Willem F Duisenberg: Changing fortunes - financing world growth
Speech by Dr Willem F Duisenberg, President of the European Central Bank, at the 2003 Spruce
Meadows Round Table, Calgary, 5 September 2003.
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It is a great pleasure for me to be part of this round table discussion today and I would like to thank the
organisers for inviting me to share some thoughts with you on the topic of financing world growth.
Since 2000, we have witnessed terrorism, war and declines in world equity markets, all of which
contributed to increasing an already ongoing deterioration in confidence in most countries. Now with
the end of the major hostilities in Iraq, the reduction in geopolitical uncertainties and lower oil prices, a
gradual upturn in world economic activity is expected and it is important that policy-makers do all they
can to support it.
Given the breadth of this topic and therefore the strong temptation to overrun on my time allocation, I
will focus on just two points. First, I would like to say a few general words about the roles and, may I
add, limitations of monetary and fiscal policy in reviving global demand, and the importance of
microeconomic policies in this respect, in particular the role of structural reform in increasing potential
growth. Second, with the help of regional-specific examples, I would like to present some future
challenges with respect to microeconomic policies and structural reforms in the world.
Monetary and fiscal policy, and structural reform
The achievement and maintenance of strong growth implies a perspective that extends beyond
shorter-term cyclical developments. Indeed, over the medium term, economic growth tends to be
negatively affected by the considerable costs associated with inflation, and the prospect of stable
prices is therefore a key factor of growth. By being strictly geared towards maintaining price stability in
a credible and lasting manner, monetary policy makes an important contribution to achieving a high
level of output and employment, and to sustaining growth. Confidence in lasting price stability removes
the inflation risk premium on interest rates, ensuring low real interest rates, which in turn foster
investment, growth and employment. Theoretical and empirical evidence clearly confirm that there is
no long-term trade off between price stability and economic growth. Trying to use monetary policy to
fine-tune economic activity or to gear it above a sustainable level will, in the long run, simply lead to
rising inflation - not to faster economic growth.
Fiscal policy also plays a key role in contributing to macroeconomic stability. Stable, sustainable and
efficient fiscal policies exert a favourable effect on long-term growth performance. They stimulate
savings, capital formation, employment and innovation. And they facilitate the task of the monetary
policy-maker in maintaining price stability. Sound public finances should rely on automatic stabilisers,
rather than discretionary fine-tuning, to dampen the cyclical fluctuations of aggregate demand. Theory
suggests that there are delays and risks associated with the latter - getting the timing wrong may result
in pro-cyclical polices and make a monetary policy orientated towards price stability more difficult. In
the medium term, fiscal policies can best contribute to sustaining non-inflationary growth by pressing
ahead with fiscal consolidation.
Ultimately, over the economic cycles, growth will reflect conditions on the supply side of the economy.
It is therefore microeconomic, and not macroeconomic, policies that can promote the supply of labour
and capital and their efficient allocation, further innovation and the diffusion of new technologies, and
as a result, mitigate problems such as structural unemployment.
Structural reforms in the labour and goods markets are a key element of any long-term strategy to
improve investment, growth and employment prospects. First, more flexible markets increase the
speed with which countries can adapt to economic shocks, thereby speeding up economic recovery.
Second, increased competition in labour and product markets is conducive to a high level of
innovation and the rapid spread of technological progress. This in turn supports long-term growth,
without contributing to inflationary tendencies. Third, structural reform may facilitate the transmission
of monetary policy. In more rigid economies, interest rate changes are transmitted to prices after a
longer delay, and structural barriers can prevent the economic efficiency gains of the primary objective
of monetary policy - price stability - from being fully realised.
It is important to mention here the close interplay between rigidities in capital, labour and product
markets, which can strengthen one another. These interdependencies mean that structural reforms in
any one of these markets will have an impact on the functioning of the others. It must be emphasised
therefore that only a comprehensive reform programme can create the necessary conditions for
stronger economic dynamism.
The need for structural reforms tends to become most urgent and evident to policy-makers during
economic downturns. But don't forget that structural reforms do not provide short-term solutions to
economic problems. Although they can have positive short-term confidence effects, it normally takes
time for their benefits to unfold. Hence I cannot emphasise enough the need to speed up the pace of
structural reforms in capital, labour and product markets.
Structural reforms in various regions of the world
Let me now turn to the issue of future challenges with respect to microeconomic policies and structural
reforms in particular economic areas. I shall start with structural reforms in the euro area, and then
move on to say a few words about structural reform in the EU Neighbouring Regions, the United
States, Latin America and, finally, East Asia.
Euro area
Economic activity in the euro area remained subdued in the first half of 2003. However, there is
increasing reason to expect that it will recover gradually in the second half of 2003 and strengthen
further in 2004. Although the outlook for price stability is favourable, having allowed interest rates to
fall to historically low levels, monetary policy cannot by itself generate lasting and sustainable growth
and employment in the euro area. Part of the weakness in economic growth in the euro area may be
linked to a lack of ambition in recent years in both fiscal and structural reforms to improve the
conditions for investment and employment in the euro area.
The euro area needs structural reforms which increase the flexibility of labour, financial and product
markets and effectively increase potential output growth, job creation and investment.
Although the extent and implementation of labour market reforms have been uneven across countries,
the efforts made in the 1990s resulted in positive progress in two areas: first, in fostering employment
growth across most sectors, which rose to 1.5% per year on average between 1997 and 2001, and
second, in helping groups, such as women, the young and old and the least educated, to enter the
labour market. Labour market reforms should now focus on reducing high structural unemployment
and increasing participation and employment rates. Indeed, it is important that, alongside social
considerations, the countries of the euro area give more weight to economic efficiency within labour
markets.
Capital market reforms can also play a major role in making the euro area economy more flexible.
Much has been achieved, not least due to the introduction of the euro, and the bulk of the Financial
Services Action Plan has been implemented. However, the further integration of national capital
markets towards a truly European financial market would be an important step towards safeguarding
markets against country-specific shocks.
Finally, greater efforts must be made to remove existing barriers in product markets. Since the early
1990s state enterprises have undergone extensive privatisation, the use of state aid has fallen and
market entry barriers have been lowered, although not evenly across all countries or sectors. In
addition, there are still significant barriers to the further removal of price pressures, and these will need
to be phased out.
EU Neighbouring Regions
The ten countries that are about to join the European Union have made considerable economic
progress in recent years in terms of macroeconomic stabilisation and structural reforms. As a group
and individually, these countries have achieved significant and sustained improvements in their
economic fundamentals. In this regard, the perspective of EU accession has been an important anchor
for policies. However, the process of catching-up in real incomes has been significantly slower than
expected at the start of transition, and today, as they prepare to join the EU, there is still a significant
GDP per capita gap with the current Member States. Improving the growth performance of acceding
countries remains an issue of vital importance. While EU membership itself and the lagged effects of
earlier reforms should foster the catching-up process, sustained policy action is needed to further
improve the growth environment in the acceding countries. Reforms should, in particular, be conducive
to capital accumulation and bring about tangible increases in total factor productivity.
In other EU neighbouring regions, efforts in structural reforms have varied considerably. Following a
severe financial crisis in 2001, Turkey witnessed a strong rebound in 2002 and began an ambitious
process to reduce inflation, while still struggling with some of its long-standing problems. This
achievement was supported by structural - though still insufficient - reforms. In Russia, after a long
delay in the early years of transition, a first package of structural reforms has been implemented in
recent years, positively contributing to the strong recovery the country has been enjoying since the
1998 crisis.
United States
Turning to the United States, labour, product and capital markets have reached a high degree of
flexibility. This reflects both the traditional market-oriented nature of the US economic system and
reform efforts over the past 20 years, including a variety of deregulation measures in the 1980s. The
flexible microeconomic structure of the US economy has helped to make it one of the strongest growth
poles in the world, with GDP growth averaging 3.3% from 1983 to 2002 (compared with 2.4% in the
euro area). At the same time, the US experience shows that no country can consider structural
reforms as "completed". In its latest Article IV report on the United States, the IMF identified a number
of areas where further efforts would be desirable, including the budgetary framework, the social
security system and the energy sector. Also, the series of corporate failures in 2001-02 revealed
weaknesses in corporate governance practices, including accounting and audit rules, which are
currently being addressed by the US authorities.
Latin America
Over the last two years, growth in most Latin American countries has been weak. This year, however,
there are signs of a modest upturn, with confidence slowly returning. This has been due, in part, to the
direction of the structural reform agendas of many countries in the region. To strengthen the
foundations for growth, policy-makers must remain committed to implementing structural reforms.
Countries that have made the greatest strides in reform are already reaping the benefits. Both Mexico
and Chile, which are at the most advanced stage of reform in the region, have proven remarkably
resilient to turmoil in regional economies and have weathered the period of weak global growth well,
considering their exposure to sluggish mature economies. Other countries in the region have
embarked on reform agendas and should be encouraged by the international community to see them
through as swiftly as conditions allow.
East Asia
As for the crisis-hit countries in Asia, economic performance has been positively correlated with
progress in reforms. Stronger average growth potential in countries such as Korea and Malaysia
reflects partly the authorities' determination in pushing through corporate reforms, reforming the
financial sector and strengthening insolvency laws. In China, the authorities have repeatedly
emphasised that banking reform, if coupled with the restructuring and privatisation of state-owned
enterprises, is key to strong growth and financial stability in the medium term.
The situation in the Japanese economy calls for urgent structural reforms. Authorities have made
some progress in addressing the fundamental weaknesses and a reform strategy has been set out.
First, banking sector reform has been appropriately focused on strengthening loan classification
practices and accelerating the disposal of non-performing loans (NPLs). However, while progress has
been made on the former issue, financial institutions still hold large amounts of NPLs in their portfolios
and more progress would be desirable. Second, a strategy to promote deregulation in the product and
labour markets has been set up. The successful implementation of structural measures in the
Japanese product and labour markets would have the benefit of not only increasing potential output
and employment, but also decreasing the vulnerability of the Japanese economy to economic shocks.
Concluding remarks
Let me conclude by first addressing the economic policy-makers in the euro area. I am convinced that
economic activity in the euro area can only be lifted to a new, structurally higher, level by far-reaching
and progressive structural reforms. In this respect, the major contribution that monetary and fiscal
policy can make is to maintain a stable macroeconomic environment, entailing price stability and
sound public finances. Moreover, as I have already argued, the effectiveness of both monetary and
fiscal policy in bringing about macroeconomic stability hinges on the microeconomic functioning of the
euro area economy, which can only be enhanced by embarking on structural reforms. I am pleased to
observe that some countries in the euro area have already realised that the only solution to
addressing the current economic slowdown lies in structural reforms to strengthen the functioning of
the economy. I warmly welcome the efforts of the governments of these countries and sincerely hope
that others will follow their example.
Second, as I have sketched out in my remarks to you today, while the need for structural reforms is
pressing in the euro area, in all other regions of the world - albeit to different extents and to address
somewhat different problems - there are benefits of structural reform to be won.
Thank you very much for your attention.