BRUSSELS (Reuters) - Slowly but surely, the European Union is shifting its message on promoting economic growth and is coming to the realization that it may have been looking for it in the wrong place.
The question is whether the bloc can come up with a strategy that convinces skeptical financial markets while keeping debt on a downward path.
For many months, the mantra has been that struggling euro zone countries must reduce budget deficits and carry out deep structural reforms - to labor markets, pension systems and via privatizations - to boost competition and stimulate growth.
The problem is that cutting spending and overhauling economies when they are already contracting tends to create a downward spiral, with the slowdown deepening and deficits becoming ever harder to reduce as a proportion of output.
What is more, the structural reforms EU policymakers are demanding - and which the likes of Italy, Spain, Greece and Portugal are battling to implement - can take years to deliver a growth benefit, while in the short-run they tend to lead to social and political upheaval.
What the EU needs instead, economists and many policymakers agree, are measures that can stimulate growth more immediately in a region responsible for a fifth of global output.
As one EU official responsible for advising leaders on how to combat the crisis succinctly put it: "Enough of the debt fetishism, it's time for a proper stimulus."
Nobel-prize winning economist Joseph Stiglitz added his voice to the debate last week, calling Europe's debt consolidation strategy "suicidal" and pointing out that a pure austerity program had never restored health.
During a debate in Vienna, he urged wealthier EU countries such as Germany to boost investment in infrastructure, education and technology, which could deliver returns much greater than the cost of capital.
"I hope ... the debate will be what are the things we can do to promote growth rather than how do we strangle each other together," he said.
A focus on investment is attractive. While Italy was left unscathed after deferring its balanced budget goal by a year, the punishment meted out to Spain by the bond market, driving its borrowing costs higher since it raised its 2012 deficit target, shows significant loosening of fiscal policy is fraught with danger.
"Even if governments were seriously contemplating significantly relaxing fiscal policy, such a change of tack would be counter-productive," said Deutsche Bank analysts Mark Wall and Gilles Moec.
In recent days the bare bones of a strategy for stimulating growth have started to come together, with the intention of launching it at an EU leaders' summit in late June.
The main focus is on increasing the capital of the European Investment Bank, the EU's long-term lending arm, to allow it to make bigger investments in infrastructure projects and related areas across the EU's 27 member countries.
The EIB financed EU projects worth around 70 billion euros in 2010, with the lending made on the basis of relatively small paid-in capital. By boosting the paid-in capital by only 10 billion euros ($13.2 billion), the bank's lending could be greatly leveraged, delivering extra investment of up to 180 billion euros.
Olli Rehn, the European commissioner for economic and monetary affairs, set out a proposal along those lines to EU member states earlier this month and the idea will be discussed by ministers in mid-May. Officials say the EIB, which has resisted the move in the past, is now prepared to go along.
"I made a call on EU member states to increase the capital of the EIB, which would be the most convincing way of providing funding for necessary investment in infrastructure and innovation in Europe," Rehn told Reuters in a recent interview.
"We don't have the luxury of time until the crisis is over. We need additional capital for the EIB for investment now," he said.
Such an initiative could help revive growth at the margins but it does not look like a game changer.
Put it against the more than 1 trillion euros created by the European Central Bank - which may have averted a credit crunch but has done little to revive a euro zone economy poised to slide back into recession - and the numbers look small.
"Complementing austerity with some federally-funded investment schemes is becoming consensual, but we don't expect any quick sizeable effect on growth," the Deutsche Bank analysts said.
At the same time, the European Commission, the EU's executive, is exploring ways of redirecting EU structural funds, which are paid to poorer member states to help them improve their infrastructure, to deliver a quicker growth lift.
The EU's long-term budget set aside nearly 350 billion euros for structural and cohesion funds between 2007-2013, but only a fraction of that - a few billion - is likely to be redirected under the Commission's plan, which is still taking shape.
The Commission on Monday sought to play down what it called "highly speculative figures" about how much could be set aside for infrastructure investment, and said it remained focused on deficit reduction at the same time.
"We are not talking about an alternative to fiscal consolidation," Commission spokeswoman Pia Ahrenkilde-Hansen told reporters. "The issue is not either fiscal consolidation or growth, we need both."
Politically, there is no prospect of giving euro zone members much leeway on debt just as new fiscal rules to ensure deficits are kept to a common minimum are being established.
"The fiscal pact is likely to remain broadly intact but, the path of deficit reduction is likely to be eased a little," said David Mackie, economist at JPMorgan in London.
He too predicted an expanded role for the European Investment Bank and "more aggressive" use of EU structural funds.
While it remains to be seen what EU leaders can come up with - and there is little at this stage to buoy financial markets to - there is certainly pressure to shift the rhetoric towards a more pro-growth agenda.
In the past week, governments in the Netherlands and Romania added to the long list of administrations that have been toppled while pursuing austerity drives.
With Francois Hollande, the growth-focused Socialist challenger, expected to win the run-off against Nicolas Sarkozy in the French presidential election on May 6, the moment is ripe for leaders to shift tack.
European Central Bank President Mario Draghi has talked about a "growth compact" and at the weekend, German Chancellor Angela Merkel backed a boost in EIB capital, although she also reiterated the need for fiscal consolidation and structural reforms.
Herman Van Rompuy, the president of the European Council and chairman of EU summits, wrote to EU leaders last week urging them to find common ground on a range of issues that could offer an economic stimulus, including energy efficiency and a single European patent, an agreement blocked for nearly 30 years.
"The emphasis should now shift increasingly to prioritizing measures that can boost growth and jobs and a return to sustainable growth," he wrote, adding that it may be necessary to hold an informal summit in the coming weeks to maintain momentum between now and the next planned summit on June 28-29.
Officials indicate that extra gathering is likely to be held at the very end of May or the first day of June, leaving leaders four weeks to flesh out their growth-boosting ideas.
Writing by Luke Baker, editing by Mike Peacock