1
Outlook for European Political EconomyDivision, Dithering, Deflation, and Decline
(but not ‘Crisis’)
Adam S. PosenInstitute for International Economics
Global Insight’s World Economic Conference09 May 2006
2
Echoes of 1930 without the violence:• Economic dislocation of the politically influential middle classes
– Credible threat of unemployment for some bourgeoisie– Competitive pressure from identifiable trading partners
• Fear of social erosion by demography and ethnicity• Failure of grand projects and international organizations• Extended growth slowdown and near-deflationary policies• Declining support for mainstream parties and liberalism
Result: Protectionism, Economic Nationalism, and Fiscal Expenditure on Symbolic Projects
Outlook for European Political EconomyDivision, Dithering, Deflation, and Decline
3
• The entire postwar system was about buying off their dissatisfaction and buying their support
• Unemployment fell largely on ‘outsiders’ by various criteria, or there were glide paths to retirement
• Even limited fiscal pressures are now hitting pensions• Restructuring is beginning to threaten established
high wage sectors and professions• The potential 1-2-3 punch of EU enlargement,
Services Directive, and Asian competition breeds fear– And outright opposition to these constructive measures
Economic dislocation of the middle classes
4
Resistance to globalization through denial at home and recalcitrance abroad
• Outsourcing remains low compared to other countries• FDI is concentrated in CEE, but with mixed feelings• Service sector liberalization will be fought all the way
– National champions yes, but even more local protections– The ‘qualifications’ barriers are very high and unaddressed– Various precautionary and privacy principles spill over
• The moment to move on agriculture was missed• Aggressive state promotion of commercial deals is
beginning to go well beyond Airbus– Discussions of EU military capabilities abet this trend
5
Restructuring is just real enough to be scary% of sectoral workforce losing jobs due to restructuring (2002-present)
0
1
2
3
4
5
6
7
8
9
Constructi
on
Commerce
Extrac
tive I
ndustries
Financia
l Serv
.Meta
l and M
achinery
MotorPost
& Teleco
mm.Eco
nomy's to
tal
% s
ecto
r's w
orkf
orce
GermanyEUbig18 less Germany
Source: Author's calculations, EMCC, OECD STAN Database
"EUbig18" consists of EU15 less Luxembourg and the four largest new members (Czech, Hungary, Poland, and Slovakia)
6
• Guest workers and immigration were always more important than publicly acknowledged– But the myth that people could be sent ‘home’ comforted
• Greater cohesion of ethnic communities threatens• Declining fertility brings echoes of post-WWI fears• As with 1920s Popular Front-type governments, there
is a feeling that cosmopolitan values went too far– Difficult to maintain citizenship definition without nationalism
• Cultural exports by US and by Islamic world seen as dangerous and divisive
Fear of social erosion by demography and ethnicity
7
The new member states will be no more fertile
1965-1975
1985-1995
2005-2015*
USA
German
yFran
ceCze
ch R
epublic
HungaryPolan
d
0.0
0.5
1.0
1.5
2.0
2.5
Historic Developments of National Fertility Rates
Source: UN World Population Prospects Database, 2004 Revision
ReplacementRate, 2.1
* - Projected
8
• Constitutional ‘No’, grudging enlargement, and underperforming euro/SGP all build-up resentment– Functionalists: EU always comes back with new initiatives
– Rationalists: The EU just went too far in adjustable specifics
• But there is no plan “B” and the means of adjustment were rejected in the constitutional vote
• Recently ignored concepts of ‘subsidiarity’ and ‘democratic deficit’ are re-emerging
Perceived failure of European Union’s grand projects and of international organizations
9
• There was a battle taking place between statism and liberalism in Brussels– Brussels has been weakened politically, which means the
force for liberalism has been taken away– Franco-German logrolling has replaced Anglo-German use
of Brussels for liberalization
• Anglo-American fantasies about ‘break-up’ are mistaken, but there is still an economic effect
• Fantasies about the positive impact of eastern enlargement are equally unfounded and mislead
Perceived failure of European Union’s grand projects and of international organizations
10
No fiscal brick wall will be hit on health care or elsewhere in the welfare state for many years• General point – unless debt dynamics are bad or
most debt is foreign-held, there is no fiscal risk– Ex Bel and Italy, there is ample national savings, low foreign
debt, and too high investment ratios for crowding out
• Health care outcomes demonstrates the Tolstoy view of medical systems (“Every happy family…)– Cost containment efforts are underway but largely on the
demand side and via the state’s bargaining power
– Ideologically, EU is getting to be like Canada defining moral superiority if not identity vs. US by health care
– There are unlikely to be supply-driven opportunities
11
No Rubinomics for the Euro ZoneItalian Interest Rates and Private Sector Fixed Investment Growth
-7
-2
3
8
13
1994
M1
1994
M5
1994
M9
1995
M1
1995
M5
1995
M9
1996
M1
1996
M5
1996
M9
1997
M1
1997
M5
1997
M9
1998
M1
1998
M5
1998
M9
1999
M1
1999
M5
1999
M9
2000
M1
2000
M5
2000
M9
2001
M1
2001
M5
2001
M9
2002
M1
2002
M5
2002
M9
2003
M1
2003
M5
2003
M9
2004
M1
2004
M5
2004
M9
Long Term Government Bond Yield Real Investment Growth
Source: IFS, January 2005 and Eurostat
1994-1998 inv.growth avrg
2.5%
1999-2004 invgrowth avrg
1.8%
Y-on-Y investment Growth,Interest Rates(%)
12
No obvious benefits from euro, either
Economic Performance before and after Maastricht Treaty for four eurozone members, 1994-2004 compared with 1984-1993
-4
-2
0
2
4
6
8
Italy Germany France Ireland Sweden UnitedKingdom
Denmark
Perc
enta
ge p
oint
diff
eren
ce b
etw
een
84/9
3 - 9
4/03
per
iod
aver
ages
Productivity Growth Unemployment Rate Real GDP GrowthSource: OECD Economic Outlook #74
NOTE: the sign on the unemployment difference has been reversed in order to facilitate visual comparison. A positive value signifies a fall in unemployment.
13
Divergence or Just Disappointment?Euro-area Real GDP growth
-3
-2
-1
1
2
3
4
5
1991
Q119
91Q3
1992
Q119
92Q3
1993
Q119
93Q3
1994
Q119
94Q3
1995
Q119
95Q3
1996
Q119
96Q3
1997
Q119
97Q3
1998
Q119
98Q3
1999
Q119
99Q3
2000
Q120
00Q3
2001
Q120
01Q3
2002
Q120
02Q3
2003
Q120
03Q3
2004
Q120
04Q3
Unweighted Average+ 1std dev-1 std. dev
Sample includes all euro-members apart from Portugal, data for Ireland are only available from 1997.Data from OECD, Quarterly National Accounts
%, Y/Y
14
Germany’s Own “ERM-Crisis”
Source: Posen and Popov Gould, “ECB Monetary Policy and Eurozone Stress”, Sept 2005- Indicators are the difference between national (1990-98) and European (1999-2004) actual rates and rates implied by the Bundesbank/ECB reaction functions using national data on output gaps and inflation. A positive value implies an excessively high de facto interest rate. Indicators extend to 2004m6 only due to forward-looking reaction function models used in estimations.
-5
-3
-1
1
3
5
7
9
11
1990
M119
90M7
1991
M119
91M7
1992
M119
92M7
1993
M119
93M7
1994
M119
94M7
1995
M119
95M7
1996
M119
96M7
1997
M119
97M7
1998
M119
98M7
1999
M119
99M7
2000
M120
00M7
2001
M120
01M7
2002
M120
02M7
2003
M120
03M7
2004
M1
Germany Italy France
percentage points
15
Expect a cut-off recovery in 2006 and ongoing drag from monetary and fiscal policies• No one should believe the euro break-up stories
• The ECB will raise rates prematurely due to the monetary pillar, which will kill off the current upswing
• Germany’s relative wage deflation will not make up for the real interest rate and wage effects
• SGP violators will stay in the worst of both worlds, tightening fiscal policy with no interest rate payoff
• All this, abetted by an eventual dollar decline and rising interest rates globally will limit growth
16
The Euro’s global role is precluded by poor relative performance and capital integration• Obstacles to financial integration in Europe
– Money and bond market progress is undeniable
– Equity and ownership market integration are slow
• Fragmented financial supervision and crisis response capabilities in the eurozone
• Unconsolidated eurozone representation in the IMF and other international fora, and
• Deficient macroeconomic stability and growth
…all remain (eurozone entrants beware!)
17
- If the euro moves but Asian currencies do not 84% - If the euro moves and Asian currencies appreciate 20% 42% - If the euro moves and Asian currencies appreciate 41% 20%
* - Estimation assumes an average 25% appreciation by all otherindustrial countries including Japan
Source: Truman, Edwin (2005) "Postponing Global Adjustment: AnAnalysis of the Pending Adjustment of Global Imbalances"(IIE Working Paper #05-6)
Appreciation of the Euro in response to a 20% US$ depreciation*
The euro is more vulnerable than the yen to dollar adjustment
18
Extended growth slowdown and deflationary policies• It is possible to paint a somewhat rosy picture for EU
performance in comparison to the past or to the US– Productivity levels, choice of leisure, some positive outliers– Labor market reforms are working in some places
• Ultimately, though, the EU has to grow faster than the US to meet the demands of demography, enlargement, and social solidarity and it is not – Real returns on capital (NIPA) have been consistently lower
and consumer prices have been higher– The slowing performance of late in the Netherlands and
Sweden, even if only cyclical, tends to undercut the claims that reforms are beneficial
• In fact, there is little sign of a growth or innovation acceleration even where R&D/Human cap are high
19
Outlook: Division, Dithering, Deflation, and Decline(but not ‘Crisis’)
• If one does not want to identify with the EU or with Atlanticism, what is left but nationalism?
• If one does not want to be Anglo-capitalist, but communism is out, what is left but protectionism?
• If government officials cannot take credit for improving economic performance, and cannot significantly redistribute wealth, what can they do but try to generate symbols of solidarity and accomplishment?
•Think the 1930s redux with nationalism minus militarism, racism minus (state sponsored) violence, and public works projects minus the fascist imagery
•But in a global economy where there is real competition
20
Result: Robust stagnation in EU3-plus
• There will be mounting reform fatigue with little to show for it, which will further weaken party support
• With a likely structural budget deficits of 1.5-2.0% p.a., gross debt will not rise enough to cause change
• The outflow of young people, capital, and ideas will be a steady trickle, not a stream, but very clear
• A dual economy (not unlike Japan) will see the best companies do the most restructuring, and vice versa
• Growth will be insufficient to lower unemployment• An anti-globalization Germany and Italy will weaken
the EU and the international economy