Global imbalances - Global policies - Lorenzo Bini Smaghi
Central bank: ecb | Type: speech | Date: 2006-04-27

Global imbalances – Global policies

Speech by Lorenzo Bini Smaghi, Member of the Executive Board of the ECBInaugural address for the 253rd Academic Year of the Accademia dei GeorgofiliSalone dei Cinquecento, Palazzo Vecchio Florence, 27 April 2006

Mr Mayor, Mr President of the Academy, Academicians, distinguished guests, ladies and gentlemen,

It is an honour and a great pleasure for me – being myself from Florence – to open the proceedings for this academic year.

The word “global” appears twice in the title of my speech.

Although it is fashionable to use this word, it nevertheless describes the context in which economic policies and international economic developments should be examined nowadays.

In my address I intend to briefly describe the main features of the globalisation process that is shaping the world economy.

I will then examine how, in a context of increasing integration, agents’ behaviour and economic policies in place in different countries have led to growing economic and financial imbalances that do not seem sustainable indefinitely.

I will subsequently outline a number of possible scenarios for the adjustment of these imbalances, some of which would unfold more smoothly while others would entail greater turbulence for the real and financial economy.

The preferred scenario, which would allow the global economy to continue to grow at a measured pace, demands close coordination of economic policies both within individual countries and between the main economic areas.

However, the globalisation process makes policy coordination more complex as it requires a greater complementarity between the various fields of action.

In this context, Europe is not yet equipped to make the contribution to the governance of the global economy that it warranted by its relative weight in the global economy.

The globalisation of the economy

Globalisation has been progressing for some time.

In recent years it has accelerated, mainly due to two factors.

The first is the huge reduction in transaction costs, in particular transport costs, which has contributed to the mobility of goods, services, capital and labour.

If one only considers how sea freight from Hong Kong to the port of Rotterdam costs less than land freight over the next 100 km on the continent, it is easy to understand how world trade has risen from less than 20% of the gross world product in 1990 to nearly 30% in 2005.

The effects of integration have been felt also in financial markets.

In the same period, foreign direct investment grew from 8% to 22% of gross product.

The same has happened to portfolio investment.

It has become standard practice for portfolio managers to offer foreign equity and fixed income funds to their clients.

The second factor that has accelerated the process of globalisation is the acceptance of market economy principles by nearly all developing countries, from China to India, Latin America and many African countries.

The ideologies of the state-run economy have been abandoned and the rules of international competition are now widely accepted.

This phenomenon is often overlooked but it has helped to lift over 200 million people out of poverty over the last 20 years, according to a World Bank estimate.[1]

It even appears that market economy principles are more accepted in emerging countries, such as China, than in some European countries.

For example, a recent survey on acceptance of the market economy conducted by the University of Maryland found only 36% in favour in France, 59% in Italy and 65% in Germany.

There is greater acceptance in Nigeria, India, Korea, the Philippines and even China, with 74%.

The process of globalisation has been accompanied by strong growth of the world economy.

In the last three years the world product has grown at a rate of 4.7% per annum – the highest rate in 30 years for a period of this length.

All regions have experienced growth, including Africa where product per capita had fallen in the 1990s.

Globalisation makes every country and every economic agent smaller and more interdependent and in some ways more vulnerable to external shocks.

Even large economies, such as the United States, are significantly influenced by external events.

For example, recent experience has shown that the decisions of US savers and investors are influenced by choices made elsewhere in the world.

In this context, distortions in the allocation of resources in one part of the world produce distortions in others, setting off a chain reaction that ultimately affects all.

For example, the agricultural policy of Europe and the United States, which tends to hinder the growth of international trade in such products, leads other countries to subsidise the production of manufactured goods, with direct consequences for industrial countries.

Another example is the subsidies to energy consumption existing in some emerging countries, which foster global demand and, consequently, international prices, weakening incentives for a more efficient use of global resources.

In essence, globalisation means greater interdependence.

It also means that in order to optimise economic choices, agents must take account of the choices of others, including those living in other parts of the world.

This not only applies to individuals but also to companies, social partners, local authorities and governments.

Operating in a global reality requires a global awareness.

To be able to understand the problems of our economies and take the right decisions, we must first understand developments in other economies and how they may affect ours.

Globalisation and imbalances

Economic and financial imbalances

The global economy currently features a number of imbalances that are interrelated and partly fuel each other.

This is why they are called global imbalances.

I will focus on the economic and financial imbalances that international institutions are currently most concerned about, i.e. those arising from growth differentials and the behaviour of investors and savers across countries.

As long as they are sustainable, economic and financial imbalances are not necessarily undesirable.

They may in fact favour greater growth by facilitating the financing of higher consumption and investment, in particular through foreign capital.

In recent years imbalances between the main economic regions of the world have widened.

These trends are not sustainable.

An adjustment may be achieved through economic policy action or through market forces.

The way in which such an adjustment will take place will impact the development of the global economy in the coming years.

This issue is high on the agenda of every international economic policy meeting – not least the latest meeting of the International Monetary Fund (IMF).

In particular, the sustainability of the existing imbalances and the risk of disruptive adjustments are being intensively discussed.

Imbalances are mainly the result of developments and policies of three large economic areas.

The first is North America, which has a growing population, a high standard of living and policies aimed at stimulating demand, primarily consumption.

The second is Asia, in particular China where the average standard of living remains low, population is ageing and policies focus primarily on external trade and exports.

India and other emerging countries, including oil-exporting countries, are in a similar position, but with growing populations.

The third area is continental Europe, with a stagnating economy and ageing population, a high standard of living although falling compared with North America, and insufficient use of resources, in particular labour.

Japan is rather similar to Europe in terms of its ageing population and standard of living.

I will briefly describe the economic imbalances of these three areas.

The external deficit of the United States

The United States has recorded current account deficits for over ten years.

This means that every year the country borrows from the rest of the world.

Last year its external deficit amounted to 6.4% of its gross domestic product (GDP).

A slight increase is forecasted for this year.

The main reason underlying the imbalance is the low level of public and private saving.

This is linked to demographic developments and to expectations of continued productivity growth.

The large public deficit is also a factor, particularly in the current phase of the cycle, as is the US tax structure which tends to discourage saving and encourage borrowing, particularly for housing purchases.

Net household savings were actually negative in 2005.

This build up of external liabilities has created a net debt vis-à-vis the rest of the world that is estimated to be close to 30% of GDP in 2005.

At this rate, net external borrowing could reach 100% of GDP in less than ten years.

Some observers tend to play down this imbalance, claiming that it is mainly an accounting phenomenon with no financial consequences.

According to this view, foreign assets held by US residents are undervalued compared with foreign investments in the US.

This view seems to be confirmed by the surplus in the balance between income received on US foreign assets and income paid on foreign investments in the United States.

However, this argument is not fully convincing.

The data on capital income are mainly recorded by the tax authorities and the incentives to declare such data differ between the United States and other countries.

There is broad consensus that the current imbalances are not sustainable.

The question is not whether the imbalances will be adjusted, but how and when.

The answer mainly depends on two factors.

The first relates to the ability of US agents to continue borrowing.

The second depends on the willingness of the rest of the world to purchase dollars and finance the US economy.

As regards the ability of US agents to borrow in order to finance a rate of consumption that outpaces production, it is necessary to distinguish between the public and the private sector.

The increase in wealth, in particular housing, has enabled households to raise indebtedness.

The strong increase in productivity and the flexibility of the US labour market have supported wages.

The labour share of total income has remained broadly stable over the last 15 years (whereas it has fallen sharply in Europe).

The US financial system has been able to respond to the demand for credit and refinancing by offering innovative products.

The low interest rates of the past four years have favoured both an increase in property value, thereby enhancing the ability of households to borrow, and a reduction in the cost of debt.

The second factor that has a bearing on the sustainability of the US external imbalance is the willingness of the rest of the world to continue financing the US economy and to hold dollar-denominated assets.

This willingness has been very extensive in past years, due to the strong growth of the US economy, the ample liquidity of the US financial system and the security provided by dollar assets.

External financing has to some extent averted or delayed the adjustment.

The question is: how long will it last?

Part of the answer must be sought by analysing the countervailing imbalances recorded in emerging countries, in particular China, which I will return to shortly.

Accumulating dollar financial assets carries two types of risk: the first is the exchange rate risk.

Unexpected depreciation of the dollar brings about a capital account loss for foreign agents holding dollar assets.

This is what General De Gaulle called the “exorbitant privilege” of the United States.

However, the euro now gives international investors the opportunity to use an alternative international reserve currency.

If the dollar becomes too great a risk and tends to depreciate, international investors may want to diversify their portfolios and reduce the exchange rate risk.

This could push up the interest rate on dollar‑denominated assets, with a tightening effect on the US economy.

If all agents were to hedge their exchange rate risk at the same time, they could trigger uncontrolled reactions in the foreign exchange and capital markets with repercussions for the world economy.

The sustainability of external financing in the US balance of payments poses another problem that has received little attention so far.

One instrument that can be used to diversify the risk associated with dollar securities is equity, particularly that of US exporting companies.

A shift from government securities to direct investments would benefit the US economy but could cause political problems.

For example, what would happen if China and other Asian countries or oil‑exporting countries began to invest heavily in strategic sectors of the US economy, or take control of banks, insurance companies or companies in the IT or energy sectors?

Concrete cases have already occurred in the oil sector and in the port services sector, raising deep concern in the United States.

Should any tendency to discourage foreign investment develop, it could severely reduce the appetite for dollar financial assets, with possible repercussions on financial markets.

The external surplus of emerging countries

Let us now turn to the countervailing external imbalance, namely the surplus in emerging economies, in particular in Asia and oil-exporting countries.

I will focus in particular on China.

China has a surplus in the current account of the balance of payments which is above 6% of GDP.

Adding direct investment flows, the basic balance records a surplus of nearly 10% of GDP.

The main reason for China’s balance of payments surplus is the strong propensity to save.

On average, China’s savings rate amounts to over 50% of GDP.

The propensity to save is mainly due to the ageing of the population, resulting from the birth control policy.

Furthermore, the transition to a market economy has entailed the dismantling of social structures which are no longer able to provide primary services such as health care, education and pension benefits.

This spurs people to save more for precautionary reasons.

Finally, the unsophisticated financial system and the policy of low interest rates do not allow savings to be channelled to productive domestic investment.

The Chinese banking system is struggling under a weight of non performing loans.

The other factor influencing the balance of payments surplus are the export incentives created through fixing of the exchange rate at a very competitive level.

Recently, China became the third largest world importer and exporter, overtaking Japan.

The export-led growth model, similar that used in the past in Europe, particularly in post-war Germany, is based on economic and political motivations.

The first is that sectors exposed to international competition can more easily attract foreign investment and technology transfer, exploiting the obvious relative advantages of the Chinese labour force.

The financing of investment in the export sector is provided mainly from abroad, despite the high level of Chinese savings.

This is due to lack of sophistication in the Chinese financial system, which does not allow productive investment to be properly targeted.

Export-led growth also acts as a magnet for migration from rural areas.

Such migration, born out of the desire of millions of people to improve their living standards, is one of the most sensitive aspects of the current phase of development of the Chinese society and constrains economic policy choices.

In order to be politically sustainable, the Chinese economy must grow at a rate capable of absorbing the supply of labour arriving from rural areas.

Given how important rural issues have been in earlier stages of China’s political and economic development, the authorities are understandably reluctant to allow the prices of agricultural products to vary solely on the basis of the international markets.

A sharp drop in the prices of agricultural products could accelerate the flow of migrants far beyond the ability of the industrial and construction sectors to absorb them.

The resulting unemployment and social instability would be made even worse by the lack of social safety-net, as I mentioned earlier.

This explains the Chinese authorities’ cautious approach to exchange rate policy.

If the yuan were to appreciate strongly to truly reflect the competitiveness of Chinese industrial products and the balance of payments surplus, import prices, particularly those of agricultural products would fall, hitting the earnings of around 800 million Chinese peasants.

Such concerns are not dissimilar to those that led to the creation of Europe’s system of agricultural compensation fund within the framework of the European Monetary System.

The purpose of this mechanism was to protect farm incomes when exchange rates between European currencies changed.

It may be interesting to underline how, in a global economy, sectoral and exchange rate policies implemented in some countries have an impact on other countries and areas, causing reactions that can rebound on the originating countries, thereby creating severe distortions in the global economy.

For example, agricultural subsidies and tariffs in industrial countries have reduced the access of developing countries to international markets in advanced economies.

International trade in agricultural products is still dominated by developed countries.

For example, the European Union’s imports of agricultural products are equivalent to only 0.6% of its GDP.[2] This provides an incentive for developing countries to subsidise their manufacturing sector which, in turn, hurts the industrial sector of developed countries, stoking protectionist pressures.

China’s growth model can hardly be sustainable over time.

First, the accumulation of massive international reserves induced by the undervalued exchange rate policy carries a severe risk.

It is estimated that a 10% appreciation of the Chinese currency vis-à-vis the dollar would produce a capital account loss of some USD 90 billion – thirty times the value of the People’s Bank of China’s capital.

Accumulating large reserves seems inefficient and difficult to justify in the face of China’s great need for socio-economic development.

Another argument is that the current exchange rate system maintains interest rates at too low a level in light of the fundamentals of the Chinese economy.

This fuels disorderly credit growth, further increasing the already high proportion of non-performing loans.

Going forward, there is a risk that the situation of the Chinese banking system, which is already fragile, deteriorates further.

The Chinese authorities seem to be well aware of the fragility of the current situation but changes are slow to materialise.

Europe’s internal imbalance

Europe, and the euro area in particular, is the third large area with an imbalance, although it differs from the other two in that it is mainly internal.

For several years the euro area’s balance of payments has been broadly balanced.

For this reason, some people believe that it is not directly involved in the adjustment of international imbalances.

This mistaken belief is due to a failure to appreciate the global dimension of imbalances.

In a global economy, internal imbalances are not divorced from the external ones.

Europe’s internal problems, which are manifested by low growth and high unemployment, are a reflection of global economic integration.

Europe’s balance of payments is broadly balanced, not because of improved competitiveness, but rather because of subdued consumption and investment, as a result of low confidence.

Europe is not in deficit because growth is slow and it has little confidence about its future.

This imbalance is just as serious as those of the other two areas.

It is pointless to dwell on the poor results of the European economy.

I will only mention that in 2006, for the sixth consecutive year, the euro area will again have one of the lowest growth rates, lagging behind not only the United States and Canada but also Japan and Africa.

The unemployment rate is forecast to remain slightly above 8%, which is higher than in any other developed economy.

The factors underlying this situation are known, and are the very same that make Europe vulnerable to the changes taking place in the global economy.

They also stem from a cultural problem, which may be linked to the ageing of the population: fear of globalisation and the inability to adapt behaviour to take advantage of it.

Besides this fear, Europe has also been slow to acquire the necessary institutional structures to try to govern or participate in the governance of globalisation, a point which I will come back to later.

This defensive attitude with respect to globalisation, which is shared even by some economists, stems in part from the conviction that in recent years external developments have had a negative impact on the European economy, in particular the euro area, as might be confirmed by the deterioration of the Balance of Payments in recent years.

The increase in oil prices, the appreciation of the euro and growing competition from new emerging countries seem to support this view.

However, it fails to take account of the fact that in the global economy the effects of single events cannot be assessed in isolation.

One example is the increase in raw materials’ prices observed in recent years.

It is intuitive to claim that this increase may have had a negative impact on European economies by deteriorating their terms of trade and reducing consumption.

A comprehensive assessment requires, however, an analysis of whether the rise in oil prices is due to a reduction in supply, as was the case in the 1970s, or to an increase in global demand.

In recent years, the general consensus has been that the rise in oil prices has been largely caused by an increase in global demand, which has had other positive effects on the European economy, in particular a rise in exports.

Certainly, it would have been preferable to benefit from increased global demand without any rise in oil prices, but this is not consistent with the way in which the global economy works.

Other considerations which are generally not taken into account relate to the improvement in consumer’s purchasing power resulting from the lower cost of imports of non-energy products, which translates into a rise in the terms of trade and lower inflation.

Finally, the abundant flow of savings from emerging countries has contributed to low interest rates in advanced economies, promoting corporate restructuring and housing purchase.

Looking at global interactions, in the context of a macroeconomic model of the euro area described in the Appendix, the external environment is estimated to have made a positive contribution to euro area growth, by on average 0.3% per annum in the period 2000-2005.

The external contribution to growth could have been even larger if the European economic structure and behaviour had been better able to exploit comparative advantages and adapt to new opportunities, which was the case in some countries, but not in others.

Globalisation facilitates the comparison across countries of the successes and failures in keeping in step with globalisation.

Several studies by the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) reveal how countries which experienced lower levels of growth tend to be those with the most rigid markets, the lowest labour force participation, in particular the female one, the lowest education rates, labour cost developments not in line with productivity, unsustainable welfare systems, struggling fiscal policies, and so on[3].

International analysis and comparisons should provide clear and objective indications of the examples to follow to maximise the benefits of globalisation.

However, this is not always the case.

Often, countries which fall behind in international competition and which are less successful tend to look for excuses, lay the blame on others (Europe being one of their favourite scapegoats), take retaliatory measures, defend vested interests and are tempted to adopt protective measures.

The Japanese experience has shown that it can take a long period of deflation before structural economic problems are recognized and addressed.

In the meantime, the per capita income remained stagnant and the country lost almost a decade of economic growth.

From this perspective, the European situation does not appear sustainable.

The pertinent question is how long it will take before the people of Europe understand that in order to maintain their standard of living they must drastically reform their economic systems.

In conclusion, the global economic situation appears to be characterised by severe imbalances, which are closely interlinked and which reflect divergent uses of global resources.

Analysing these imbalances leads to a broadly-held conclusion: they are not sustainable.

Global adjustment scenarios

A variety of global adjustment scenarios can be envisaged.

I will describe three.

First, a benign scenario, in which the phasing out of the factors which caused the imbalances leads to a gradual and orderly adjustment.

The second scenario envisages the possibility of a disorderly adjustment, mainly led by financial markets, where doubts regarding the sustainability of the situation could cause abrupt changes in the prices of financial assets.

In the third scenario, the adjustment is supported by coordinated economic policies, taking into consideration both domestic and external requirements.

Benign adjustment

A scenario of gradual adjustment should primarily involve an increase in savings in the United States, to levels that are compatible with the long-term rate of investment.

A slowdown in consumption would have a moderating effect on imports, thus gradually reducing the external deficit.

This scenario could occur, in particular, if real estate prices were to stabilise, thereby moderating household indebtedness, which in recent years has grown very fast.

Recent developments may favour this type of scenario.

Interest rate increases implemented in the United States over the last two years are cooling the real estate market.

High energy prices should also slow US household consumption.

This scenario might lead to a slowdown in world growth.

This risk could be mitigated if the weakness of consumption were offset by a pick-up in investment and exports, as a result of a relative easing of financing conditions and an improvement in the competitive position of the United States.

A reduction in savings in Asian countries, in particular China, and an increase in private consumption and investment, could also have a positive impact on imbalances.

The Chinese government recently acknowledged the need to increase welfare spending in order to promote a more equitable and sustainable development.

However, it is not clear how fast this can be translated into more sustained domestic demand.

A gradual slowdown in the US economy could have a dampening effect on the European economy.

This could be offset in part by an increase in exports to Asia, if domestic demand in these countries were to rise, and to the oil-exporting countries.

Exports to the United States represent around 15% of total European exports, compared with 4% to China, 3% to Japan and 11% to the rest of Asia.

As a whole, the Asian economies account for a larger proportion of exports from European countries than the United States.

Disorderly adjustment

The second scenario is characterised by a sudden financial market adjustment, whereby the willingness to finance the US current imbalances at the prevailing conditions would fall.

Exchange rates and interest rates would adjust rapidly to balance demand and supply of financial assets denominated in different currencies.

It is difficult to assess the impact of such a scenario.

It depends in part on the relationship between financial market and real economy developments, which is not always linear.

As far as the United States is concerned, some observers predict that even a sudden adjustment of the US dollar exchange rate would have a very limited impact on the US economy.

According to this view, short and long-term US interest rates are primarily influenced by domestic factors.

The US capital markets would not be affected by exchange rates fluctuations.

The high flexibility of the US economy and its capacity to absorb shocks – such as the bursting of the “dot-com” bubble at the end of 2000, the impact of the terrorist attacks of September 11, the oil shock and the Iraq war - seem to confirm this theory.

Previous experience of adjustment of the US dollar exchange rate, for example in the second half of the 1980s, also seems to confirm that the depreciation of the US dollar could have a limited impact on US inflation.

In my opinion, such arguments should be used with caution.

The experience of the 1980s is not completely comparable with the current situation.

In 1985, the US economy was less dynamic, and the unemployment rate over 7%, which contributed to dampen inflationary effects.

In the current situation of almost full employment, a depreciation of the dollar could further stimulate demand, leading to inevitable upward pressure on prices.

An increase in short-term interest rates, and also perhaps in long-term interest rates, could prove necessary to counter this upward pressure.

In this case, repercussions on the stock and real estate markets, and perhaps also on bond markets, could not be ruled out.

Another cause for concern is the reaction of oil markets to foreign exchange turbulence.

It is not impossible that a depreciation of the US dollar could induce commodity exporters to raise prices in US dollars.

This could further deteriorate in the US Balance of Payments.

Another reason why the current situation differs from that of the 1980s is that the US dollar is no longer the only international reserve currency.

The euro and the yen constitute equally secure alternative investments.

Recent experience has shown that the yields on euro and yen financial assets may remain lower than dollar yields, confirming the lower level of risk.

Sharp exchange rate fluctuations could lead international investors to demand an extra premium for holding financial assets denominated in US dollars.

Overall, it is not prudent to maintain that in the current global economic context the US capital markets are protected from international conditions, in particular, from changes in the strategies of foreign investors.

If one concurs with the theory that the global savings glut has been one of the main reasons for the recent low interest rates, it is not then logically possible to maintain that a reduction in the savings glut will not have an impact on US interest rates.

For Europe, a disorderly adjustment could lead to a fall in competitiveness, with a negative impact on exports and growth.

The size of this impact would depend in part on the behaviour of Asian currencies.

If Asian currencies were to remain pegged to the dollar, the burden of adjustment would fall mainly on Europe.

This scenario could trigger strong protectionist pressures, which could fuel political and commercial tensions between Europe and Asia.

According to IMF forecasts, a disorderly adjustment could have a strong negative impact on the world economy.

Coordinated adjustment

This scenario is characterised by a set of economic policies, possibly coordinated at international level, that are aimed at addressing global imbalances, both domestic and external, and at limiting negative repercussions on financial markets.

In the United States, fiscal policy should promote both an increase in private savings, through appropriate incentives, and a reduction in government borrowing.

This would be consistent with the need to ensure sustainable US public finances over the medium term, given the rise in spending on health and welfare forecast for the end of this decade.

In Asia, and particularly in China, the exchange rate policy should become more flexible in order to allow an appreciation in line with market conditions and the large current account surplus.

This policy would be consistent with the adoption of domestic monetary conditions that are better calibrated to the needs of the Chinese economy.

Furthermore, it would put an end to the continued accumulation of currency reserves.

The exchange rate appreciation should be accompanied by policies aimed at stimulating domestic demand and welfare policies aimed at supporting consumption and safeguarding the weakest parts of society.

The Chinese financial markets should also be developed to allow savers to invest in market instruments and to reduce precautionary savings.

Europe’s contribution to reducing global imbalances does not consist of increasing or reducing net savings, since they are broadly balanced.

The European imbalance is internal.

There is even a risk that this imbalance might worsen with adjustment scenarios that lead to a slowdown of the world economy or disruptive market fluctuations.

For this reason, Europe’s priority is to reduce its domestic imbalance through structural reforms which improve the functioning of markets and foster productivity growth.

This will also allow the European economies to better withstand external shocks.

It is largely recognised, including by most policy-makers, that the above-mentioned actions are needed to promote a gradual adjustment of domestic and external imbalances.

These recommendations are reiterated in all G7 and other international institutions’ communiqués.

However, implementation has been slow.

Some progress has been made, but there is a long way to go before the goal is reached.

This is certainly no reason to reduce efforts.

On the contrary, they must be strengthened to encourage the adjustment of imbalances and to allow the global economy to grow in a sustainable manner.

Global policies

The difficulties involved in taking the necessary steps to promote adjustment do not just originate in domestic problems, but also in the complexity of coordinating economic policies in an increasingly globalised world.

This has repercussions not only for the effectiveness of economic policies, but also for the public acceptance of globalisation.

According to a survey carried out two years ago, Europeans are on average in favour of globalisation, but maintain that it should be governed[4].

A market economy can only function on the basis of a system of rules, for example in terms of property rights, and cannot do without some form of “social contract”.

The literature has widely demonstrated that neither a market economy nor an efficient system of resource allocation can exist without a system of rules.

Globalisation poses the same problem at a world level.

Who sets the rules of the game?

Who enforces them?

Today, the answer is very different from what it was sixty years ago after the Second World War.

This is because globalisation renders all countries smaller, including the United States.

The role and functioning of international institutions has changed because it is no longer thinkable for anyone to impose rules.

Rules must be negotiated with everybody.

To weigh in the negotiating process, it is important to be representative.

This is why globalisation leads to the emergence of a limited number of global “players” of systemic importance, such as the United States, China and India, and of regional groupings, such as the European Union.

Strategic interactions become increasingly complex in the light of the coexistence of the regional dimension (of which Europe is a major example) and of the multilateral dimension in the overall governance of the global economy.

If the structure of the global economy evolves into an oligopolistic system with a limited number of large-scale players, it follows that in the long run no single European country will be large enough to play an important role in the multilateral system.

A projection of the current growth rates suggests that within the next twenty years the relative weight of the United States and the European Union may fall from 30% to 20% of the world economy, while that of China could exceed 10%, putting it in second place.

The largest European country, Germany, will not exceed 3%.

By 2050, China and India may overtake the whole of Europe.

The European dimension will become vital for the governance of the global economy.

This begs the following question: given the importance of governing globalisation, is Europe getting ready to play a role in the multilateral system?

The answer is not simple, because the reality of Europe is complex and somewhat contradictory.

A key aspect of global policy is consistency, from the monetary and financial matters to trade, development, etc. For example, the global payments imbalances have several dimensions, commercial, financial as well as monetary.

Their adjustment requires action in the fields of foreign exchange policy, fiscal policy, industrial policy, trade policy and anti-trust policies.

International cooperation require commitment and concerted action on several fronts.

Economic policies, even when implemented separately by independent policy-makers, must be consistent with each other.

They cannot be conducted optimally if synergies are neglected.

From this point of view, the European integration process remains largely incomplete and there is a risk that within its current institutional structure, Europe is not able to face up to the challenges of globalisation.

Europe’s influence is constrained by the fragmented nature of its economic policy initiatives.

The degree of homogeneity in the positions of the European Union vary considerably depending on the policies and on the international fora.

On monetary and foreign exchange policies, the European Central Bank and the Eurogroup (the finance ministers of the twelve countries that have adopted the euro) take common positions and represent them consistently at the relevant meetings.

The success of the euro as an international currency is a confirmation of the unified approach.

However, the euro involves only 12 out of the 25 EU Member States.

When it comes to trade, there is also a single policy but the European Commission represents all 25 countries within the World Trade Organisation.

The fact that foreign exchange and trade policies in Europe concern different groups of countries makes it difficult to take advantage of synergies and to implement complementary action.

For this reason, a Europe of concentric circles, with different levels of participation in its policies, risks being an inadequate and weak Europe, which cannot play a strong role in the global system.

In many key international fora, such as the G7, G20, IMF (with the exception of monetary issues) and the World Bank, EU countries usually act in a piecemeal way.

This reduces Europe’s influence.

One example is development policy, which forms an integral part of global economic policy, above all in dealings with emerging countries.

In theory, Europe has its own development policy, which is the basis for providing considerable financial assistance, in particular, through the European Commission and the European Investment Bank.

Europe as a whole provides around 50% of total aid to developing countries.

Nevertheless, European countries continue to participate on an individual basis in the international development institutions, such as the United Nations, the World Bank, the multilateral development banks or the Paris Club, coordinating their activities only on a very basic level.

The same is true for the IMF, where European countries’ membership is only broadly coordinated.

Although their overall voting share exceeds 30%, they have less influence than the United States, whose contribution stands at around 17%.

The sole argument advanced against a closer integration of the EU’s external representation, or at least the euro area, is that the political conditions are not yet right.

This argument is so tautological to appear ironic.

The lack of political will in Europe to join forces risks triggering a vicious circle.

Europe – and in this case the concept of Europe is taken to mean the people of Europe – does not view globalisation in an unfavourable light, but would like it to be governed so that the rules of the game are applied.

On the other hand, Europe itself – and here the concept of Europe is taken to mean political Europe, i.e. the European Council, European Commission and European Parliament – has not succeeded in equipping itself with an institutional structure which would allow it to participate and contribute efficiently to the governance of globalisation.

Consequently, Europeans do not see the added value offered by Europe and tend to lose confidence in it.

Each individual European country is not sufficiently large to contribute fully to the governance of the global economy.

Giving up on Europe or accepting passively the difficulties involved in progressing towards closer European integration means renouncing to playing any role in the governance of globalisation.

This fuels the fear of globalisation among European citizens and encourages the search for alternative false solutions, which risk further distancing Europe from global competition.

This closes the vicious circle which our continent is currently in.

The way out is to accept the challenges and overcome the fears of globalisation.

Accepting the challenges of globalisation means accepting what has already been accepted in those countries and regions which have been more successful, i.e. more integration and international mobility of goods, capital, services and labour.

This means reforming the economic system, bringing down barriers and ending subsidies in order to enhance the functioning of the markets.

In order for this to happen, we need a Europe that is stronger internally and internationally, which is perceived by its citizens as a source of progress and cooperation to face up to daily challenges of globalisation.

Thank you for your attention.

[1] See the report by the World Bank (2001) entitled “Globalization, Growth and Poverty: Building an Inclusive World Economy”

[2]

An analysis by an economist at the International Monetary Fund demonstrates how protectionism and subsidies in the agricultural sector have been reflected in a reduction in the agricultural imports of industrialised countries from the levels that would theoretically have been desirable.

However, many developing countries are themselves relatively closed to trade in agricultural products.

See C.

Paiva (2005), “Assessing protectionism and subsidies in agriculture: a gravity approach”, IMF Working Paper No 05/21.

[3] See for example Nicoletti G. and Scarpetta S. (2005): “Regulation and economic performance: product market reforms and productivity in the OECD”, OECD.

In this article, the authors identify a clear link between product market reforms aimed at increasing competition and the rise in labour productivity, which constitutes a key determinant of long-term output growth.

[4] According to the survey of Flash Eurobarometer, Globalisation, EOS Gallup Europe (2004), 62% of European citizens (75% in Italy) think that globalisation is a process should be governed.

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