New study: Europe needs public investment to achieve its geopolitical goals and revive its economy
13 October 2025
Without more public investment, the EU cannot become greener, more competitive or more resilient. Well-targeted public investment brings strong economic returns and can be financed – even through borrowing – without destabilising national budgets
image credit: unsplash.com/Eduard Delputte
Europe faces a dilemma. Under the EU’s fiscal rules, public debt should not exceed 60% of economic output (GDP), yet more than half of all euro area member states are currently above that threshold. The rules also stipulate that budget deficits must be capped at 3% of GDP, but many euro area countries are unlikely to meet that target this year.
At the same time, prominent economists warn that Europe urgently needs to spend far more to achieve its geopolitical objectives and to breathe new life into its faltering economy. Former European Central Bank President Mario Draghi estimates in his 2024 report that the continent faces an annual investment shortfall of between 4% and 5% of EU GDP, including in energy security, digital infrastructure and decarbonisation. But how can this gap be narrowed, given the pressure to implement fiscal consolidation?
Private and public investment
The answer lies partly in mobilising private investment, but also in boosting public investment. Whether this gap can be closed depends largely on how public funds are spent, according to a new study by the Vienna Institute for International Economic Studies (wiiw). The authors, Philipp Heimberger and Cara Dabrowski, estimated the trends and macroeconomic effects of public investment across the 27 EU member states since the year 2000. Their findings show that public investment – even when financed through borrowing – does not necessarily present a problem for strained public finances.
Investment vs consumption
The key issue is how the money is spent, whether it is used for government consumption or for productive investment. ‘If it’s for investment, then it can justifiably be financed by borrowing,’ says Philipp Heimberger, one of the study’s authors. Even credit-financed investment may not jeopardise debt sustainability, explains the economist: ‘Public investment has a multiplier of around 1.5. In other words, for every additional euro that the state invests, if the state invests one additional euro, real economic output rises by approximately 1.5 euros. For infrastructure investment, the multiplier may be even higher. Given the resulting boost to the economy, the public debt ratio does not have to rise.’
An investment with a high multiplier largely pays for itself over time through higher tax revenue, especially if it addresses genuine infrastructure needs. By contrast, government consumption has a fiscal multiplier of less than one – so much of its impact may rapidly dissipate.
Concerns that public investment could crowd out private investment are unfounded, the study finds. On the contrary, well-targeted public investment may be expected to crowd in additional private investment. ‘According to the Draghi report, the EU faces an annual investment gap of EUR 750bn to EUR 800bn,’ says Cara Dabrowski, co-author of the study. ‘While governments need not close that gap entirely on their own, additional public investment equivalent to around 1% of EU GDP would be both sensible and justified to achieve such strategic objectives as the green and digital transition.’ The challenge lies in achieving this without breaching fiscal rules.
Mobilising funds
Heimberger outlines several potential strategies. ‘For countries with limited fiscal space, one option is to boost national co-financing of EU funds, as this spending is excluded when the European Commission evaluates compliance with EU fiscal rules,’ he explains. Another approach would involve establishing a new European investment fund – modelled on the soon-to-expire COVID-19 recovery fund (the Recovery and Resilience Facility) – to support higher levels of public investment.
More fundamentally, Heimberger argues that public investment should be allowed to be credit-financed: ‘It would have made sense to generally exempt relevant investments from the new EU fiscal rules.’ European policy makers have allowed EU member countries to trigger the national escape clause to exempt additional military spending, but much of that falls under government consumption, rather than investment.
Governments could, in principle, reprioritise spending to create room for investment, but that would not necessarily be the best solution. As Heimberger cautions, when it comes to closing large investment gaps over an extended period, simply reallocating funds – for instance, from social spending to public investment – is neither realistic nor advisable.
Europe needs a policy shift
Simply forgoing investment is not an option either. Europe has relied heavily on foreign demand to fuel growth. The EU’s fiscal policy in the 2010s was unduly restrictive, suppressing domestic demand and cutting public investment; this contributed to the development of a major productivity gap compared to the US. Public investment figures for the 27 EU member states reflect that: net investment (gross investment minus depreciation) hovered at close to zero for several years.
Such a growth model is poorly suited to a world defined by geopolitical rivalry and resurgent protectionism, as exemplified by Donald Trump’s tariffs on all the US’s major trading partners and the slowdown in exports to China. ‘Europe should focus on developing domestic engines of growth,’ argues Heimberger. ‘Public investment can play a crucial role in this.’