- Jacques de Larosière – President, EUROFI
- Roberto Gualtieri – MEP and Chair, ECON Committee, European Parliament
- José-Manuel González-Páramo – Board Member, BBVA
- Axel A. Weber – Chairman of the Board, UBS Group AG
The economic prospects look brighter in the EU but shortcomings continue to slacken the pick-up in overall activity
A number of cyclical factors has provided increasing support for euro area activity: lower oil prices are bolstering real disposable income, thus supporting private consumption. The depreciation of the euro exchange rate is supporting exports. The "stressed" countries which have implemented labour market reforms, pension reforms, and financial sector reforms are now well ahead of some other countries that were not pressed by the markets.
Public sector indebtedness, labour market rigidities, insufficient financial integration are hampering the recovery. Demography is also a major impediment to European growth. 2011 was a watershed moment for Europe. This was indeed the date from which the potential workforce of Europe began shrinking.
The most useful way to address those shortcomings is not to start from the ideal of a perfect monetary union but rather to examine how to use the instruments that are available to achieve a politically viable and realistic process.
Given the high structural unemployment level and low potential output, implementing structural reforms and getting the labour market more flexible are of the essence to restore sustainable growth within the EU and need to gain momentum across the euro area countries.
The Spanish set of policies and the Irish one have been enlightening examples for countries who were not under the same stress, such as France or Italy, and who did not have that enormous real estate bubble that forced Spain and Ireland into immediate significant reforms because of the market pressure.
Improving the fiscal and economic framework without changing the Treaty is another key priority to restoring sustainable growth.
Setting up a more binding mechanism regarding the convergence of structural reforms and introducing a strong incentive based on this mechanism is a relevant proposal in this perspective. The progressive building up of a European fiscal capacity will not be possible without democratic legitimacy and this will take time.
Another priority is financial integration.
There is a clear EU agenda. Issues to be addressed include a complete banking union with a common deposit guarantee system. In addition, legislative work needs to start in order to build the Capital Market Union (CMU). A long-term vision accompanied by an ambitious agenda for further action will be necessary in order to achieve the ultimate aims of the CMU.
Global banks delivering global capital market expertise are a cornerstone for the building up of these markets in Europe. The Capital Market Union should be an open one, not a Union that solely eliminates internal barriers to capital flows but one also that opens the EU to global capital markets. In this perspective, the Commission should seek a close regulatory dialogue and cooperation with foreign regulators to ensure that international standards and principles are transposed in a consistent way across jurisdictions.
Securing pensions is another very important issue. In a demographic context where the European workforce is shrinking and taking into account the lasting low interest rates environment, the whole issue about pension systems and redistribution will become more pressing. Germany undertook some difficult reforms with respect to pensions and balancing systems with Chancellor Schroeder's Agenda 2010 back in 2002-2004; this was the right thing to do, even if the government at that time risked their own survival to push those reforms through. If Europe does not balance these systems, all the other reforms will be confined to optimisations around the perimeters of a very limited growth potential.
It would be necessary to find a policy of integrating people from the global level into the European workforce.
Immigration is indeed a way to secure a growth rate in Europe that is beyond Europe's own potential. However hard it is to open up and have immigration. The demographic situation is complex. In a country like Germany, for instance, where there is more or less full employment, the constraints of demographics indeed lead to the solution indicated, that is more immigration, even if it is very complicated politically. Eventually it is bound to happen in order to escape from the demographic growth trap. The situation is different in countries like France or Italy which have a very high unemployment rate. It is difficult to explain to French citizens who are unemployed or who contribute very heavily in terms of their contributions and taxation to the unemployment benefits for others, that it makes a great deal of sense to open the borders and have more people amongst the candidates for the workforce. But that is a very complicating factor.
SummaryThe moderator asked the panel to consider what the main impediments to business investment in the EU might be: a sagging economy, lack of demand, financial constraints, not enough access to markets or banks, lack of economic visibility, too much regulation making the life of enterprises more difficult, operating margins of some firms that are too low, excessive tax burdens, or disincentives for long term investment.
According to him, each country should have its own agenda to deal with its own structural problems. The question is whether they are taking the appropriate steps to achieve this through national measures, or whether they should be helped to improve through some form of European governance. For example, a body of experts could be formed to meet twice a year with the Commission to review the (possibly insufficient) progress by member countries on these structural measures. This might be considered too much of an intrusion into national policies but on the other hand, it could help frame policies in a more systematic way. EU integration should also perhaps focus on achieving more sustainable growth, for example in the areas of energy and digital technology.
From 1998 to 2015, over a period of 17 years in cumulative terms, US productive investment in volume terms, related to GDP, has been 20 points higher than in Germany, which is one of the best countries in the EU. Productivity gains are much higher in the US than in the Eurozone. Between 2000 and 2014 productivity grew by a cumulative 10.7% in the US but only by 1.4% in the Euro area. The issue is why this is the case. The aging population in Europe is a factor, but it is not the only factor and, to some extent, it can be corrected.
1. The economic prospects look brighter
A leader of the industry stated that the projections of growth of the Eurozone are from 0.9 to 1.4 to perhaps 1.9 at the end of next year. It is very important to understand why this is so. The ECB policy has contributed to this improvement but there are also cyclical factors behind: fiscal policies are being more neutral; commodities and oil prices are also helping. These are tailwinds, of course, and the ECB is acting in a way that should receive some praise, notwithstanding the caution with which one has to exit from these actions because this is not going to be easy.
He pointed out that it is certainly true that investment is lagging but it would be futile to try and find a single explanation for this vulnerability. There are common factors like demography or the institutional fragility of the Union but then there is a need to distinguish between countries. Stressed countries have problems with demand and financial conditions. Maybe taxes are more an issue in France or Italy.
2. The "stressed" countries which have implemented labour market reforms, pension reforms, and financial sector reforms are now well ahead of some others that were not pressed by the markets.
There has been much progress in the institutional build-up of the Union. The Banking Union has taken a big step forward. The Euro at ‘version 2.0' is a different thing compared with the Euro created by the founding fathers. The surveillance framework has improved somewhat, so that now peer pressure is more effective than it was intended to be.
However, a lot of fragility remains there, as illustrated by the "Grexit" episode. It is very clear that progress must still be made on at least three fronts. One is to press for an institutional rebuilding of the Euro and this means completing the Banking Union very much along the lines expressed in the Five Presidents' report; a backstop for the Single Resolution Fund is needed. Very serious consideration must be given to a European Single Deposit Guarantee Scheme, and the Capital Markets Union must be built.
Second, on fiscal matters, there is little in the way of having some kind of fiscal shock absorber. The Five Presidents' report gives a number of hints on how this fiscal capacity can be achieved. It is not just about legal issues, because according to the report of the experts chaired by Gertrude Tumpel-Gugerell, much progress can be achieved within this framework if some conditions are fulfilled. At the very end of this, there is the issue of legitimacy and talking to the people again.
Finally, the speaker reminded the audience that structural reforms are the Achilles heel of all these constraints. The predicted growth rates of 0.9, 1.4, and 1.9 are above the potential rate of the Eurozone, which is below 1%. This could be dramatic and is very difficult to maintain for long. In order to unleash growth forces, structural reforms must be taken seriously. Less progress has been made on structural reforms, and the fact that the ownership of structural reforms remains at the national level is an issue. Perhaps consideration should be given to strengthening the EU surveillance framework or using some limited fiscal capacity to sweeten the short-term reforms. But it is indeed true that many rigidities remain in labour markets and product markets, not even including the digital area. Although there is a better position now than a couple of years ago, much remains to be done.
The moderator also noticed that Spanish experience is striking, including the depth of the reforms that have been engaged in for the labour market in particular, and on the rather rapid results achieved on exports, and therefore on the balance of payments, and also on employment and growth. The Spanish set of policies, perhaps also the Irish ones to some extent, have been an enlightening example for countries who were not under the same stress, such as France or Italy, and who did not have that huge real estate bubble that forced Spain into immediate significant reforms because of the market pressure. Those countries are a case in point. Italy is taking significant actions in its own way and biting the bullet.
France has been reacting, but it should move more in basically three areas, the moderator added. One is reducing public expenditure, where 57% of GDP is spent. This is a record high, and much is unproductive and should be reduced very significantly. The average in Europe is 10 percentage points less, which is an enormous difference. Another issue is labour market mobility and the third issue is regulation, not financial regulation, but one related to the life of companies. It is very difficult to enter into a market. When a small, business enters, the company has to be as it gets bigger it encounters thresholds which make it more difficult. If they could be given a little bit of air and breathing space, it would be worthwhile. Mr Macron is unlocking some supply side constraints and this is a move in the right direction but much more has to be done. There must be a prise de conscience on a large scale.
Nevertheless, more is needed, in particular in some countries which have been lagging behind in terms of structural reforms. It might be a good idea to provide some form of common understanding and surveillance or monitoring of these things.
3. Completing the Banking Union and building the Capital Markets Union (CMU).
A public decision maker emphasised that the situation in Europe now is more optimistic. A lot of improvement has been made and the European Commission is addressing many issues that are required to address the shortcomings mentioned. Then he summarised the shortcomings which hinder the relaunch of sustainable growth: these are insufficient financial integration, and too much financial fragmentation; there is a lack of demand and investment, and insufficient convergence in terms of enhanced economic policy coordination and convergence of structural reforms. The major "basic" shortcoming that makes Europe a less perfect system in comparison to the US is that it is not a federal state.
The most useful way to analyse those shortcomings is not to start from the ideal of a perfect monetary union but rather to examine how to use the instruments that are available to achieve a politically viable and realistic process.
The first pillar is clearly financial integration. There is a clear EU agenda, as was indicated by Mr. Juncker in Parliament two days ago. Issues to be discussed include a complete banking union with a common deposit guarantee system. The banking union must also be completed in terms of fiscal backstop and bridge financing. In addition, legislative work needs to start in order to build the Capital Market Union (CMU). The Parliament will support notably the swift implementation of the proposals on securitisation. The CMU project is indeed crucial in order to benefit from real and well-regulated financial integration. The main issue is to better reconcile the short-term and long-term measures.
There must also be a check on the economic impacts of the whole regulatory framework. On the one hand, there is a need to assess where there exists overlapping and excessive curbing of lending capacity. On the other hand, regulatory loopholes related to shadow banking must be addressed.
4. Improving the fiscal and economic framework without changing the Treaty
The fiscal and economic policy framework is a more complicated area. Following recent reforms (e.g. six pack, two pack, EU semester), a model of economic policy governance for the Eurozone is indeed beginning to emerge.
The main objective at this stage, according to this public decision maker is to define what can be improved within the current Treaty framework and how to move beyond the current economic arrangements. In this perspective, Parliament will consider the proposals of the Berès report that set out some clear measures that could be taken within the current Treaty framework e.g. convergence guidelines to be defined by a co-decision process at the EU level, a gradual building up of a fiscal capacity within the Union budget to create progressively an unemployment insurance mechanism.
One of these proposals is to set up a more binding mechanism regarding the convergence of structural reforms and introduce a strongly incentive based mechanism. If a member state for instance complies with its targets in terms of economic policy convergence, then it would be able to access a fiscal capacity. Such an arrangement can be built within the current framework and can be the embryo for a fully-fledged fiscal capacity. However it is necessary to be realistic: the progressive building up of such a European fiscal policy will not be possible without democratic legitimacy. This will take time. It is not possible to create fully-fledged EU politics in a few years but this is being done. Europe is moving in the right direction. The Parliament will contribute to give strength and energy to this process.
The speaker responded to a Chair's question about how this perspective fitted in with the discussions with the UK, and whether the UK would support this kind of vision expressed by having a larger budget, perhaps financing in a federal way the unemployment problems of countries that have respected the fiscal targets.
According to the speaker, it is in the strategic interest of the Eurozone and Europe that the UK should stay in Europe. This is why it is necessary to be very careful in order not to create problems during the referendum campaign. The Eurozone integration should not be done at the expense of single markets; this is absolutely crucial.
The outcome of the Labour party leadership election is also relevant. It is hoped that the Labour party will support UK membership in the EU. This is essential. The Labour members in the Socialist and Democratic political groups of the EU Parliament are fully supportive of UK membership of the Union, whoever becomes the leader.
The two elements, a stronger EMU integration and a robust single market and Union are fully compatible. Instruments to make them so exist. It is not necessary to create a Eurozone parliament; the existing institutions can be used. The government of the Euro belongs to the Commission and at the same time the Commission is a body of the EU. So there can be a multi-speed integration within the current framework.
The moderator stressed that it is necessary to strengthen and deepen the institutional construction of the Eurozone whilst not jeopardising the basic understanding of those who are not part of the Eurozone but part of the EU. It is a delicate operation. The Chair asked how the integration of the European Stability Mechanism (ESM) in the institutional system might be achieved.
A public decision maker answered that for a number of reasons, a specific Treaty establishing the ESM was signed by the member states of the Eurozone. An amendment to the Treaty was proposed. However the Court decided that Treaty change was not even necessary. Recently, the European Financial Stability Facility (EFSF) has been used again and the procedure, even if no longer appreciated, showed that a Union instrument such as the EFSF could be used to avoid something like a rebate mechanism, or avoid the liability of non-Euro members.
It is very interesting to see how it could work. An ESM within the Union budget could be part of the Community construction but at the same time not make a non-Euro member liable. This would need a Treaty change, but this direction can also be achieved within the current Treaty because nothing prevents the creation of a dedicated budget line financed by member states within the present budget. For example, there is an existing Euroflex project between Belgium and France with a line in the budget financed by the two countries and earmarked. There are no procedural or legal obstacles; this is more a matter of political will.
5. The Capital Markets Union should be open, not merely one that eliminates internal barriers to capital flows, but also one that opens the EU to global capital markets.
The European project of a Capital Markets Union is a very important one. It is a European harmonization project. But a leader of the industry stressed that the view that for a return to growth it is necessary to strengthen capital markets only within the European Union is incorrect. Capital markets are global, but the planned Capital Markets Union (CMU) is too focused on a level playing field within the Union, and too little focused on an open union. Standards are driven internally within the EU by fostering convergence of standards like MiFID and EMIR. According to this speaker, It would make it much easier for the Union to raise capital in the global market by having an open Capital Markets Union rather than just harmonizing domestic rules and unintentionally raising market access barriers externally.
In the US, the focus is entirely on US rules. The US supervisory framework is very complex. Non-US financial institutions that do not comply fully with those rules face market access barriers. The same is now happening in Europe. If Europe were to build an open capital market, Europe would be much more successful. In this regard, the Commission should seek close regulatory dialogue and cooperation with foreign regulators to ensure that international standards and principles are applied in a consistent way across jurisdictions.
In order to achieve this, a pan-European institution should oversee this development. With respect to the Banking Union, the ECB has taken that role. With respect to the Capital Markets Union, the European harmonization process is slow and cumbersome; no one is really driving the process. Europe should establish an SEC-like capital market regulator that has the authority to drive the project forward. ESMA to date is not set up as a European SEC-like regulator would be.
6. Demography is a main impediment to European growth
This leader of the industry pointed out that in addition to the long list of impediments to European growth already mentioned, demographics play a major role. Unfortunately, dealing with aging is highly contested, emotional and a national policy issue, as well as a redistribution issue at the global level.
2011 was a watershed moment for Europe, not only due to financial fragmentation between the core and the periphery. 2011 was the year in which the potential workforce in Europe peaked. The economic tailwinds of the past decades caused by the growth of the potential labor force have swirled into headwinds. The biggest impediment to economic growth in countries such as Germany and Italy is the decline in the potential labor force and the growing fraction of retired people or economically inactive people.
7. In order to overcome the demographic challenge, it would be helpful to find a policy of integrating immigrants from outside of Europe into the European workforce in a transparent and reasonable way. This has yet to occur.
Demographics is a global problem. The global potential workforce grew at 2.0% in 2008, but its growth rate is declining precipitously. According to projections by the United Nations, by 2017 the potential work force will grow at only 1.0%. This is a one percentage point decline in less than 10 years, which is being reflected in a significant decline in the world's potential economic growth rate.
In Europe, the growth rate of the potential labor force dropped from +0.6% in 2008 to –0.4% in 2015, a decline of one percentage point in just seven years, and the contraction will accelerate in the coming years. The potential support ratio (the number of working age people supporting a non-working elderly person) is declining massively. The current ratio of 3.5 in Europe will decline to 2.0 in 30 years. In Germany and Italy, the situation is worse: the support ratio will decline from 2.9 to 1.6 in Germany and from 2.6 to 1.4 in Italy.
Demographics is one of the major economic challenges facing Europe in the longer term. Labor market reforms are therefore of utmost importance, and some are already being implemented. Securing pensions is another very important issue. Zero interest rates are exacerbating the pension problem. Pension entitlements that were promised will not be achievable. Redistribution questions will become more controversial, as the pie is shrinking and the number of people expecting a slice is increasing. Those who bake the pie will get a declining share of that pie for their own consumption in the future.
The US will face fewer demographic difficulties, since demographics there are different. If Europe does not face up to this issue, then it faces a tough future. Germany undertook some difficult reforms with respect to pensions and sustainability of social security systems under Chancellor Schroeder's Agenda 2010 back in 2002–2004. The government at that time risked its own political survival, but this was the right thing to do. If Europe does not tackle these problems, its growth potential will be very limited even if it successfully implements all other reforms.
The moderator agreed but commented that the demographic situation is more complex than the previous speaker described. In a country like Germany, for instance, where there is more or less full employment, the constraints of demographics indeed leads to the solution indicated that is more immigration, even if it is very complicated politically. Eventually it is bound to happen to get out of the demographic growth trap.
The situation is different in countries like France or Italy which have a very high unemployment rate. It is difficult to explain to French citizens who are unemployed or contribute very heavily in terms of their contributions and taxation to the unemployment benefits for others, that it makes a lot of sense to open the borders and have more people amongst the candidates for the workforce. That is a very complicating factor. This very optimistic view on immigration should in reality be more complex and whilst it may be the right attitude on immigration, it is easier to be open-minded from the position of a country that has managed its reforms in the past and is close to full employment.
The moderator of the session also queried the previous speaker's position on capital markets. It was suggested that it could be more advisable to open the European capital markets to the world because it is the world that is important in terms of savings and capital, and therefore an inward looking view of this problem should be avoided. The moderator opined that the capital market in Europe is already open. There are no restrictions to inflows of capital from abroad. The system of wealth management funds is a very open system. It is a sort of passport-like system where if the basic conditions of surveillance in terms of the treatment for consumers are in order, there is no problem. It is not a fortress. It may be true that too much energy is being spent on the equalisation of each directive in each country, but this does not hinder the openness of the market.
The leader of the industry said that there are a number of reasons why some peripheral countries have unemployment rates of 20% and above. First, there is the mismatch issue. If the unemployed have the wrong qualifications or through prolonged unemployment have lost qualifications, they cannot be reintegrated into the workforce. European unemployment has a strong mismatch component.
The second concern is youth unemployment. That is the biggest problem in Europe. Youth unemployment does not exist because these people are not well qualified; sometimes they are the best qualified people available. In the US, millennials drive the labor market and the future of innovation in companies. The problem in Europe is the social security systems. It is much easier to have a 25 year-old never join the workforce, since that is relatively cheap for governments, than to have a 55 year-old leave the workforce and be replaced by a 25 year-old. So Europe's greatest problem is its failure to deal with the unemployment rate among the brightest, youngest and most promising in society in the right way. It is a problem in many countries. It is not a big problem in Germany, because the labor market has an apprenticeship system and the young are integrated into the workforce early in life.
The Capital Markets Union clearly needs to be followed through. The European Banking Union was not built in a day; it was a contested project. The European Union will not be built in a day. It is designed as a long-term project, but should focus more on fast track implementation, and put a couple of things in place now.
The European Union is only to some degree an open capital market, and access to capital markets in Europe flows through banks. The European capital market is much less developed than the capital market of the US, which has the deepest, most liquid market. European banking markets might be integrating internally, but for non-European banks such as Swiss banks, the ability to provide cross-border services into the European markets is very limited; in fact more limited now than they were before some of the harmonization. The harmonization in the EU led to new barriers. This is not just something that is true for Europe; it is also true for the US. Nowadays, there is almost a standoff between European institutions on the one side, and US institutions on the other, due to the non-compatibility of global rules between the European markets and the US markets, to the detriment of global markets.
Global banks are needed to accelerate the evolution of European capital markets. Capital markets will not evolve by themselves or by having small infant players build up capital market expertise. European capital markets can only emerge when global banks deliver global capital market expertise and help Europe build up these markets. The issue of global capital market access is one-to-one linked to the free access of global banks to the European capital markets
The moderator then pointed out that the present regulatory system has inadvertently limited the capability of large cross-border banks in Europe to improve on the trans-border aspects of their activities because that is the most costly in terms of capital requirements. Therefore, in a rather strange fashion the system of global banks in Europe has in part shrunk; according to their balance sheets, they have diminished. The pattern of those balance sheets has become more local. The contradiction is that the objective is a global capital market in Europe, but in the same breath without strong banking groups in Europe. It is important to also open the doors to local banks that want to be more international.
A public decision maker concluded that there was no contradiction in forging ahead with the Capital Markets Union. Many benefits can be gained out of the creation because there has never been a market for securitisation etc. There is much to gain if a deeper effort is made, and at the same time there should be additional work to make the capital markets more open. The difficulties are clear because all the trends now are against global banking. There is the TLAC, the separation of banking activities, the Dodd Frank... The speaker did hope that financial services could be included on the agenda of the TTIP with the US, but this has not happened. Current trends, including those at an international level, are against a really open global market.
The moderator noticed that public may complain about globalisation but globalisation is actually shrinking. It is localisation that is happening now.
The speaker agreed that there is no contradiction, according to him. Addressing the problem of financial fragmentation within the EU is a precondition to having a real open EU which is a protagonist in a global financial system of capital markets. The other way around cannot work, so really it is taking a step in that direction. There will be a fight to convince US counterparts that the TTIP is not being watered down, but on the contrary, is supporting the broader regulatory agenda of FSB and Basel, so the building up of an integrated financial system in Europe has to be done in a global perspective.
If one looks at Europe from a global and historical perspective, it is obvious that there is a need to compensate the demographic trend with more openness. This is true and is happening in a very complicated way. There should be a little caution about the arguments saying there is no problem of internal demand or of investment. The risk of this argument is that it becomes used too predominantly. This argument can be supported provided that it does not become a kind of Malthusian argument not to address the concrete problem that economic policy has had during the last year.
By V. La Via - Director General, Italian Treasury, Ministry of Economy and Finance, Italy
By R. Gualtieri - MEP and Chair of the Committee on Economic and Monetary Affairs, European Parliament
By L. Frieden – Vice Chairman, Deutsche Bank Group
By A. A. Weber - Chairman of the Board, UBS Group AG