Jean-Claude Trichet: The process of European economic and financial
integration
Keynote speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the
Journalist Symposium "Konvent für Deutschland", Berlin, 5 December 2007.
* * *
1. Introduction1
Es ist mir eine große Ehre, als Gastredner zu diesem Journalisten-Symposium in Berlin
geladen zu sein, um über die wirtschaftliche und finanzielle Integration in Europa zu
sprechen. Der Gedanke ist nicht neu. Bereits als der Vertrag von Rom vor einem halben
Jahrhundert unterzeichnet wurde, stand der freie grenzüberschreitende Verkehr von Waren,
Dienstleistungen, Kapital und Personen im Mittelpunkt der Bemühungen der
innereuropäischen Politik, die schließlich zum europäischen Binnenmarkt führen sollten.
[It is a great pleasure for me to be invited as a guest speaker to this Journalist Symposium in
Berlin to talk about European economic and financial integration. The idea of financial and
economic integration is not new. Even at the time the Treaty of Rome was signed, half a
century ago, the prime focus of intra-European policies was on facilitating the free flow of
goods, services, capital and people across national frontiers, an initiative which was to
become the Single Market.]
If you will allow me, I will now continue in English.
Today, the European Union comprises 27 countries and a population totalling 494 million
people, with Romania and Bulgaria joining in January of this year. The impressive
enlargement of the EU has gone hand in hand with the successful creation of Economic and
Monetary Union among 13 of the EU countries and 317 million citizens. The 13 will become
15 in January of next year, when Cyprus and Malta join the euro area, adding another 1
million people to the population of the euro area.
However, Europe still needs to make progress to fully reap the benefits from the euro. In this
respect, achieving the objective of the "Konvent für Deutschland", which is to enhance the
ability to make reforms in Germany, is urgently needed. This brings me to the issue I should
like to address today, namely that of European economic and financial integration. First, I
should like to share with you some facts on the process of economic and financial integration
in Europe. Second, I should like to talk about economic adjustment processes. Smooth
adjustment processes are further enhanced by economic and financial integration and are
crucial for the proper functioning of the European economies.
2. Economic and financial integration in Europe
Allow me now to elaborate on three aspects of economic integration in Europe, namely trade,
labour mobility and business cycle synchronisation.
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 and 2006, to stand at around 32% of GDP. The
share of intra-euro area exports and imports of services increased by about 2
percentage points in this period, to almost 7% of GDP.
As trade integration within the euro area becomes stronger, the region is also
becoming more open 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. German extra-euro area trade contributed particularly strongly to these
developments, increasing from 31% of German GDP in 1998 to 51% in 2006.
German trade is a good example of the fact that the euro area is an open economy
and not a "fortress Europe". By comparison, in the United States, exports and
imports of goods are lower, representing about 22% of GDP and trade in services
6% in 2006.
ii) A second aspect of the process of economic 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, the decline in inflation differentials across the euro area countries has
been impressive in recent years. The level of dispersion is currently at a lower level
than that among 14 US Metropolitan Statistical Areas.2 Dispersion in real GDP
growth rates across the euro area countries has been fluctuating around a level
similar to the one observed in output growth across regions within the United
States.3
iii) Labour mobility within the EU constitutes a third aspect of economic integration that
I should like to mention. Labour mobility offers additional choices to workers. It can
dampen the effects from country-specific shocks and decrease the risks of wage
pressures as labour markets tighten. Available evidence suggests that, overall,
cross-border labour mobility is still limited within the European Union with regulatory
barriers still existing, even within the euro area itself with respect to labour from
Slovenia, for example. Germany belongs to the countries which currently prevent
labour mobility from some EU countries. This comes at a time when many
companies are reporting problems in finding properly skilled labour. For instance,
the German industry currently reports very significant shortages of labour, according
to a survey by the European Commission.
Comparable figures on labour mobility for the EU and the United States are difficult to obtain
and any such figures should be interpreted very cautiously. Still, in the United States,
geographical labour mobility appears to be far higher.
Let me now turn to financial integration in Europe. The introduction of the euro has
contributed to intra-European financial integration which, in turn, has facilitated the free
movement of capital in the euro area. Financial integration strengthens competition and
raises the potential for stronger non-inflationary economic growth.4 It also improves the
smooth and effective transmission of the single monetary policy throughout the euro area.
Financial integration also 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.
According to academic research, in the United States, 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 for speeding up financial integration in
Europe. In a more recent study, it was found that the situation in the euro area countries has
begun to converge towards that of the United States as inter-euro area country capital flows
increase. It was found that in what would become the euro area countries (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, points to an increasing degree of integration of
euro area financial and banking markets since 1999.7 Moreover, the size of capital markets -
in terms of the ratio of the total value of stock, bond and loan markets to GDP - has
increased substantially since 1999, and has the potential to grow even further, as seen from
a comparison with the United States. In the period 1995-99, it was 177% of GDP in the euro
area and 279% in the United States; in 2005-06 it had increased to 256% in the euro area,
and 353% of GDP in the United States. In Germany this ratio rose from 202% to 229% of
GDP.
Integration in retail banking, by contrast, has been slow so far. There are still significant
differences in bank deposit and lending interest rates across euro area countries. In the euro
area, the cross-country dispersion is higher than the intra-regional dispersion of the same
rates in the United States.8
This notwithstanding, overall there is evidence of growing economic and financial integration
among the countries of the European Union. The adoption of the euro has 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, a lot
4
A research study conducted by London Economics estimated the benefits of the integration of European
bonds and equity markets to be around 1% of additional GDP over a ten-year period. London Economics,
2002, "Quantification of the macroeconomic impact of integration of EU financial markets", Report to the
European Commission. See also "EU Productivity and Competitiveness: an Industry Perspective. Can Europe
Resume the Catching-up Process?" by Mary O'Mahony and Bart Van Ark, European Communities, 2003, for a
comparison of the financial sector contribution to annual labour productivity growth in the United States and
the euro area.
5
See P. Asdrubali, B. Sørensen and O. Yosha, 1996, "Channels of interstate risk sharing: United States
19631990", Quarterly Journal of Economics Vol. 111.
6
See S. Kalemli-Ozcan, B. Sørensen and O. Yosha, 2004, "Asymmetric shocks and risk sharing in a monetary
union: Updated evidence and policy implications for Europe", CEPR Discussion Paper No. 4463.
7
"Financial integration in Europe", ECB, 2007.
8
C. Kok-Sørensen and T. Werner, 2006, "Bank interest rate pass-through in the euro area; a cross-country
comparison", ECB Working Paper No. 580.
BIS Review 145/2007
remains to be done, for example, that of increasing intra-euro area labour mobility and
financial integration in retail banking.
3. Adjustment processes in the euro area
Economic and financial integration are prerequisites for the smooth functioning of the euro
area. In a monetary union like the euro area, where regional monetary and exchange rate
policies are no longer available options, it is important to ensure that market adjustment
mechanisms function properly. Such mechanisms are needed in order to prevent a country
or region, after experiencing a country-specific shock, from entering into a period of
protracted low growth and higher unemployment, or into a long period of overheating.
There are many factors that can improve the resilience of the euro area economies to
adverse shocks. In this context, the ECB's monetary policy contributes to the proper
functioning of adjustment mechanisms within the euro area by ensuring price stability, by
being credible in ensuring price stability and therefore by anchoring such price stability in
economic agents' expectations and decisions. This anchoring of expectations is important for
enabling market participants to set suitable prices. And let me add that the best way to
anchor inflation expectations is through an independent and accountable central bank.
German history provides the best possible example of this.
Well-designed structural policies that enhance flexibility in product and labour markets are
crucial for absorbing shocks more effectively. Needless to say, the responsibility for the
implementation of such policies is in the hands of national governments, of parliaments, and
of social partners.
In this context, the Lisbon strategy is a fundamental and ambitious programme designed to
draw Europe's attention to the urgency of structural reforms. Such reforms improve long-term
growth prospects in the euro area by, on the one hand, positively affecting labour
participation and, on the other, improving labour productivity growth through the promotion of
innovation and technological change. We know very well that structural reforms often face
both resistance from economic agents and sensitivities in public opinion. Therefore, it is
essential to understand and communicate that the medium to long-term benefits of structural
reforms will significantly outweigh any short-term cost. The ECB therefore strongly supports
governments in their implementation of structural reforms. For instance, in Germany, the
labour market reforms, implemented a few years ago, have significantly contributed to job
creation, lower unemployment and the recent economic upswing. It is essential that those
results are not jeopardised by interrupting or even reversing the reform process.
Unemployment in Germany is still high and further reforms are required to better utilise the
labour potential here in this country.
More specifically, on the labour market, economic flexibility can be promoted by removing the
institutional barriers to flexible wage and price-setting mechanisms. Let me stress that
governments and social partners share responsibility for ensuring that wage determination
appropriately takes into account labour market conditions at the industrial, sectoral and
regional level and does not jeopardise competitiveness and employment.9 Governments
should be aware that wage setting in the public sector very often serves as a role model for
the private sector. Moreover, sufficient wage differentiation is needed to improve employment
opportunities for less skilled workers and in regions or sectors with high unemployment. In
this respect, excessive wage regulations are undermining job creation, in particular for young
and less qualified workers as well as for all those who face problems entering the labour
market. In particular, setting minimum wages at levels which are not in line with productivity
reduces the employment chances of less skilled workers and of the unemployed.
As seen in Germany following unification, the period of adjustment can be painful, but
reforms and unit labour cost moderation are finally paying off and they are contributing to
robust growth. I remember some observers arguing several years ago that much stronger
wage increases were needed in Germany for higher growth. The recent evidence does not
confirm this view. On the contrary, the increased competitiveness seen in the German
economy - thanks to moderate unit labour cost developments - has been an important
prerequisite for the very strong job creation observed in recent years.
Not only in Germany, but also in the euro area as a whole, employment growth has been
impressive in the eight and a half years since the euro changeover. Employment growth
amounts to 14.9 million persons in the euro area, as opposed to only 3.8 million in the
previous eight and a half years.
Reforms are also needed in product markets. Let me first stress the importance of fully
completing the Single Market, particularly in services and network industries. A deeper
integration of markets would stimulate price flexibility by fostering competition and open
product markets. Greater cross-border competition and the integration of markets across the
euro area countries would contribute to lower prices. It could also enhance the adjustment
processes in the individual countries in the event of asymmetric shocks or differing cyclical
developments.
It is also important to promote further financial market integration and the development of
readily available opportunities for portfolio diversification. This would help to attenuate the
impact of country-specific shocks, as I mentioned earlier.
National authorities can make a substantial contribution to ensuring the proper functioning of
adjustment mechanisms within the euro area by conducting a well-designed fiscal policy. As I
have stressed on many occasions, the best contribution fiscal policy can make to the proper
functioning of the euro area is by being sustainable and medium-term oriented, fully in line
with the orientations of the Stability and Growth Pact. Moreover, fiscal policy can and should
also focus on increasing the effectiveness and efficiency of the public sector itself through
high quality expenditure and tax policies. Large and inefficient public sectors are putting a
brake on growth by imposing a high tax burden on the economy and channelling resources
into unproductive uses.
In this respect, we welcome the efforts of the German government to reduce the regulatory
burden further. In addition, the latest fiscal developments in Germany have been
encouraging. For the first time since German reunification, the general government is
expected to record a balanced budget, after having recorded a deficit above the Maastricht
Treaty's threshold of 3% of GDP over the period from 2002 to 2005. While partly based on
revenue-increasing measures, such as the increase in the standard VAT rate at the
beginning of the year, the success with fiscal consolidation can also be significantly attributed
to expenditure restraint. Indeed, the share of government expenditure to GDP has dropped
by 41⁄2 percentage points over the past four years, reaching a level considerably lower than
the euro area average. At the current juncture, it is important that the government stay on
course, maintaining moderate expenditure growth while strengthening the incentives to work
and invest. If policies continue on the path of structural expenditure restraint and lasting
improvement in fiscal balances, Germany could become a fiscal role model in the euro area
and would be well prepared for fiscal challenges in the short and long run.
It is particularly important that countries prepare themselves for less favourable economic
conditions and the rising fiscal burden, in the longer run, associated with population ageing.
In this context, the gradual increase of the pension age in Germany is an important step in
the right direction. It will help to reduce the large ageing-related fiscal burden on the younger
and active generations.
Let me finally mention the crucial issue of competitiveness, which is one of the most
important market-based adjustment mechanisms in a monetary union.10 Competitiveness is
usually assessed on the basis of various measures of cost and price competitiveness11,
complemented by accounting for some "non-price" factors, such as the quality and the
technological content of the goods produced.
A special feature of competitiveness differentials in the euro area is their persistence. Over
the period between 1999 and 2006 there is a difference of up to around 25 percentage points
between the euro area countries with the lowest and highest cumulative growth rates for unit
labour costs for the economy as a whole. Germany and Austria belong to the first group of
countries, while Ireland, Portugal and Greece belong to the second. Persistent differences in
competitiveness may be a normal phenomenon when an economy is in the process of
sustainable catching-up, leading to a higher level of per capita income, or whenever an
economy has to cope with structural changes or past shocks of any nature that would be
reflected in a new relative price equilibrium.
That being said, persistent losses in relative cost competitiveness can also relate, for
instance, to a number of structural rigidities leading to inertia in price and wage formation.
They may be worrying signals for an economy, indicating a need for caution. Hence,
developments in price and cost competitiveness across the euro area economies need to be
closely monitored.
It is important for all parties concerned - the private sector, social partners, the national
public authorities - to contribute to flexibility in prices and wages. In this manner,
economically unjustified losses of competitiveness would be avoided and the risk of possibly
protracted adjustment costs through the competitiveness channel minimised.
4. Conclusion
Ladies and gentlemen, let me conclude. The single currency and Economic and Monetary
Union have been an impressive and remarkable success, perhaps Europe's most
remarkable since the Treaty of Rome was signed. It is up to all of us to consolidate this great
success and ensure that it is reinforced in the years to come. As regards monetary policy,
Europe can count on the European Central Bank and the Eurosystem to be faithful to its
primary mandate and to deliver price stability in the medium run to our 317 million fellow
citizens. As regards other policy areas, which do not depend on the central bank, let me
stress the three areas where sound policies are absolutely of the essence: sound fiscal
policies, fully in line with the Stability and Growth Pact; structural reform policies, fully in line
with the Lisbon strategy and the achievement of the Single Market; and last but not least
appropriate monitoring of the relative cost competitiveness indicators in the euro area.
It is encouraging to see that past reforms have contributed to job creation and reduced
unemployment. It is important that governments continue in this direction and do not reverse
past reforms just at the point when they are starting to bear fruit.
Thank you very much for your attention.