Managing dangerous imbalances in the global economy

Managing crisis exit strategies in Europe

1. Introduction: Global imbalances

I am particularly delighted to participate to this panel on global imbalances.

For many years now the EU has been vocal on the need to address global imbalances and thus prevent that they unwind abruptly and send ripples across the global economy.: For example:

• We were strong supporters of the IMF initiative in 2005 to invite the main parties concerned US, China, Japan, Saudi Arabia for the oil producing countries and the euro area to have a common assessment and agree on what each party had to do to. This initiative was known as the Multilateral Consultation on Global Imbalances.

• The recommendations reached were clear and remain valid. They were that:
o the US should increase national savings,
o China should rebalance growth towards domestic demand.
o The euro area, though being broadly balanced, and hence not part of the problem, could be part of the solution with policies to increase growth and thus add to global demand.

• Europe and China started to take measures, although probably not at sufficient speed. On the US side, however, it has taken the crisis to reduce the unsustainable level of domestic consumption. The announced intention of the current administration to change the US growth model to rely more on exports sounds promising.

The crisis has temporarily mitigated global current account imbalances. But it has made fiscal imbalances more acute both in the US and in Europe. That is why exit strategies must be at the centre of the discussion.

I will thus concentrate my comments on the exit strategy of the EU and talk about the case of Greece and the current discussion about the euro area.

2. The EU’s response to the crisis

The EU’s response to the downturn has been swift and decisive. It has encompassed monetary and fiscal stimulus, and measures aimed at ensuring the stability of the financial sector).

Regarding the fiscal stimulus, the measures adopted in the EU as well as the effects of automatic stabilisers amount to about 5% of EU GDP in 2009 and 2010.

The European Economic Recovery Plan provided a commonly agreed framework under which national governments could coordinate their fiscal response to the crisis, taking into account that countries differed in terms of their pre-crisis situation and the degree of fiscal space to implement measures.

Measures agreed were broadly intended to yield quick effects, be temporary, and consistent with the objective of increasing growth potential.

In Europe like in the US and other parts of the world the stimulus must be eventually withdrawn.

Europe is working it the direction of designing and where necessary starting the implementation of exit strategies. This is proving to be the right approach, because:
• the fiscal deficits resulting from the stimulus comes on top of significant pre-crisis debt levels in some countries
• markets, that till now were insensitive to debt and divergences among countries, are suddenly uneasy about the sustainability of current debt levels in some countries.

3. the EU exit strategy : some general principles and orientations

• For most countries, actual withdrawal may wait until the recovery is firmly established

• Countries face different circumstances, and must tailor their exit strategies appropriately. Overall the EU should move in the implementation of exit strategies in 2011.

• The two main objectives must be:

o Sustaining recovery
o Ensuring fiscal sustainability

• Of course, in the case of Greece the urgency of fiscal and other imbalances makes it necessarily to act boldly now .

• But even for those countries that can afford to still support demand an exit strategy must be designed and properly communicated.

• It is very important not to lose sight of the objective: exit strategy towards what? Towards long term sustainable growth and the green economy of the future

• Thus a successful exit strategy is holistic, takes into consideration all key challenges and links the short term challenges with the long term sustainable growth vision.

• Co-ordination is essential on the exit strategies as it was at the moment of the stimulus packages, both within the EU and globally.

• The G20, provides a useful framework in which exit strategies can be globally coordinated

Moving forward from the general principles to the more concrete contents of the exit strategy leads us directly to the issue of the current debate on fiscal challenges in Greece and the seriously exaggerated public debate that this may eventually lead to sovereign default, including in other euro area countries.

Of course, some commentators have predicted disaster at every step of the EU integration process, including both before and after the launch of the euro. They were proven wrong every time.

The current debate is often too narrow, and suffers from misunderstandings and misinterpretations about the EU and the Euro area and generally neglects at least two key aspects:
– the benefits of the euro and
– some key elements of the uniqueness of the EU directly relevant to this debate.

3.1. Reminding the obvious: The Euro has brought about huge benefits.

o To countries like GR, with a history of high public debt, high interest rates and inflation, the euro has improved access to capital, lowered the level of inflation and the volatility of both exchange and interest rates
o To countries like Germany with higher competitiveness and increased historical ability, it has further improved that competitiveness by offering privileged access to markets for their goods and services and reduced the tensions on the DM that used to be common during financial stress.
o To all participating countries macroeconomic stability and a single currency have greatly contributed to the creation of a more open and competitive internal market
o In the most recent crisis, the euro has clearly been an anchor of stability. Imagine for a moment, how the crisis could have unfolded without the euro. The coordination problems would have multiplied. 16 European central banks would have had to struggle for a coordinated liquidity provision while trying to keep exchange rates and inflation expectations in check, or engage in negotiations about currency swaps.
o This contributed greatly to the very good overall economic results for the EU, the last 10 years:
 GDP per capita increased roughly as in the US
 16 million new jobs were created in the EU, more than in the US in the same period and important structural reforms were implemented in most countries.
 The euro’s importance in the international markets and as reserve currency expanded beyond the weight of the legacy currencies it replaced

o Last but not least, the euro by contributing to a more coherent, more open and more stable Europe has bought benefits to our neighbours, to our partners around the world and to the global economy

o It is not by chance that
 countries within the euro want to continue reaping its benefits; and that,
 there is a waiting list of candidates to join.

3.2. Aspects of the uniqueness of the EU

Many people tend to compare the EU institutional setting with their own ones or other traditional or theoretical systems and to draw conclusions from comparisons that can be simplistic or irrelevant. But the EU and the Euro area are unique political and economic experiments. There are at least two aspects of this uniqueness that are directly relevant here:

i. The EU is not state. It is a Union of sovereign states and committed to remain so. Thus:
 Although it is natural to compare the EU constantly with a state, it does not make sense to expect the EU to act like what it is not.
 Each sovereign State must assume its part of the responsibility, for example in case of fiscal discipline, and that is why in fact solidarity can only be built on responsibility

ii. The EU approach has been since the beginning a gradual one. The whole European integration itself was built on a step-by-step logic and approach.
The founding fathers of the EU did not provide a definition of the arrival point or final form of the EU. They provided us a with method of integration based on
– solid steps reinforcing the process of integration
– a culture of learning quickly from experience, from both successes and errors
– becoming stronger through successfully facing crises and rising to the challenges

In this sense the Euro is still work in progress: much but not everything is sorted out in advance. Not all questions about the future can be answered today. Thus what is important is to properly evaluate the capacity of the EU:
– to react and adjust,
– to anticipate and manage the next step,
– to avoid the next crisis,
– to consolidate the gains and prepare the future.

4. Exit strategies in the EU : Rising to the challenge again

As I said already, the exit strategy depends on the situation of the country (deficits, debt levels, current account balances, competitiveness).

There an obvious short term challenge: the situation in Greece

The EU has responded in an appropriate way involving both responsibility and solidarity.

Hence the drastic program of deficit reduction amounting to 4% of GDP in 2010 and structural reforms prepared by the Greek government to regain fiscal sustainability and competitiveness.

On the basis of this responsible response and the commitment of the Greek government, the other Euro area Member states agreed at the summit of EU Heads of State and Government “to take determined and coordinated action, if needed, to safeguard financial stability in the euro area as a whole”.

EU Finance Ministers will meet again in March to monitor the situation and decide whether additional measures being taken by Greece to reduce its deficit are in line with what is deemed necessary.

Obviously, there are also longer term challenges: the Greek situation also put the spotlight on the longer term unfinished business in the euro area.

When the Commission conducted in 2008 a thorough assessment of the ten years of the euro (published in our Report on EMU@10), it concluded that there are still outstanding challenges related in particular to
• the accumulation of intra euro-area competitiveness imbalances;
• euro-area governance related mainly to the longer term fiscal sustainability

It was obvious from the beginning to all that a monetary area needs fiscal discipline and convergence in terms of the competitiveness of national economies.

First, governance: the crisis showed that the established mechanism of fiscal policy coordination within the euro area was not working sufficiently well.
Indeed, if fiscal discipline and co-ordination had started earlier and had been more comprehensive, fiscal imbalances would not have grown that far and some countries would be in better position in terms of fiscal sustainability. Co-ordination matters for the EU as a whole, but it is particularly important for euro-area Member States.

Second, competitiveness: Because of important macroeconomic imbalances accumulated over time, some euro-area countries have been hit particularly hard.
• One group of countries have been running very large and persistent current account deficits reflecting the strength of private domestic demand compounded by losses in price competitiveness due to an inappropriate response of wages to productivity growth. Countries with entrenched current account deficits should restore competitiveness.
• Conversely, other euro-area Member States have been running large current account surpluses. As the global economy seems to be rebalancing, this group of countries also face formidable adjustment needs in terms of strengthening domestic demand.

On those very important two counts, the economic crisis made obvious that the system in place needed improvements. Difficulties do not mean that it was irrelevant or that it profoundly failed. It rather means that it needs to be deepened and reinforced.

Here too we have learned from this crisis and we are reacting. Improvements to economic policy coordination are already under way:
– the Stability Pact known mainly for its 3% limit on public deficits (and threshold of 60% of GDP for the public debt) created in 1998, was revised in 2005. Flexibility was introduced concerning the target of 3% together with more requirements in terms of medium term objectives. For example, MS should take account of the economic cycle and reduce their deficits in a sustainable way. The Commission and Finance Ministers are working on further improved monitoring and surveillance mechanisms related to the Stability Pact.
– The scope of surveillance by the European Commission and of the peer review by Finance Ministers has been enlarged to competitiveness issues.
– The various planning and reporting instruments for the surveillance of fiscal and structural policies have been reviewed or are in the process of being reviewed to ensure consistency of exit strategies and pave the way for higher, sustainable growth. (There are many peer review processes: the Lisbon strategy review once a year, the ECOFIN provides broad economic policy guidelines on the basis of provisions of the Treaty and recommendations to MS, several reports on internal market completion, employment policies etc.)
Overall all the processes of monitoring and surveillance are in the process of being reinforced in a way that should make us individually and collectively more able to face the challenge of the time.

All Member States have also articulated exit strategies as parts of their stability and convergence programs (3 year rolling submitted annually) catered to their own situation and coordinated within the EU rules-based coordination framework.
For most countries, it is imperative to continue implementing the agreed stimulus measures in 2010 and start withdrawing them in 2011. While helpful in the short term, the unprecedented stimulus measures, in combination with automatic stabilisers and the sharp reversal of revenues, have led to a significant deterioration of public finances.

5. Exit towards sustainable, green growth

The exit strategies are oriented towards sustainable growth.

The “exit” means the entry into a different economy: we are aware that we will not return to the situation before the crisis. We must face up long-term realities – globalisation, pressure on resources, ageing, technological trends – and tap our full potential.

This is the basis of the new EUROPE 2020 reform agenda along three main axes:
(i) Improving productivity through knowledge and innovation

(ii) an inclusive high employment society: this means empowering people through high levels of employment, using flexicurity, modernising labour markets and social protection, and

(iii) tackling climate change, accelerating the roll-out of smart grids and genuine EU scale networks, modernising the EU’s industrial base, and turning the EU into a resource efficient economy.

For each of these, commonly agreed headline targets will be set reflecting where the EU wants to be by 2020. These targets will be then translated by Member States into national targets, taking account of their differing starting positions.

Conclusion

First, the EU, as challenges grow, is reinforcing its policy response. The crisis has provided the opportunity to gain new awareness of challenges and to put in place the necessary adjustments to correct them.

Thus the EU:
• has reacted up to now in an appropriate and proportional way to the short term Greek public debt difficulties
• is demonstrating a new focus as a result of the current challenges in addressing the longer term challenges of fiscal sustainability and convergence of competitiveness, within the unique EU institutional framework (which is a great asset)
• is working actively and advancing on the Exit strategies
• is addressing actively the root causes of long term sustainability of growth through its Europe 2020 work program that prepares the green economy of the future

Second, International cooperation is an indispensable requirement. The world needs to coordinate the exit strategies as it coordinated the reactions to the crisis and the stimulus packages. Issues like dealing with post-Copenhagen climate change or moving towards the green economy of the future require unprecedented international and multilateral coordination. I would add on the line of what Pascal Lamy said that sustainable growth globally is probably only possible if it is based on and supported by an advancing positive global agenda on trade and investment. Significant progress in the WTO DDA negotiations must be recognized as an urgent priority for all.

Third: underneath the challenges and the crisis there is opportunity. Crisis is a Greek word. The same is true for catharsis. Greece can enter into a new era of an economic policy focused on fiscal sustainability and increased competitiveness thus addressing the roots of the problem with the view of long term sustainability. Close monitoring and surveillance should be seen as the best form of assistance and the best expression of solidarity. The huge margins of structural improvements of the Greek economy have to be seen positively in that context.
The same sense of opportunity underneath the crisis is true for the rest of the EU. Current difficulties are obviously helping the EU to focus better on the elements of the long term both fiscal and growth sustainability.

Thus, and this is my fourth and last point, Europe from the point of view of global imbalances will continue to be a stabilising factor and it will continue to lead the global adjustment including on issues related to climate change and environmental imbalances. Europe does face the challenge of improving its growth capacity and thus contribute further to the solution of global imbalances. Long term sustainable growth is now the top priority of the work of both the European Commission and the European Council.

We wish that our other key global economic partners do at least as much and address in a coordinated way the policies that are at the heart of global imbalances. We also wish that they take their responsibility in ensuring that the exit from the crisis is coordinated and leads to a globally sustainable, green growth.
GREECE

290 billions euros debt
12.7% deficit
Plan: below 3% by 2012 , Commission adopted the plan
Almunia: “achievable but not easy”, close monitoring, assessment every 3 months, close monitoring almost permanent
Monitoring and peer pressure is a form of support> decisions are politically difficult.

Odysseus after 10 year of a permanent crisis made it home
Those who did not return were his sailors who killed the holly cows of the sun god
In other words those who did not apply the right/wise policies did not make it

Crisis and Catharsis are both Greek words

European Council?
Finance ministers?
The Council also asks Greece to present a report by 16 March 2010 setting out the timetable for implementing budgetary target measures for 2010, and another by 15 May outlining the policy measures needed to comply with the Council’s decision. Quarterly reports should be submitted thereafter.
To the extent that a number of risks associated with the specified deficit and debt ceilings materialise, Greece shall announce, in the report to be presented by 16 March 2010, additional measures to ensure that the 2010 budgetary target is met.
The Council calls on Greece to design and implement as soon as possible, starting in 2010, a bold and comprehensive structural reform package. It sets out specific measures, covering wages, pension reform, healthcare reforms, public administrations, the product market, the business environment, productivity and employment growth.