How to make the most of public investment? This question is critical in today’s tight fiscal environment. Given that sub-national governments in OECD countries carry out more than two-thirds of total capital investment, they have a crucial role to play in this area. In order to identify good practices for governance of public investment across levels of government, the report focuses on lessons that can be extracted from the management of stimulus packages during the global crisis in 2008-09. Indeed, these strategies were largely based on public investment, and sub-national governments played a key role in executing them.

The OECD Secretariat is particularly grateful to the Korea Institute of Public Finance (KIPF) for its support of the research that provided critical input to this report, in particular to Mr. Junghun Kim, Director of Fiscal Research, and Chair of the OECD Network on Fiscal Relations across Levels of Government. The OECD is also grateful to the delegates of the Territorial Development Policy Committee (TDPC) for their rigorous feedback on the initial drafts. The draft report was discussed at the TDPC Committee meeting in December 2010. Updates and fact checks by national delegations were received in the first quarter of 2011.

OECD member countries and regions currently face a narrow path to long-term growth. As stimulus packages are phased out, the priority of many OECD member countries is to restore fiscal sustainability. In 2011, gross government debt is expected to exceed 100% of GDP in the OECD area, with some countries moving well beyond this figure. After the stimulation period of 2008-09, public investment is now a target of cuts in many countries and regions, and seems in some cases to be used as the adjustment variable. Faced with the challenge of supporting growth in such a tight fiscal environment, national and sub-national governments face the imperative of “doing better with less.”

Given that sub-national governments in OECD countries carry out more than two-thirds of total capital investment, they have played a key role in executing national stimulus packages during the global crisis. The effectiveness of recovery strategies based on public investment thus depends largely on the arrangements between levels of government to design and implement the investment mix, in particular to bridge the policy and financial gaps across levels of government, facilitate public-private co-operation and enhance transparency and accountability in the use of funding at all levels. Part I of the report highlights good practices and lessons learned, focusing more extensively on country examples developed in the second part of the report, i.e. Australia, Canada, France, Germany, Korea, Spain, Sweden and the United States. As stimulus packages are phased out, many countries have moved toward fiscal consolidation and public investment is particularly targeted as an adjustment variable. Just as co-ordination between levels of government was important to implement recovery measures, multi-level governance arrangements and place-based approaches are necessary to better prioritise reduced public investment and make the most of it.

The Australian economy weathered the crisis better than other economies in the OECD area. Australian GDP grew by 2.41% in 2008 and 1.24% in 2009, at a time when most other OECD economies were going through a deep recession. GDP growth was 2.6% in 2010 and is expected to reach 3.5% in 2011 (Economist Intelligence Unit, 2010). Yet, some regions in Australia, especially those with a focus on mining, tourism and manufacturing, seem to have suffered disproportionately from the crisis.1 Australia’s overall very robust position was owed to a comparatively less exposed banking sector, the government’s fiscal surplus and swiftly introduced stimulus measures, the Reserve Bank of Australia’s monetary response as well as China’s continued demand for Australian commodities.

Due to a sounder banking system, a less-leveraged corporate sector and strong public finances, and significant monetary and fiscal policy stimulus, the Canadian economy weathered the global financial crisis relatively well. The robustness of the Canadian banking sector reflected a conservative risk culture reinforced by effective prudential supervision. Canadian banks were better capitalised and less leveraged than their international peers and mainly engaged in retail banking as opposed to investment activities, all of which are characteristics shared by banks that emerged relatively unscathed elsewhere in the OECD. Even though official liquidity support was available, Canadian banks maintained their ability to raise capital from the markets and did not tap available public borrowing guarantees or require expansion of deposit insurance limits (OECD, 2010).

Due to a sounder banking system, a less-leveraged corporate sector and strong public finances, and significant monetary and fiscal policy stimulus, the Canadian economy weathered the global financial crisis relatively well. The robustness of the Canadian banking sector reflected a conservative risk culture reinforced by effective prudential supervision. Canadian banks were better capitalised and less leveraged than their international peers and mainly engaged in retail banking as opposed to investment activities, all of which are characteristics shared by banks that emerged relatively unscathed elsewhere in the OECD. Even though official liquidity support was available, Canadian banks maintained their ability to raise capital from the markets and did not tap available public borrowing guarantees or require expansion of deposit insurance limits (OECD, 2010).

Germany’s export-reliant economy has been hit hard by the global financial crisis. With the collapse of global demand real GDP fell by more than 6.5%1 from the beginning of 2008 until the second quarter of 2009 (OECD, 2010). The impact of the global financial crisis varied across regions. In 2008 GDP fell by 7.2% in the western Länder and by only 4.5% in the eastern Länder. The largest downturns occurred in those Länder with a large share in export-oriented manufacturing such as Baden-Württemberg. The crisis in the real economy, which was almost exclusively due to a decline in international trade, was accompanied by a severe banking crisis. German banks which had heavily invested in the US housing market required substantial government intervention.

As an export-oriented country with an open capital account, Korea has been severely hit by the global financial crisis. The decline in exports was particularly sharp given Korea’s concentration on medium and high-technology products, which are very cyclically sensitive. Korea’s GDP decreased by 17% (at an annual rate) in the fourth quarter of 2008, more than double the average drop of GDP in OECD member countries (OECD, 2010a: 22). However, it should be mentioned that the Korean economy was already slowing prior to the intensification of the global financial crisis in September 2008, reflecting the US recession that had begun in December 2007, rising oil prices and the impact of tighter monetary policy.

Spain experienced a period of sustained economic growth before the global financial crisis hit in the second half of 2008. Spanish GDP declined by 3.6% in 2009 and was expected to contract by another 0.5% in 2010. With negative growth rates throughout 2010, the economic downturn in Spain will be longer than in most other OECD member countries (OECD, 2010).

The decline in international demand hit Sweden’s export-oriented economy particularly hard. Swedish GDP decreased by 0.5% in the second half of 2008 and by 4.7% in 2009 before recovering in 2010. Swedish GDP was expected to grow by 2.6% in 2010, but with fiscal policy in neighbouring countries tightening, it is expected to slow down to 1.6% in 2011 (Economist Intelligence Unit, 2010). Unlike the Swedish banking crisis of the 1990’s, which had its origin in the collapse of domestic real estate prices, the recent crisis was mainly caused by increased exposure to international markets (Öberg, 2009). Swedish banks had accumulated substantial buffers during the profitable years preceding the crisis and thus weathered the financial turmoil relatively well compared to other countries. Nevertheless, they still experienced several funding problems and required liquidity assistance by the Swedish Government.

The 2008-09 financial crisis and recession inflicted considerable damage to the US economy – most notably a significant tightening of credit and the loss of one-quarter of household net worth between the middle of 2007 and early 2009 (OECD, 2010a). The US has lost more than 8 million jobs since the beginning of the crisis; the unemployment rate had risen to 10.1% by the end of 2009. Most states have suffered significant job losses. According to the analysis “Geography of a Recession” published in the New York Times, job losses have been most severe in areas that had experienced a big boom in housing, those that largely depend on manufacturing and those that already had the highest unemployment rates before the crisis (New York Times, 2010). H However, the economic recovery in the United States from arguably the most significant recession since the Great Depression of the 1930’s is underway, amid substantial economic stimulus, but uncertainty remained high in mid-2010 on the pace of recovery (OECD, 2010a).