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4 Factors determining real convergence

4.3 Investment

Investment the key to growth in candidate countries

Indicators of investment are a good barometer of the growth potential of an economy 1. (See Graphs A.10 and A.11 on investment, in annex) Investment (as measured by gross fixed capital formation) is higher in relation to GDP in the applicant countries than in current EU Member States - 25% of GDP as against 20% in 1998. It is essential for this differential to be maintained or even increased if the applicant countries are to achieve the high growth rates necessary to catch up with the EU economies. High investment per se is no guarantee of success - it must be well targeted and coupled with technical progress (see below) - but it is a necessary condition.

The level of investment, however, differs significantly between applicant countries. In the Czech Republic, Slovakia and Poland, investment is as high as 30% of GDP. By contrast, in the countries with the lowest levels of GDP per head, it is generally much less (only around 11% of GDP in Bulgaria in 1998).

In the Union, Portugal, the country with the second lowest level of GDP per head, has the highest investment in relation to GDP (28%), while in Spain and Greece, as well as Ireland, it is also well above the EU average. Sweden, on the other hand, with GDP per head around the EU average, has the lowest level (17% of GDP).

The Capital stock: lagging economies still have much catching up to do

In judging the effect of capital formation on economic performance, it is important to consider not just current investment flows, but also the accumulated stock of capital which these have built up over time.2 The data on this, however, involve a high degree of estimation and should be regarded as indicative only. Nevertheless, some interesting conclusions can be drawn.

The main observation is that more prosperous countries have a larger stock of capital than less prosperous ones. In the three cohesion countries, capital stock in 1999 is estimated at only EUR 33,000 per head as opposed to EUR54,000 in the EU as a whole and EUR 75- 80,000 in Denmark, Germany and Austria. (See Table A.19, in annex) and Graphs A.12-A13 on net and gross capital stock, in annex) The cohesion countries, therefore, have only 60% of the capital per head available in the EU as a whole.

Since the capital stock is built up over a great many years, it tends to change only slowly and is dominated by past investment. This is most clearly so for buildings, which can be used effectively for decades, though even machinery and equipment can often have a useful life of 10 years or more.

Nevertheless, because of the higher rate of investment, the gap between the cohesion countries and the rest of the EU is narrowing, if slowly - 10 years ago capital stock in the former averaged only 54% of that in the EU as a whole. However, while the cohesion countries are catching up in relative terms, in absolute terms they still spent less than the EU average on investment per head of population over the past decade - EUR 10,000 as opposed to EUR 13,000.

Investment in knowledge: the basis for long-term growth

While capital expenditure on physical assets is important, intangible investment in research and development, education and information technology is becoming even more important for economic development in the Union.

Growth over the long-term, therefore, is attributable not to just to an increase in the fixed capital stock, but more significantly to technical improvements which increase the efficiency with which capital - and labour - is used.3 Moreover, the information revolution means that investment in technological advance is likely to become even more important in the knowledge-based economy of the future.

It is, therefore, important to review the extent of investment in knowledge across the EU as well as in fixed assets. This gives rise to somewhat different conclusions, since many of the countries with below average rates of fixed investment are among the largest investors in technology. In particular, Sweden, with the lowest fixed investment rate in the EU, has the highest rate of investment in knowledge(see Graph 9 on investment in knowledge). France, the UK and Finland are similarly low investors in physical assets but high investors in knowledge.

On the other hand, the three cohesion countries, as well as Ireland, spend less than average on investment in knowledge. While their high rate of expenditure on fixed capital formation is closing the gap in their capital stock with the rest of the EU, their low investment in less tangible assets is not a secure basis for longer-term growth in a digital age.

  1. Gross fixed capital Formation is investment net of disposals. Gross refers to the fact that it does not take into account depreciation or consumption of capital. Fixed means that only investment which is used for more than a year is considered.
  2. Gross capital stock is calculated by taking by cumulating past investment and deducting the cumulated value of investment that has been retired. Net capital stock includes depreciation and is thus probably the better measure. Throughout this analysis investment stock is therefore defined as net capital stock, although the results are very similar if gross capital stock is used.>
  3. eg Abramovitz (1989) "Thinking about growth"

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