Jean-Claude Trichet: Competitiveness and the smooth functioning of the
Economic and Monetary Union (EMU)
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the
University of Liège, Liège, 23 February 2011.
* * *
I. Introduction
What should we understand by the concept of competitiveness, what does it mean in
particular for the euro area - and how should we act upon it? These are the questions I
would like to explore with you today. They are questions I have been contemplating all my
life as an economic policy-maker.1 And they are questions that are central to the future of the
national economies of Europe - and of particular importance among those that constitute our
Economic and Monetary Union.
Competitiveness is a difficult idea to nail down decisively and is commonly used to depict
very different things - from securing export market shares, through taxation of corporate
profits, indexation of wages and investment in high-tech, to boosting productivity growth.
In my view, the appropriate definition of competitiveness is a country's ability to achieve
sustainable improvements in the economic living standards and job opportunities of its
citizens in an open economy. Therefore, competitiveness is about the entirety of our
economic lives in a time of globalisation.
It is obvious that being successful in terms of price and cost competitiveness is one key
condition for enhancing living standards and job creation in open economies. Exports are
naturally an important part of the picture. But all sectors of our economies are involved in
competitiveness. Public goods and services - and private goods and services. Tradable
goods and services - and non-tradable goods and services. Financial services firms - firms
active in all parts of the real economy - and households and governments.
As diverse and multifaceted as our countries are, as manifold are the means of achieving
sustainable long-term economic growth and job creation.
The objective of achieving sustainable long-term growth in an open economy is both
European and global. It has to do with the thriving of nations within Europe, as well as within
the global economy that is undergoing very rapid structural changes.
The European Union is the world's largest economy and trading partner. It is therefore very
appropriate that it has designed its own strategy of developing its growth potential in
tomorrow's global economy. This strategy, called Europe 2020, is focusing on three main
areas: education, research and innovation; resource efficiency; and high employment and
social cohesion. These elements are all relevant for Europe's competitiveness in a global
economy, and the ECB fully supports the Europe 2020 strategy.
Today, I would like to focus on the aspect of competitiveness that is internal to Europe's
Economic and Monetary Union, i.e. the euro area. In such a union, competitiveness must be
examined at national levels, with a view to take into account in particular the very high level
of interdependence between economies created by the single currency. Therefore,
competitiveness is not only about raising our economic living standards: it is also about
strengthening the cohesion of the economic union. I will therefore focus my remarks on what
arrangements of competitiveness surveillance we need in the euro area, and how this could
be further enshrined in the current economic governance framework that is examined by the
EU Council and the European Parliament.
In an economic and monetary union, it is of the essence, by implementing sound economic
and fiscal policies, to avoid too large and too sustained divergences. That is why the Treaty
devotes an entire chapter to the "economic policies" of the union, with a particular focus on
countries that have adopted the single currency.
In an economic and monetary union, the Member States must develop and share a common
economic understanding of mutual surveillance. This common understanding of the
implications of being members of a currency union should ensure that structural features of
the economies help them to preserve their relative competitive position in an open
environment while ensuring collective stability. Such collective stability, as opposed to
sustained and large imbalances, implies in particular that macroeconomic policies need to be
fully consistent with a stability-oriented monetary policy.
I should emphasise that this in no way means that competitiveness or avoiding internal
imbalances is about making everybody look the same. The economic diversity that we enjoy
in Europe is an asset that we should seek to strengthen rather than dissipate.
What matters, however, is that diversity does not lead to large, persistent divergences. To
prevent such divergences from arising, we need a common framework that ensures that all
Member States - within their specific national settings - stay committed to regain, when
necessary, consolidate and preserve their relative competitiveness.
Misguided national economic policies can lead to the emergence of excessive
competitiveness gaps between the members of the currency union. The primary symptoms
of such competitive gaps are usually mounting current account deficits, significant
accumulated differences in indicators of price and cost competitiveness, leading, in
particular, to inflation rates persistently above the euro area common objective.
Such developments are also associated with tensions, painful adjustment processes and
spillovers for other members.
It is for these reasons that the European Central Bank (ECB) regularly provides analysis and
insight into the importance of competitiveness for Economic and Monetary Union.
Indeed, it is now five and a half years since the ECB injected an analysis of relative
competitiveness into the European policy surveillance.
When, around 2005, the signs of imbalances and divergences in key nominal developments,
in particular in prices, costs and wages, started to accumulate significantly, the Governing
Council sent the first analysis to the Eurogroup. The focus was on price and cost
developments in individual countries; the message was one of divergence that warranted
interpretation, assessment and policy action. At the same time, an ESCB Task Force was set
up to look more deeply into competitiveness issues of the individual euro area countries.2
Ever since, the ECB has provided updates of the analysis to the Eurogroup. The information
on unit labour costs, productivity and sectoral wage developments in euro area countries
have become a recurrent theme distributed at these meetings.
Since 2007, the ECB has undertaken regular, comprehensive competitiveness reviews of
developments in individual euro area countries. And in 2010, the ECB provided a detailed
outline of how the Governing Council envisages a competitiveness framework for the euro
area.
In my remarks tonight, I would like to focus on the main issues at stake - for national
economies in general and for members of the euro area in particular.
I will begin by reminding you of some of the stylised facts that have characterised economic
developments in the euro area over the past 12 years, as well as some of the fallacies about
competitiveness that I have encountered over the years.
I will then outline the key elements of a framework for analysis and action on
competitiveness, and subsequently discuss the implications for the current proposals on the
strengthening of macroeconomic surveillance from a euro area perspective.
II. Some empirical evidence
Let me give you some stylised facts about macroeconomic developments in the euro area
over the past decade or so. For now, I will just provide you with the data, without going into
their causes and policy implications.3
1. Between 1999 and 2009, nominal unit labour costs grew by 24% in cumulative
terms in the euro area as a whole. In Austria and Germany they grew by 13% and
8%, respectively; in Greece and Ireland, they grew by 34% and 38%, respectively.
2. Between 1999 and 2009, public sector wages in the euro area grew by close to
40%. In Germany, they grew by 19%; in Ireland and in Greece, they grew by more
than 100%, roughly 50 percentage points more than private sector wages.
3. Between 1999 and 2007, residential property prices in the euro area rose on
average by around 6% per year. In Greece they rose on average by 9.5% each
year; in Ireland they rose each year by almost 12%.
4. Household indebtedness in the euro area average rose from about 50% of GDP in
1999 to about 65% of GDP in 2009, an increase of about 30% over the period. It
doubled in the economies with the highest increase.
These are some illustrative facts. Let me now turn to some fallacies that I hear sometimes
when discussing these and similar facts.
III. Fallacies on competitiveness
Discussions on competitiveness often reveal misconceptions or fallacies that, in my view, are
wrongly guiding the debate.
Fallacy No 1: "Only the tradable sector matters for competitiveness", some say. "There is no
problem with the competitiveness of our economy: companies in the exporting sector are
doing well, prices are low and profits are good."
Fallacy No 2: "Public wage developments do not affect an economy's competitiveness",
some say. "Since the public sector is sheltered from international competition, developments
in public sector pay have little connection with the private sector and certainly not with the
international competitiveness of companies."
Fallacy No 3: "Let's discount wage and cost developments with the (relatively) high current
domestic inflation rate and we get a benign picture", some say. "Our wage increases of 6%
are fully justified because we have 2% productivity and 4% inflation; moreover, the higher
inflation rate is purely a catching-up phenomenon because we are growing so fast."
Fallacy No 4: "Intra-euro area current accounts don't matter", some say.
"The current
account balance reflects inter-temporal optimisation of savers and investors; moreover,
current account deficits are good as they reflect capital inflows, attracted by higher returns."
Fallacy No 5: "Fiscal consolidation can harm competitiveness", some say.
"Fiscal
consolidation is going to have dampening effects on growth and can weaken
competitiveness, which requires substantial government expenditure."
IV. Key elements of a competitiveness strategy
So if these points are fallacies, what is the right strategy for economies in general and the
euro area in particular? Let me share with you my reflections on five key elements of what I
think is the correct diagnosis:
1. First, the non-tradable sector is essential for the competitiveness of an economy.
Hence, we must look at all sectors when assessing competitiveness.
2. Second, are much more important than
wage developments in the public sector
is generally realised. Therefore, the public sector must set its compensation levels
with the implications for the whole economy in mind; it must be aware of its role
model.
3. Third, less than 2% but close to 2% over the medium term - namely the level of
medium-term inflation that is ensured as an average in the euro area by the ECB -
is the right benchmark to use for all countries to calculate competitiveness indicators
in real terms. Hence, one must not be misled into price-wage spirals by temporary
inflation differentials.
4. Fourth, the current account balance is an important summary indicator that may
signal losses of competitiveness and emerging imbalances. As a result,
policymakers should monitor this balance closely, and especially the related external debt
accumulation.
5. And finally, sound public finances are a pre-condition for sustained
competitiveness. This is yet a further reason for fiscal solidity.
Let me elaborate on each of these elements.
1. The non-tradable sector is essential for the competitiveness of an economy
There are two main reasons why the non-tradable sector is essential for an economy's
competitiveness. First, non-tradable goods and non-tradable services are important inputs for
the production of tradable goods. Hence, rising prices in the non-tradable sector push up
costs in the tradable sector. Second, price and unit labour cost increases in the non-tradable
sector will ultimately lead to upward pressure on unit labour costs in the tradable sector
(López-Salido et al., 2005). This second-round effect pushes up the productions costs of
tradable goods and reduces the competitiveness of the tradable sector.
There is some recent evidence that those countries with higher growth of unit labour costs in
services and construction than in industry and manufacturing have experienced a worsening
of their current accounts (see, for example, Zemanek et al., 2010).
If unit labour costs in the non-tradable sector persistently exceed those in the tradable sector,
firms in export industries may see themselves forced to squeeze their profit margins because
they are unable to pass on higher input prices to world prices. Price and cost pressures from
an expanding non-tradable sector induce exporters to reduce their margins. Thus, at first, the
exporting industry might not be doing too badly and export prices remain unaffected. But the
industry is gradually getting squeezed, rather than expanding. This not only reduces the
relative weight of exporters in the economy, but also the overall growth potential.
2. Public sector wages are much more important for competitiveness than is
generally realised
In the euro area, the government wage bill accounts, on average, for more than 10% of GDP
and more than 20% of the total compensation of employees. It is already clear from the
sheer size of this sector that public wage increases can have a very important signalling
effect for private sector wage negotiations.
The larger the public sector is, compared with the tradable sector, the stronger will be the
signal for wages in the private sector, and therefore the influence on the unit labour costs in
the private sector, taking due account of productivity developments. Hence, the larger the
public sector, the more important, and the more challenging, will be its role in the overall
evolution of cost competitiveness.
Evidence reveals an important influence from public sector wages to private wages in many
euro area countries. Public wage spillovers seem to be particularly important in countries that
have experienced high and volatile public wage growth. Thus, rapid increases in unit labour
costs and severe losses in intra-euro area competitiveness do not come as a surprise in
these countries (Pérez and Sanchez, 2010 and Holm-Hadulla et al., 2010).
3. Less than 2% but close to 2% over the medium term is the right benchmark to
use for euro area countries to calculate competitiveness indicators in real
terms.
In the euro area, the average annual inflation rate over the first 12 years of the euro was
1.97%. This outcome is in line with the ECB's definition of price stability of below, but close
to, 2%. This definition is deeply entrenched in medium to long-term inflation expectations,
which confirms the ECB's credibility and the public's confidence in the ECB's ability to deliver
price stability over the medium term. The ECB therefore provides the nominal anchor for
future price developments in the euro area as a whole.
Now, in a currency union, it is a natural phenomenon that Member States, at times, have
different inflation rates. These differences can result from some differences in the economic
development level of Member States, their position in the business cycle or their dependence
on trade and hence global developments.
So temporary deviations from the euro area-wide inflation average should not be a matter of
concern. Indeed, they constitute an important potential adjustment channel within a currency
union where exchange rates are fixed. But inflation differentials can turn into a source of
concern when they become large and persistent.
For a significant period of time, persistent above area-wide inflation rates in some Member
States had been regarded by some as justified on the grounds of catching-up effects. The
argument is that lower-income countries usually import productivity gains in the tradable
sector, which in turn leads to higher economy-wide inflation due to the adjustment of nominal
wages across sectors. This is the Balassa-Samuelson effect.
But increasingly evidence suggests that this effect has been overstressed as an explanation
for inflation differentials in the euro area. In some cases, these differentials were not driven
by healthy catching-up effects, but were largely the outcome of inappropriate macroeconomic
policies and debt-financed booms in domestic demand.
Thus a medium-term inflation rate of somewhat below 2% over the medium term is the
appropriate benchmark also at the national level. Unit labour costs, and therefore wage
developments, after having taken due account of the labour productivity increases, need to
be consistent with this.
Moreover, using contemporaneous (or lagged) inflation as a benchmark for wages can lead
to a nominal persistent spiralling of both wages and inflation over and above the average of
the euro area. This would lead to a progressive loss of cost competitiveness. This is why
central bankers are against wage indexation, particularly in a single currency area.
4. The current account balance is an important summary indicator that may
signal emerging imbalances and losses of competitiveness.
For the record, let me first stress that a current account deficit, just like a current account
surplus, does not necessarily point to economic malfunctioning. Indeed, it can be optimal for
a country, given the macroeconomic conditions. This is also true in a monetary union, where
some differences in national current account balances are a normal feature.
Capital flows, for example, may be favouring Member States with better growth prospects
and higher expected returns, related to catching-up processes and successful structural
reforms, and current account balances may diverge across countries as a natural result of
responses to asymmetric shocks.
Increasingly, however, larger current account deficits, in combination with significant losses
in competitiveness, high levels of private and public indebtedness and overheating in
nontradable sectors, may signal domestic macroeconomic imbalances and deeper structural
problems.
Countries with large current account deficits or worsening current account balances, for
example, often exhibit cumulated losses in price competitiveness, and vice versa, which
again, in turn may be related to price and cost developments that are not economically
justified. Rather than financing productive investment in the tradable sector and fostering the
export performance, capital inflows in deficit countries might fuel asset prices and household
and corporate debt.
Hence, even if inter-euro area current account balances do not matter because of the same
currency and will not trigger exchange rate crises, at the euro area level, internal current
account imbalances are relevant for policy-makers, as one of the major indicators of the
fundamental functioning of their economies.
5. Sound fiscal policy is a pre-condition for sustained competitiveness
Some observers are concerned that fiscal consolidation at the current juncture might dampen
economic growth and also provide negative externalities by constraining demand for trading
partners. I disagree with this view.4
On the contrary, I see three main reasons for fiscal
consolidation being presently positive for medium-term economic growth and
competitiveness.
First, experience from past episodes of fiscal consolidation suggests that, in a situation of
sizeable fiscal imbalances, short-term costs of fiscal adjustment in terms of forgone
economic growth tend to be contained or very limited, provided that consolidation is pursued
as part of a comprehensive reform strategy. Experience also suggests that the success of a
fiscal consolidation strategy strongly depends on its design. Adjustment on the spending
side, accompanied by structural reforms to promote long-term growth, has typically been the
best strategy, especially when combined with a credible long-term commitment to fiscal
consolidation.
Second, in a situation where fiscal sustainability is being questioned, consolidation boosts
confidence, which is a pre-condition for the consolidation of the present recovery and for
sustainable medium-term growth.
Third, public authorities need to preserve the ultimate capacity of public finances to intervene
in difficult circumstances. This is already true when our economies are going through the
usual business cycle. The reconstitution of fiscal buffers is always necessary. It is even more
necessary when our economies are coping with exceptional circumstances, such as the
recovery from the deepest economic crisis in over 60 years. The soundness of public
finances and the creditworthiness of the sovereign signatures are therefore a decisive
component of economic and financial stability in a medium and long-term perspective.
V. Implications for the reform of the European surveillance framework
Let me now discuss what the implications of these insights are for the surveillance of
economic policies in Europe, and in particular how the above five elements should be
reflected best in the existing European framework of macroeconomic surveillance and in the
envisaged new elements of this framework.
Within an economic and monetary union, national economies form an interdependent
system, in which spillovers are important for the cohesion of the union. It is not
straightforward for countries to take account of these spillovers sufficiently on their own. This
is the reason why strengthened surveillance at the euro area level is needed to prevent
economies from falling behind by losing competitiveness and becoming subject to
macroeconomic imbalances.
I have already mentioned developments in prices, costs and wages, current account deficits
and indicators of private and public sector indebtedness as well as countries' external debt
position.
For many years, I have strongly advocated in various European fora that the accumulation of
substantial losses of competitiveness, as revealed by developments in unit labour costs
among other indicators was not sustainable. Therefore, I trust that this is where a
surveillance framework aimed at preventing and correcting macroeconomic imbalances has
to start.
Of course, these elements are not the only ones we have to analyse carefully. As I have said
before, economic reality is much more complex than just a pure set of indicators.
Nevertheless such basic indicators are central for starting the analysis and for understanding
the policy considerations.
Let me therefore briefly sketch out the key indicators that ECB staff have been selecting after
reviewing and assessing the relevance of a much wider set of variables. These indicators
shall provide early warning signals when macroeconomic imbalances emerge and when
countries are experiencing significant losses in competitiveness, or when there are risks
thereof. The seven key indicators in the view of ECB staff are as follows:

a long-term measure of the growth of unit labour costs;

the stock of a country's net external debt as a ratio to GDP;

the national inflation rate;

the current account deficit as a ratio to GDP;
 the private and government debt ratios;

and the stock of private sector credit.
These variables are all common economic indicators, they are easily available from official
statistics and they are broad based. They have been selected to keep the first diagnosis as
simple as possible, while still covering the most relevant dimensions of economic fitness.
Such a scoreboard of indicators can help focus our attention on the key issues and trigger
more detailed surveillance procedures in cases in which indicators rise beyond certain
predefined threshold levels.
The European Commission and the related Council working group have been working
intensively on such a framework, including an alert mechanism on the basis of a limited set
of macroeconomic indicators - similar to those I have just presented - which would initiate
more detailed surveillance procedures.
The current discussions are based on the Commission's proposal for a new framework that
will apply to all 27 EU Member States with a preventive and a corrective arm.
Without going into all the technical details, let me make very clear once again which
fundamental elements in its design should be improved. The ECB's Governing Council,
being responsible for ensuring price stability, has a major interest in the smooth functioning
of the euro area economy. In this respect, the ECB considers it fundamental to set up an
effective surveillance mechanism in the euro area that avoids the challenges that some
countries are currently facing. The ECB published yesterday its opinion on the proposals
made by the European Commission (ECB, 2011). It regards these proposals as appropriate
for the Single Market, but considers that they need to be strengthened as regards the euro
area. With respect to the new macroeconomic surveillance framework, the ECB calls, in
particular, for the following specific measures to strengthen the framework for the euro area:
First, the specific nature of membership of a monetary union should be indicated more
explicitly. This should be reflected in differentiated indicators and thresholds of the
scoreboard for the members of the euro area, in comparison with the other members of the
European Union. Tighter thresholds for competitiveness indicators in the scoreboard are
required for the euro area countries. The set of indicators for the euro area countries should
focus on the detection of macroeconomic imbalances, and therefore they should refer to
losses of price competitiveness, private and public sector indebtedness and external
indebtedness indicators. They differ by nature from the much wider set of indicators reviewed
to assess progress in structural reforms in the context of the Europe 2020 strategy to
enhance sustainable growth and employment in Europe. These are the concepts that will
address the "thriving of nations in the dynamic global economy" which I alluded to at the
outset.
Second, a clear focus of the surveillance framework can be maintained best if only cases of
macroeconomic imbalances that hamper the smooth functioning of monetary union are
addressed. The framework proposed by the European Commission is symmetric with respect
to detecting, preventing and correcting both excessive losses as well as gains in
competitiveness. I think that a totally symmetric approach misses an important point: the
European Union and the euro area are not closed economies. On the contrary, they are
amongst the most open economies in the world. Gaining more competitiveness through the
improvements in one particular economy is a win-win game for all members: we are not
playing a zero sum game. Therefore, a totally symmetric approach runs the risk that the
surveillance lacks focus and becomes distracted from the most serious challenges to the
monetary union, which are significant losses of competitiveness, persistent current account
deficits, unsustainable increases in asset prices, including real estate prices, and high
external and internal levels of indebtedness. Given the magnitude of the imbalances
accumulated, the required policy action is urgent in some Member States.
Third, a much greater degree of automatism should be introduced into the macroeconomic
surveillance framework. A substantial discretionary power puts the credibility of the
macroeconomic surveillance mechanism at risk, if the rules and enforcement measures are
not consistently applied. Therefore, the possibility of derogation from the imposition of
sanctions on the grounds of exceptional economic circumstances or at the request of a
Member State should be avoided.
Fourth, in the same vein as the reforms introduced in the Stability and Growth Pact, financial
sanctions in the macroeconomic surveillance framework need to be applied at an earlier
stage and gradually, to provide Member States with the right incentives to comply with the
policy recommendations. This implies that financial incentives - such as an interest bearing
deposit - should be applied after the first instance of non-compliance or non-cooperation by
a Member State, while the current proposals foresee fines only after a repeated failure of a
Member State to comply with Council recommendations.
I am convinced that the European Parliament, with its co-decision power, will improve the
framework very significantly and trust that the proposals above are helpful in this respect.
VI. Conclusion
Let me draw to a conclusion. Competitiveness improvements will enhance a country's ability
to achieve sustainable improvements in the economic living standards and job opportunities
of its citizens.
Europe's 2020 strategy is fully part of the overall concept of competitiveness. It is, in a way,
the "external" angle of competitiveness in the global economy. Today, I focused more on the
"internal" angle of competitiveness, to strengthen the economic management of the Single
Market and, more specifically, of the euro area.
When the data are analysed within an appropriately comprehensive framework, several
fallacies become evident. We know that we must look carefully at the non-tradable sector
when assessing competitiveness. We must monitor public wage developments very closely.
We also understand - and this is absolutely fundamental - that a euro-wide price perspective
must dominate over national computations when discounting nominal evolutions including
revenues and wages. We see that the current account provides an important summary
indicator. And finally, we trust that appropriate fiscal consolidation will lay the foundations for
sustained competitiveness of our economies.
Figuratively speaking, competitiveness is not about becoming athletes in a world sprint
competition. It is about staying fit and thriving for the long term. It is also about avoiding
falling behind and ultimately becoming more dependent on others.
Because the community benefits, competitiveness is not about becoming richer at the
expense of others - the infamous beggar-thy-neighbour philosophy. Competitiveness is
about individual and collective health, with the two of them being mutually reinforcing.
We also need a commitment to sound and sustainable public finances and sound national
economic policies. Both must be monitored by a rigorous, credible and focused surveillance
framework.
A rigorously implemented Europe 2020 strategy, coupled with a reinforcement of the
governance framework before the European Parliament that we are calling for, will pave the
way for prosperity and stability of the EU and the euro area in tomorrow's global economy.
The contribution of the single monetary policy to this process is clear. Monetary policy
provides a reliable nominal anchor for households, enterprises, savers and investors that
euro area-wide consumer prices will increase, as in the past 12 years, in line with the ECB's
definition of price stability over the medium term.
Our 331 million fellow citizens can rest assured that the ECB is fully faithful to its primary
mandate. By maintaining price stability over the medium term and by solidly anchoring
inflation expectations at a level consistent with our definition of price stability, monetary policy
can make the best contribution to the achievement of sustainable long-term economic growth
and job creation.
Thank you for your attention.
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