Nout Wellink: Prospects for a unified Europe
Speech by Dr Nout Wellink, President of the Nederlandsche Bank, at the European Institute in
Washington DC, 30 April 2001.
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Introduction
The European Institute has asked me to focus on the topic of economic diversity in Europe. It is a key
issue, and I am glad to share with you some of my ideas on it. At the end of my speech, I will allow
myself to take a broader view and consider the longer-term prospects for Europe. But first, I will
discuss a more down-to-earth issue of immediate relevance to us all: the prospects for economic
growth in Europe. The key question is: With declining US growth, will Europe be the white knight that
rescues the world economy from slowing?
Growth prospects for Europe
The European economy is on solid ground. Real GDP growth in the euro area amounted to 3.4% in
2000, which is the highest growth rate of the past ten years; at the same time, the ECB remains
successful in maintaining inflation at low and stable levels; employment growth has been higher than
in the US for each of the last three years; and finally, high fiscal deficits have been eradicated, and are
a thing of the past. So, the background is encouraging. In at least two respects, the euro area
economy is currently less vulnerable than the US:
First, Europe has a positive rate of personal savings, serving as a buffer against unexpected
contingencies, such as a sharp decline in equity prices. With a negative personal savings rate, as in
the US these days, shocks in equity prices may have relatively large effects on consumer expenditure
and, hence, economic activity. This is all the more so, as shares are more widely held in the US. In
1999, the average American family's equity ownership was worth 174% of its disposable income,
roughly twice the German figure.
Second, and connected with the first observation, the current account position is stronger in Europe
than in the US. The US current account has reached a record deficit of 4% of GDP. This reflects the
fact that business investment in the US has become more and more dependent on foreign sources of
finance. As a consequence, a change in international investor confidence away from the US is likely to
aggravate a significant slowdown in economic activity, and thereby to lead to a downward spiral in the
external value of the dollar. We don't see this right now, but it has happened before.
This is not to deny that the current US slowdown will affect Europe. The familiar truism that Europe
catches a cold when the US sneezes still applies. Although direct trade links are limited, other
channels are more important. In today's global economy, disturbances on US financial markets impact
significantly on their European counterparts. A decline in US economic prospects will also undermine
European producer and consumer confidence. But even if the uncertainties concerning the European
economy materialize, domestic economic conditions in the euro area seem to be more robust than in
the US. In 2001, euro area GDP is expected to grow more or less in line with potential, and faster than
the US economy. Nevertheless, since imports of goods and services count only for about 16% of GDP
in the euro area, it would be misguided to think that Europe could be the one-and-only power engine
for the world economy. A buoyant global economy requires healthy growth in both Europe and the US.
Economic diversity in the euro area
So far, I have discussed the euro area as an economic entity. I will now talk about the euro area as a
collection of 12 separate EU countries. Recall that the UK, Sweden and Denmark are EU member
states not participating in monetary union for the time being. Taken on their own, these 12 euro area
countries were small in comparison to the US. But with the establishment of monetary union, these
countries have integrated important aspects of their economies into a single euro area economy. In
many respects, the euro area and the US are comparable. For instance, the euro area has a
population of 300 million people; the US has 270 million people. The share of the euro area in world
GDP is 16%, which is slightly less than the US share of 22%. On the other hand, the share of euro
area exports in world exports is 19%, whereas the US share is 15%.
In spite of monetary union, economic diversity across the euro area has not disappeared completely.
Growth differentials between countries have been more or less stable over the last decade; inflation
rates have converged in the run-up to monetary union, but have diverged somewhat since.
Divergences in Europe attract much more public attention than do regional differences in the US. This
is striking, since in fact economic differences across the US do not vary greatly from those across
Europe. Admittedly, the dominating position of large member states in Europe is unprecedented in the
US. Germany counts for 32% of euro area GDP, France for 22%. Taken together, California, New
York and Texas count only for a modest 28% of US GDP. But on the other hand, GDP in our smallest
euro area member state, Luxembourg, is roughly the same as the share of small states like Vermont,
South Dakota or Maine. Consider another example. In Europe, the Finnish economy is heavily
dependent on only one sector, telecom. I am sure, the Nokia trademark rings a bell here, too. But take
Texas: it is heavily dependent on the oil industry. Such differences in economic structure can cause
differences in cyclical patterns among regions, both in Europe and in the US. These differences also
explain differences in exposure between regions to economic shocks, a phenomenon well known in
the US.
Maybe economic divergences in Europe attract much more public attention than in the US because
the euro area has a very short history. Or maybe divergences in Europe catch the eye due to the fact
that we are used to thinking about economic divergences in terms of sovereign countries. Probably,
both answers contain elements of truth. But there is an additional reason why regional divergences in
the US do not attract much attention. Regional differences in the US tend to cancel each other out in
the medium term. It is common for a US state to have inflation and economic growth above the federal
average in a particular year, and to have inflation and growth rates below average few years later.
With only two years after the establishment of monetary union, we do not know whether this will also
be the usual pattern in the euro area.
US states do not diverge persistently from federal trends. That is due to economic mechanisms that
restore equilibrium. A very important mechanism is labor market flexibility. If there are lay-offs in one
part of the US, people tend to move to other, more buoyant regions. Every year, more than 2% of the
American population moves to another state to find a job. A further mechanism that contributes to
restoring equilibrium in the US is income transfers by the federal government. To be honest, similar
redistribution mechanisms to absorb shocks on an interregional basis are less developed in Europe.
Labor mobility is limited across Europe, and even within countries. Fiscal transfers between countries
would be politically difficult to implement and they lack public support. In addition, the current
European Commission budget is very small in comparison to the US federal budget, and certainly too
small for significant fiscal transfers. Instead, our system relies much more on the intertemporal
absorption of shocks within individual countries. This works through automatic stabilizers in national
budgets, which are large in comparison with US state budgets. According to the so-called Stability and
Growth pact, member states should have fiscal surpluses in boom years in order to allow for possible
deficits during economic downturns. They must also keep deficits below 3% of GDP; over the cycle,
budgets of member states are required to be in equilibrium or in surplus. In the European context, the
Stability pact is a much better mechanism for smoothing divergences than income transfers between
countries would be.
As regards monetary policy in the context of economic diversity, an important consequence of
monetary union is that varying national monetary policies and national exchange rates can no longer
cause divergent business cycles or inflation differentials. Until the early 1990s, interest differentials
and, more importantly, exchange rate disturbances often caused economic divergence. In the run-up
to monetary union during the second half of the 1990s, more uniformity emerged. In 1999 a single
monetary policy was established that took away these potential causes of regional divergences. From
1999 onwards, the ECB has aimed at low and stable inflation in the euro area as a whole. The single
monetary policy is not in a position to influence the dispersion of inflation rates across the euro area.
However, the ECB is aware of inflation and growth differentials. Large economic divergence could
undermine public support for the single monetary policy of the newly created ECB, as divergences
make a 'one-size-fits-all' monetary policy less appropriate for certain parts of the area. Again, like in
the US, a second reason for our interest in regional divergences is that they can provide early signals
of area-wide developments. In this respect, there is no major difference between the ECB and the
Fed. The Fed reports regularly on US regional developments in its Beige Book.
The fundamental difference between the euro area and the US concerns market flexibility and
economic stability. The European model has benefits associated with greater economic stability for
economic agents than in the more dynamic US economy. Recall, for example, the more generous
European social safety net. However, doing it the European way comes at a price in terms of less
flexibility. For instance, the American model is more adapted to integrating new technologies. The
major challenge for Europe is to increase market flexibility without risking the benefits of its current
system.
European economic structures are improving. On 1 January 1993, Europe created a single market.
Only six years later, the common monetary policy was put in place. Budgetary discipline has improved
considerably over these years. More recently, Europe has abolished most barriers to competition in
the telecommunication and energy sector. Reforms are under way on a broad front. For example, at
the Stockholm summit of EU heads of government last month, new steps were announced to make
Europe more competitive and knowledge-based. Several initiatives relate to removing obstacles to the
mobility of workers between European countries. The most practical step forward was the agreement
on proposals prepared under the chairmanship of Alexandre Lamfalussy aimed at taking away the last
hurdles to a fully integrated European capital market. Subject to the energetic implementation of
structural reforms, especially those in the field of labor markets and social security, Europe will be able
to benefit more from new technologies, and trend economic growth will increase.
Many countries in Europe show encouraging signs that progress on structural issues is under way.
Take France for example. Flexible work schedules have recently been introduced on a broad scale.
The government has reduced the state's stake in banking, air transport and telecoms. France has also
made a first step in lowering the fiscal burden with a one percentage point reduction in VAT last year.
There are also developments that point to another direction, for example recent government plans to
double redundancy pay by employers. But, on the whole, France has moved from a vicious cycle of
higher unemployment and welfare charges to a virtuous growth cycle.
Enlargement and closer cooperation across Europe
Taking a broader view across Europe, one can say that the coming EU enlargement to Eastern
Europe bolsters prospects for structural reforms. Currently, negotiations are under way with 12
accession countries. Imagine how different the EU will look when they have joined. The EU will then
consist of 27 countries; its population will increase by 30%, though GDP will increase by only 5%. It is
difficult to imagine that enlargement to the East would occur without reforms leading to lower
agricultural subsidies, fewer transfers from so-called cohesion funds and more efficient social security
systems. The more so as our policies, in contrast to US policies towards their Latin American
backyard, are aimed at full integration of accession countries in the EU. However, the new states that
we want to welcome to the ranks of the EU must realize they have to bear the main burden of
adjustment. Their first step is to enter the EU. In this context, they have to adopt European legislation,
to implement EU environmental standards etcetera. When they subsequently prepare for joining
monetary union, the accession countries will have to continue the adjustment process in order to
successfully converge towards the standards of the euro area. This could take several years after EU
entry. However, the potential for structural reform and, therefore, for additional growth is immense.
Apart from enlargement, closer cooperation in several policy areas is another major theme within the
EU. In this respect, monetary union works as a catalyst for more cooperation on economic policies.
For instance, tax structures are moving closer together across the euro area. Another sign in this field
concerns the euro area Council of ministers of finance. They have an unprecedented power to fine
member states with excessive budget deficits. This Council can also make recommendations to
member states with economic policies that are inconsistent with broad policy guidelines. They made
such a recommendation recently to Ireland. It is understandable that within the EU, euro area member
states want to cooperate more closely. For example, the euro area ministers of finance have
intensified their cooperation in the so-called euro group.
With closer European cooperation on monetary and economic issues, it is natural that cooperation on
other policies will increase too. However, there is no ultimate goal for closer political integration. Some
dream about the United States of Europe, but Europe will not be ready for this within the foreseeable
future. Others think of a United Europe of States. Anyhow, there is a growing understanding among
European political leaders that Europe cannot develop faster than the people want. As I see it, from
time to time this can mean that there is a pause at the current level of integration. But there is no
moving backward. As it stands, we have to be realistic and focus on issues that have to be resolved at
relatively short notice. The main issue now is how to deal with enlargement to Eastern Europe in terms
of decision-making processes. If we want to have both enlargement and closer cooperation on
particular issues, there is a need for pioneering groups of member states that move closer together on
these issues. That is unavoidable; whether you refer to these groups as 'centers of gravity',
'avantgardes' or in the best tradition of Eurocrat-speak 'member states of a multi-tiered Europe with variable
geometry, in concentric circles with a hard core'. Last year's Nice summit has cleared the ground for
this flexible approach.
Concluding remarks
Let me conclude. European economic growth prospects are favorable. Euro area economic diversity is
a fact of life, but not very different from the US situation. Admittedly, the European economy has
considerable progress to make in structural reform. But the improvements so far are genuine and are
likely to last. Closer European cooperation on economic and political issues is under way. If I may
quote the American economist Lester Thurow from his 1992 bestseller Head to Head: 'future
historians will record that the 21st century belonged to the House of Europe'. End of quote. In this
environment, a common European culture is emerging. As of January 1, 2002, euro notes and coins
will give European citizens a concrete sign of their common identity. Nonetheless, some cultural
differences will remain, just as in the US. Joe-six-pack as the average American is only virtual reality. I
am sure that someone from New Jersey is very different from someone from Texas. Also in Europe,
we will keep national traditions. I was born Dutch. Now I feel European, but a Dutch European. I am
proud of that.