Jean-Claude Trichet: Building Europe in a globalised world
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at Challenges
of the Twenty-first Century: European and American Perspectives Series, Harvard
University, Boston, 23 October 2007.
* * *
1. Introduction1
It is a great pleasure for me to be invited to Harvard University to talk about a key issue: how
can Europe best adapt to a globalised world? Let me start by saying that the idea of the
European Union and the concept of the single currency originated about 50 years ago. They
resulted from a desire of European nations to create conditions for lasting peace and
prosperity after the two devastating wars of the first half of the 20th century. Initially, the
prime focus of intra-European policies was on how to facilitate the free flow of goods,
services, capital and people across national frontiers, an initiative which was to become the
Single Market. Serving as a role model in the creation of such a genuine common market in
Europe was the unified market of the United States.
Today, the EU is considerably larger than it was all those years ago. It comprises 27
European countries and a population totalling 494 million people, with Romania and Bulgaria
joining in January this year. 13 of these countries are members of the Economic and
Monetary Union (i.e. the euro area with its 317 million inhabitants) and have introduced the
euro. The 13 will become 15 in January next year, when Cyprus and Malta join. Importantly,
the impressive enlargement of the EU and the successful creation of the euro area have
gone hand in hand with Europe's integration into the global economy. Globalisation provides
great opportunities for flexible economies. However, Europe still needs to make progress in
this field in order to fully gain from globalisation.
This brings me to the issue I would like to address today, namely the building of Europe in a
globalised world. First, I would like to share with you some thoughts on Europe in a global
context. Second, I would like to provide some facts on the process of economic and financial
integration in Europe and - as a comparison - the United States. Finally, I would like to talk
about how globalisation influences European macroeconomic policies.
2. Europe and globalisation
Globalisation has indeed increased significantly over the last couple of decades. Let me first
present some figures on the degree of global openness. Thereafter, I would like to provide
some examples of the impact of globalisation, especially on Europe's economies.
Global trade openness - measured as world exports and imports of goods and services as a
share of world GDP - has practically doubled over the last 20 years. In 1986 it accounted for
34% of world GDP; in 2006 the figure was 61%. A key factor has been the increase in trade
in intermediate goods and services as a result of the rising internationalisation of production
processes.
Financial systems have also been deeply affected by globalisation. The share of gross
international asset holdings in world GDP - which provides a measure of financial openness
- has grown eightfold over the last 25 years and now stands at more than 130% of world
GDP.
Globalisation is triggering major transformations all over the world, not only in Europe. For
instance, globalisation has had an impact on inflation.
Economic theory has identified numerous channels through which globalisation can influence
price developments. Without doubt, globalisation and the associated rise in world trade have
contributed to import price moderation2, notably in the manufacturing sector, which is
primarily due to increased imports from low-cost countries. Furthermore, the widespread
opening-up of emerging countries and of almost all former centrally planned economies has
significantly increased the labour pool available, leading to dampening pressures on labour
costs, especially for unskilled labour.3 Globalisation can also exert indirect downward
pressure on inflation, as increasing international competition may limit the pricing power of
domestic corporations. However, at the same time, the sudden emergence of fast-growing
economies in the global economy is exerting very significant upward pressures on
commodity prices. This has been particularly visible since 2003. In addition, the prices of
certain agricultural products have also risen recently.
Despite intensive research, there remains significant uncertainty about the overall role and
impact of globalisation. Even though the net effect of these counterbalancing forces is mostly
believed to have reduced the level and volatility of inflation, how long this disinflationary
effect will last remains an open question. Still, in view of the much lower price levels of the
economies in emerging markets, they are expected to increase their market shares in the
developed economies, which in turn will help to contain import price pressures there.
Ultimately, globalisation is an opportunity, not a threat. Globalisation fosters economic
prosperity and raises living standards. It may facilitate increased labour inflows to the euro
area, which, in certain sectors, would help to reduce bottlenecks in labour markets and
hence ease wage pressures. Meanwhile, resources are allocated to the most profitable
activities across the world. In addition, globalisation helps to intensify the exchange of
investment capital for know-how between regions. As a matter of fact, the euro area has
become an attractive place for foreign direct investment (FDI). IMF statistics reveal that FDI
into the euro area amounts to more than 30% of euro area GDP, whereas the comparable
figure for the US is 16%.
In sum, increasing globalisation leads to structural changes that are sometimes difficult to
quantify. Developed economies need to be sufficiently flexible in order to absorb these
structural changes smoothly. Overall, however, these developments should be seen as
increasing economic prosperity as they improve the international allocation of resources. In
addition to globalisation, European countries are facing the challenge of integration in their
product, labour and financial markets. I will turn to these issues now.
3. Economic and financial integration in Europe and a comparison with the
United States
In a monetary union, economic and financial integration is crucial as it ensures smooth
adjustment processes to economic shocks. In a monetary union like the United States or the
euro area, where regional monetary and exchange rate policies are options that are no
longer available, it is important to make sure that other shock adjustment mechanisms
function properly. Such mechanisms are needed in order to prevent a country or region from
entering into a period of protracted low growth and higher unemployment, or into a long
period of overheating, after experiencing a country-specific shock.
Allow me, now, to elaborate on four main features of economic and financial integration in
Europe, namely trade, financial integration, labour mobility and business cycle
synchronisation. I will also compare these features with those in the United States, in order to
illustrate some of Europe's achievements and remaining challenges.
i) First, economic integration has been reflected in a marked increase in intra-euro
area trade in goods and services. Let me mention some figures. The share of
exports and imports of goods in terms of GDP within the euro area increased by 6
percentage points between 1998, the year before the adoption of the euro, and
2006, when it amounted to around 32% of GDP. The share of intra-euro area
exports and imports of services increased by about 2 percentage points from 1998
to 2006, to almost 7% of GDP.
As trade integration within the euro area becomes stronger, the region is also
becoming a more open economy to the outside world. The share of extra-euro area
exports and imports of goods rose by about 9 percentage points between 1998 and
2006, to around 33% of GDP. Over the same period, the share of extra-euro area
exports and imports of services increased by about 2 percentage points, to almost
10% of GDP. These developments clearly show that we are not witnessing the
creation of a "fortress Europe". On the contrary, the euro area is a more open
economy than the other two G3 economies, the United States and Japan. In the
United States, exports and imports of goods represented about 22% of GDP and
trade in services 6% in 2006. The corresponding figures for Japan were 27% and
6%.
ii) As a second feature, the introduction of the euro has contributed to intra-European
financial integration which, in turn, improves the free movement of capital in the euro
area. Financial integration enhances the efficiency of economic mechanisms,
strengthens competition and raises the potential for stronger non-inflationary
economic growth.4
Financial integration also improves the smooth and effective
transmission of the single monetary policy throughout the euro area. More precisely,
financial integration helps financial systems to channel funds from those economic
agents that have a surplus of savings to those with a shortage; in particular, it
enables agents to effectively trade, hedge, diversify and pool risks. As a result, there
is a better sharing and diversification of risk. In the US, over the period 1963-90,
capital markets smoothed out 39% of the shocks to gross state product (the
equivalent to GDP), the credit channel smoothed out 23% and the federal
government, through the fiscal channel, 13%.5 Around 25% of the shocks were not
smoothed out. Hence financial markets and financial institutions contributed 62% to
the absorption of idiosyncratic state shocks. We therefore see from the US example
that the financial channel can be much more important than the fiscal channel. This
is an additional reason to speed up financial integration in Europe. In a more recent
study, it was found that the euro area situation has begun to converge towards the
situation of the United States and that there is already modest but non-negligible
insurance through inter-state capital flows. It was found that in the euro area
(excluding Luxembourg), capital markets would have smoothed out about 10% of
the country-specific shocks to GDP between 1993 and 2000.6
A set of indicators published by the ECB also points to an increasing degree of
integration of euro area financial and banking markets.7 For instance, there is
significant evidence that euro area corporations are taking advantage of the
possibility to raise funds. As a result, the euro corporate bond market has grown
significantly since 1999, and has the potential to grow even further, judged by a
comparison with the US. In 1999, the outstanding volume of bonds issued by
nonfinancial corporations was just 3.9% of GDP in the euro area and 24.3% in the US;
by 2006 it had increased to 12.5%, but relative to GDP the US corporate bond
market is still one and a half times larger than that of the euro area.
Integration in retail banking, by contrast, has been slow so far, although it has
picked up in the last two years. There are still differences in bank deposit and
lending interest rates across euro area countries, whose cross-country dispersion is
higher than the intra-regional dispersion of the same rates in the US.8 However, a
number of indicators point to increasing cross-border banking activities in the euro
area, such as the growing cross-border share in the financial holdings of banks as
well as cross-border mergers and acquisitions.
In terms of fiscal transfers, obviously in the US there are inter-regional transfers
which add to the degree of integration, while transfers in the euro area are almost
exclusively domestic and not cross-border.
iii) Labour mobility constitutes the third feature of integration that I would like to
mention. Labour mobility may dampen the effects from country-specific shocks or
decrease the risks of wage pressures as labour markets tighten. Comparable figures
on labour mobility for the euro area and the US are difficult to obtain and any such
figures should be interpreted very carefully. Available evidence suggests that,
overall, cross-border labour mobility is still limited in most parts of the European
Union with regulatory barriers still existing, and even within the euro area with
respect to labour from Slovenia. Linguistic, cultural, legal and other differences
between countries and the costs involved in moving residence also play a role.9 In
the period 2000-2005 only 0.1% of the working-age population of the then EU 15
Member States moved away from their country of origin to another country in the
EU. Furthermore, only a small proportion of individuals - 0.4% of the EU's
workingage population - commuted across a national border to work. In the US,
geographical labour mobility appears to be far higher. Evidence suggests that
around 3.1% of the country's total working-age population moved from one state to
another each year between 2000 and 2005.10
iv) A fourth and final feature of the process of economic and financial integration is the
degree of synchronisation or co-movement between different cyclical positions
across the euro area countries. This degree of synchronisation has increased since
the beginning of the 1990s. In other words, a large number of euro area economies
now share similar business cycles.
In addition, current inflation and output growth differentials between euro area
countries are relatively limited compared with the past. Indeed, the decline in
inflation differentials across the euro area countries has been impressive in recent
years. At the beginning of the 1990s, the dispersion in inflation rates across the
countries which now belong to the euro area was, on average, around 6 percentage
points (standard deviation measured in unweighted terms). Last year, the inflation
dispersion was only 0.7 percentage point. This implies that dispersion in the euro
area is currently broadly in line with inflation dispersion among the 14 US
Metropolitan Statistical Areas, where it has fluctuated around 1% in the last two
decades. Dispersion in real GDP growth rates (standard deviation measured in
unweighted terms) across the euro area countries has been fluctuating around a
level of 2 percentage points over the past few decades. This is similar to the
dispersion observed in output growth across regions within the United States.11 Still,
with a view to further enlargements of the euro area, these issues need to be kept in
mind. For the proper functioning of the single monetary policy in Europe all
participating countries are required to display high degrees of convergence with
each other and to do this on a sustainable basis. In all enlargement decisions for the
euro area, we refer to some clearly defined "convergence criteria" and apply them in
a very strict manner. We did so in the past and will do so in the future.
In sum, there is evidence of growing economic and financial integration among the
countries of the European Union. The adoption of the euro has particularly
contributed to this development by reducing information costs, enhancing price
transparency and eliminating exchange rate risk between countries in the euro area.
Nonetheless, in some fields, Europe is lagging behind the US and a lot remains to
be done, for instance, in order to increase labour mobility and financial integration in
retail banking. Progress in these fields is clearly needed in order to adapt to a
globalised world.
4. How globalisation influences European macroeconomic policies
As I claimed earlier, globalisation and integration brings clear benefits to the economy. At the
same time, however, European policy-makers need to ensure that Europe quickly adapts to
a globalised world.
Globalisation increases the pressure on national policy-makers to implement reforms and to
pursue structural policies that enhance competition and foster flexibility in product and labour
markets. In fact, globalisation brings opportunities for flexible economies but penalises rigid
ones. In many euro area countries, structural reforms have been too slow to facilitate the
reallocation of resources to their most productive uses and to foster labour productivity
growth and technological progress. The implementation of structural reforms is envisaged
under a wide-ranging programme for economic, social and environmental reform in the EU, a
programme known as the Lisbon strategy. In particular, Member States are required to
reduce tax burdens on low-wage earners, to bring wage developments into line with
productivity, to raise the skill level of the workforce as well as to adopt active ageing
strategies to encourage older workers to stay in the workforce. This strategy should increase
the flexibility of, and lower the adjustment costs for, European firms and workers confronted
with globalisation. Improving competitiveness is the main condition for making globalisation a
success for the citizens of Europe.
As for fiscal policies, in the global economy, capital and labour mobility puts pressure on tax
bases. Rather than a "race to the bottom", with only tax rates reduced, we begin to see tax
reforms that make a country more "competitive" and more attractive for investment and
human capital. On the expenditure side, the influence of globalisation appears to be more
limited. We should expect a tendency towards smaller but more efficient budgets, with
"higher-quality" public spending. This implies, for example, more emphasis on "tomorrow" -
i.e. investment and education (also for older workers) - and less on "yesterday" - e.g. less
money spent on unemployment benefit for unskilled workers or on large and inefficient public
administrations. On this issue, the debate has only started in the European Council of
Ministers of the EU Member States (ECOFIN). In this respect, a number of important moves
towards structural reforms are also currently under discussion in the ECOFIN to make the
public sector more efficient. Finally, in a globalised world, the soundness of public finances
becomes ever more important. The links between financial markets are growing closer and
all governments must ensure the sustainability of their fiscal positions. In this context, the
ECB calls upon the Member States of the EU to comply fully with the Stability and Growth
Pact, an agreement which aims to ensure that they conduct prudent fiscal policies.
Globalisation changes the environment also for monetary policy-making. As I mentioned
earlier, globalisation intensifies global competition - for example by reducing the pricing
power of firms - and necessitates adjustments to relative prices. In the presence of nominal
rigidities, changes in relative prices and the pricing power of firms can affect inflation in the
short run. But even in the long run, when all adjustment processes have come to an end,
globalisation is likely to affect the transmission of economic shocks to inflation.
Let me give you an example to illustrate the effects of globalisation on the transmission of
shocks. I will consider the case of a shock to production costs, e.g. due to high wage
pressures in one country. Increased competition implies reduced pricing power of firms. In
response to increases in costs, competitive forces may prevent individual firms from
adjusting prices by as much as in a low-competition environment. As a consequence, shocks
to production costs might have a smaller effect on domestic inflation than what we are seeing
today but a larger effect on output and employment.
In Europe, this implies a very important message to the social partners, notably trade unions
and employers' organisations. Excessive wage agreements in a highly competitive
environment have much higher costs in terms of growth and employment than they had in
the past. Social partners in Europe seem to have understood this, as inflationary pressure
coming from labour costs has been much lower in recent years than in previous decades.
This, in turn, has led to significant employment gains in Europe, now amounting to 14.9
million new jobs created since the euro was introduced, compared with only 3 million jobs in
the 81⁄2 years before its launch. This gives us hope that the structural reforms which have
been implemented in recent years have helped to create jobs.
But we cannot simply assume that these trends will continue. Therefore, the pursuit of price
stability will remain a demanding task. Central banks will need to carefully monitor the
changes to the structure of the economy and to the behaviour of economic agents brought
about by globalisation.
How should monetary policy respond to the effects of globalisation on inflation? I would like
to stress that globalisation does not affect the central role, the capability and overriding
responsibility of central banks to preserve price stability.12 In the long run, when adjustment
processes are over, globalisation will affect real quantities only. After all, whatever the
influences being exerted in the context of globalisation, the basic tenet of monetary policy
remains: in the long run, inflation is a monetary phenomenon. Globalisation can at times
mean fairly rapid changes in relative prices. In such an environment, I would argue that a
credible commitment to maintaining price stability is essential. Most importantly, such a
commitment helps consumers and firms to accept changes in relative prices while the
aggregate price level is largely unaffected. Central banks should not prevent efficient
changes in relative prices triggered by a move towards a new equilibrium due to
globalisation, but they are well advised to prevent significant second-round effects from
spreading to other parts of the economy.
5. Conclusion
Ladies and gentlemen, let me conclude. Economic integration within Europe has gone hand
in hand with Europe's integration into the global economy. These forces call for structural
adjustment in order to fully grasp the opportunities they provide. To this end, we should make
our markets even more flexible and promote further economic and financial integration in
Europe's economies. At the same time, we need to have fiscal policies which are disciplined,
in line with the objective of reaching balanced or surplus budgets over the medium term.
Finally, monetary policy-makers need to carefully monitor the ongoing structural changes
globalisation brings about. In this context, monetary policy has to ensure that inflation
expectations are well anchored, which means a strong commitment to pursuing price
stability. Thank you very much for your attention.