Ernst Welteke: On the eve of EU enlargement
Speech by Mr Ernst Welteke, President of the Deutsche Bundesbank, at Danmarks Nationalbank,
Copenhagen, 29 October 2001.
* * *
I
Ladies and Gentlemen
It is a pleasure for me to have the opportunity today to present some of my views here at Danmarks
Nationalbanken. Thank you very much for your warm welcome.
I have been fortunate to have had the opportunity yesterday to get around a little in Copenhagen and
in the northern part of Sealand. Time and again I note and appreciate the friendly atmosphere that
exists in Denmark.
And time and again, as a European, I experience a real sense of regret that Denmark will not be one
of the countries to make full use of the common European currency from 1 January 2002. Well, I hope
you will acquire a taste for the euro later on.
In terms of economics, there are three things that relate Germany and Denmark to each other.
Denmark's most important trading partner is Germany. Denmark's coasts and islands are a favourite
destination for German tourists. And, of course, Denmark and Germany have a strong common
interest in the upcoming eastward enlargement of the EU. That brings me to why I am here today - to
discuss this vital topic with you.
II
Unfortunately, no discussion of economic issues can take place today without due consideration being
given to the devastating terrorist attacks on New York and Washington.
When the attacks were launched on the United States of America on 11 September, the world
economy had already weakened significantly. For the first time since the mid-seventies oil crisis, the
G-7 countries are slowing in step, although the nature of the slowing is country-specific. As a result,
world trade growth is down to two percent after growth of 12 percent in 2000 [due to a WTO estimate].
The economy in the United States had been slowing down sharply, led by lower investment spending
following the IT-investment boom. Via the link to external demand, shrinking US investment
expenditure had a negative impact on emerging markets in south-east Asia. Japan has not yet
emerged from its decade-long slump. The banking crisis in the 1990s and unresolved structural
problems still weigh heavily on the Japanese economy.
The world economy today finds itself in a state of heightened uncertainty. The events in New York and
Washington have undermined the confidence of both businesses and consumers. The extent and the
duration of the military encounter as well as the extent of the anthrax incidents will determine the level
of confidence among consumers and businesses in the coming months.
Part of the current uncertainty lies in the fact that indicators refer to the period before the watershed
date 11 September. This portion of uncertainty will recede as ever more figures cover the post-attack
period.
In the euro area, economic growth is currently significantly below potential. The economy grew by only
half a per cent in the first quarter and stagnated in the second quarter. Business and consumer
confidence had been falling even before 11 September and the reduction in unemployment has come
to a halt at 8.3 percent. The return to the presumed potential growth path of 21⁄2 percent a year will be
delayed.
There are, however, a couple of reasons to remain optimistic for the economic prospects of the euro
area in the medium term. The expansionary effects of this year's interest rate cuts are still in the
pipeline. It takes some quarters for interest rate measures to start affecting the real economy. In
addition, low real interest rates make for favourable financing conditions throughout the euro area.
Increased use of information and communication technology will bolster potential growth. In this
respect, the euro area is in a rather favourable position. A major portion of potential productivity gains
of IT investment are yet to be realised. Heavy overinvestment in IT had been avoided in the euro area.
Definitely good news is on the price front. Inflation in the euro area has been falling since reaching its
peak in May [3.4%]. In September, consumer prices were 2.5 percent higher than in the previous year
[August 2.8%]. Early indicators such as producer prices and the prospected German inflation rate in
October [2.0%] point to a further fall in inflation in the near future.
Monetary policymakers in the Eurosystem have lowered official interest rates during the course of this
year by 100 basis points, acknowledging lower price pressure over the medium term. The
Eurosystem's monetary policy measures are tailored to the medium-term outlook for price stability. If,
in the Governing Council of the ECB, we see the possibility of reducing interest rates further without
compromising price stability, we will do so.
For fiscal policy, it is of the utmost importance that the current situation be assessed in a realistic
manner and that the instruments available are applied carefully. Activism and excessive zeal are
perfectly understandable - but detrimental. The appropriate stance for fiscal policy now is to make use
of built-in stabilisers. There is no room for extra spending programmes in the euro area, as these
would clearly compromise consolidation efforts. Furthermore, it is plainly impossible to ensure that
additional spending is timed precisely to meet the economies' needs. An extra budget may even turn
out to have a procyclical effect.
There is, however, room for structural reforms in the euro area. Higher flexibility of labour and product
markets can, first, bolster confidence in the euro area. It will, second, enable the euro area to even
better cope with external shocks.
Economic and financial links bring economic weaknesses in other parts of the world to our doorstep
faster now than ever. The euro area, however, is well equipped to weather many a storm. In its brief
history, the Eurosystem, has already dealt with three external shocks and crises. The keywords are
"the Asian crisis", "the oil price shock" and now "terror". That means that we have withstood what has
been regarded as the worst case scenario for the new currency.
Looking back on three years of European monetary union we can therefore safely say that in the
Eurosystem we have coped with various forms of stress. Our success is founded on the common
stability orientation. The Eurosystem is obliged by the EC Treaty to maintain price stability. Fiscal
policy is committed to sound public finances by means of the Stability and Growth Pact. Productivity
growth is now usually taken into account when wage agreements are negotiated.
A generally stable currency and markets that trust the stability-orientation of central banks make for
lower price increases in times of crises. They also anchor inflation expectations at low levels .The
greater currency area is able to cushion external shocks. Now, with a common currency, Europe is
taking a more important place in the world arena and will therefore be able to assume a position of
greater responsibility.
III
Ladies and Gentlemen,
The attacks on New York and Washington coincide with the intensifying of a debate about the
opportunities and threats of globalisation. Both issues are linked to some extent. Both lead to the
conclusion that isolationism is not a workable concept in today's world.
Therefore, a need arises for us all to get involved in the debate. A broad based appreciation of the
world economic order coupled with the prospect of prosperity for developing countries will cut the
ground from under the terrorists' feet in the long run.
One of the answers to the questions posed by recent events is to expand international trade. The
World Trade Organisation - the WTO - is crucial in this respect. At its meeting in the state of Qatar in
November, the Ministerial Conference will formally confirm China's admission to the WTO. One billion
more people will then benefit by trade liberalisation.
A new round of world trade negotiations must not fail again. In the current situation, it would be wrong
to restrict openness. Quite the reverse - the opening of the world's economies must be speeded up.
Empirical research1 confirms that if the degree of an economy's openness - measured by trade
volume as a percentage of GDP - rises by one percentage point, GDP per capita rises by two
percentage points. Clearly, this is only a rule of thumb, but these gains would represent nearly one
trillion of additional world GDP annually. That equals about one-tenth of the US economy.
Developing countries derive exceptional benefit from free trade. If international trade were liberalised
completely, they could see an increase of three percent in their annual GDP or - more impressive -
three times the foreign aid they receive annually. Even if this figures exaggerated the effects, let's not
forego that globalisation dividend!
Higher trade volumes and, of course, inward direct investment provide opportunities to participate in
prosperity. Thirty years ago, for example, South Korea, was as poor as Ghana. Thanks to
industrialisation, to high internal savings and to its integration into the world economy, it is now as rich
as Portugal. Globalisation is not a zero-sum game. It is to the benefit of all people. Therefore the
advanced countries must avoid trying to protect certain industries. Isolationism is clearly not a
promising alternative.
Balancing interests internationally cannot stop at world trade. As the emerging markets' share in the
world economy increases, they need to be integrated into the institutional arrangements of the world
economy. In 1996 the Bank for International Settlement admitted emerging markets such as South
Korea, China and Russia. Emerging markets play a key role in heightening the acceptance of the
world economic order.
As a dedicated European, I would like to see Europe playing a mediating role. Europe does not seem
to be a superpower destined to attract admiration or envy. Europe is therefore virtually predestined to
be a mediator in balancing interests in the world.
Today, looking after national interests is done less and less effectively at the national level. After the
terrorist attack, this has become obvious for a whole host of policies. Domestic and foreign policy are
no longer separate issues. A transnational approach is now called for. Again, isolationism is no longer
an option.
In Europe, we have already gone a long way towards this new approach. Monetary policy currently
completes this process. Monetary policy in the euro area is denationalised.
In Europe we will go further along this path as we advance towards EU enlargement.
IV
In June, the European summit in Gothenburg proclaimed the accession process "irreversible". It is
envisaged that negotiations with the first group of countries will be complete as early as the end of
next year. We can truly say that we are on the eve of the eastward enlargement of the EU.
Fifty years after the signing of the Treaty of Paris, the European Union is more attractive than ever. It
is a success. The entire history of the European Union is one of enlargements. In a first sweep the
Union extended northwards - Denmark, Ireland and the United Kingdom joined the "club" in 1973.
During the 1980s Greece and then Portugal and Spain became new member states - in what was
known as the southern enlargement. In 1995 the accession of Austria, Finland and Sweden rounded
off the picture.
The EU has some experience of enlargement already. In principle, therefore, any upcoming
enlargement should be no big deal. In practice, however, it is a big deal. The eastern enlargement is
special; indeed it is unique for three reasons.
(1) Most of the accession countries are still working on their transition. Former communist states
have become democracies, state-led economies are being transformed into market-led
economies. This is a demanding process. For the people that are now reaching out towards
the EU many things have already taken a turn for the better. Joining the European Union and
one day becoming full members of European monetary union are the logical steps on a path
to freedom, stability and prosperity.
(2) The upcoming enlargement is also special in terms of its scope. Negotiations are currently
being held with 12 countries. Once they have all joined the EU, the number of member
1
Frankel, Jeffrey and David Romer (1999). "Does Trade cause Growth?" In: American Economic Review 89(3), p 379-399.
states will have nearly doubled. The EU institutions need to be reshaped if they are to be
appropriate to the larger community. The upcoming enlargement is, therefore, an opportunity
to improve the functioning, the transparency and thus the acceptance of the European
Union.
(3) A further challenge is presented by the substantial heterogeneity which exists between the
EU and the group of accession countries. The people in the twelve accession countries will
increase the EU population by roughly one-third. Nominal GDP, however, would rise by five
percent only. The wealth gap between the current member states and the accession
countries is larger than that between the countries involved in the earlier enlargements. In
addition, there is a striking degree of heterogeneity among the accession countries
themselves. GDP per capita ranges from 24 percent (Bulgaria) to 82 percent (Cyprus) of the
EU average.
Contemplation of EU enlargement always provides an opportunity to review the benefits of integration.
Integration is most clearly visible in monetary policy. The single monetary policy is designed for the
euro area as a whole. Sharing a stable currency has become a hallmark of European economic
integration. Some two months ago details of the new banknotes and their safety features were
presented to the public. We are now halfway through the frontloading phase of distributing the new
currency. Intensive information campaigns are being conducted. Monetary integration is thus taking on
shape and meaning for the man and woman in the street.
The single monetary policy - even during the run-up to EMU - has provided many countries with an
unprecedented degree of price stability. Trade has intensified and financial markets in Europe are
integrating fast. Businesses, consumers and investors alike are seeing the benefits.
And even more is to be gained. Three countries are currently "member states with a derogation"
(Article 122 of the Treaty). This basically means that they do not yet participate in European Monetary
Union, implying that there is still some scope for enlargement within the EU as it is at present. The
single currency is the consequent development of the common market. The status of "member state
with a derogation" is designed to be an intermediate stage on the path to full EMU membership.
V
EU accession is basically a political process that passes through three stages. Accession partnerships
prepare accession to the EU which will culminate in full EMU membership. EU accession is conditional
on the fulfilment of the "Copenhagen criteria". These encompass,
first, "the stability of institutions guaranteeing democracy, the rule of law, human rights, and
the respect for a protection of minorities" - the political criterion;
second, "the existence of a functioning market economy as well as the capacity to cope with
competitive pressure and market forces within the EU"; and
third, "the ability to take the obligations of membership, including adherence to the aims of
political unification, as well as Economic and Monetary Union (EMU)".
The Copenhagen criteria define the common ground of the future European Union.
Integrating countries is, however, about far more than simply defining common ground. Economic
integration is crucial, as the very stability of the large monetary union hinges on economic cohesion. A
monetary union can only be stable over the longer term if - as the Treaty states in Article 121 - "a high
degree of sustainable convergence" is achieved. I would like to present my view of what a "high
degree of sustainable convergence" is.
"Sustainable convergence" encompasses all three types of convergence: nominal convergence, real
convergence and structural convergence. Each type is important in its own right.
The Maastricht "convergence criteria" are set out to measure nominal convergence. These fiscal and
monetary criteria relate to the inflation rate, capital-market interest rates, sustainable fiscal policy and
exchange-rate stability. They are, in a way, both "stability criteria" and "convergence criteria". They
ensure that a country is not pursuing policies which might have an adverse effect on the stability of the
common currency.
Anti-inflationary monetary policy is at the core of a stability-oriented policy. In most of the accession
countries the process of disinflation is well under way. Hyperinflation is an issue of the past. This year
all accession countries (with the exception of Romania2), have one-digit inflation rates. Expected
outcomes range from 1.3 percent (Lithuania) to 8.5 percent (Hungary and Bulgaria3).
Weighted average CPI inflation in the 12 accession countries has been going down since 1999 at a
rate of about two percentage points a year and will be slightly more than 8 percent this year. An
average inflation rate of 8 percent a year is still four times higher than price stability as defined by the
Eurosystem. Disinflation policies will have to be pursued further.
The so-called Balassa-Samuelson effect has been given much attention recently. According to this
theory, countries are expected to have to deal with relatively higher inflation rates during the process
of catching up. As they experience high productivity growth in the tradeables sector, wages in the
non-tradeables will tend to go up in sync, leading to a higher overall rate of inflation.
This effect, however, does not suggest the Maastricht criteria to be revised. The inflation criterion
already allows for inflation to diverge by 1.5 percentage points from the three best performing
members of the currency union. Nor does the Balassa-Samuelson effect suggest to loosen the two
percent ceiling for price-stability in the euro area, which leaves enough room for price increases due to
catching up.
Sustainable convergence in inflation rates is crucial. Inflation rates can be kept at a sufficiently low
level only if other policies comply with the stability orientation. Prudent wage policies will contribute to
containing overall price developments. Structural policy also has a role to play. Currently, 25 percent
of prices in accession countries are still administrated. Microeconomic reforms and further price
deregulation have to be carried out. Only then can the price mechanism fully work through to the
economy - a defining feature of a fully functioning market economy.
Fiscal policy is of special importance in this respect. Excessive deficits are to be avoided. The public
sector deficit is the decisive measure of a government's demands on the financial markets. It is the
benchmark for its stability orientation. Last year general government deficits among the accession
countries ranged from 0.4 percent of GDP (in Estonia) to 7.1 percent of GDP (in Malta). Eight of the
accession countries had not yet met the Maastricht budgetary criterion. However, the debt criterion
- public debt less than 60 percent of GDP - was met by a broad majority of the accession countries.
There are still a few years in which to pursue convergence and to prove its sustainability. Nominal
convergence is not a goal to be reached at a certain point in time; it is, rather, the natural and
sustainable state of a stable currency union.
Apart from nominal convergence, real convergence is of importance in a monetary union. I use the
term here in the sense of synchronicity of business cycles. The Governing Council of the European
Central Bank designs monetary policy appropriate to the euro area as a whole. A country whose
business cycle gets grossly out of step might suffer if it is subject to a monetary policy that is
inappropriate to its national economy.
However, marching in absolute lockstep is not necessary, as can be seen in the USA, where certain
regions grow faster than others. Growth rates of states and regions within a currency union may differ
to some degree. It is the size of the gap between actual and potential growth rates which matters. If
potential output growth rates differ, actual growth rates can differ as well. They do not necessarily
indicate a lack of real convergence.
VI
In the longer run, stability must be built on economic integration. An extensive body of theory has
evolved on the characteristics of optimum currency areas. Most important is, that prices and wages
must be able to adjust flexibly. Mobility of goods, labour and capital shall provide for market
integration. Therefore central criteria call for a high degree of structural convergence.
We have to distinguish between different types of structural differences. Most critical are structural
differences that may hamper market integration. These structural differences we must work to abolish
as they may hamper the functioning of the monetary union. For example, differing regulatory
frameworks may prevent financial markets from integrating.
2
Romania has already indicated that it would prefer accession to take place after 2004.
3
Bulgaria also prefers a later accession date; IMF data.
However, there are two other types of structural differences which are not in themselves a problem for
a monetary union.
First, there are diverse structures of production and consumption. Countries specialising in
different areas will tend to exchange goods and services. Complementarity of economic
structures entails market integration and is in no way detrimental for a monetary union.
Second, there are structural differences that help us to cross-check the sustainability of
nominal and real convergence. The Treaty explicitly quotes the state and development of the
balance of payments and unit labour costs.
Again, structural differences which hamper market integration have to be removed. The degree of
market integration is crucial in assessing EU enlargement. Much has been achieved in terms of
market integration between the 15 EU member states and the accession countries since the iron
curtain was lifted in 1989. Bilateral "Europe Agreements" with the EU paved the way for future
integration.
Early on, reciprocal free trade in industrial products was complemented by steps towards the free
movement of services and capital. The EU is by far the most important trading partner of the
accession countries. Around 65 percent of their exports are destined for one of the 15 EU member
states. A slightly lesser share of their imports originates in the EU. EU imports from the accession
countries grew at an annual rate of 12 percent between 1989 and 1999. If they continue at that pace,
they will double every six years.
We can see clearly why trade has presented opportunities for both trading partners. The EU has
specialised in advanced technological products. The transition countries import these investment
goods in order to revamp their economy. They have shifted their exports from resource-intensive
goods towards labour-intensive goods, thereby utilising their comparative advantage.
The complementarity of production structures allows specialisation gains to be exploited and the
international division of labour leaves everybody better off. At 50 percent, the share of intermediate
goods in accession countries' trade - exports as well as imports - is rather high. This indicates how
well the newcomers have already been integrated into international production chains.
With the early liberalisation of capital, market integration has been furthered to a considerable extent
by foreign direct investment (FDI). During the 1990s some two-thirds of capital inflows in the accession
countries originated from the European Union. Again, the neighbouring states Austria and Germany
have been the most actively involved.
Labour markets are a lot less integrated internationally than goods and capital markets. Freedom of
movement is one of the "four basic freedoms" of the single market in the European Union. Labour
mobility within the EU - that is, both migration and cross-border working in border regions - is possibly
the most sensitive issue in the current debate on EU enlargement. At least this is true of Germany and
Austria. Anxieties abound - and they need to be taken seriously.
Economic integration can only take place if the four basic freedoms are granted. There is neither a
way nor a need to exempt the labour market. Only then can we make full use of the market
mechanisms. Moreover, a meaningful judgement of achieved convergence requires all four basic
freedoms to be granted.
How much migration and cross-border working is to be expected? At the moment labour mobility is
strictly regulated. Emigration from central and eastern European countries into the European Union
peaked in 1990. Afterwards, when things improved in those countries, net emigration receded.
Emigration became more costly than staying at home. No serious study predicts that EU enlargement
will lead to extended migration. As long as the accession process is being pursued seriously, the
potential for intensified migration looks rather limited. This was also the experience at the time of the
southern enlargement.
The financial sector in accession countries still has some way to go. The banking sector in general is
still tiny, highly concentrated and foreign-owned. Total banking assets in the EU are more than twice
GDP. Of the transition countries, only the Czech Republic has total banking assets the size of its GDP.
In all the other transitional economies involved in the enlargement process, the corresponding figure is
only one-half. It is foremost the private sector that suffers from the low degree of financial
intermediation.
Capital account liberalisation is a precondition for financial integration. However, fully liberalised
capital flows entail certain risks for stability as long as the financial sector is still underdeveloped. We
should allow sufficient time for financial integration between the accession countries and the EU to
take place in order not to destabilise vulnerable financial sectors in the European emerging markets.
VII
Ladies and Gentlemen!
We are on the eve of enlarging the European Union eastward. Much has been attained so far - as
regards the transition to fully-functioning market economies, in terms of macroeconomic stability, and
in terms of prosperity.
However, the process of political, economic and financial change is still far from complete. To become
full members of European monetary union requires accession countries to be fully-functioning market
economies with a clearly defined stability orientation.
I am strongly in favour of EU enlargement. I am strictly against setting up new hurdles. I am also
strongly opposed to the slightest compromise of the long-term prospects for a stable European
monetary union. It is in our own best interest and in the best interest of the accession countries for
nominal and structural convergence to be fully achieved before EMU is enlarged.
Warsaw, Prague and Budapest are essentially European capitals. A European Union is incomplete
without the central eastern European countries.
With the eastern enlargement, things will come full circle in Europe. Mutual understanding of the
people is bound to deepen, as relations grow ever closer in a union sharing basic convictions. A free
and democratic enlarged European Union is a reliable and a stable partner in the world economy - in
times of strain or prosperity.