Willem F Duisenberg: The euro as a catalyst for integration and competition in
EMU
Speech by Dr Willem F Duisenberg, President of the European Central Bank, on the occasion of the
30th Economics Conference "Competition of Regions and Integration in EMU", Vienna, 13 June 2002.
* * *
Ladies and Gentlemen,
Here in Vienna, exactly one hundred years ago, Joseph Schumpeter embarked upon his university
studies at the School of Law and Political Science. He was a promising young student with ambitions
in academics, politics and business. Already, at the age of 22, he had published his first works and
would soon become one of the youngest holders of a doctorate, the youngest private teacher and the
youngest professor in Austria.
Joseph Schumpeter has become known as one of the foremost representatives of the famous
Austrian School of Economics. He has influenced economic thought, in particular, by introducing
innovation as a source of economic dynamics. According to Schumpeter, economic development was
a dynamic process, a disturbance of the economic status quo. The real challenge for capitalism,
therefore, was to create and destroy economic structures in a process he called "creative destruction"
This, he maintained, was the essence of economic development, a process defined by the
implementation by the entrepreneur of new production combinations.
I believe that Schumpeter would be very interested in the topic I want to discuss today. My speech is
about the euro as a catalyst for integration and competition in EMU, or, in other words, about
economic growth and adjustment in the euro area. Both high, sustainable economic growth and the
ability to adjust smoothly to changes in the economic environment require further economic integration
and competition. This, in turn, is closely linked to the process of structural reform, which, to use
Schumpeter's words, can be seen as a necessary precondition for a dynamic economic process, a
disturbance of the economic status quo. The introduction of the euro acts as a catalyst for this
dynamic process of structural change.
In my speech today I will address the following topics. I will first talk about the link between European
integration and the euro, and then argue why an increasingly competitive and dynamic society raises
the need for further structural reforms. However, reforms are also important for the smooth functioning
of a monetary union, a point I will discuss next. Finally, I will assess the progress that has been made
with the structural reforms in the euro area so far and discuss how the single currency has already
benefited the euro area's economy, acting - as formulated in the title of my speech - as a catalyst for
integration and competition.
A single currency for a single market
A natural starting point for my topic today is the adoption of the Single Market Programme in 1985,
paving the way for the famous four "liberties" established in the European Treaties: the free movement
of goods, services, labour and capital.
After the adoption of the Single Market Programme, it became increasingly clear that the potential of
the internal market could not be fully exploited while the relatively high transaction costs linked to
currency conversion and the uncertainties associated with exchange-rate fluctuations persisted.
Indeed, the single currency should be seen as a necessary complement or, in fact, the crowning
achievement of the Single Market.
That said, we have not reached the end of the development of the Single Market. Instead, I see the
euro as facilitating further economic integration. For example, countries with the same currency tend to
trade more with each other than they would with countries with different currencies. In addition, a
single currency fosters the formation of a single financial system. By increasing price transparency,
reducing transaction costs and fostering competition, the euro acts as a powerful catalyst to the
economic integration process in the euro area. Last, but not least, our common currency is also a
powerful symbol for all citizens of the euro area that integration has reached a new level. As we
approach the first summer holiday season since the introduction of euro notes and coins, increasing
numbers of people in Europe will, themselves, experience the practical advantages of a single
currency.
The impetus the euro gives to economic integration and growth should not only be regarded as an
opportunity for Europe, but also as a necessity in a world of innovation and globalisation. Over the last
few decades, the world economy has become ever more integrated. We have witnessed a strong
expansion of international trade and capital flows and an increase in competition. Behind these
changes there are several underlying factors. Among the most important is rapid technological
progress, leading to dramatic reductions in transportation costs and an unprecedented increase in
information processing capabilities. Policy measures have also supported the globalisation trend, with
the loosening of restrictions to trade and the liberalisation of capital movements.
This panorama shows that we live in a dynamic and competitive world, where the ability to innovate
and adjust to changing economic circumstances has become even more important than before. In this
respect, Schumpeter's thoughts haven't lost anything of their relevance. On the contrary; in a dynamic,
ever-changing economic environment, entrepreneurs have to be all the more innovative and sensitive
to new opportunities. The regulatory framework formed by the laws, rules and regulations that
influence economic behaviour, should thus provide the right incentives for innovation, dynamism and
economic growth.
The EU Heads of State and Government have recognised that, in order to improve the functioning of
the Single Market and to enhance the economic growth potential of the EU, its regulatory framework
has to be modernised and reforms are needed. Somewhat more than two years ago, the Lisbon
European Council formulated a strategic goal for this decade, namely "to become the most
competitive and dynamic knowledge-based economy in the world". The Lisbon strategy established a
comprehensive reform agenda which aims to overcome existing fragmentation and inefficiencies in
many different areas. This has provided a major political impetus for further progress in the field of
structural reform that I very much welcome. The European Council aims to increase the potential GDP
growth rate to around 3% per year, an objective which can only be achieved if steady progress on a
broad range of reforms is made. Whether or not this objective is met hinges partly on the capacity to
improve mobilisation of available labour resources. In this regard, one of the explicit objectives set at
the Lisbon summit is to raise the EU-wide employment rate to 70% of the working age population by
2010.
In order to achieve the Lisbon objective, it is crucial that progress is systematically controlled and
evaluated. In this context, the Broad Economic Policy Guidelines for the Member States and the
Community play a particularly important role. This is the overall framework for the co-ordination of
economic policies, in particular, those related to fiscal and structural policies. In order to fulfil this role,
the Broad Economic Policy Guidelines have, in recent years, been enhanced in several ways. They
have become more operational through the use of more concrete recommendations in both the
general and country-specific parts. Moreover, within the overall process of policy co-ordination,
increased emphasis is being placed on implementation. To this end, the European Commission has
introduced a comprehensive implementation report that assesses the extent to which EU Member
States have followed the policy recommendations. I fully support these changes.
As you know, the most recent Spring meeting of the European Council, the second "follow-up"
meeting to Lisbon, took place in Barcelona earlier this year. The conclusions of the Barcelona Summit
demonstrate that a strong political will and thorough preparation of the technical details are needed if
the European Union is to meet the ambitious economic, social and environmental objectives that it set
for itself at the Lisbon Summit. The successful introduction of the single currency is the best proof that
these ingredients are indispensable. The main point now is that the relevant Council formations, the
European Parliament and the Member States take the necessary steps to rigorously implement the
structural reform agenda agreed in Lisbon and confirmed in Barcelona.
Why are structural reforms important?
Structural policies cover a wide range of areas and instruments. Among the most commonly discussed
are microeconomic regulations implemented in product, labour and financial markets. Among other
things, such regulations encompass competition policies, entry barriers, tax and benefit systems, state
aid, employment protection rules, education and training, as well as incentives given to research and
development. They are important for two main reasons since they enhance the economic growth
potential and facilitate the adjustment to economic change. Let me say a few more words on these two
reasons.
First, structural policies are just one of many factors determining the rate at which the economy can
grow, although there are many other factors which influence the rate of economic growth. Some
factors, such as changes in demand conditions, have temporary effects on economic growth, whereas
others, such as the rate of growth of the working age population and capital stock, as well as the
increase in productivity, have long-lasting effects. It is this latter type of factor, however, that
determines the potential growth rate of an economy. These components, in particular the growth of
employment and productivity, can be influenced by structural policies. Changes to tax and benefit
systems, for example, can help to mobilise the unused labour potential in the economy by making it
financially more attractive to accept a job. This could lead to a better use of the supply side potential of
the economy. The third factor, productivity growth, can be influenced in several ways: by increasing
competition, facilitating investment, encouraging enterprise and innovation and improving the
workforce's skills. Structural policies have particular importance for monetary policy. They allow the
economy to grow at a higher rate, on a sustained basis, without creating inflationary pressures.
However, structural reforms are not only important for economic growth, they also increase
adaptability to economic shocks. Adaptability concerns the economy's ability to adapt and respond to
changing economic conditions. It is the ability to shift resources from areas in recession to booming
areas, something which is key to the successful functioning of a monetary union. Under EMU, member
countries are unable to use country-specific monetary and exchange rate policies to address
countryspecific shocks. The adjustment to such economic fluctuations will therefore have to take place
through other adjustment mechanisms. Without price and wage flexibility and mobility of production
factors, economic shocks would lead to lower economic growth and higher unemployment. Let me say
a few more words on the important role of these adjustment mechanisms in a monetary union.
The theory of optimal currency areas
Ever since the idea of EMU was launched, a discussion has ensued as to whether the whole or part of
Europe would be an optimal currency area. The optimal currency area theory defines a set of
mechanisms that might be set in motion when a participating country or region, in a monetary union, is
hit by an asymmetric shock. First, adjustment to the shock might come from domestic price or wage
changes, thereby altering the real exchange rate without changing the nominal exchange rate.
Secondly, migration of production factors might act as an adjustment channel. These flows of labour
and capital are facilitated by a high degree of economic and financial integration of the countries
participating in the union.
In addition to this, the theory of optimal currency areas has also something to say on the similarity of
shocks affecting countries or regions in a monetary union. In this respect, the degree of trade and
financial integration are often considered. Trade and financial integration may tend to lead to more
similar economic developments in the respective countries or regions in a monetary union, reducing
the likelihood of asymmetric shocks and increasing the economies' abilities to adjust to these shocks.
So far the theory, let me now move on to the practice. I will now focus on two adjustment mechanisms:
price-wage flexibility and factor mobility. A host of empirical studies on these mechanisms has been
undertaken for the euro area. How well does the euro area measure up against these two criteria?
Price and wage flexibility
There is broad agreement that price flexibility is low across euro area countries in comparison with the
United States. In the euro area, price flexibility for goods and services is hampered by trade barriers,
continuing state aid to several sectors and, more generally, a lack of competition in sectors that have
been dominated by monopolies or state owned enterprises.
Low wage flexibility is also an important factor behind the lack of price flexibility in the euro area. Many
studies indicate that in comparison with the United States, real wages are relatively inflexible in
Europe. More specifically, I mean that the downward responsiveness of real wages to the level of
unemployment is more limited in Europe than in the US. There are, however, notable differences
across countries in the euro area.
Let me also mention the potential links between the flexibility of product and labour markets. Reforms
in one area are likely to have effects across markets. For example, reforms leading to more flexible
product markets might improve the performance of the labour market. If regulations on setting up a
business are loosened, employment creation is also likely to increase. Similarly, labour market reforms
might also have an impact on product markets. For example, labour market reforms may improve the
extent to which differences in skills or productivity are reflected in wage differentials, which could affect
prices. More generally, more flexible labour markets allow companies to adjust to economic changes
with greater ease.
Factor mobility
Let me now turn to the second adjustment mechanism, the mobility of factors of production. Changes
in price levels, in product and labour markets, can also be triggered by a migration of factors of
production. If a country or region is affected by a negative output shock and markets do not clear
instantaneously, unemployment will rise. Workers will, therefore, tend to migrate to other regions. The
same might be true for capital: if a negative output shock made capital obsolete and reduced
profitability, investors would tend to move their funds to other regions. This adjustment mechanism has
two limitations. First, the migration of labour and capital involves transaction costs. Moreover, it is
doubtful whether this mechanism is very efficient when a country or region is hit by a temporary shock.
Therefore, factor mobility seems a suitable adjustment mechanism only in case of a permanent shock
and if prices or wages are rigid.
Several studies have found that labour mobility within the United States is two to three times higher
than in Europe. This result is confirmed by the persistence of regional unemployment differences in
Europe.
Overall, it can be concluded from empirical studies that the degree of wage-price flexibility and factor
mobility is relatively limited in the euro area. The lack of adjustment mechanisms in the euro area
should, however, not be exaggerated. Euro area countries are highly integrated both in terms of trade
and financially. As I have just explained, a high degree of trade and financial integration may lead to
more similar economic developments across euro area countries.
In addition, the optimal currency area properties are likely to evolve over time. The irrevocable fixing of
exchange rates and the introduction of the single currency may lead to a convergence in the
production and export structures of economies in the euro area, thereby reducing the risk of future
asymmetric shocks. This argument is often referred to as the "endogeneity" of the optimal currency
area hypothesis. Hence, according to the endogeneity literature, the euro area could gradually
become more of an optimal currency area, after the introduction of the euro. More generally, it has to
be borne in mind that all empirical studies on whether the countries that have entered the euro area
constitute an optimal currency area are based on historical data. These data refer to regimes with
flexible or fixed-but-adjustable exchange rates. In short, the regime shift to a monetary union may
have an impact on economic structures and may alter some of the conclusions drawn on the basis of
these historical data.
Progress made with structural reforms in the euro area
Some people say that central bankers are professional sceptics whose job it is to point to economic
risks and weaknesses. Having listened to me so far, I can imagine that you may find some degree of
truth in this. Let me tell you, however, that the euro area has recently seen many changes and
innovations that go in the right direction. And I am pleased to be able to tell you that many of these
changes are directly, or indirectly, related to the euro. Let us have a closer look at three areas of
change: financial markets, product markets and labour markets.
Financial markets
The first area I want to discuss are financial markets. There is ample evidence that financial markets
have some way to go before national demarcation lines will effectively disappear. Henceforth, there is
still a significant potential for further financial market integration in the euro area. Financial market
integration has been driven by global developments, such as advances in information technology,
falling communication costs and standardisation of products. It has also been supported by European
Commission initiatives.
A main policy initiative that has contributed to financial market integration is the Financial Services
Action Plan. EU Heads of State and Government have agreed to implement the Financial Services
Action Plan by 2005, at the latest, and to achieve fully integrated risk-capital and securities markets by
2003. The groundwork for the latter was prepared by a Committee of Wise Men called the Lamfalussy
Group. On wholesale markets, measures to facilitate raising capital on an EU-wide basis, through
common rules concerning prospectuses, is targeted for adoption in 2002. In addition, legislative
proposals on financial statements for listed companies and a common legal framework for a single
market for securities and derivatives are close to being adopted. We, at the ECB, fully support these
initiatives. I would like to stress, however, that the successful and timely implementation of the
Financial Services Action Plan will be very difficult without the continuing commitment of the Member
States.
The integration of financial markets would not only facilitate cross-border capital flows towards their
most productive uses, but it could also serve as a catalyst for structural reform in other markets. For
example, the impact of product market reforms, aimed at easing the restrictions on creating a
business, are likely to be reinforced if a well-functioning risk capital market, which efficiently channels
the necessary funds from investors to beginning entrepreneurs, is in place.
The euro has made a spectacular impact on financial markets in the euro area. Concrete examples of
its impact are the integration of the money market, the explosive growth of the euro-denominated
corporate debt market and a wave of consolidation among intermediaries and exchanges. These are
very fundamental changes. The surge of euro-denominated corporate debt, for example, has helped
to finance the wave of mergers and acquisitions in the European corporate sector and shows how a
larger and deeper single financial market can help to strengthen Europe's competitiveness.
Product markets
Let me now turn to product markets. The pace of liberalisation has differed considerably across
countries and sectors in the euro area, leaving ample room for further reforms. Whereas the
integration of goods markets is relatively advanced, shortcomings still exist with regard to the
integration of service industries. Most of the barriers to integration in the service sector appear to be
due to national regulations, for example administrative procedures for setting up subsidiaries in other
euro area countries. Regulatory barriers along these lines reduce competition in services, thus
keeping prices above the level that would be expected in a fully integrated market.
More progress has been made with regard to the integration of goods markets and regulatory reforms
in network industries. Here too, positive macroeconomic effects can be discerned. Owing to an
increased number of competitors, prices in some network industries, such telecommunications, have
started to decline, in particular in those industries and countries which liberalised earlier. The initiatives
in the telecommunication sector show how reforms that succeed in increasing competition in
previously sheltered sectors considerably enhance productivity and lower prices. As network industries
provide inputs to the rest of the economy, this may also increase the rate at which the economy can
grow without creating inflationary pressure. Nevertheless, an important unfinished agenda remains to
be tackled in almost all network industries. In order to reap the full economic benefits, it is important
that reforms in network industries are accompanied by an appropriate regulatory framework which
ensures non-discriminatory access to the bottleneck infrastructure and more generally, a "level playing
field" for all market participants. The quality of the regulatory framework has a considerable impact on
the extent to which potential price falls due to structural reforms in network industries will be achieved.
Another instrument available to reduce distortions to competition is state aid policy. State aid subsidies
weaken the incentives for companies to improve their efficiency, enabling the less efficient to survive
at the expense of the more efficient. Although there are still substantial differences between euro area
countries, the overall trend is towards a reduction in state aid levels. Another positive development is
that the transparency of state aid policies has improved as a result of the publication of a new state aid
register and a state aid scoreboard by the European Commission.
The impact of the euro on these processes, which has led to more competition, cannot be
overestimated and goes far beyond the mere abolition of intra-European exchange rates and the
introduction of common notes and coins. The single currency opens up the euro area product markets
further and will be a major impetus to competition and integration by increasing the transparency of
prices across borders. Investment will also benefit as euro area companies no longer have to insure
against exchange rate movements within the euro area and there are indeed indications that direct
investment into the euro area has strongly increased since the start of EMU. Overall, the euro will give
new impetus to the initiatives taken in the 1980s to establish a truly integrated internal market.
Labour markets
Progress with labour market reforms has become evident from the increase in employment-intensive
growth in the euro area. It is very interesting to note that job creation has held up reasonably well over
recent years. During the first three years of EMU, some 6 million jobs have been created in the euro
area versus 3.5 million in the US. The unemployment rate in the euro area has declined from almost
11% in 1997 to slightly more than 8% in 2001 (which is still too high). On the supply side, the
employment rate, particularly in the case of women, has increased considerably, along with the
proportion of part-time jobs and temporary contracts in total employment. Euro area average
participation rates are, nevertheless, still below those of the US or the Scandinavian countries.
The explanations for this job-rich growth lie in structural changes in the labour market and wage
moderation. Government policies have generally improved labour market performance in euro area
countries. A number of countries have lowered marginal tax rates in order to make their tax systems
more employment-friendly. Many countries have targeted tax cuts at the lower end of the labour
market in particular. These measures have contributed to a higher demand for low-skilled workers.
Nevertheless, marginal tax rates still remain high in some countries. Some progress has also been
made with the introduction of part-time or more flexible working contracts and practices.
In addition to government policies, there are signs of a gradual change in labour market behaviour
related to the wage formation process. Discipline seems to have improved in that field over the past
decade. Such a change, resulting from lower inflation expectations, is important. Furthermore, there
seems to be a growing awareness that, in a single currency environment, the price increases and loss
of competitiveness generated by excessive wage settlements cannot be compensated by an
exchange rate depreciation and may directly result in a loss of jobs.
Looking ahead, it is crucial that social partners continue to adhere to moderate wage developments,
since this is one of the prerequisites in fostering employment and maintaining a favourable outlook for
price stability in the medium term. In this respect, there is some cause for concern with regard to
ongoing wage negotiations.
The wage formation process also seems to have undergone changes. In a majority of euro area
countries, there are signs of a gradual trend towards more decentralised bargaining and more
flexibility at lower bargaining levels. This seems to happen, mostly informally, through clauses that
allow firms to deviate from the sectoral or central wage agreements according to the financial situation
of the firm or sector. This is encouraging. The outcomes of wage bargaining should allow not only for
appropriate wage developments in the overall economy, but also for adequate wage differentiation
across sectors, regions and firms. This will make it easier to account for local conditions, such as
unemployment, productivity or profitability differentials across sectors, regions and firms.
In short, labour market reforms have, in general, been going in the right direction in recent years and
the benefits of these positive developments are clear. However, progress has been rather uneven
across countries and areas. In many areas important reforms have not yet got off the ground. For
instance, few changes have been made regarding employment protection policies in euro area
countries, which remain amongst the strictest in the industrial countries. Furthermore, in almost all
euro area countries, reforms targeting unemployment benefit systems have only made slow progress.
At the same time, significant mismatches between labour demand and supply are still present along a
number of dimensions. All this shows that large structural problems remain and need to be solved.
What needs to be done to speed up labour market reforms? This is a difficult question, not least
because the euro area labour markets are still very heterogeneous. Each country should identify the
root causes of its labour market deficiencies and implement appropriate corrective measures.
However, there are some areas of reform that apply to many, if not all, euro area countries. Improved
job mediation, education and training, to mention just a few examples, all help towards making the
matching process more efficient. In addition, euro area countries need to ensure that tax and benefit
systems make work pay. Reforms to tax and benefit systems should increase work incentives,
profitability and competitiveness and consequently labour supply and demand. At the same time, it is
important to ensure that tax-benefit reforms are undertaken without jeopardising the long-term
sustainability of public finances.
Conclusion
Ladies and Gentlemen. Joseph Schumpeter taught us that economic development consists of the
continuous introduction of new combinations of products and means of production. He taught us that
this process involves the incessant mutation of the economic structure from within, destroying the old
and creating a new. In today's dynamic, ever-changing economic environment, entrepreneurs have to
be all the more innovative and sensitive to new opportunities. The regulatory framework has to be
designed in such a way that it allows this to happen by providing the right incentives for innovation,
dynamism and economic growth.
Today's dynamic society also requires an increased ability of markets to adjust smoothly to changing
economic circumstances. This is all the more true of a monetary union, where member countries are
no longer able to use country-specific monetary and exchange rate policies to address country-specific
shocks. In such an environment, other adjustment mechanisms are needed such as price and wage
flexibility and factor mobility. Structural reforms can contribute to a better functioning of these
adjustment mechanisms by fostering integration and competition. The relationship between
integration, competition and the single currency works in both directions. The euro itself has already
contributed to more integration and competition and will continue to do so in the future. Its impact is
most clearly visible in financial markets, where a single money market has been created and a deep,
liquid bond market has encouraged a surge in debt issuance by the corporate sector. In product
markets, the euro has an important impact on the cross-border transparency of prices, acting as a
catalyst for trade. Finally, with regard to labour markets, the wage formation process shows signs of
increased flexibility and labour market reforms are starting to go in the right direction. Overall, the
single currency contributes forcefully to more integration and competition, acting as a powerful driver
for the further enhancement of the Single Market and creating an environment which - I am sure -
Schumpeter would have enjoyed.
Thank you very much for your attention.