Guy Quaden: Challenges for the European economy
Speech by Mr Guy Quaden, Governor of the National Bank of Belgium, at the Foreign Bankers'
Association in the Netherlands, Amsterdam, 27 May 2004.
* * *
Ladies and Gentlemen, Members of the Foreign Bankers' Association in the Netherlands,
I am very pleased and indeed I think it is a great honour for me to have been asked to be the keynote
speaker at the 2004 Annual General Meeting of your Association.
As you have noticed I have decided to talk about "Challenges for the European Economy" but of
course I fully realize that I myself am facing a great challenge this evening, as I am aware that I am
following in the footsteps of a large number of distinguished speakers you have invited for your
previous lectures. I would only like to refer to Jean-Claude Trichet, Otmar Issing, Eddy George or
David Dodge, colleagues or former colleagues within the Eurosystem or the G10 Governors' Group. I
hope my presentation will be as interesting as that of my colleagues I have the greatest admiration for.
The European economy is facing many challenges: consolidating the current recovery, redressing
public finances which have deteriorated in many countries, reducing unemployment which is still too
high and preserving the social cohesion, preparing for the ageing process and in particular its financial
consequences, but I think one of them is now the most important: improving Europe's growth potential.
Its realisation is a prerequisite for meeting the other challenges mentioned.
From the outset I want to make it absolutely clear that I am neither a eurosceptic nor a europessimist.
So, I fully acknowledge and admire the resounding success European integration has achieved in two
fields over the past few years.
As a central banker I would of course first like to refer to the introduction of the euro which, as you all
know, was brought about in two stages. On 1 January 1999 financial markets started using the euro
while the single monetary policy of the Eurosystem was implemented. Three years later the
introduction of euro notes and coins led to the general use of the single currency by all economic
agents, thereby doing away with national currencies.
This changeover to the single currency was the final touch of European monetary integration and had
a profound effect on the deepening of the single market through the elimination of the exchange risk,
the reduction in transaction costs and the increase in price transparency. This improvement of the
single market will enhance the overall efficiency of the European economy and, other things being
equal, also its growth performance.
However, it is doubtful whether the population of our countries correctly perceived the latter
advantage. Indeed, the introduction of the euro unfortunately coincided with a severe slump in
economic activity: while in 2000 real GDP growth in the euro area reached 3.5 p.c. it declined during
the following years to reach a mere 0.4 p.c. in 2003.
Earlier this month European integration achieved another major success.
Ten new member states joined the European Union, which now makes European reunification almost
complete. However, this historic event occurred immediately after a period of sluggish economic
growth which left the European economy somewhat weakened. Therefore, the enlargement, instead of
generating enthusiasm, has in many instances given rise to misgivings among the population and
even among the enterprises. The concern regards the possible delocalisation of enterprises and
significant job losses.
At microeconomic and sectoral level, the integration of the ten new Member States will undoubtedly
entail some adjustments and shifts but overall it should result in a win-win situation. The past decade
has already brought a strong expansion of trading links between the old and new EU Member States.
As purchasing power in those countries catches up and their markets become more accessible,
European firms are set to expand their potential outlets while the continuing dismantling of trade
barriers and harmonisation of the regulatory framework will gradually create a level playing field. The
expansion of trade leading to increasing specialisation, and hence greater productivity, as well as
consumers having a wider choice will produce benefits that are much larger than the costs of
integration.
These two recent major events show that insufficient growth is a real cause for concern for the
population in our countries which feels insecure about their employment. This factor obscures the
achievements European integration has reached and so prevents people from believing in the
dynamism of European unification. Therefore weak growth could be a factor entailing growing
euroscepticism, especially in Western Europe.
For the coming months a reasonable optimism is justified. While the latest positive signals need to be
confirmed by future developments, they underpin the expectation that the gradual recovery in the euro
area will continue and will strengthen over time. The conditions are in place.
First, the global economic upturn continues to be robust and broadly based, both geographically and
across sectors, and world trade has also strengthened. In this context of a favourable external
environment, euro area exports are expected to grow significantly this year and the next.
Second, favourable financing conditions, improvements in corporate efficiency and earnings and the
strength of global demand help investment. Over time, consumer spending should also be supported
by growth in real disposable income and better labour market conditions.
The latest data point to a stronger than expected recovery of real economic activity in the euro area at
the beginning of 2004. According to Eurostat's flash estimate, euro area real GDP increased by
0.6 p.c. quarter on quarter in the first quarter of 2004, after rising by 0.4 p.c. in the fourth quarter of
2003 (revised upwards from 0.3 p.c.).
Concerning the prospects, the slight decline in May in the two business confidence indexes which are
the most closely watched in the euro area - the German IFO and the National Bank of Belgium index -
does not question the strong improvement recorded since the end of last year.
Obviously the consolidation of the recovery is, as often, subject to some risks and uncertainties.
Consumer confidence is still relatively weak in many countries and the strong rise of oil prices is of
course not good news for the European economy. There is no free lunch. The strong growth in the
United States and Asia has sustained economic activity in the rest of the world, but has also caused a
rise in commodity prices. As regards oil, it is clear geopolitical uncertainties also contribute to rising
prices. However one should not overdramatise either.The solidity of the euro exchange rate has
limited rising oilbills for us. Moreover, owing to energy saving measures and the use of other types of
fuel the relative weight of oil in the production of goods and services has declined markedly over the
past thirty years.
On an annual basis, the latest public and private sector forecasts point to growth in the euro area of
1.6 p.c. to 1.7 p.c. in 2004 and more than 2 p.c. next year. This is however not a reason to be satisfied
and complacent. In the EU or in the eurozone we speak of a recovery when growth is approaching
2 p.c. while in the US they speak of a recession when growth is falling to 2 p.c. ! And, on the other
hand, while most of the rest of the world is already enjoying robust growth, the recovery in Europe
remains gradual and overly dependent on booming international trade.
What is also needed are efforts to make the European economy more resistant to external shocks as
those which have reduced its growth in the latest years and to increase its long term growth potential.
Europe has to cope with a structural problem of low economic growth. The growth performance of the
euro area is weak from an international point of view, in particular vis-à-vis the United States: over the
past 10 years the American economy has shown an average GDP growth of 3.3 p.c., while the euro
area could only reach an economic growth of 2 p.c. The euro area only succeeded in achieving a
higher growth rate in 2001 when the United States were hit by a severe but short slowdown. The
following years the American economy however showed a much stronger recovery than the euro area
and now again acts as the main growth engine for the world economy.
Yet it is important to note that data for the eurozone are averages for twelve countries and that a
country like Finland in the euro area (and more generally the Nordic countries) has booked in the most
recent decade performances in the field of growth and employment rates which are comparable to
those of the US and are much better than those of countries like Germany and Italy.
Given an unequal population growth - it is higher in the US - a further analysis shows that the gap in
real GDP growth between the US and the euro area that opened up in the mid-1990s is half the size if
measured in per capita terms. The remainder is due to differences in productivity growth (the increase
in overall labour productivity in the US, measured by real GDP per person employed, reached on
average 1.9 p.c. in the last 10 years, almost twice as much as the 1 p.c. recorded in the euro area)
and to a much lower level of labour utilisation in the euro area. In the euro area unemployment rates
are currently around 3 percentage points higher, labour force participation rates more than
10 percentage points lower and annual hours worked per employed person lower by more than
300 hours.
Europe is of course not the US. It has its own specificities which should be taken into account. So at
least part of the gap in average hours worked between the US and the euro area should be attributed
to structural preferences rather than to structural rigidites.
However, when discussing this issue it has to be borne in mind that households also take into account
the institutional environment, including tax, social security and pension systems when deciding on their
labour supply.
Moreover, the problem to what extent the present European system is sustainable cannot be ignored.
The so-called European model has come under increasing pressure from demographic factors.
Further policy changes towards stimulating labour supply are inevitable if living standards and social
cohesion are to be preserved.
Unlike social preferences and rigidities, macroeconomic policies m ust not be seen as an explanation
of the weaker growth in the euro area.
First of all this holds true for monetary policy. As you know, the Treaty of Maastricht unambiguously
provides that maintaining price stability constitutes the primary objective of the European Central
Bank.
According to the definition of the ECB which was clarified about a year ago and which aims to create a
stable anchor for price expectations, price stability implies an annual rise in the harmonised index of
consumer price for the euro area below but close to 2 p.c. This objective must be maintained in the
medium term. Central bankers can not prevent external shocks, such as a rise of commodity prices on
the international markets, from resulting in a temporary rise of inflation. But, they have to preclude
second-round effects.
In its conduct of monetary policy, the ECB has already gained a high degree of credibility with market
participants as is shown by moderate inflation expectations. These expectations remaining in line with
its target the ECB was able to cut its key interest rate to historically very low levels (2 p.c. in nominal
terms and actually zero in real terms). Monetary policy thus made its own contribution towards
stabilising economic activity in the euro area.
Ensuring price stability, as well as confidence in the euro, is the best contribution to higher and
sustainable growth the ECB can make because it also allows for the advantage of low medium and
long term market rates which in many European countries are still more important for the financing of
investments by enterprises, households and government.
In the fiscal sphere, almost all the governments in the euro zone allowed the automatic stabilisers to
take full effect during the recent slowdown, and that effect was often reinforced by discretionary
measures. Between 2000 and 2003, the budgetary deficit of general government in the euro area has
grown from 0.9 p.c. of GDP to 2.7 p.c. The deficits of some countries have even exceeded the
threshold of 3 p.c.
Fiscal policy has thus not been an impediment to recovery. One might however wonder whether the
stimulation of the economy intended by the fiscal easing in many countries was not eroded by the
adverse impact which such a relaxation of discipline can have on the climate of confidence.
It seems that people in Europe more and more have a "Ricardian perception" of fiscal deficits. They
are more aware of the enormous challenges and costs our ageing society entails. People in the
different European countries are really worried about the long-term sustainability of public finances.
High fiscal deficits will only worsen their anxiety and so incite them to increase their precautionary
savings.
In this context, the rules of the Stability and Growth Pact are appropriate. It is not correct to describe it
as a fiscal straitjacket. Starting from a budget in balance or in surplus at the peak of the cycle, a
country can let the automatic stabilisers fully operate when the activity is slowing down. The main
problem with the Pact is, I think, that better incentives are needed to respect fiscal discipline during
good economic times.
So I hope that the forthcoming recovery will be the right moment for the European governments now
facing budgetary difficulties, to put their finances again on the right track, so that in that field it will be
possible to reconcile short time flexibility with long term sustainability. In that case fiscal policy may
again become an element of the required lasting macroeconomic stability.
It is by paying more attention to the quality of public finances and by rendering the structure of taxes
and that of expenses more growth oriented that Governments can contribute to stimulating Europe's
growth potential. I refer to expenditures such as education and improvement of human capital, public
investment in infrastructure and research and development. R & D could become a comparative
advantage of Europe. At the moment Europe invests 1.9 p.c. of GDP in R & D and is thus lagging
behind the US figures and the Lisbon target (3 p.c.).
Over the past years, European policymakers have become more aware of this growth problem Europe
is facing. So, in March 2000, during the Lisbon summit, an ambitious strategy was adopted aiming to
increase the rate of sustainable economic growth and even to enable Europe to become the most
competitive and dynamic knowledge-based economy in the world in 2010.
In order to achieve such a strategic goal the Lisbon agenda has brought together the different strands
of reform policies on product, labour and capital markets aiming at promoting a more efficient
allocation of resources and at higher growth potential. Moreover, in order to facilitate monitoring of
progress with reforms, quantitative targets have been fixed to measure progress in particular on the
labour market in achieving for instance higher participation and employment rates.
The Lisbon agenda was excellent in terms of diagnosis. Until now it has however not been given a
sufficiently powerful implementation.
One cannot say that there was no progress in the last years in the field of structural reforms, but much
remains to be done. The pace of reform needs to be significantly stepped up if the Lisbon targets are
to be achieved. The review carried out by the high level group chaired by former Prime Minister Wim
Kok provides an excellent opportunity to accelerate the process.
Progress has been most tangible in deregulating and integrating product and financial markets.
Since the introduction of the euro, the pace of financial markets' reform has been impressive. This
includes policy-induced reform, such as the Financial Services Action Plan initiated by the European
Commission in the spring of 1999. Reform also covers market-led initiatives, as for instance the
development of electronic trading platforms. As you know, the different financial markets have reached
different levels of integration. So integration in euro money markets was achieved very quickly after
the introduction of the new currency while for instance the euro area equity market, despite advances
such as the setting up of Euronext, remains among the least integrated. Thus there is still need for
continuation and completion. New progress should result from the cohesive and effective interplay of
free competition, coordinated action by all market participants and policy enforcement by public
authorities.
Much progress has also been made regarding the integration and level of competition in
productmarkets. However substantial barriers to free competition continue to exist, particularly
preventing the integration of services' markets and effective competition in network industries.
Fostering competition in these fields should also contribute to a downward effect on prices. Further
regulatory reforms should be accompanied by a sustained reduction in state aid - particularly if it
constitutes economically questionable and sector-specific measures. In the end, this will promote the
entry of new players, enhance innovation and reduce the tax burden.
High unemployment and insufficient employment rates are still preoccupying. The labour market
participation rates of women and the youngest and oldest age groups remain too weak in many
countries. Thus far, progress with the implementation of labour market reforms has been uneven in the
euro area. In some countries, significant achievements in terms of lower unemployment are already
visible. Others are lagging behind. It is important to enhance the flexibility of labour markets to make
the whole European economy better able to absorb economic shocks. Reforms are also needed not
only to reduce non-wage labour costs and increase incentives for job creation but also to ensure the
sustainability of the social security systems.
The challenges are known and the analyses are completed. Now the implementation should be
focused on. As I have said at the beginning of my speech, I am neither a eurosceptic nor a
europessimist. So I believe Europe can implement the Lisbon agenda. The introduction of the euro
was a splendid example of a not easy but successful structural reform. It can be and it should be
followed by others.
The framework through which the Lisbon agenda is implemented relies largely on a peer pressure
mechanism, mainly depending on goodwill of governments in individual EU countries. The pressure
must be reinforced, including by clearly identifying and publicising successful and lagging country
cases accross the EU and possibly industrialised countries more generally.
Communication must also be improved. The transition from the pre-reform to the post-reform
equilibrium conditions normally takes time and we must recognise that within this period some
uncertainty may occur. For this reason the implementation of social reforms requires a strong
leadership and a continuous explanation effort. We have to convince our public opinion that our
countries would be better off - with more growth and more jobs - if we could deliver the reforms of the
Lisbon agenda.
I shall conclude with a last remark: the current recovery of economic activity, as welcome as it is, must
surely not constitute a pretext for postponing a program of reforms, as its implementation is essential
to achieve stronger and more sustainable growth in the long term.