Andreas Dombret: Current challenges for the European economy
and international trade
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank,
at the German Chamber of Commerce, Beijing, 25 May 2017.
* * *
1 Introduction
Ladies and gentlemen, probably all of you know that the Chinese name for Germany is "déguó",
meaning "land of virtue". Therefore, we can safely say that trade relations between China and
Germany were born under a lucky star. However, there are some clouds on the horizon casting a
shadow on the future of international trade.
Without any doubt, this proposition needs further explanation. Thus, I will begin my statement
today by briefing you on the economic situation in the euro area. Afterwards, I wish to present you
the most important developments affecting the future of international trade - not only between
Germany and China, but more generally the future of the international trading system as a whole.
Namely, I will talk about the rise of protectionism in a number of large economies.
By the way, it is reassuring that China has so far pledged to maintain a stance that promotes free
trade, as it did at the World Economic Forum in Davos, and is even looking for ways to expand it.
But I do not want to speak primarily about the policies of governments, but about what each of us
- including central banks and international companies - can do to steer the debate on trade away
from harmful protectionism.
2 Economic situation in the euro area
2.1 Positive economic outlook for the euro area
But first, let me look at the general economic outlook for the euro area and consider the factors
influencing future economic growth in Europe. Since the financial crisis, the pace of recovery in
the euro area has been slower than in the United States, not to mention fast-growing emerging
economies like China. Lately, however, the economic recovery in the euro area has become
increasingly broad and robust.
For the euro area, just in the last few weeks the economic development has been slightly on the
upside. The concrete data as calculated by the ECB staff shows that for the euro area, we are
looking at sound GDP growth of 0.5% for the first quarter of 2017. At the same time, inflation for
April 2017 stood close to the ECB target at 1.9%. Unemployment in March was at 9.5%, down
from its peak of 12% in 2013. On the whole, the euro area economy is looking increasingly
healthy and is set on a growth path.
But looking to the future, we can see several factors dampening growth in Europe. Politically,
the UK vote to leave the European Union has been a setback for the European project, but this
decision is supposed to have a limited impact on the European economy as a whole, given the
significant but limited weight of UK GDP. Even the Bank of England hinted in its most recent
statement that the rate increase anticipated for 2019 might take place sooner than expected. Of
course, the Bank of England stressed that this will depend on the outcome of the Brexit
negotiations.
One persistent problem of the euro area economy is unemployment. I mentioned just now that
euro area unemployment stood at 9.5%. However, if we look at the wider statistics published by
the ECB on unemployment and underemployment, including discouraged workers or workers
who are not able to work as much as they want, we are rather looking at 18%. With the exception
of Germany, where the combined figure is under 10%, most big euro area economies such as
France, Italy, and Spain, still are facing the same problem of persistent and widespread
unemployment and underemployment, especially among the young. The wider unemployment
statistics have been falling slowly since early 2014 as well, but because people tend to lose their
skills and their social capital when they are unemployed for a long time, helping these people
retain or gain skills and getting them into jobs is vital for sustaining the recovery.
Because it is not yet clear when inflation will stabilise close to 2%, and because underlying
inflation excluding energy remains below target, the ECB governing council has chosen to
maintain, for the time being, its accommodative monetary policy stance with negative rates and
extensive asset purchase programmes. However, at the April press conference, ECB president
Draghi conceded that "the growth risks were moving towards a more balanced configuration."
In sum, despite Brexit and the persistence of unemployment in many European countries, the
short-term outlook for the European economy is cautiously optimistic. Fundamental weaknesses
such as persistent unemployment need to be addressed by governments with structural
reforms. Until these underlying problems are resolved, political risks will remain the biggest threat
to European economies over the medium to long term.
The danger exists that populist parties could make European countries unable to respond
effectively to crises and changes. I will discuss the underlying causes of this political risk later on:
Dissatisfaction with free trade and flirting with protectionism.
3 Future of international trade
Looking at the global landscape, positive economic data are not only coming from Europe. For
the first time since a brief surge in growth in 2010 we are experiencing a synchronised recovery
that is taking place broadly across Europe, the United States, as well as in China and emerging
market economies. This synchronised recovery will support international trade and vice versa. At
the same time, we have witnessed public attacks on international trade and the system that
supports it, which is based on the free flow of goods and capital.
Protectionist sentiment in developed economies is rising. Promises to cut back on free trade
have resounded with voters in some developed countries. While it is still unclear what - if any -
protectionist policies will actually be implemented and how they will affect international trade, it is
clear that leaders in government and business have not been able to persuasively defend the
virtues of free trade, and that the future of international trade will depend precisely on their ability
to do just that.
Let me brief you about this discussion and the action that has to be taken. We have to adopt a
stance that is both correct and compassionate. That is: Restrictions on international trade will do
much more harm than good and would be a historic mistake. And we must be compassionate:
Even though the reasoning of those who call for protectionism is ultimately wrong, we have to
recognise that there are parts of society who believe international trade is responsible for taking
away their jobs.
3.1 Is free trade useful?
For a long time, the usefulness of international trade has been undisputed, and international
policymakers have concentrated on ever-more detailed arrangements and standards. That is no
longer the case anymore: The core of the international trade system is being questioned.
Protectionism is back, and even mercantilism, dead for centuries, has reared its ugly head again.
In this context, I am convinced that this trend is leading us down the wrong path. The social and
economic issues that countries across Europe and around the world are facing are not at odds
with the conventional wisdom regarding international trade, and they cannot be solved by falling
back into protectionism.
What globalisation statistics show is that economic integration does indeed raise aggregate
1
wealth. Worldwide exports and imports have reached roughly 60% of global GDP , and there has
been a surge in global economic integration in recent decades. At the same time, real income
2
has been growing globally and across the income spectrum since the 1980s.
These developments are not accidental side effects. Indeed, trade theory predicts a more
efficient allocation. This happens for a variety of reasons, such as comparative advantage or
economies of scale. Economic integration also facilitates the transfer of knowledge, bringing
innovation to places that would otherwise not have benefited from new technologies.
At the same time, just because trade leads to gains overall does not mean no one will be left
worse off. This has been studied since the early days of international economics. Recent
surveys have identified groups that have suffered from international trading arrangements, at
3
least relative to their national peers. Think about communities in the American Midwest or
Northern France: both are regions where manufacturing jobs have disappeared with devastating
effects on the social fabric of their communities. Some shifting of manufacturing jobs is not proof
that international trade theories have failed - indeed it is part of the evidence that the theories are
right. Accepting trade theories thus means accepting that there may - and most probably will -
be negative consequences for some communities.
3.2 Mill's solution
The answer to this political-economic problem was given a long time ago by John Stuart Mill and
4
can be put simply as "free trade plus compensation" . Compensation can take many forms. The
member states of the euro area tend to provide extensive social benefits. At the same time, the
euro area countries trade freely with each other and we conclude from this that free trade and
compensation are not mutually exclusive.
Let me be clear that assistance in the form of benefits is not the only and certainly not the most
effective way to help people. First, I am also talking about measures to retrain workers: Such
active labour measures are found to significantly reduce unemployment and long-term
5
unemployment in OECD countries . Second, we should value the positive effects of international
standards. They help to maintain a level playing field and to prevent a regulatory race to the
bottom in policy fields that serve the whole of society. Think about international labour standards
as an example.
However, not all countries are implementing these measures. Why is that? The populists'
solution to the problem is "cut down on free trade, it's hurting jobs!" The problem with this
solution is that it is deeply misleading. First, there is more than one reason for the loss of
manufacturing jobs. Advances in efficiency due to technology and automation have permanently
reduced the number of workers needed to manufacture a given output. The managing director of
the IMF Christine Lagarde highlighted in a recent speech that "technology has been the major
factor behind the relative decline of lower- and middle-skilled workers' incomes in recent years,
6
with trade contributing to a much lesser extent." Erecting trade barriers will do nothing to recover
jobs lost as a result of automation. While it is true that some manufacturing jobs have moved to
emerging countries, all theory and evidence shows that international trade has been a net gain
for Europe, the United States, as well as for the rest of the world. We have to confront all those
who distort the facts about the supposed benefits of protectionism, because following their
advice would be a disaster for world trade and would not help those who feel left behind. The
opposite would be the case, since protectionism would reduce the size of the total economic pie,
leaving society worse off on the whole.
At the same time, we must not fall into the trap of self-complacency. The "Washington
early 21 century . Its proponents have welcomed the advance of free trade in the name of
economic efficiency. While their argument is technically sound, they have not provided any
answers for those who have seen their share of the pie stay the same size or even get smaller.
We have to admit that, as part of this consensus, policies were recommended that generally
reject any form of "free trade plus compensation". To be fair, such a balanced approach has not
been rejected because of any lack of compassion, but because it was believed that a minimum
of regulation would be beneficial for trade and economic development. Indeed, almost 20 years
ago Harvard economist Dani Rodrik, one of the most distinguished scholars in the field of
international economics and political economy, accurately noted that "governments today actively
compete with each other by pursuing policies that they believe will earn them market confidence
and attract trade and capital inflows: tight money, small government, low taxes, flexible labor
8
legislation, deregulation, privatization, and openness all around."
I think his observation explains why not enough attention was given to Mill's advice about "free
trade plus compensation". We are at risk of a backlash against international trade because
leaders in some countries have not been able to give convincing answers to those who have
seen their standard of living decline, either due to free trade or due to technology. In this sense,
leaders in institutions, government, and business should not discount or oppose sensible
measures in the field of regulations or social security, because these measures help defend the
consensus that free trade is beneficial for us all.
3.3 Outlook for future Free Trade Agreements
At this point, and after so much gloom, it is time to not only talk about the threats to international
trade but to share a few ideas about the opportunities opening up for trade.
One development that is sure to gain in importance in the coming years and decades is trade not
only in goods, but in services. Historically, we have focused on trade in what are known as
tradable, manufactured goods. But technology is continually expanding the range of tradable
services. Think about internet e-commerce platforms that can provide their distribution service
from anywhere in the world, think about a professional consultant, a programmer or even a
medical doctor, professionals who use modern technological tools of collaboration and
communication and who can provide their services from anywhere in the world.
In fact, we could very easily be holding our meeting today by video conference, although I myself
very much prefer making and maintaining contacts on a personal basis. There will surely always
be a need for personal dialogue.
The planned Trans-Pacific Partnership contained provisions that addressed the blurring between
tradable goods and supposedly non-tradable services. Even though the future of the treaty is
currently uncertain, finding an international trade framework for digital goods and services will
continue to be highly relevant.
There are more examples of developments favourable to international trade. One such example
is the Trade Facilitation Agreement, which entered into force on 22 February 2017 after it was
9
ratified by two-thirds of the World Trade Organization's members. Another example is the CETA
treaty between the European Union and Canada that is in the process of being ratified and
10
adopted. The "one belt, one road" initiative was promoted with much publicity at a summit in
11
Beijing just ten days ago. While it remains to be seen whether the proposed project will meet
European standards of fairness and transparency, it clearly shows that enthusiasm for
international trade is far from dead.
4 Conclusion
Ladies and gentlemen, I have argued that even if international trade is far from dead, we can no
longer take it for granted that the conditions and moods favouring international trade will prevail in
the future.
In Europe and in other developed countries, there is an open discussion on the merits and
drawbacks of international trade. We have to join in this discussion if we are to preserve and
expand international trade. We will have to think long and hard about how to implement the
principle of "free trade plus compensation", that is how to help those who are losing out to adapt
to the changes brought about by international trade and technological progress.
In this way, citizens in Europe, in China, and all over the world will recognise that international
trade is a virtue in our societies, not a threat.
Thank you for your attention.
1
Source: Penn World Tables Version 8.1.
2
Source: Milanovic, B. (2013). Global income inequality in numbers: In history and now. Global policy. 4(2): 198-
208.
3
On domestic distributional consequences of international trade, see, for example, Acemoglu et al. (2016).
Import competition and the great US employment sag of the 2000s. Journal of Labor Economics 34(S1): 141-
198; McKinsey (2016). Poorer than their parents? A new perspective on income inequality. Available online:
www.mckinsey.com/global-themes/employment-and-growth/poorer-than-their-parents-a-new-perspective-onincome-inequality.
4
John Stuart Mill argued in 1825 for the possibility of winners compensating losers in the context of the repeal of
the Corn Laws. See: The Collected Works of John Stuart Mill, Volume IV - Essays on Economics and Society
Part I, ed. John M. Robson, University of Toronto Press, 1967. Available online:
oll.libertyfund.org/titles/244#Mill_0223-04_311.
5
On the effectiveness of active labour measures: ftp.iza.org/pp84.pdf, p.10.
6
Speech of Christine Lagarde at Bruegel think tank, April 12, 2017. Available online:
www.imf.org/en/news/articles/2017/04/07/building-a-more-resilient-and-inclusive-global-economy-a-speech-bychristine-lagarde. On this issue see also the findings of the IMF in the World Economic Outlook April 2017,
Chapter 3, p. 122f. Available online:
www.imf.org/en/Publications/WEO/Issues/2017/04/04/world-economicoutlook-april-2017.
7
A summary on the debate is given by Joseph Stiglitz in "The Post Washington Consensus Consensus". The
Initiative for Policy Dialogue, 2008. Available online:
policydialogue.org/files/events/Stiglitz_Post_Washington_Consensus_Paper.pdf.
8
Dani Rodrik (2000). How far will economic integration go? Journal of Economic Perspectives, 14(1).
9
Source: www.wto.org/english/tratop_e/tradfa_e/tradfa_e.htm.
10
Source: ec.europa.eu/trade/policy/in-focus/ceta.
11
Source: www.xinhuanet.com/english/special/201705ydylforum.