The EU needs to close a competitiveness gap and boost investment: What is the role of subnational governments and cohesion policy?

The EU needs to urgently boost its competitiveness and catch up with the global leaders in the green and digital transitions. According to former European Central Bank President Mario Draghi, this will require an “enormous amount of money in a relatively short time”.

The challenge is not just to find the money, but also to deliver that investment in a way that strengthens the European social model. We need to take into account the subnational dimensions in the design and management of this investment effort. 

Challenges and requirements of public investment 

Addressing these challenges will require both private and public investments. In order to boost private investment, regulatory and administrative reforms will be needed to support business creation, removing intra-EU barriers to trade and entrepreneurship, or levelling the playing field.  

For the public sector, this means delivering public goods that unlock private investment, while
co-funding private investments where there are strong social returns. But how do we identify these projects and make the most of this investment in a tight fiscal context for many
OECD countries? 

While investment programmes and policies can be designed and implemented by central governments, most public investments are actually shaped at the subnational level.

According to OECD data, on average 55% of public investment in OECD countries is managed by subnational governments. In some countries, this share can reach 70-90%. Subnational governments are not just responsible for delivering these investments, but also for designing a large share of these investments and steering private investment through levers over planning. And rightly so – subnational governments have better knowledge of local needs, conditions and markets, as well as better connections with local businesses and investors.  

At the national level, programmes designed by Ministries often fail to reap the benefits from synergies and complementarities across sectors at the local level.  This is especially true of investments in the climate and digital transitions, which must be guided by regional challenges and opportunities. Despite the need for some uniform features such as carbon pricing or common aspects like connectivity to electricity and internet grids, most public investment policies will need to be differentiated across cities, regions and territories to adapt to different geographical features, sector needs and resources. There is an implicit recognition of this in the fact that subnational governments are already trusted with 69% of climate relevant public investment across 33 OECD and EU countries. 

Subnational dynamics in public investment 

This simple fact explains why large stimulus plans implemented after the 2008 crisis did not have their expected macroeconomic impact across OECD countries. While central governments were trying to stimulate the economy, subnational governments were caught in a “scissors effect”, with reduced revenues and increased social expenditures. As a result, they were forced to cut public investment, offsetting national stimulus plans and resulting in a collapse rather than an increase in investment in the years after the crisis, especially in Europe.  

In 2008-09, the relative “failure” of recovery strategies was exacerbated by the fact that investment packages were poorly co-ordinated across sectors and local governments. In Spain, out of more than 1,000 projects, only six implied inter-municipal co-operation. The projects also tended to focus on short-term immediate needs: “shovel-ready” projects rather than long-term strategic investments. 

Designing effective investment policies 

It is important to draw the right lessons from such policy episodes. And one in particular stands out: an effective investment strategy at the national level needs to integrate a subnational perspective. 

Learning from experience, post-COVID recovery packages seem to have been better designed across OECD countries. Fiscal support helped to avert a fall in subnational public investment similar that which occurred after 2008.  

In the US, the Infrastructure Investment and Jobs Act (IIJA), the CHIPS and Science Act (CHIPS), and the Inflation Reduction Act (IRA), have all introduced a renewed place-based component to the post-COVID investment strategies. However, the EU Recovery and Resilience Fund (RRF) created in aftermath of COVID crisis is still designed in a sectoral way and lacks a coherent subnational approach. 

In the EU, Cohesion Policy has benefited from many successful experiments with place-based investment policies, guided by well-established mechanisms to co-ordinate activity across levels of government and sectors. While some of its delivery mechanisms can be further simplified, this unique policy tool should inform the evolution of other of EU policies, notably the RRF.  

Towards a comprehensive competitiveness strategy 

An EU Competitiveness strategy that embraces a place-based approach would also be in a better position to integrate different aspects of the European social model. Indeed, without such a model, there is a risk of aggravating spatial imbalances and affordability pressures. This risk is especially acute in investments in the green transition.

Lagging regions stand to benefit least from green jobs and lose most lose from the phasing out of polluting industries. This poses the risk of becoming part of a “second tier” Europe burning with resentment and opposition to climate policies such as carbon taxation.  

Summing-up, the recent productivity and GDP per capita gaps that have emerged vis-à-vis the US economy call for a bolder European competitiveness strategy. Large investments will be needed to close the gap. But these investments need to be well managed, and here Cohesion Policy offers a useful guide: a partnership effort between national and subnational governments, rooted in the European social model.   

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