID-19 crisis was a stark contrast, in the form of an ambitious fiscal expansion program. This program, which includes more than €800 billion in loans and grants until 2026 to the different EU countries (€160 billion to Spain), has marked a shift in the use of public investment as an “adjustment variable” in the face of a crisis.

Figure 5.8 compares the pattern of public investment during the 2007 crisis and the COVID-19 pandemic. Between 2007 and 2011, public investment contracted by 21.3%, with public education (down 40%) and social services (cut by 32%) being the most affected components. The response to the COVID-19 crisis was very different. Not only did total investment not fall, but it grew by 19.2%, and so did its various components: education (41%), public health (29%) and social services (60%).

Spain is one of the countries with the largest allocation of Next Generation EU funds. Specifically, it has approximately €77 billion in transfers and up to €83 billion in loans, resources that have already been partially channelled into the economy during 2021–2023. This European funding has helped Spain to incorporate in its General State Budgets for 2021, 2022, and 2023 an average of around €30 billion per year in new public investment, making it one of the EU countries that is implementing the Recovery, Transformation, and Resilience Plan most rapidly. This implementation has been designed in two phases: a first one during the three-year period 2021–2023, focused on achieving a solid counter-cyclical impact, and a second one in 2023–2026, aimed at strengthening and completing the highest impact projects through the mobilization of loans.

The economic impact of this investment program on Spanish economic growth is noteworthy. As is well known, an increase in public investment can positively affect economic growth for two reasons. First, it has a positive short-term impact on aggregate demand, increasing private investment, employment, and household consumption. Second, public investment also has a supply-side effect, boosting—as mentioned above—the economy’s capital stock and, consequently, its efficiency and productive capacity in the medium and long term.

Empirical literature consistently highlights that the value of fiscal multipliers can significantly fluctuate depending on a variety of factors, such as the phase of the economic cycle, the level of public debt, the exchange rate regime and the degree of economic openness (Fatas and Mihov 2009; Gechert and Rannenberg 2014). However, there is a strong consensus that public investment’s short- and medium-term multipliers, particularly in downturns, are notably high and almost always greater than 1 (IMF 2014; Auerbach and Gorodnichenko 2012).

This multiplier effect has been empirically tested in the case of the Spanish economy over the last three years. The Ministry of Economy estimates that over 2021–2023, the impact of the public investment program on GDP was 0.3% in 2021, 1.2% in 2022, and 1.4% in 2023, as we can see in Figure 5.9. These estimates are in line with the analysis of the Bank of Spain (Fernández Cerezo et al. 2023). In fact, economic authorities estimate that the economy recovered its pre-COVID-19 GDP level in 2022, two years ahead of schedule, thanks to the impact of the Recovery Plan. And they further expect the positive impact of public investment on GDP to remain high for the next three years, with an average annual impact of 1.2 % until 2026.

The contribution of each type of investment to economic growth is certainly variable. As shown in Figure 5.10, sub-programs related to sustainable infrastructure, urban and rural development, and digitalization lead the impact of investment on GDP, concentrating 66% of this impact. Within these sub-programs, projects for the deployment of high-speed networks and other railway infrastructures, the MOVES plan (for electric mobility), and investment in broadband networks (digitalization) are particularly important.

These investments are followed by the science and health sub-program, which accounts for 11% of the total impact of the plan to date. Within this sub-program, investments related to health infrastructures, research projects in personalized precision medicine and the development of the Artificial Intelligence strategy stand out. In addition, the important process of modernization and digitization of public administrations contributes more than 7% of the total impact of investments on GDP.

Finally, investments directly related to the energy transition sub-program, as well as the launching of a new vocational training system, are of particular importance.

5.5 Conclusions

The challenges ahead for the European Union are enormous, and member states need to take firm steps to ensure the green transition, the digitalization of the economy and the strengthening of industry while guaranteeing social cohesion. To meet the European Commission’s own investment targets, the European Central Bank’s Fiscal Policies Division recently estimated (Bouabdallah et al. 2024) that EU countries need to leverage additional public investment above what is already being implemented under the Next Generation EU funds. Specifically, they estimate the need to mobilize more than €900 billion for the whole of the EU during the period 2025–2031. Assuming that Spain takes up 10% of this investment (equivalent to the share of its GDP in the Eurozone), this would imply the need for an additional increase of almost €13 billion per year for the period 2025–2031, i.e. an increase of close to 1% of Spanish GDP in net public investment in the coming years (Fig. 5.11). The recent Draghi report on European competitiveness sets even more ambitious investment targets.

Like the rest of its European partners, the critical debate facing the Spanish economy is evident: to what extent can these crucial investment needs be reconciled with the new fiscal rules?

Over the last few decades, numerous voices—from academia, governments and the business world—have questioned the Stability and Growth Pact due to its fiscal rigidity, its pro-cyclical nature and its inability to cope with recessions and economic crises, as well as its continuous contractionary effect on public investment. In March 2020, the European Commission activated its “general escape clause”, which allowed the pandemic to be dealt with swiftly and flexibly. It also contributed to highlighting the need to reform the fiscal rules. This reform took place in the first half of 2024 and was approved by the European Parliament in April this year.

However, the new fiscal rules, despite being made more flexible in some aspects, still maintain a general orientation marked by the need to meet strict fiscal consolidation thresholds and have not incorporated any kind of Golden Rule to protect public investment. Therefore, there is a relevant threat of short-circuiting the recovery process of public investment in Spain and other countries, depending on how these new fiscal rules are implemented in the following year.

Last June, the European Commission opened the excessive deficit procedure for France, Italy, and five other EU countries. Spain has not been included in this procedure. However, the new fiscal rules establish that countries will be obliged to reduce their structural deficit by 0.4% per year, not only until the observed deficit reaches 3%, but also until the structural deficit reaches 1.5% to create a fiscal buffer for times of adversity. This implies that fiscal consolidation will have to continue over the coming years, also in Spain.

How should this fiscal consolidation be understood? The Directorate-General for Economic and Financial Affairs of the European Commission recently published “The Implications of Public Investment for Debt Sustainability” (Motyovszki et al. 2024: 1), which states that “without offsetting fiscal adjustments via the primary balance, a temporary increase in public investment implies a lasting increase in the debt-to-GDP ratio […] In other words, debt stabilization would require subsequently higher primary surpluses, implying that public investments must eventually be paid for by fiscal adjustments”.

In fact, according to Darvas et al. (2024), fiscal adjustments required under the new Stability and Growth Pact would be substantial for Spain: to achieve the intended structural primary balance objectives, the average annual fiscal adjustment would have to rise to 0.8% of GDP (in the case of a four-year adjustment period) and to 0.5% (in the case of a seven-year adjustment period).

The risk that this approach poses for public investment in countries like Spain is stark: the idea that a lasting increase in public investment is only feasible through continuous primary surpluses (probably sustained at the expense of public services) could undermine the current recovery of Spanish gross fixed capital formation, which has already been dragged down for a whole decade, as we have seen.

Moreover, this approach does not fit with recent empirical evidence from countries like Spain. We have already seen how fiscal consolidation in Spain was carried out during the Great Recession at the expense of public investment, which acted as an “adjustment variable” suffering massive cuttings. Paradoxically, this approach not only hindered effective fiscal policy but also damaged the very sustainability of public finances that it was intended to ensure, due to its contractionary effects on the economy (Labat-Moles and Summa 2023; Di Bucchianico 2019; Rosnick and Weibstrot 2015). However, over the last three years, Spain has adopted a very different approach to reducing deficit and debt over GDP ratios. Between 2020 and 2023, Spain has reduced them faster than was achieved in the 2010–2016 austerity period (Fig. 5.12). This has been possible through various tax reforms that have improved public revenues and, above all, due to economic growth, which has allowed the debt and deficit to be reabsorbed.

Obviously, the continuity of this growth is not independent of the fiscal policy pursued. As shown in Uxó et al. (2024), it is possible to design a fiscal policy strategy for Spain based on an expansion of public investment and an increase in public revenues (currently below the European average in the case of Spain).

This partially balanced budget expansion would allow the structural challenges of the Spanish economy to be faced, mobilizing more investment and reducing the unemployment rate while continuing to consolidate the public debt to GDP ratio. On the contrary, fiscal policies explicitly designed to reduce public deficit through freezing public expenditure will probably prove counterproductive.

Furthermore, and as we can see in Figure 5.12, the Spanish public deficit, excluding public gross fixed capital formation, is already nearly zero. Returning to the logic of public investment acting as the “adjustment variable” of fiscal consolidation and reducing this investment to ensure sustainable primary surpluses would be a policy mistake. It would reduce medium- and long-term economic growth potential, lower aggregate demand, and ultimately undermine fiscal sustainability itself.

References

Auerbach, A., and Y. Gorodnichenko (2012) “Fiscal Multipliers in Recession and Expansion”, NBER Working Paper 17447, National Bureau of Economic Research, Cambridge, Massachusetts.