Jürgen Stark: The agenda for the competitiveness of Europe's economy
and financial system
Speech by Mr Jürgen Stark, Member of the Executive Board of the European Central Bank,
at Ambrosetti Finance Workshop, Cernobbio, Italy, 5 April 2008.
* * *
Ladies and gentlemen,
I wish to thank the organisers of this event (Ambrosetti) for their invitation, which allows me
to speak about the competitiveness of the euro area - a topic which has even become more
of a prime concern in many advanced countries in view of the increasing challenges resulting
from globalisation. Given the varied facets of "competitiveness" - that I broadly define as "the
ability of an economy to compete in international markets" - I would like to start by reviewing
some specific aspects of economic and financial performance of the euro area. I would
continue thereafter with some aspects regarding the performance of the euro area banking
sector, including the link between financial development and the transmission of monetary
policy. Finally, with a view to reforms which aim at improving further the performance of the
euro area economy and financial system, I will draw some lessons from the recent financial
turmoil.
Real and financial aspects of euro area competitiveness
Starting by an assessment of the competitiveness of euro area firms and thus their capacity
to play a leading role in world markets, losses in world export market shares over the last
decade point to increasing challenges for the euro area. While being partly an adjustment to
the emergence of new competitors, and most notably China and India, with lower labour
costs, this may in principle also reflect losses in price competitiveness against other
advanced competitors or a more unfavourable export specialisation. Nevertheless, it is
important to note that most other advanced competitors have also experienced export market
share losses over the same period. On a more positive note, recent analyses of highly
disaggregated data, at the product and variety level, further show that instead European
firms have gained market shares in the high-price and high-quality segment of mature
sectors.1
However, important differences remain with regard to the export performance across
individual euro area countries. Unfavourable price and cost developments thereby often
seem to have been a major cause of a weaker export performance. Contrarily, the relatively
stronger export performance of Germany appears, to a large extent, be due to very moderate
increases in labour costs. Other factors such as differences in the export specialisation - the
product range and product quality - and the geographical orientation certainly have also
played a role. For example, due to its higher share of capital goods exports, Germany might
have also benefited, to a greater extent, than both Italy and France, from the sustained world
demand. Italy and France, by contrast, have a significantly higher export specialisation in
consumer goods.
In the medium-term, however, it is in particular the lower productivity growth, which weighs
on the competitiveness of European firms. Since the mid-1990s, productivity has slowed
down substantially in the euro area, leading to a productivity gap with the US. While this gap
is closing more recently, improvements in euro area productivity seem to be cyclical and not
of a structural nature. At the same time, labour markets in euro area countries have
witnessed an increase in participation rate and a decline in the unemployment rate. However,
the employment rate still falls behind the objective of 70% set by the Lisbon strategy, and
unemployment rates remain unacceptably high in a number of euro area countries. These
weaknesses in economic performance point to continued rigidities and imperfections in the
euro area economy.
To ensure that the advantage of European exporters in specific high value added varieties is
not eroded over time, to regain price competitiveness across all euro area countries, and to
improve labour market performance and potential output growth, the euro area needs to
implement structural reforms directed to boost productivity growth and enhance the
functioning of both labour and product markets.
This is even more crucial in a monetary union. Since euro area countries can no longer rely
on monetary policy and nominal intra-euro area exchange rate adjustment to adjust to
adverse shocks and the challenges posed by globalisation, other adjustment mechanisms
become even more important. In this context, wage and price flexibility plays a pivotal role.
The smooth functioning of the price mechanism is a prerequisite for the efficient allocation of
resources across different sectors and over time. In the same vein, the mobility of capital and
labour across countries and regions and between different sectors is of particular importance
in a monetary union. It is therefore essential that governments establish an institutional
framework which allows the economic adjustment processes to function efficiently and
effectively. In particular, setting appropriate incentives for economic agents and thus
enhancing the overall growth performance of the economy require further progress in
following 5 main policy areas:
• Policies enforcing competition in product markets and promoting further integration,
which will reduce excessive price margins and set incentives for entrepreneurs to
become more productive.
•
Improving the business environment, enhancing innovation and increasing the skill
level of the workforce play a key role in boosting labour productivity.
•
Increasing the flexibility of labour market, which would ensure that wages are
aligned with productivity developments and reflect competitiveness at the sectoral
and firm level as well as the regional employment situation.
•
Other measures devoted to human capital accumulation, through improving higher
education systems and supporting training and life-long learning, and a higher share
and more efficient expenditure in research and development, enhance productivity
growth in the long-run and also increase non-price competitiveness.
•
In addition, further efforts are also needed to improve the access to financing,
especially as regards small and medium-sized enterprises (SMEs) and the access
of start-up firms to venture capital financing. As most recently highlighted in
empirical work2, small successful European firms are apparently less able to grow
than comparable US firms due to the poorer access to financing.
Over the past decade, progress in these areas has been uneven across euro area countries.
Some significant efforts have been made and countries see the benefits from these reforms
coming in. However, the reform process needs to continue and the past years of good
economic performance are no reason for complacency or even a reversal of past reforms.
There is still a long way to go if we want to attain the objective of the Lisbon Strategy to make
the European Union "the most competitive and dynamic knowledge-based economy in the
world".
Let me now turn to the competitiveness of the euro area financial sector. Financial efficiency
has made large progress since the introduction of the euro and has contributed to the
competitiveness of the euro area, by accelerating the speed of capital reallocation.
Generally, in an efficient financial system, information is accessible and widely distributed.
An efficient financial system usually enhances economic growth, whereas, by contrast,
information asymmetries or insufficiently developed markets may lead to financing
constraints, often especially for SMEs. Therefore, a well-functioning financial system is an
EU policy priority as it allows the economy to fully exploit its growth potential, fosters the
accumulation of capital and the diversification of risk.
Evidence on euro area financial development
Let me start with the size of capital markets, on the basis of which financial development can
be assessed, which is an important feature also for the competitiveness of the financial
system.
The size of euro area capital markets has increased markedly since the introduction of the
euro. On average, euro area capital markets, when measuring size including both domestic
securities (bonds and stocks) markets and the amount of bank lending to the non-bank
private sector, tend to be smaller than the capital markets in the United States and the United
Kingdom, but roughly comparable in size to Japanese capital markets.
In the euro area, Luxembourg, the Netherlands and Ireland have the largest capital markets
relative to their economy (GDP). In addition, some euro area countries with smaller financial
sectors have experienced strong growth in their capital markets over the past 15 years, for
instance Ireland, Portugal and Spain.
This development of euro area capital markets is important as financial systems with larger
overall capital markets generally allow a faster reallocation of capital and provide easier
financing for real investment, thus fostering productivity. Financial development increases the
ability of industries to exploit global growth opportunities that may arise from technological
innovation, unanticipated demand shocks or price changes.3 In particular, industries which
are structurally highly dependent on external financing, benefit from better financial
development in the sense that they are able to grow faster compared with an environment of
less developed financial systems.4 It is also important to note in this context that both
securities markets and the amount of loans granted contribute positively to economic growth.
The sometimes cited relative share of market versus bank financing therefore appears not to
be a key variable for the positive impact of capital markets on economic growth.5 In addition,
with the "originate and distribute" banking model, the borders between bank and
marketbased financing became blurred to some extent during recent years.
With respect to the current turbulences, the relative advantages of traditional bank financing
versus market-based financing and the symbiotic relationship between bank and
marketbased financing may be re-discussed. Generally, traditional relationship banking implies
close monitoring and a reduction of information asymmetries, whereas market-based
financing (including securitisation) allows a wide (re-)distribution of risk. Some rebalancing of
these two key features may be necessary in order to achieve both an appropriate monitoring
and sharing of risks.
With respect to monetary policy, more developed financial markets, such as developed bond
markets or the availability of securitisation, tend to increase competition and the speed of the
pass-through of market rates to bank rates in the banking sector for specific bank product
segments.6 Especially in those segments, for which market-based financing is an alternative
(for instance for long-term loans to non-financial corporations), an increase in the speed of
pass-through seems to have occurred in the euro area during recent years.
Overall, the monetary transmission mechanism benefits from integrated and well-developed
financial systems in the sense that it leads to a more similar and, in part, faster pass-through
of market rates to bank rates. Efforts to strengthen bank competition and enhancing the
availability of alternative capital market-based instruments as well as access to financing
should therefore be expected to improve the monetary transmission mechanism.
At the same time, one has to acknowledge that several studies7 on the productivity of the EU
(euro area) from an industry point of view come to the conclusion that the differences in
productivity growth between the US and the EU (euro area) may be partly due to differences
in the financial sector. While the productivity performance of the financial intermediation and
insurance and pension funds sub-sectors was comparable between the EU and the US,
according to some studies the main difference was in the sub-sector "activities auxiliary to
financial intermediation".8 While productivity measurement is particularly difficult in the
services sector, and, hence, also in the financial sector, such differences in productivity
growth may be partly related to a higher development and integration of the US financial
system, which may facilitate the exploitation of economies of scale. At the same time, with
respect to the current situation, it is still too early to assess the longer-term effects of the
current turbulences on the gap in productivity growth between the two economic regions.
In this context, there is evidence of a considerably positive effect of financial development on
EU economic growth. Assuming that the EU would reach the same level of financial
development (defined as the sum of domestic credit and stock market capitalisation to GDP)
as the US, it is estimated that the overall effect on annual EU value added growth would be
between 0.5 and 1.0 percent.9
Evidence on euro area financial integration
Let me now turn to financial integration, which is one important dimension of the efficiency of
a financial system. Let me begin by recalling that the ECB and the Eurosystem have a keen
interest in the progress towards financial integration in Europe as it is of key importance for
the conduct of the single monetary policy, as it enhances the smooth and effective
transmission of monetary policy throughout the euro area. In this respect, the Eurosystem
strongly supports the initiatives of the European Commission in the field of financial
integration.10
In a fully integrated financial system market players follow a single set of rules and have
equal access to the market and are treated equally when operating in the market. In this
6
See Gropp et al. (2007).
7
See several papers and books written by Bart van Ark, Robert Inklaar, Robert McGuckin, Mary O'Mahony,
from the University of Groningen, The Conference Board and the National Institute of Economic and Social
Research and in particular the report "EU productivity and competitiveness: an industry perspective. Can
Europe resume the catching-up process?" office of Official publications of the European Communities,
Luxembourg, 2003.
8
According to the OECD, this sub-sector "... includes the provision of services involved in or closely related to
financial intermediation, but not themselves involving financial intermediation.". These services include for
instance the activities of stock exchanges and brokerage services.
9
See Guiso, Jappelli, Padula and Pagano (2005).
10
In December 2005, the European Commission released its "White Paper on Financial Services Policy
20052010", which shapes the current policy programme in the field of financial services.
BIS Review 41/2008
light, let me mention some key achievements which were reached during the past with
respect to financial integration of the euro area.
Generally, market segments close to the single monetary policy are very much integrated,
especially the unsecured interbank money market.
The high integration in the euro area money markets has been supported by the high degree
of integration of large-value payment systems.
TARGET 2, which was introduced in November 2007, provides now an even more uniform
wholesale payment system infrastructure by means of a single technical platform. Besides
the technical harmonisation, TARGET 2 also discontinued the differentiation in the fees
between intra- and inter-Member State payments and thus, led to a further harmonisation of
prices. Last but not least, a reduction of average prices is also expected in TARGET 2.
Let me now turn to euro area bond markets. Besides the euro area government bond
markets which are increasingly driven by common factors since the introduction of the euro
and the removal of the exchange rate risk, also the euro area corporate bond market is quite
well integrated. In fact, euro area corporate bond markets seem to be largely driven by
common factors, rather than by country-specific ones. In addition, cross-border holdings of
debt securities increased markedly over the past ten years, suggesting that investors are
increasingly diversifying their portfolios across the euro area.
Progress has also been made in the integration of euro area equity markets. [While local
shocks to equity markets continue to be important, an increasing share of the total domestic
equity volatility can be explained by euro area-wide shocks ("variance ratios").11] As regards
cross-border equity investments, it can be noted that euro area residents doubled their
holdings of equity issued in other euro area countries between 1997 and 2005 (as a share of
their total portfolio of shares issued in their own country and elsewhere in the euro area) to
reach around 30%, in particular on account of institutional investors. By contrast, the share of
euro area equity assets held outside the euro area remained at a much lower level and
increased only slightly.
The euro area banking sector - strong and weak points
Compared with securities markets, the process of financial integration has advanced more
slowly in the banking sector. Against this background, let me discuss the strengths and
weaknesses of the euro area banking sector.
Let me start the discussion of strengths and weaknesses from a structural point of view, with
respect to the integration and efficiency of the banking markets.
First, on the positive side, the internationalisation of EU banking groups has increased during
recent years. This has resulted, to a large extent, from the overall rise in terms of value in
cross-border mergers and acquisitions in the euro area banking sector since 2004. In 2005,
the value of cross-border bank M&A deals was particularly high, mainly owing to the
acquisition of the Bayerische Hypo- und Vereinsbank by UniCredito Italiano. Generally,
cross-border M&A activity is one way to increase competition in the banking sector, which
tends to contribute positively to economic growth.
While cross-border M&A activity tends to increase competition, extensive public ownership of
banks constitutes a possible distortion of competition in the banking sector, which also works
against the development of capital markets.
In addition, while the integration in the wholesale and capital-market related banking market
has advanced well during recent years, the still fragmented retail banking market can be
regarded as a further weakness of the euro area banking sector. This can be seen, for
instance, in the dispersion of interest rates on loans and deposits from banks to non-financial
corporations and households.12
In addition, in contrast to large-value payment systems (TARGET, TARGET 2), retail
payment systems in the euro area are still fragmented. However, the SEPA (Single Euro
Payments Area) initiative aims at achieving a fully integrated market for retail payment
services in the euro area with no distinction between cross-border and national payments,
meaning that in the end all euro payments will be "domestic". In fact, since the end of
January 2008, the first step has become reality with the launch of "SEPA Credit Transfer",
which allows sending euro payments quickly, and in the same way, to any beneficiary in
Europe. Overall, the launch of SEPA is a major step in the integration of the euro area retail
banking sector.
In addition to a structural discussion of the strengths and weaknesses of the euro area
banking sector in the light of the performance of the financial system, one may also look at
the banking sector in the context of the financial turmoil.
Starting from the US sub-prime market, several reasons may lie behind the spill-over of the
turmoil to other market segments. A global macroeconomic environment characterised by
sustained growth, low inflation, muted long-term interest rates, a long period of very
favourable credit conditions, abundant market and funding liquidity, and relatively low official
rates may have strengthened investors' appetite for risk and increased the "hunt for yield".
This, in turn, may have brought about an under-pricing of risk. In addition, the "originate and
distribute" banking model, compounded with the proliferation of new and complex financial
instruments, notably structured finance products has contributed to a dispersion of credit risk
in the financial system and an increased indebtedness of non-financial sectors.13
In this context, the loosening of credit standards and a probably riskier lending attitude may
be identified ex post as a weakness of the banking sector. As banks were able to transfer
part of their credit risk, they were able to extend further loans.
In addition, there was a widespread underestimation of risks and a lack of transparency in
the context of the extensive use of derivative products, partly related to their evaluation by
rating agencies, leading to mistrust between market participants, an increase in the cost of
funding and liquidity shortages in the course of the turbulences. This underestimation of risks
may be seen as another key weakness of the banking sector.
Against this background, let me finally discuss the need for potential reforms with respect to
preventing and handling financial crises. It seems clear that some very important lessons can
be drawn from the turmoil for market players as well as for public authorities.
Let me just mention few key areas where reforms are needed. First, with respect to banks,
the turmoil has highlighted that some risk categories have been underestimated, especially
liquidity risks relating to banks' commitments to structured investment vehicles and conduits.
Second, market players seem to have relied excessively on ratings of complex assets. This
has been the case in part due to the wide distribution of risks through the financial sector
which made the assessment of the value of the underlying asset difficult for the investor.
While, on the positive side, credit risk transfer has facilitated a widespread sharing of risk in
the financial system over recent years, the recent financial turmoil made clear that more
transparency and monitoring is needed on the credit risks and where they ultimately reside in
the financial system. Finally, with respect to public authorities, it seems of high importance
that there is a smooth and effective cooperation and exchange of information between
supervisory authorities as well as between them and central banks in the detection of threats
to the financial system. Particularly, with respect to central banks, it is their own interest to
contribute to an orderly functioning of money markets and to solidly anchor inflation
expectations in order to avoid additional volatility in already highly volatile financial markets.
Concluding remarks
Let me briefly conclude by summing up what all of this means for the outlook of the euro
area.
First, from the real economic side, there are encouraging signs indicating the good potential
of the euro area to successfully adapt and to remain competitive going forward.
Nevertheless, there are important challenges ahead and to implement the necessary
structural reforms will be decisive to raise productivity growth and, hence, to foster the
competitiveness of euro area firms.
Second, with respect to the financial side, the financial development of the euro area has
increased markedly since the introduction of the euro. This is particularly important as a well
developed financial system allows economies to better allocate resources to industries with
good growth opportunities and thus experience faster overall economic growth. In addition,
the financial integration of the euro area has made large progress during recent years. This
has increased the competitiveness of the euro area. Notwithstanding some reforms, which
appear necessary especially following the experience of the recent financial turmoil and
further steps which are needed on the way to a fully integrated euro area financial system,
the progress already achieved is highly beneficial for the efficiency and competitiveness of
the euro area financial system and will ultimately foster the performance of the euro area
economy.
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