What drives investments in EU states? Drawing on a new paper, Mariarosaria Comunale presents an analysis of investments in Lithuania, using a broad set of possible drivers, including EU funds and uncertainty

Comunale, Mariarosaria

English

LSE Research Online

Measuring	the	impact	of	EU	funding	and	uncertaintyon	investments	in	LithuaniaWhat	drives	investments	in	EU	states?	Drawing	on	a	new	paper,	Mariarosaria	Comunale	presents	an	analysis	ofinvestments	in	Lithuania,	using	a	broad	set	of	possible	drivers,	including	EU	funds	and	uncertainty.Before	the	Covid-19	outbreak,	business	investments	had	almost	returned	to	pre-crisis	levels	in	the	euro	area,	withsome	differences	across	countries.	In	Lithuania,	investments	were	also	expected	to	be	buoyant,	given	the	need	formodernisation	and	automation,	as	well	as	improvements	in	the	use	of	EU	funds.	Investment	growth	accelerated	toan	average	of	7.7%	in	2017-2019	(see	Figure	1).	The	most	important	contribution	to	this	came	from	businessinvestment,	while	public	investment	had	slightly	more	volatile	growth	rates	and	generally	relied	more	on	EU	funds.Last	year,	more	innovation-oriented	investments	gained	momentum	and	they	now	represent	10%	of	totalinvestments	in	the	country.Figure	1:	year-on-year	growth	rates	in	investmentsSource:	Author’s	calculations	based	on	Eurostat	and	Bank	of	Lithuania	data.In	a	recent	paper,	I	looked	specifically	at	Lithuania’s	investment	performance	for	business,	government,	and	othertypes	of	investments,	including	Information	and	Communication	Technology	(ICT)	and	Intellectual	PropertyProducts	(IPP).	The	aim	was	to	try	to	disentangle	the	possible	drivers	and	effects	of	shocks.	A	deeperunderstanding	of	ICT	and	IPP	investments	and	their	main	drivers	can	also	help	policy-makers	decide	what	to	targetto	increase	these	investments,	thus	contributing	to	their	countries’	further	development	towards	a	more	innovativeand	modern	economy	(Lithuania	still	ranks	40th	in	the	Global	Innovation	Index	as	of	2020).I	made	use	of	a	common	framework	across	categories,	namely	a	Bayesian	VAR	model	with	data	from	the	firstquarter	of	1997	to	the	fourth	quarter	of	2019,	in	order	to	draw	meaningful	comparisons.	In	the	set	of	drivers,	Iincluded	some	specific	ad	hoc	factors	for	Lithuania,	such	as	the	amount	of	EU	funding	received	since	joining	the	EUand	a	measure	of	macro-financial	uncertainty	provided	by	Yannis	Largent	and	Arne	Gieseck,	which	reflects	bothinternational	and	domestic	uncertainty.As	other	possible	drivers,	I	included	foreign	demand,	a	broad	index	of	Real	Effective	Exchange	Rate	(REER)	totake	into	account	price	competitiveness,	domestic	private	consumption,	gross	operating	surplus	(as	a	proxy	forprofits),	credit	impulse	(based	on	loans	to	non-financial	corporations)	and	real	lending	rates	to	non-financialcorporations.	I	included	two	dummy	variables:	for	2009	as	a	shift	due	to	the	global	financial	crisis	and	co-financing,and	a	dummy	for	2016	due	to	a	new	EU	funds	programme.Business	and	public	investmentsLSE European Politics and Policy (EUROPP) Blog: Measuring the impact of EU funding and uncertainty on investments in Lithuania Page 1 of 3		Date originally posted: 2021-01-05Permalink: https://blogs.lse.ac.uk/europpblog/2021/01/05/measuring-the-impact-of-eu-funding-and-uncertainty-on-investments-in-lithuania/Blog homepage: https://blogs.lse.ac.uk/europpblog/The	outcomes	of	the	historical	decompositions	of	total	investments	were	mostly	in	line	with	the	literature	as	I	foundkey	roles	for	demand	side	factors	and	uncertainty.	I	did	see	some	crucial	differences	across	types,	however,	asthey	are	indeed	quite	heterogeneous	in	terms	of	incentives,	decision	making	and	financing	sources.Business	investments	are	very	much	linked	to	the	conditions	of	demand-side	factors	(either	domestic	or	foreign)and	uncertainty.	I	did	not	find	very	robust	results	for	more	supply-related	factors.	EU	funds	do	feed	investmentsover	time,	but	I	see	a	crowding-out	following	a	shock	in	the	short	run	(Figure	2).	There	is	a	specific	accountingcharacteristic	of	EU	funds	which	may	affect	our	results:	EU	funds	are	accounted	in	a	cash	flow	way	(all	together	atonce),	while	investments	are	more	continuous	and	distributed	over	time;	therefore,	the	periods	over	which	they	areaccounted	are	different.	At	quarterly	frequency,	this	issue	can	be	significant.	Secondly,	the	projects	can	be	co-financed	by	Lithuanian	receivers,	for	an	amount	which	changes	over	time.Figure	2:	Impulse	responses	of	business	and	government	investments	to	a	shock	in	EU	fundsNote:	The	shock	is	one	standard	deviation.	The	confidence	bands	are	at	68%.EU	funds	are	mainly	directed	toward	government	investments.	I	did	find	a	positive	reaction,	albeit	small,	in	relationto	EU	funding	shocks.	There	is	also	a	pro-cyclicality	in	government	investments	and	a	positive	correlation	withbusiness	investments.	This	“crowd	in”	process	may	take	place	through	direct	investments	in	the	private	domain	andthe	direct	encouragement	of	certain	types	of	private	investment	that	are	more	productive.	In	addition	to	this	directeffect	of	EU	funds	on	public	investments,	there	is	also	an	indirect	effect	via	the	Real	Effective	Exchange	Rates.	Anincrease	in	EU	funds	makes	the	country	richer	via	a	boost	in	demand,	then	increasing	inflation	and	ultimatelypushing	the	Real	Effective	Exchange	Rate	up.	Therefore,	both	government	investments	and	competitiveness	seemto	have	a	degree	of	synchronisation	with	the	business	cycle.Innovative	investments	vs	traditional	categoriesThere	are	some	major	differences	between	innovative	categories.	ICT	equipment	is	more	linked	to	traditional	typesof	investments	as	it	is	a	sub-category	of	machinery.	IPPs	include	rather	intangible	assets	(computer	software,databases,	and	entertainment,	literary	and	artistic	originals)	and	a	general	category	of	research	and	developmentand	green	economy	projects.Uncertainty	shocks	seem	to	matter	positively	only	for	IPPs,	suggesting	more	risk-prone	types	of	investments(Figure	3).	When	uncertainty	is	higher,	investors	can	be	driven	to	safer	assets	and/or	to	more	cutting-edgeinvestments.	In	Lithuania,	it	seems	rather	the	latter,	with	IPP	investments	benefitting	from	an	increase	in	macro-financial	uncertainty.Figure	3:	Impulse	responses	of	innovative	investments	to	a	shock	in	uncertaintyLSE European Politics and Policy (EUROPP) Blog: Measuring the impact of EU funding and uncertainty on investments in Lithuania Page 2 of 3		Date originally posted: 2021-01-05Permalink: https://blogs.lse.ac.uk/europpblog/2021/01/05/measuring-the-impact-of-eu-funding-and-uncertainty-on-investments-in-lithuania/Blog homepage: https://blogs.lse.ac.uk/europpblog/Note:	The	shock	is	one	standard	deviation.	The	confidence	bands	are	at	68%.EU	funds	contribute	positively	to	both	types;	however,	for	ICT,	the	effect	is	very	small	and	seen	in	the	medium	run,while	IPPs	show	a	larger	and	more	significant	positive	response	in	the	short	to	medium-run	–	up	to	a	year	and	ahalf	(Figure	4).	This	is	also	in	line	with	the	rationale	of	the	recovery	plan,	for	example,	which	aims	for	a	quickpositive	impact.	In	addition,	the	IPP	investments	may	benefit	even	more	from	a	positive	shock	in	EU	funds,	as	thereare	several	programmes	for	direct	funding,	in	the	form	of	grants	or	contracts.Figure	4:	Impulse	responses	of	innovative	investments	to	a	shock	in	EU	fundsNote:	The	shock	is	one	standard	deviation.	The	confidence	bands	are	at	68%.Ultimately,	as	for	more	traditional	categories,	uncertainty	and	demand	factors	–	alongside	profits	–	are	the	mostimportant	drivers.	As	for	roads,	bridges	and	infrastructures	(government-related	construction	investments),	EUfunding	is	definitely	an	important	positive	driver.	This	type	of	construction,	as	well	as	dwellings	and	transportation,	islinked	to	EU	cohesion	funding.	For	instance,	there	is	an	ongoing	major	EU-funded	project,	Rail	Baltica,	connectingthe	Baltics	with	the	European	rail	network.Note:	This	article	gives	the	views	of	the	author,	not	the	official	views	of	the	Bank	of	Lithuania,	the	ECB,	theEurosystem,	EUROPP	–	European	Politics	and	Policy	or	the	London	School	of	Economics.	Featured	image:	Bankof	Lithuania	headquarters	/	Credit:	Pofka	(CC	BY-SA	4.0)LSE European Politics and Policy (EUROPP) Blog: Measuring the impact of EU funding and uncertainty on investments in Lithuania Page 3 of 3		Date originally posted: 2021-01-05Permalink: https://blogs.lse.ac.uk/europpblog/2021/01/05/measuring-the-impact-of-eu-funding-and-uncertainty-on-investments-in-lithuania/Blog homepage: https://blogs.lse.ac.uk/europpblog/

Measuring the impact of EU funding and uncertainty on investments in Lithuania

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Measuring the impact of EU funding and uncertainty on investments in Lithuania

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