Jean-Claude Trichet: How to elevate the potential growth rate of Europe
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the Ludwig Erhard
Lecture, Berlin, 16 October 2006.
* * *
Sehr geehrte Damen und Herren, sehr geehrter Professor Doctor Tietmeyer - ich möchte lieber
sagen: mein lieber Freund Hans; ich freue mich sehr, heute im Rahmen der V. Ludwig-Erhard-Lecture
anlässlich des 75. Geburtstags von Professor Tietmeyer hier bei Ihnen zu sein und meine Gedanken
zur Steigerung des Potenzialwachstums in Europa mit Ihnen zu teilen.
First of all, Dr Hans Tietmeyer is a pioneer of Economic and Monetary Union and the euro, and so, for
obvious reasons, I feel close to him and responsible for ensuring that his work on the European project
is continued. I particularly share his views on how to conduct monetary policy. Allow me to quote him
to illustrate my point, "In the longer run, monetary stability has proved to be unequivocally beneficial
for growth and employment. Moreover, it is the most social of all conceivable economic strategies"1
Second, and on a more personal basis, I pride myself on being among his friends for more than 20
years.
Thanks to leaders like Hans, who shared the same vision for the future of Europe, in 1999, 11
European countries introduced the single currency, followed later by Greece. Slovenia will join the
euro area next year. The introduction of the euro has been a remarkable success, acknowledged not
only in Europe but in the whole world. However, to continue fully exploiting the benefits of the euro,
Europe has to face important challenges that require major policy measures. Indeed, when comparing
the euro area's economic performance to that of the US in terms of growth, there is clear evidence of
the fact that we have still a lot of progress to make. Since 1996, the annual growth rate in the euro
area has averaged 2.1% per year2 compared with 3.4% in the US, reflecting a particularly mediocre
euro area's growth potential. As a result, while in 1996, the GDP per capita level in PPP in the euro
area represented 84% of the US level, it represented only 76% in 2005.
Increasing potential output growth in Europe is today a priority for the euro area, as potential output
growth is one of the major catalysts for improvement in living standards. It is also an important issue
for the central bank, as potential output can be thought of as the maximum output an economy can
sustain in the medium and long term without a rise in inflation.
I will first review the past economic growth performance of the euro area, focusing on some of the
underlying factors of potential output growth, namely labour resource utilisation (or labour supply) and
hourly labour productivity growth, in particular in comparison with the US and other advanced
industrialized economies. Then I will elaborate on the kind of reforms which I consider essential to
increase the potential growth rate and the prosperity of Europe in the future.
The economic performance of the euro area since the mid-1990s
Let me start with an assessment of the euro area's economic performance by:
first recalling a few general facts,
then, analysing the euro area labour market and labour productivity performance in more
detail.
As I already mentioned, over the period from 1996 to 2005, euro area output grew on average by
about 1.3 percentage points less than in the US, and the gap appears to be persistent3.
The main factor which explains these developments is the diverging trend in hourly labour productivity
growth. Labour productivity growth is indeed typically the most important determinant of long-term
potential output growth. During the 1980's and the first half of the 1990s, hourly labour productivity in
the euro area grew on average by 2.4%, decelerating to on average 1.3% between 1996 and 2005. By
contrast, US hourly labour productivity growth rose from 1.3% to 2.2% over the same period.
At the same time, the euro area witnessed a slight improvement in the utilisation of labour, which
increased on average by 0.3% between 1996 and 20054 compared with 0.1% in the US] when defined
as the total annual hours worked divided by the total population. Labour utilisation reflects the extent
to which the potential labour resources in an economy are actually utilised and therefore has a direct
influence on output growth. The slight improvement in labour utilisation mainly reflects the significant
rise in the euro area employment rate from 58% in 1996 to 63.5% in 2005, accompanied by a decline
in the aggregate unemployment rate from 10.7% to 8.6%. However, the increase in employment has
been partly dampened by a fall in the average annual hours worked per person of 0.4% per annum
over the same period [compared with a fall of 0.2% in the US].
Let me now describe in more detail four features of the European labour market and labour
productivity performance that will provide some useful insight on progress achieved by the euro area
economy and its weaknesses.
First of all, despite the progress recorded on the labour market side, the overall employment rate in the
euro area remains low by international standards [63.5% in the euro area compared with 71.5% in the
US in 2005] and the unemployment rate is clearly too high [8.6% compared with 5.1% in the US in
20055. Moreover, in 2005 the number of annual hours worked in the euro area was 1603 compared to
1804 in the US. All in all, this clearly suggests that there is still considerable room for improvement as
regards increasing the level of labour resource utilisation in Europe.
Second, while the prime-age male employment rate in the euro area is comparable to that observed in
the United States, when we look at the youth, female and older worker employment rates, the
disparities are considerable. The female employment rate was 55% in the euro area and 66% in the
US, the older workers employment rate was 40% in the euro area and 60% in the US, the youth
employment rate was 37% in the euro area and 54% in the US6. These figures appear to be
consistent with an "insider-outsider" characterisation of the European labour market, where structural
impediments prevent those groups "at the margin" of the labour market from entering and participating
in the labour market.
The rise in the overall employment rate in the euro area over the last ten years has been mainly driven
by an increase in the female and older workers employment rates, partly reflecting the progress made
by structural reforms and wage moderation policy in some European countries. Nevertheless, and
turning to my third point which relates more specifically to hourly labour productivity growth
performance, specific policies aiming at increasing employment particularly in the unskilled segment of
the labour market have certainly contributed to the observed slowdown in labour productivity growth.
However, this apparent trade-off between labour utilisation and productivity is likely to be a temporary
phenomenon that should fade when the economy reaches a higher "equilibrium" labour/output ratio.
However, it is worth mentioning that the US managed at the same time to increase both labour input
and labour productivity. This leads to my final point. There is indeed another factor that explains the
difference in the rate of labour productivity growth in Europe compared with the US, which in my view
is a major policy concern, namely the fact that Europe is lagging behind in terms of innovation and
more specifically the diffusion of information and communication technology (ICT). Several authors
have already highlighted the major role of ICT in the revival of labour productivity growth in the US.7
While the ICT sector is the single most important source of productivity growth, it represented only
40% of EU productivity growth compared with 60% in the US. In 2004, total R&D investment in the
euro area accounted for 1.9% of GDP and the ICT sector represented as much as 20% of this amount,
while in the US, 2.8% of GDP was spent on R&D and the ICT sector represented as much as 30% of
this total.8 Even more important is the effect ICT diffusion has had on productivity in the US economy,
particularly in the services sector, with a substantial impact on retail and wholesale business and on
the financial services sector. ICT investment, which is a good indicator of ICT diffusion, represented
4% of GDP in the US over the period from 1996 to 2004 compared with only 2% in the euro area.9
The structural characteristics of the US economy - a more flexible labour market, a higher degree of
competition in product markets and lower barriers to entry for new firms - were apparently more
conducive to exploiting the opportunities provided by new technologies. By contrast, the productivity
growth performance in Europe was characterised by a lack of technology diffusion across sectors,
particularly in the services sector.
The need for further structural reforms in Europe
Overall, this brief assessment of the underlying causes of Europe's disappointing longer-term growth
performance provides a mixed picture of the European economy. Of course, I focused on a specific
set of supply-side determinants of economic growth. Economic growth is also influenced by other
factors, including the macroeconomic policy framework. I will deal with some of these aspects,
including the contribution of monetary policy to sustainable output growth, later on in my speech.
The lack of sufficient structural reform in Europe is, in my view, a major cause of the difference in the
rate of economic growth in Europe compared with the US and with some other advanced industrialized
economies, and of the fall in potential output growth in Europe. All in all, it appears that the overriding
policy concern for Europe is how to simultaneously achieve solid employment and productivity growth.
I will therefore now turn to those structural reforms that have the potential to increase both euro area
labour productivity growth and labour utilisation, and therefore long-term growth potential. It is clear
that embarking on the path of such major structural reforms is easier said than done, especially in the
current environment, where the European economy is facing a number of important challenges,
including rapid technological change, ageing populations as well as accelerating globalisation. For
instance, ageing will not only put pressure on public finances by driving up ageing-related expenditure,
but will most certainly also bring down the potential growth rate of Europe if no reforms take place.
According to the European Commission's projections, the impact of ageing populations alone could
reduce potential output growth in Europe by nearly half by 2040, from the present rate of 2%-2.25% to
around 1.25% if structural reforms are not carried out10.
All in all, these challenges will require major efforts to increase the output growth and adjustment
capacity of the euro area in general and the flexibility of workers in particular. European governments
should take advantage of the recent favourable growth developments to push ahead with structural
reform.
Without aiming to be exhaustive, I should like to highlight some of the key priorities for reform in four
main areas, namely:
Getting more people into work,
Increasing competition,
Unlocking business potential,
And finally, supporting an innovative environment.
First of all, well-functioning labour markets are extremely important in fostering higher economic
growth. The differences in labour market developments, especially with regard to the level of labour
utilisation, between the US and Europe has prompted some economists to suggest the existence of a
"European model" and a "US model", related to the trade-off between labour and leisure.11 One view is
that the lower levels of GDP per capita in Europe reflect a European preference for more leisure time.
However, we should bear in mind that lower participation rates are not necessarily associated solely
with personal preferences, but are also triggered by the legal and regulatory environment, tax systems
and social institutions. Benefit systems that are too generous discourage job searching, early
retirement schemes encourage early withdrawal from the labour market - employment rates for older
workers aged from 55 to 64 stood at just 40% in the euro area in 200512 and at around 60% in the
US13 - and marginal tax rates that are too high discourage labour market entry and have a downward
effect on average hours worked. Necessary measures to increase labour utilisation or labour supply
include the reform of tax and benefit systems to address these problems and increase incentives to
work. Measures aimed at reconciling motherhood with professional life, such as the provision of
childcare, should also raise participation rates. Furthermore, the use of flexible forms of work such as
part-time and temporary work may also provide further working incentives.14
High unemployment rates in the euro area and in particular high youth unemployment rates,
amounting to 17.8% in 2005 compared with 11.3% in the US15, clearly suggest the need to spur not
only labour supply but also labour demand. In this context, there is a need to promote wage flexibility
and to address labour market rigidities. Adjustments should be made to employment legislation where
it impedes the hiring of younger and older workers in particular.
And reform does pay off. Indeed, the European countries that did engage on the path of such reforms
in particular Denmark, Ireland and the Netherlands have achieved success in reducing unemployment
and stimulating job creation, despite significantly different economic conditions16. In 2005 the
unemployment rate in these countries stood below 5.0%, while their overall employment rate was
above or close to the US level. To achieve such remarkable success, these countries reformed their
tax and benefit systems by reducing for example tax wedges on labour income and by carrying out a
stricter enforcement of job search rules and a better surveillance of eligibility17. They also increased,
when needed, the flexibility of their labour market by easing employment protection legislation (EPL),
in particular as regards temporary workers.
What all these countries also have in common is a significant reduction of product market regulation
(PMR). This leads to the second prerequisite for higher medium to long-term growth: increasing
competition towards establishing efficient and well-functioning product markets.
Most studies point to the potential competitive pressure has to increase employment, at least in the
long run, and to boost productivity trends by improving production efficiency and by enhancing the
incentive to invest and innovate. The links between competition and productivity growth are now both
theoretically and empirically well-established. The ECB and the Eurosystem as well as the
Commission have been working in this domain of research.18
In the EU, some progress has been made in this regard.19 For example, several network industries,
like telecommunications, are now fully or largely open to competition. A lot remains to be done: the
extension and deepening of the EU internal market remains a priority. With service-related activities
representing around 70% of value added and employment in the euro area, more competition in the
EU service markets is absolutely of the essence.
In this context, the adoption of the Services Directive by the European Parliament in February 2006
constitutes a step forward in the right direction even if it has been somewhat watered down which I
regretted. Let us also stress that the mere adoption of Internal Market directives does not
12
Eurostat data.
13
OECD Employment Outlook 2006.
14
See, for example, Genre, V, R Gomez-Salvador and A Lamo (2005): "European Women: Why do(n't) they work", ECB
Working Paper Series, No 454, March 2005.
15
Eurostat data.
16
See IMF (2006) paper "Lessons from successful labour market reformers in Europe".
17
See Grubb (2000).
18
For further information on this topic, see European Commission (2004), "The link between product market reforms and
productivity: direct and indirect impacts", the EU Economy: 2004 Review.
19
See the ECB Occasional Paper Series No 44 "Competition, productivity and prices in the euro area services sector", by the
Task Force of the Monetary Policy Committee of the ESCB, April 2006.
BIS Review 97/2006
automatically produce benefits. Once adopted, directives must be transposed into national law and
enforced in order to produce benefits and Member States have the primary responsibility for these
tasks.
The third prerequisite for higher growth in the euro area is the unlocking of business potential by
creating an entrepreneurial-friendly economic environment. Europe needs more new and thriving firms
willing to reap the benefits of opening markets and to embark on creative or innovative ventures for
commercial exploitation on a larger scale. It is increasingly new and smaller firms, rather than large
ones, that are the major providers of new jobs20. The contribution from firm dynamic processes to
aggregate labour productivity growth and innovation also plays a major role, in particular in high-tech
industries21. All in all, an entrepreneurial-friendly economic environment would imply less red tape for
small and medium-sized enterprises (SMEs) to help them develop at home and across borders, as
well as positive action to ease access to the finance they need. As regards risk capital markets,
venture capital (VC) financing is also crucial. Without these funds, many new and innovative
companies will simply not emerge. And Europe is significantly lagging behind in this field, as VC
financing in Europe remains only a fraction of what it is in the US relative to the size of their
economies. The immense importance of having an entrepreneurial-friendly economic environment is
however increasingly appreciated by European governments, and several initiatives at national or EU
level have started to implement actions for "better regulation". For example, in March 2006, the
European Council called for the establishment of "one-stop-shop" arrangements in each Member State
by the end of 2007, which would enable a company to be set up in one week. Today, the number of
days needed to set up a new business in the euro area ranges from eight days in France and Portugal
to 47 and 38 days in Spain and Greece respectively, compared to only five days in the US22.
Fourth, to fully exploit productivity potential, the labour and product market reforms I just mentioned
need to be accompanied by policies that help to diffuse innovation and technological change. This
includes, inter alia, measures to support innovation through higher investment in research and
development (R&D). The immense importance of this issue, and the great opportunities provided by
investment in research, are also increasingly appreciated by European governments and firms.
Europe has set itself the target of achieving a share of 3% of GDP by 2010 and some progress seems
to have been made in this regard. According to a recent EU pilot survey on R&D investment,
European companies expect their global investment in research and development to grow by about
5% per year over the next three years, which represents a considerable improvement over recent
years. At that growth rate, provided it would effectively materialize, European companies would be
doing as well as their US counterparts in terms of R&D investment for the first time since a large
number of years23. The survey also found that European companies continue to prefer to locate R&D
activities in their home country, with Germany, the United Kingdom and France topping their lists of
favoured destinations.
To make these measures most effective, they need to be accompanied by efforts to improve the
labour force's level of education and expertise.
The impact of education on growth may be related to innovation, as well as the adoption of new
technologies. Policies aimed at improving human capital are usually considered to be of the utmost
importance in this field. One possible explanation, commonly mentioned in literature, is that the
diffusion of innovation and new technology is associated with a rapid decrease in learning costs over
time triggered by the increasing number of users. More widespread knowledge about how to exploit
new technology would obviously speed up the rate of diffusion and foster non linear effects as regards
the benefits associated with it.
Better education and training also helps to reduce mismatches in the labour market and allows for a
smoother reallocation of workers between sectors and firms.24
All in all, meeting the challenges of technological progress and ensuring the labour force's
employability and flexibility, requires that human capital is continuously adjusted to labour market
needs through improved education and training, as well as lifelong learning.
The last decades have already brought about an enormous increase in the level of educational
attainment, the so-called "catch-up effect in education". In the euro area, according to OECD data for
2003, an average of 73% of those aged from 25 to 34 had attained at least upper secondary
education, compared to only 46% of persons aged from 55 to 64.25
However, so far investment in human capital in Europe is still clearly inadequate for a
"knowledgeintensive" economy. In 2005, the US annual expenditure on higher education institutions per student
was 17,890 EUR, while in the euro area only about 7,402 EUR was spent. Furthermore, we need
more high quality scientists and researchers. In the EU we have about 5.3 scientists and researchers
per thousand workers, compared with the US's nine per thousand.26
The state of structural reform
If euro area countries now summon up their strength and ambitiously push forward with structural
reform, this will support and broaden the improvement in economic activity in the euro area. This is
why the ECB has always encouraged the implementation of structural reform within the so-called
Lisbon Strategy, which was put in place during a meeting of the European Council of Heads of State
and Government in Lisbon in 2000. Over these first few years, progress has been made in some
areas, as is also indicated by an increase in the euro area employment rate. Still, the reforms have not
been far-reaching enough and their implementation, in particular, has been too slow, particularly as
regards the urgency of these reforms and the opportunity costs associated with this slow motion.
Against this background, the mid-term review of the Lisbon Strategy in 2005 led to a re-launch of the
process by shifting the strategy's focus to growth and employment. Also, a number of changes were
made to the governance framework of the Lisbon Strategy in order to improve the implementation rate
of structural reforms. One outcome of this process was that all EU countries had to prepare National
Reform Programmes (NRPs) outlining steps for structural reform for the period from 2005 to 2008.
Overall, the NRPs appear to reflect a stronger political commitment to the reform process in the
context of the Lisbon Strategy, and all euro area governments acknowledge the need for further
reforms and the benefits arising from implementing such reforms. It has also been acknowledged that
a well-functioning and competitive Internal Market is particularly important for the euro area inasmuch
as it will enhance its capacity to adjust smoothly to asymmetric shocks. This will help to more fully reap
the substantial benefits of the single currency.
In this context, the NRPs appear to be an important step forward and these efforts are welcomed by
the ECB. Indeed, the potential gains are very significant. A recent study finds that if Europe reaches
the objectives set down in the Lisbon Strategy (in particular, full implementation of the internal market
for services, a reduction of administrative burdens, improvements in human capital as well as the R&D
and employment targets), EU GDP could be 12 to 23% higher than otherwise and employment
increased by about 11% by 2025.27 These figures might look impressive. But these orders of
magnitude are not out of reach. Fancy that if only we could go back to our labour productivity yearly
progress level of the 80's, namely 2.5 %, we would gain each year around 1.2 % of growth knowing
that our present average yearly level is 1.3 %...
Macroeconomic stability to support higher and sustainable growth
As mentioned earlier, the supply-side determinants of long-term growth that I have emphasised should
not be understood as an exhaustive explanation for the growth performance of the European
economy. We should also look beyond the microeconomics of the supply-side and ensure an
appropriate macroeconomic framework in Europe. I am referring now to the national fiscal policies and
the single monetary policy.
First of all, sound fiscal policies in Europe are of the essence because they ultimately are supporting
growth and stability. Through various channels, including favourable "ricardian" confidence effects,
prudent fiscal policies contribute to lower risk premia on long-term interest rates and thus to more
favourable financing conditions. This, in turn, promotes investment and long-term growth. It is,
amongst others, for these reasons - to have a stable and sustainable fiscal framework for economic
growth as well as to support a stability-oriented monetary policy - that the EU has adopted the
Stability and Growth Pact.
Beyond that, the "quality" of public finances matters also enormously for growth. The level and
composition of government taxes and expenditure has an impact on the way markets function, and
they can hinder - or promote - growth. Reducing public spending inefficiency, would pave the way to
financing tax cuts. And public expenditure directed towards productivity-enhancing physical and
human capital accumulation rather than towards propping up failing enterprises or "sunset industries"
is, of course, growth-promoting.
I do not need now to explain in detail why we at the ECB insist that the best contribution monetary
policy can make to growth is to maintain price stability. I am in the presence of Hans about whom Time
magazine wrote in 1997 "If the Romans had a god of central banking, he might look like Hans
Tietmeyer". Let me make a brief comment about the role of monetary policy in fostering sustainable
economic growth in Europe.
What a central bank must do and can do is to avoid, to the extent possible, the negative effects on
long-term growth of the uncertainty caused by high, variable and unanticipated inflation. The variability
of inflation increases uncertainty and exerts a major negative influence on investment and thus on
potential output as well as on other components of aggregate demand. The environment of price
stability in line with our definition, the credibility of the ECB in delivering price stability over time and
therefore the solid anchoring of inflation expectations, are paving the way for the favourable levels of
medium and long term market rates, lending support to sustainable economic activity.
* * *
Lieber Hans, wer hätte sich vorstellen können, dass ich hier, in Berlin, fast acht Jahre nach der
Einführung des Euro, als Präsident der Europäischen Zentralbank, sagen kann, dass der Rat unserer
Institution das Vermächtnis der Glaubwürdigkeit, des Vertrauens und der Stabilität der europäischen
Währungen, von denen die Deutsche Mark die wichtigste war, intakt gelassen hat. Du weißt, wie stolz
ich selbst war, als Bewunderer und Freund von Dir, dass meine eigene Währung, der französische
Franc, nach fünfzehn Jahren „wettbewerbsmässiger Desinflation" auch zu einer des stabilsten
Währungen geworden war.
Wer hätte sich vorstellen können, dass ich hier in Berlin hinzufügen kann, dass dieses Vermächtnis
der Glaubwürdigkeit, des Vertrauens und der Stabilität nun das Privileg von 313 Millionen Mitbürgern
in Europa ist. Am 1. Januar 2007, in weniger als drei Monaten, werden es 315 Millionen in 13 Ländern
sein.
Es war unser Versprechen, Hans. Das Versprechen, dass wir unseren Mitmenschen, den Haushalten,
den Sparern und allen Wirtschaftsakteuren gegeben haben. Wir haben ihnen versprochen, dass die
neue Währung mindestens so stabil und vertrauenswürdig sein wird wie ihre nationalen Währung
vorher.
Dank Dir, Hans, dank Wim, dank Otmar, dank allen unseren Weggefährten im EZB-Rat kann ich Ihnen
allen sagen, zusammen mit Jürgen und Axel: Wir haben unser Versprechen in der Vergangenheit
gehalten, wir halten es in der Gegenwart, und wir werden es auch in Zukunft halten.
* * *
Permettez-moi de dire, en conclusion, dans la langue de Molière après celle de Goethe, que je suis
confiant dans l'avenir de l'Europe. L'Europe est une entreprise historique que l'on doit apprécier dans
la durée. La signature du Traité de Rome a un demi-siècle, le discours de Robert Schumann sur la
communauté du charbon et de l'acier plus d'un demi-siècle. Qui aurait pu penser en 1950 que nous
aurions au tout début du siècle suivant une Union européenne de vingt cinq et bientôt vingt sept pays,
un parlement élu au suffrage universel, une cour de justice établissant sa jurisprudence sur toute
l'Union, un marché unique de 450 millions d'habitants et la même monnaie pour 12 pays et bientôt 13,
regroupant 315 millions de concitoyens européens ?
Nous vivons aujourd'hui, sur le plan politique, après le double non néerlandais et francais, un moment
de doute, de trouble, un temps d'hésitation devant l'avenir. De tels épisodes nous en avons vécus
plusieurs au cours des soixante dernières années. Nous les avons toujours dépassés et la
construction européenne a repris son cours. Les raisons que nous avions hier de nous engager dans
l'immense entreprise de l'Union européenne et d'approfondir cette union sont toujours valables ; sans
doute même sont-elles encore plus fondées aujourd'hui qu'hier. C'est pourquoi je suis confiant dans
notre capacité de surmonter à terme nos difficultés présentes : les rendez-vous historiques de
l'Europe doivent s'apprécier dans la longue durée. Par ailleurs l'imprévisibilité du cours actuel de
l'Union politique est la marque même de l'histoire qui se fait.
Jean Monnet, cet optimiste, dont les idées sont la source même de la construction européenne, écrit à
la fin de ses Mémoires :
« Ceux qui ne veulent rien entreprendre parce qu'ils ne sont pas assurés que les choses iront comme
ils l'ont arrêté par avance se condamnent à l'immobilité. Personne ne peut dire aujourd'hui la forme
qu'aura l'Europe où nous vivrons demain, car le changement qui naîtra du changement est
imprévisible ».
Je vous remercie de votre attention.