"Emerging from the crisis stronger together"
How we can make Europe more resilient,
prosperous and sustainable
HJ Schoo lecture given by Klaas Knot
Amsterdam, 1 September 2020
Ladies and gentlemen
It is an honour to give this year's HJ Schoo lecture. I have to say, it was a bold choice from the organisers
to let me loose on you for an hour. There's a YouTube video doing the rounds of me being interviewed
on the current affairs programme Buitenhof. While I'm talking, text appears below explaining what it is
I am actually saying. A bit like subtitles. Unfortunately, that is not a luxury I can offer you this evening.
But I will try to keep the economic jargon to a minimum. Even though you seem like an audience who
can keep up.
I never knew Hendrik Jan Schoo personally, so in preparing for this lecture, I went a bit deeper into the
man and his work. And as I was reading about him, I started wondering how he would have felt about
me-a President of De Nederlandsche Bank- being chosen to give the lecture called by his name. Schoo
was primarily a political thinker, with an acute sensitivity to the deeper currents running through society.
Economics did not feature prominently in his work. But there was something else that struck me about
Hendrik Jan Schoo. And here I will quote from Marc Chavannes's description of him: "Schoo was a
selfmade man, from an everyday background. Reluctantly absorbed into the elite, he remained overtly
concerned about the risks ordinary people face." That last sentence resonated with me, because I
realised that also fits my job description. "Managing the risks ordinary people face." Or, to be more
precise: managing the financial risks ordinary people face, over which they have no control themselves.
Because make no mistake. What central banks do directly affects your life and that of everyone else
around you. They ensure prices remain stable. That banks, insurers, pension funds and other financial
institutions are sound and ethical. And that you can make payments efficiently and securely. So the
economy can flourish and ordinary people can make a living, safe in the knowledge that their money will
retain its value and is protected.
My own economic coming of age happened during the deep recession at the beginning of the eighties. I
was a youngster of about 15, and evening after evening I would watch news reports about the
bankruptcies. Unemployment and inflation had skyrocketed, and the hole in public finances kept getting
deeper. I also saw the consequences for society, sometimes up close. Falling prices on the housing
market meant the mortgage on my childhood home was 'underwater'. I still remember very well the
stress that caused my parents. How can an economic system get so out of control? The question
fascinated me. It was the beginning of my lifelong interest in economics.
And now once again, we find ourselves in an economic maelstrom, but this time under unprecedented
circumstances. One glance around this room is enough to see that. The pandemic has pushed the global
economy into deep recession. The Dutch economy has also suffered a heavy blow.
Fortunately, the Dutch economy has a strong foundation. As Dutch Finance Minister Wopke Hoekstra so
aptly put it, the government entered the crisis with deep pockets. This allowed it to absorb much of the
blow for households and businesses. And thanks to their robust capital buffers, banks have the room to
continue lending. This shows why it is so important to build up buffers in good times. Yes, De
Nederlandsche Bank is singing the same old tune again. I am sure you recognise it. But, as one of my
predecessors once said: the old tunes are often the best.
Our economy's strong foundation means we will also ultimately recover from this crisis. But I am honestly
more concerned about Europe.
The European economy is expected to contract sharply this year. The ability to recover from such a blow
is certainly not equal in all European countries. I am particularly concerned about the southern member
states. Not only because most of them have been hit by the coronavirus. But also because these
countries' economies had already been struggling for over a decade. What we have seen in recent
months is that the debate quickly turns to the future of the euro. That is bad news for Europe.
All this raises some important questions. Questions I would like to address together with you this
evening. Why is it that economic shock waves, such as the banking crisis of 2008 and now the
coronavirus crisis, are constantly throwing European cooperation out of balance? And how can we make
Europe more resistant to these types of shocks, not just in view of this crisis, but with an eye to the
future?
Ladies and gentlemen,
I will highlight why there is a tendency in Europe towards economic divergence between north and south.
I will show you how we still benefit greatly from European cooperation. But also that we have to do
something to correct the imbalances if we are to preserve the advantages. I will argue that we can do
something, by finding common responses to common challenges, and through enhanced coordination of
economic policy between the north and south. That is by no means straightforward, but it is
indispensable for a smoothly functioning monetary union and a strong Europe, in the interests of
sustainable prosperity for ordinary Dutch people. In other words, emerging from the crisis stronger
together.
The challenges facing us
I'd like to start by saying something about the economic advantages Europe has given us, and continues
to give us. [Figure 1]
Figure 1: Emigration. Waving off departing family members as their boat leaves port.
I think you will recognise this sort of archive photo. An ocean liner. People on the quayside, waving off
family and friends, sometimes flapping a handkerchief. The archetypal image of post-war emigration. In
the period from 1945-1967 around half a million Dutch people left these shores for countries such as
Canada, America, Australia and New Zealand, in search of a better life. They were not the only ones. In
the years following the Second World War several million Europeans left the continent. And with good
reason. In 1947 the outlook for Europe was sombre. The continent was financially devastated, everything
was in short supply, and reconstruction efforts were slow to develop.
The outbreak of the Cold War paralysed European politics. Europe was perhaps very close to becoming
a failed continent.
But fortunately, history took a different course. Europe focused on emerging from the ruins of two world
wars and decades of bitter division to become one of the most free and prosperous places on Earth. We
have by now become so used to this, that we sometimes forget what an astonishing feat it was. And
that astonishing European feat, ladies and gentlemen, is in no small part thanks to European cooperation.
Take the European single market, the whole body of rules that facilitates the free movement of people,
goods, services and capital. There has been considerable research into the benefits of the single market.
Two conclusions invariably emerge from these studies: the first is that each member state benefits from
the internal market, and the second is that small, open economies, such as the Netherlands, benefit the
most. That is what you can see here in the graph. [Figure 2]
Figure 2: Estimated benefits of the single market, in EUR per household
Taken together, the studies show that membership of the single market benefits households in the
Netherlands by between 6,000 and 10,000 euros every year. Even when we take into account the Dutch
contribution to the EU budget, there are still substantial welfare gains for the Netherlands. In other
words, in the Netherlands we have the European single market to thank for a big piece of our pie.
But you may now ask: how about the euro, our common currency? How does that balance out? As you
know, the creation of the euro was primarily a political project. Discussions on economic and monetary
union gained momentum after the fall of the Berlin wall. Germany once again became a unified nation.
The other European partners, principally the French, were keen to ensure the reunified Germany stayed
embedded in a united Europe. That was the deal that Mitterrand made with Kohl: unification for you;
the euro for us.
As well as political reasons, there were also strong economic arguments in favour of a common currency.
A single market like the European market, where there is intensive trade between countries, benefits
from fixed exchange rates. This reduces uncertainty surrounding foreign investments, and makes it
easier to compare prices between states. And in turn, that promotes competition and trade.
The success of the single market is therefore built on the bedrock of the euro.
But a single currency also unfortunately brings disadvantages. Certainly for a group of countries that
differ quite a bit from each other economically. For example, one common currency means one common
rate of interest, and that rate is not always suited to each country. This can contribute to the build-up
of debt, or to rocketing house prices. Irreversibly fixed exchange rates do not just offer stability, they
also imply that countries can no longer use their exchange rate as a way to restore their competitiveness.
Partly because of this, not all euro area countries have benefited equally from the euro. To put it bluntly:
countries with stronger economies, such as the Netherlands, have benefited more than countries with
weaker economies.
So why does a common currency work in favour of stronger economies? Allow me to explain.
To do so, I will use the Netherlands and Italy as examples. Exchange rates between euro countries were
frozen, as it were, when the euro was introduced in 1999. Since then, productivity growth in has been
higher in the Netherlands than in Italy. This is what economists refer to when they talk about 'stronger'
and 'weaker' economies. Productivity growth means you can make more or better products with the
same means of production and thus offer better value in terms of price to quality. In order to keep Italian
products competitive with Dutch products, the Italian currency would have had to depreciate against our
currency. As a result, Italian products would become cheaper. Before the guilder and the lira became
irreversibly linked, we regularly saw this kind of depreciation of the lira. But that is of course no longer
possible now. You can see that very well in this graph, which shows the exchange rate of the guilder
against the Italian lira.[Figure 3]
Figure 3: Historical exchange rate of Dutch guilder against Italian lira.
At the beginning of the 70s you needed nearly 6 guilders to buy 1,000 lire, but in 1999 you could get
1,000 lire with just over 1 guilder. As long as Italian productivity growth lags behind Dutch growth, the
only alternative is for Italian wages to also lag behind Dutch wages. But our wage growth is already only
very modest. That would imply that there is virtually no more room left for wage growth in Italy. And
with our in-built tendency to resort to wage moderation at every recession, Italian wages even need to
be reduced from time to time. Wage cuts in other words. Economists are good at coming up with these
sorts of pure, conceptual solutions. But do you remember the weeks of protests in the early 1980s, when
the first Lubbers cabinet cut public sector pay? When trash was piled high in the street? Cutting monthly
income simply causes practical problems, and that applies just as much to Italians as it does to the
Dutch.
Thanks to the euro, the Netherlands has enjoyed a stronger competitive position than if we still had our
own currency. Compared to southern Europe, but also compared to the rest of the world, thanks to the
weaker euro exchange rate. And that boosts our exports. It is how we in the Netherlands obtain such an
enormous trade surplus: we export much more than we import. This generates higher operating profits
for business and also increases tax revenues for the Dutch State. You could say that the euro always
gives a little boost not only to the Dutch economy, but also to the Dutch treasury. For a country like
Italy, where productivity growth is lower, roughly the opposite applies. At the risk of oversimplification:
the absence of an exchange rate between euro area countries is a benefit to the stronger economies,
while it is a relative burden to the weaker economies.
That is why the stronger and the weaker economies have a tendency to diverge. If this imbalance persists
for too long, it will lead to problems like we saw during the 2011 European debt crisis, when several
southern euro area countries experienced major financial problems.
Well, you might say: "Tough luck, but that's just how it is." Did we not agree in the Maastricht Treaty
that countries in the euro area have to look after their own finances?
The famous no bail-out clause. If only it were so simple. Of course, each country is still responsible for
its own economy and public finances. But in 2011 we learned the painful lesson that we cannot just
abandon struggling euro area countries to their own fate. This would unleash financial forces that could
bring about the disintegration of the euro. The economic and political havoc that would then arise is
literally incalculable. You just would not know how it would unravel. So that is something we would
definitely not want to happen. As long as the phenomenon of divergent growth exists, stronger
economies will occasionally have to step in to help weaker ones.
But it would be much better to tackle the root cause of this growth divergence. These differences between
north and south are not after all a God-given natural phenomenon. You might be wondering: why don't
these southern member states carry out reforms to make their economies as productive as in Germany
and the Netherlands? Yes, well, ultimately that is what has to happen. And it is also an uncomfortable
fact that in recent years many opportunities have been missed. Not only in terms of reforming the
economy, but also in terms of putting public finances in order and cleaning up bank balance sheets.
Building up buffers in good times, fixing the roof while the sun is shining. Yes, still the same old tune.
Yet people in the north who keep grumbling about this do have a point.
But you know, the Italians have a nice expression for that: se mia nonna avesse le ruote, sarebbe una
carriola. If my grandmother had wheels she'd be a wheelbarrow. But now we all have a new crisis to
contend with, the coronavirus crisis. And what is particularly cruel about this crisis-and I might add
hazardous for Europe-is that it is precisely the countries in the euro area with the most vulnerable
economies that have now also been hit hardest by the virus. That of course has nothing to do with the
euro. But it does mean those countries are being hit hard yet again. Like the Netherlands, they, too, will
have to intervene decisively to mitigate the effects of the coronavirus on citizens and businesses.
Consequently, their government debt will rise further. And they were not in a financially strong position
to begin with. As a result, there is a risk that governments in these countries already have to start
introducing austerity measures before the economy has been able to recover. That would in the first
instance further exacerbate the economic downturn. Take a country like Greece. At the end of 2019,
Greece's public debt was already 175% of its GDP. Greece is the red bar all the way to the left of this
chart. [Figure 4]
Figure 4: Wide divergence of public debt in euro area countries
Greece is not able to support its economy in the same way as the Netherlands. Just for comparison:
175% amounts to more than three times the Dutch public debt.
So if we do nothing, we will see further divergence between euro area countries. And the risk of recurring
euro area crises. But there is something else that also worries me in this respect. And that is waning
public support for the euro as a result of this growth divergence. Public support for the euro among euro
area citizens remains high. That is good news. But can we take it for granted that it will stay that way?
Southern Europe reaps relatively little benefit from the euro. And in northern Europe, people often feel
they are being called on to bail out their Mediterranean partners time and again. Structural transfers of
wealth generally spoil the atmosphere. Not only for the providers-but uncomfortable feelings of
inferiority can quickly arise among receivers. You can even observe this in countries where wealth is
transferred between regions. Take Belgium and Italy for example. If we also doubt the work ethic of the
Italians, a country where the average worker works almost 300 hours more per year than in the
Netherlands, you can imagine that this does not benefit relations. [Figure 5]
Figure 5: Cover Elsevier Magazine
I would like to stay on this subject of public support, because there is another potentially dangerous
trend I detect in northern Europe. And that is the lagging public support for free trade in general. There
is for instance a growing group of Europeans who believe that globalisation has been good for their
country as a whole, but not for them personally. We can see similar developments in our own country.
For example, more than one in five Dutch people think globalisation offers more disadvantages than
advantages. People on lower incomes in particular feel they are on the receiving end of the
disadvantages. Unfortunately, there is some truth in that. Dutch businesses have benefited greatly from
free trade, the single market and the euro. For Dutch households, this applies to a lesser extent.
In recent decades, household disposable income growth has not kept pace with growth in the economy
as a whole. Just take a look at this graph. [Figure 6]
Figure 6: Household income grows at a slower rate than the economy
The red line represents the growth of the Dutch economy as a whole since 1995. The blue line shows
the available income of households. Why are these two lines growing apart from each other? Well, to a
large extent it is because the share of our national income that workers receive (the labour share of
income) has been steadily declining, while the share going to providers of capital has increased.
Incidentally, this is not a typically Dutch phenomenon. We can also observe this trend in other Western
economies.
The fact that workers in the Netherlands are getting a smaller and smaller piece of the economic pie is
also due to globalisation and technological progress. But there is something else going on in the
Netherlands. And that is the flexibilisation of the labour market, which has gone too far. That is
something that all sides can agree on. The often vulnerable position of flex workers is already a cause
for concern from a social perspective. But on top of that-and now I return to my argument about
Europe-it has also contributed to the fact that working people are getting an increasingly smaller piece
of the economic pie. And if a large proportion of them start to see "Europe" first and foremost as a
private party for businessmen, with scant benefits for their own pockets, then that will undermine
support for the European project.
Good. To sum up what I have said so far. The euro is a pillar of the single market, and brings us
considerable prosperity. However, the euro also tends to lead to diverging economic growth within
Europe. The current coronavirus crisis exacerbates this phenomenon. If we do nothing, then we run the
risk of ending up in a new euro area crisis, and public support for European integration could come under
pressure. In the weaker economies of southern Europe, because they do not reap enough of the benefits.
And in the stronger economies such as the Netherlands, due to uneven distribution of benefits, and with
it the willingness to help out southern European states.
I think that is what we in the Netherlands should be worried about. Not only based on our own clear
economic self-interests, but also because Europe is about so much more than the financial benefits. We
see that the balances of power on the world stage are shifting. One superpower retreats into confusion,
while new superpowers emerge. Unfortunately, these are not always countries which share the values
we do. For many refugees, Europe is that beacon of freedom, peace and prosperity for which they are
prepared to risk their lives. A sign of our strength, and at the same time a challenge for European society.
And then there is still the climate crisis. If we want to realise our ambition to limit global warming to
less than 2 degrees Celsius, then we will have to complete the transition to a climate-neutral economy
by around 2050. Substantial investments are required to achieve that. Investments that will get off the
ground much more easily if we increase the price of emitting carbon and other greenhouse gases. In
short, how are we going to make sure we emerge from this economic crisis in a more sustainable way?
The shifting balances of power, the refugee crisis, the climate crisis. You don't have to be a Europhile to
know that we can tackle these transnational challenges better at European level than at national level.
These challenges call for European cooperation within a strong European Union. And this is inextricably
linked to strengthening the foundations of our currency union. This is perfectly possible. The
imperfections in the Economic and Monetary Union I outlined earlier are not like the coronavirus, which
hit us out of nowhere. We created them ourselves. And that means we can also fix them ourselves, if
we want to.
But there are three things we need to do for that to happen. The first is to fight this coronavirus crisis
collectively and effectively. European heads of state did an excellent job this summer by creating the
Next Generation Recovery Fund. The second is that the countries in the currency union should better
coordinate their fiscal policies, with the level of public debt playing a more central role. And the third is
that we also need to better coordinate other areas of our economic policy. Now let me take you through
how I envisage this.
Emerging stronger from the crisis: an agenda
This summer, European leaders wasted no time in setting up a European recovery fund. Their decision
was an important step in the fight against the coronavirus crisis. During the public debate, comparisons
were made with the Marshall Plan, the US aid programme to help rebuild post-war Europe. I think it is
a very apt comparison. The elements that made the Marshall plan a success are reflected in the plan for
a European recovery. The recovery fund is not emergency aid but is intended to support public
investments in countries that strengthen economic growth potential. The receiving countries retain an
important degree of responsibility for how the money is spent, within certain set conditions. The financing
has been structured in such a way as to ensure southern European countries do not accumulate ever
more debt. And the fund is big enough to really make a difference.
It is also good that priority is given to investments in digitisation and making the economy
climateneutral. That way we can kill two birds with one stone: we narrow the gap between those leading the
way and those lagging behind, and we invest in the sustainable growth capacity of the euro area.
The strength of this proposal lies not only in its collective, but also in its temporary nature. Structural
transfers from one country to another can quickly lead to bad feeling, as we have seen elsewhere.
That is not the case with the recovery fund. The fund is temporary, there are no direct transfers between
countries, nor do countries assume responsibility for each other's debts.
The recovery fund is therefore an excellent initiative. But that it is not enough, which brings me to the
second item on my list. If we want to put an end to divergent growth in Europe we will also have to
coordinate fiscal policy more closely. In recent years, European fiscal rules have been particularly focused
on the maximum budget deficit, the well-known 3% of gross domestic product. But as a result, in practice
the rules proved to be strict during bad times, and ineffective during the good times. Thus accentuating
the peaks and troughs of our economy, instead of smoothing them. Moreover, there was scant attention
for the differences between countries. For example, after the financial crisis of 2008, any country with
an excessive deficit had to consolidate its public finances roughly all at the same pace, regardless of the
level of public debt at the outset.
There is one lesson I think we can take from this: we need to pay more attention to public debt levels.
The Maastricht Treaty sets a public debt limit of 60% of GDP, although there is some flexibility.
You can exceed this threshold, as long as you bring public debt back down to the 60% reference value.
This limit must regain its prominence. It is a recognisable benchmark, and allows countries the room to
temporarily increase their debt during economic downturns. However, the pace at which countries are
required to return to below this limit needs to vary more than it does now, taking their individual
economic situation into account. In economically more favourable times, countries with higher
government debt levels should have to make greater efforts to reduce their debt than countries with
lower debt levels.This does more justice to differences in starting positions, and the European economy
will also benefit if all countries do not tighten their fiscal reins at the same time.
In addition to restoring the 60% limit, I believe that in reducing public debt, we should put more
emphasis on reforms that promote economic growth. Rather than the austerity measures that often
constrain growth in the first instance. Without robust growth, it is simply very difficult for countries with
high levels of public debt to bring their debt back to a healthy level in relation to the size of the economy.
We have seen that.
If austerity is unavoidable, fiscal rules should at least protect public investment. This investment, for
example in infrastructure, sustainable energy, education and science, has all too often fallen victim to
austerity measures. Heavily indebted countries have seen the erosion of their economic growth potential
due to chronic under-investment. As a result, they are left lagging even further behind.
If we take another look at the Netherlands, what does this mean for Dutch fiscal policy in the forthcoming
term of government? Dutch public debt is expected to increase from around 50% to 60% of GDP in the
coming years. This is a sharp increase, but thanks to our comfortable starting position, we will end up
at a level that is still manageable. That is why I see no reason to cut spending or raise taxes at this time.
After all, our economic recovery could still be fragile in 2021.
What we do need to do now is strengthen the growth potential of the Dutch economy with structural
reforms and temporary, targeted investments. This is not of course a plea for unbridled growth in
government spending. After all, there will always be new, unexpected setbacks. So I think it is wise to
be wary of new policy initiatives that place a structural burden on government finances.
This addresses fiscal policy in Europe and in the Netherlands. The third point on my European to-do list
for tackling growth imbalances is to improve coordination in other areas of economic policy. I have
already talked about the divergent competitiveness of the euro area member states. And how this
contributes to large trade surpluses in some countries, and large trade deficits in others. To effectively
tackle this problem, all member states must play their part. Weaker economies need to implement
reforms that increase their productivity and competitiveness. This is good for exports, for economic
growth, for employment, and for public debt. The point I want to make here is that these reforms are
more likely to succeed if the stronger economies also do their fair share. For these countries, that means
implementing reforms that give households more room to spend, so that they can boost imports and
reduce their trade surpluses. This will not only help the weaker economies, but also benefit the stronger
ones. Behind large and persistent trade surpluses, there are often underlying problems, such as savings
retained by companies for tax reasons, or stagnant wage growth.
If I apply that to the Netherlands for a moment, it means we also have work to do. It means we have
to critically review our tax system, so that labour can be taxed less heavily and workers get to retain
more of their pay. And we need to tackle the imbalances in the labour market between permanent and
flex workers, by reducing tax differences between contractual employees and the self-employed. As far
as I am concerned, these are the key challenges for the coming term of the government.
Summing up, I have talked to you about the recovery fund, and the coordination of fiscal and other
economic policies. So, have we covered everything, then? No, not entirely. There is still something else
to discuss. The recovery fund that the European heads of state agreed on is a one-off and temporary
solution. As I said before, I think that its strength lies precisely in the fact that it is one-off and temporary,
and I mean it. After all, it is the euro area countries themselves who have primary responsibility for
ensuring and maintaining a healthy economy, and consequently for the reforms and investments needed
to achieve that. Northern euro area countries need to reform to bring about higher wage growth and
domestic demand. Southern euro area countries need to reform to become more competitive and reduce
their debt burden.
But let's be realistic: this will take time. Even with the right policies in place, countries such as Greece
and Italy will most likely need decades to get to where they need to be. In the coming years their levels
of public debt will still be too high to weather another recession without taking far-reaching austerity
measures, especially if it involves a deep euro area-wide recession. They will have to go to great lengths
to maintain public investment under these circumstances. Foreign investors will not be thrilled by the
prospect of a structurally higher tax burden. This means there is a risk that these countries could fall
further behind again. Which would again overshadow our objective of creating a stronger monetary
union.
So, we will have to find a way to deal with these situations. To be quite honest, I don't know what the
best course of action is. While the recovery fund sets a relevant precedent, we have already established
that structural transfers can leave a sour taste in the mouth. Another option is to allow debt restructuring
within the monetary union. This means a country meets with its main creditors, such as the banks, to
discuss how to reduce its debt position without jeopardising its euro membership. However, this option
is not without significant obstacles either - especially since a major proportion of this debt is still
concentrated with local banks. Public debt write-downs would lead to significant losses for these local
banks and possibly also trigger capital flight, and consequently still jeopardise the country's euro
membership. This is roughly the scenario that played out in Greece. So both options⁠-a permanent fund
as well as debt restructuring⁠-have their own, serious impediments. As long as the issue of divergent
growth is not resolved, the strongest shoulders in the European caravan will from time to time have to
bear a heavier load to ensure no-one gets left behind. This will require a great deal of serious thinking
in the years ahead.
All in all, I believe the agenda I have outlined would put us on the way to a stronger currency union.
With European governments investing in sustainable growth, both individually and working together.
Through more closely aligned economic policy.
Alignment implies reciprocity, and a fair division of rights and responsibilities. For us, here in the
Netherlands, it would mean having to relinquish a degree of our national autonomy. I realise that is a
difficult step to take. No country is prepared to give up part of its sovereignty lightly. It takes courage.
And what will we get in return? The prospect of a more stable and prosperous monetary union, in whi