Jean-Claude Trichet: The European economy - current situation, prospects,
challenges
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the "Forum
économique international des Amériques" Conférence de Montréal, Montreal, 30 May 2005.
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Mr Prime Minister,
Mr Mayor,
Mr President,
Ladies and Gentlemen,
It is with great pleasure that I have come to attend the debate and discussion at the international
economic forum of the Americas/Montreal conference, and more especially to address you today. The
issue chosen for the forum this year, "Success at a time of turbulence", is especially relevant in a world
beset by constant economic, financial and technological change. So I would like today to share the
European experience with you. Allow me first of all to discuss the recent development of economic
activity in the euro area, the better to underscore the prospects and to describe the challenges to be
faced if Europe is to make its own contribution to the growth of a world undergoing in-depth
transformation and thus tending to be turbulent.
The economy of the euro area: a stable macroeconomic situation, but economic dynamism that
requires further stimulation
Since its establishment over six years ago, Economic and Monetary Union has helped to provide a
stable macroeconomic environment. Over the past few years, the annual inflation rate in the euro area
has remained slightly higher than our own definition of price stability, that is a rise in prices of less than
2 % and close to 2%. Yet this situation is more a reflection of temporary shocks linked in particular to
the trend in the price of crude oil, than to any underlying inflationary trend, which remains generally
moderate today. Inflation expectations have remained anchored at under 2%, in line with our definition
of price stability. The fact that the run of oil price hikes has not jeopardised the stability of inflation
expectations is no mere coincidence. It is a mark of success, showing the high credibility level of the
young European Central Bank, which has proven capable of convincingly providing businessmen in an
economic area with a population of some 306 million, with a stable anchorage point for their price
expectations. Thus, as long as inflation and inflation expectations remain solidly anchored to levels
compatible with price stability, monetary policy will make a crucial contribution to economic growth by
fostering an exceptionally low interest level on the short, medium and long-term markets, and by
creating an economic environment that entails minimal distortion and that helps businessmen to make
the best decisions.
In the medium term, the euro area's prospects rest on crucial factors that should not be overlooked.
Allow me to briefly run through them. On the external level, worldwide activity is fated to remain
healthy and it is expected to help sustain European exports. On the internal level, investment should
continue to benefit from financial conditions that are, historically speaking, exceptionally favourable in
the euro area. It should benefit also from an improvement in businesses' results and their increased
productivity due to past restructuring. Moreover, private consumption is likely to grow in keeping with
the growth in real income that is expected to continue.
Yet in the shorter term, since the second half of 2004, growth in the euro area has been modest,
below the area's potential growth rate. It is still positive, of course, but modest. There can be no doubt
that the increasing cost of raw materials (with crude oil heading the list) has led to increasing
uncertainty over economic prospects and that it continues to loom as a risk of far from secondary
importance, as indeed do imbalances at the global level. Furthermore, consumers are taking their time
to rediscover the path of confidence, doubtless on account of a still difficult situation in the labour
market, of difficulties and delays in the implementation of basic reforms, and of a feeling of insecurity
due to insufficient budget consolidation.
Sure enough, a good monetary strategy guaranteeing the solid anchoring of price stability is a
necessary precondition for economic growth. It is not a condition that is sufficient in itself, however. A
budget strategy guaranteeing healthy public finances and structural reforms making it possible to raise
the level of potential economic growth are also crucial. An examination of the trend in labour
productivity in Europe and in the United States is particularly enlightening in this connection.
Over the past few years, despite tangible progress in terms of overall employment growth and activity
rates, a slowdown in the rise in hourly productivity in the euro area has been the main cause of the
gap in economic growth between the euro area and the other major economy in the industrially
advanced world, namely the United States. This, especially because over the same period of time the
United States has enjoyed a strong boost to its hourly productivity, thanks in particular to its efficient
use of new information and communication technology. Thus while growth in hourly productivity in the
1980s stood at 2.4% on average in the euro area and at 1.3% in the United States, that trend inverted
between 1996 and 2004, with an annual average in the euro area and in the United States of 1.3%
and of 2.5% respectively.
The lack of sufficient structural reform in Europe is, in my view, the main cause of the gap in economic
growth between Europe and the United States that we have seen over the past few years. If we are to
impart a fresh thrust to Europe's growth potential and to help boost consumer and business
confidence, we need to work on the European economy's most crucial underlying weaknesses and to
implement basic reforms. Allowing the labour market to work better with a view to boosting growth in
employment and productivity, completing the establishment of a large single market, and promoting
investment and innovation will be the best way of allowing the European economy to adapt to
international competition, to foster the development of businesses, and to accelerate economic growth
and the creation of lasting employment.
Structural reforms
I must say that - although uneven across European countries - significant progress in the
implementation of structural reforms has been made, and such an effort should be recognised.
However, there is still a long way to go. In Lisbon in 2000, Heads of State and governments have
committed to make the European Union "the most competitive and dynamic knowledge-based
economy in the world, capable of sustainable economic growth with more and better jobs and greater
social cohesion". The decision on the specific structural reform measures, their design and actual
implementation should be left to the Member States. While getting closer to one another, EU countries
still differ in many respects: in their structure, economic development and institutional setting. Leaving
it up to the national actors to decide on their reforms is just the natural consequence of such
differences. However, these reforms should take the EU consensus on policy priorities and objectives
as a clear and common reference point. Again, let me stress that implementing structural reforms is
not an easy task; it needs a lot of courage and determination on the part of governments, parliaments
and social partners. However, these reforms are most definitely needed, along with stability-oriented
monetary and fiscal policy, as an essential ingredient to ensure higher prosperity and job creation in
Europe. Let me now focus on two areas where I think further progress is most urgently needed: labour
and product markets.
In product markets, there are still considerable productivity gains to be reaped in Europe by removing
the remaining barriers to competition that still remain at national and EU level. The creation of a
common market based on the free movement of goods, services, people and capital is a cornerstone
of the European Union since the Treaty of Rome. The completion of the single market, in particular in
the sector of financial services, is of the essence.
An essential factor of technological progress and diffusion is human capital. Indeed, thanks to
technological advancements, economic activity becomes increasingly knowledge-based and jobs shift
from low to high-skilled workers. However, investment in human capital development in Europe
remains insufficient, and a strong focus should be put on improving education and training systems.
Europe also suffers from insufficient quantitative and qualitative efforts as regards investment in
research and development (R&D). As an example at present only two EU countries exceed the target
for R&D spending of 3% of GDP. All the other EU countries lag behind. More efforts in this field are
clearly needed.
Further reforms in labour markets are also crucial in order to improve the flexibility of the labour
market. It is essential to provide incentives for more people to enter the labour market. Increasing
labour participation and utilisation is a core challenge for policy, particularly for females, the young and
older workers. Some countries have started to implement reforms in order to reduce the disincentives
to work. Unemployment insurance schemes have been amended and early retirement incentives have
been reduced. Take for instance Denmark and Sweden, where various reforms to improve work
incentives and avoid labour supply constraints have been implemented. In Denmark, measures aimed
at reducing taxes on labour income. In Sweden, reforms mainly targeted older workers, immigrants
and younger workers. Well, both Denmark and Sweden have already exceeded all the EU
employment targets, including those for women and for older workers. These are two examples where
the reform progress in this area has produced clear benefits. However, although unemployment
insurance systems have been streamlined, in a number of cases, together with high marginal tax rates
and social security contributions, they continue to provide a disincentive to take up work.
EU enlargement
Meeting these challenges has become even more important with the historic enlargement of the
European Union in May last year from 15 to 25 Member States. Let me first stress that I am convinced
that the enlargement entails opportunities and benefits for the EU. The economic benefits of
enlargement are sometimes neglected in discussions, often overshadowed by fears, such as the risk
of mass migration after opening up borders with the new Member States, involving increased pressure
on labour markets and welfare systems of the other Member States. I do believe that the EU
enlargement will contribute positively to economic growth and welfare in the EU as a whole. It will
provide new opportunities to trade and investment flows. The enlargement of the Internal Market will
strengthen the degree of competition as the accession of the new Member States has increased the
number of suppliers within the Internal Market. In addition, enlargement has enhanced the scope for
economies of scale, as the extension of the Internal Market increased the size of the market available
to suppliers. This should translate in lower prices and increased productivity, thereby contributing to a
higher potential growth. However, these benefits will not be realised automatically. Again, in this
respect too, there are substantial benefits associated with the implementation of structural reforms. In
particular, a forceful and prompt completion of the enlarged Internal Market in both the old and the
new Member States is essential to fully exploit the benefits of the present enlargement.
Let me say a few words on the ERM II membership which has already been decided for six currencies
out of the ten currencies of the new Member States. Having proceeded with the necessary structural
adjustments, participation in ERM II can be an important means of anchoring exchange rate and
inflation expectations, and of promoting discipline. It can help orient macroeconomic policies to
stability, while at the same time allowing for a degree of flexibility, if needed, through the wide standard
fluctuation band and the possibility of adjusting the central parity. In any case, there is not a uniform
path to the adoption of the euro and each country will be judged on its own merits before adopting the
euro. And, as required by the Treaty, the sustainable convergence of the economies concerned will be
carefully checked both in the interest of the country concerned and in the interest of the euro area as a
whole.
Fiscal discipline
Finally, I would like to discuss another major challenge that Europe is going to have to face over the
next 50 years: an ageing population. A few figures may help to illustrate the magnitude of this
challenge: According to the forecasts of Eurostat, the European statistics institute, the population of
working age (people aged between 15 and 64) is going to drop from 67.2% of the overall population in
2004 to 56.7% in 2050. At the same time, the proportion of retired people (in other words, people aged
65 or over) is going to rise from 16.4% of the overall population in 2004 to 29.9% in 2050. These
figures are self-explanatory. We are on the eve of an unprecedented demographic upheaval which is
going to put a major strain on public finances. Ageing is going to translate into significant additional
budget costs, generally estimated for the next few decades (and only for pensions) at between 3 and
5% of GDP in the majority of European countries. These forecasts show quite clearly that
demographic change without appropriate reform is likely to weigh down very heavily on public finance.
I would like to draw your attention to the most important effects of these developments on the
sustainability of public finance and growth.
The pressure that an ageing population will have on public spending could threaten the sustainability
of public finance. Without a change in policy, public spending due to ageing will lead to a growth in
deficits and to an inevitable increase in the public debt. These developments will also reflect on
businessmen's forecasts. A drop in confidence in Government signatures due to forecasts of an
increased risk of default on the public debt could multiply "risk premia" and foster a financial
environment less conducive to investment and growth.
With an ageing population, spending on share-out pension systems is going to increase at the same
time as the social security contribution base decreases. In the light of such a situation, adjustments in
the parameters of these systems, such as for instance a rise in the real retirement age, seem to be
essential. And more fundamental changes to the structure of pension funding seem to be essential
too. Growing pressure on the funding of public health systems also calls for courageous reforms.
Reform of social safety nets is one of the crucial factors, among many others, that will allow us to
control the public debt, to guarantee the sustainability of public finance, and to boost growth potential.
The immediate adoption of a strategy of ambitious reforms along with a firm and credible budget
consolidation policy would help to boost Europe's growth potential without delay. In the case of the
euro area economies, boosting businessmen's confidence in budget sustainability and in long-term
economic stability as well as in the maintenance of a suitable welfare policy and of reasonable
compulsory contribution rates would more than make up for the negative effects that the reforms and
budget consolidation might have on demand in the short term. The larger the imbalances forecast, the
more these "Ricardian", non "Keynesian", effects are likely to be seen. And an ageing population
means major budgetary imbalances in Europe's future, naturally if the countries concerned fail to take
appropriate action.
In the face of a challenge of this nature, it is crucial to implement the new version of the Pact for
Stability and Growth in a stringent manner. The Pact is essential from the standpoint of the Economic
and Monetary Union's cohesion, and in that connection it is one of the keystones of confidence in
Europe's economic stability, thus one of the keystones of investment and growth. So it is necessary to
work with determination on budget consolidation and on bringing down the public debt in order to take
on the challenge of an ageing population and to safeguard the credibility of the European budgetary
framework.
Mr President, Ladies and Gentlemen, Europe is facing today five major challenges. Three of them are
major challenges that equally apply to all the long industrialised countries. The last two others are
specific to Europe and do not exist anywhere else in the world.
The diagnosis is now clear as regards the first three challenges - the challenge of new technologies,
the challenge of globalisation, the challenge of population ageing - which does not mean either that
they are easy to solve... For the first challenge, facilitate the deepening and broadening in the whole
economy of science and technology, in particular - but not only - of information technologies. For the
second, organise the new economic framework stemming from the generalisation of the market
economy and the very fast economic development of Asian emerging countries. For the third, draw the
consequences of population ageing in order to ensure the sustainability of public finances. The US,
Canada and other industrialised countries must tackle the same issues.
But in addition - and this is a unique situation in the world, a privilege and at the same time a great
historic responsibility - Europe must face two other challenges.
On one hand, Europe has engaged into a long-term process aimed at ensuring its unity on the basis of
a voluntary Union between States. These States share in common some elements of their sovereignty
and have already decided to create a single market with a single currency. This is a very ambitious
historic transformation.
On the other hand, Europe must a the same time meet the challenge of a rapid geographic expansion
of an immense historical magnitude. We were still 12 countries when the Maastricht Treaty was
negotiated. We are now 25, and virtually already 27. In Europe, are therefore intertwined a unique
"vertical" economic and political transformation and a geographic "horizontal" expansion of an
immense significance.
Five major challenges to face, two more that the other industrialised countries. All these challenges
are exciting, all stem from important successes - scientific progress, the economic take-off of big
developing countries, progress in medicine, the deepening of the pacific unity of Europe, the fall of the
iron curtain - but these challenges are also demanding and difficult. After the French referendum and
before the Dutch referendum, we are facing today a difficult moment for Europe and for our 458 million
European fellow citizens. It is not the first time, and probably not the last time. In his Memoirs Jean
MONNET, whose ideas and action are at the roots of the European endeavour writes: "Those who do
not want to start an endeavour because they are not fully sure that things will go as they have planned
in advance, are condemning themselves to be immobile." I am sure that Europeans will together find
the way allowing them to overcome present difficulties as they did it in the past.
The European Central Bank has a clear mandate given by the Maastricht Treaty. It preserves today
and will preserve tomorrow, as it did in the past, price stability and confidence in the currency, which
are necessary conditions to sustainable growth and job creations. Confidence is a key word in present
circumstances. Europeans can rely on the ECB and on the Eurosystem as a whole to preserve and
consolidate this confidence.
I thank you for your attention.