The Forum Issue 2

“It is only when the tide goes out that you learn who has been swimming naked,” said José Manuel Barroso, quoting investor Warren Buffett in remarks opening the 12th Annual Brussels Economic Forum. Barroso noted that at the outset of the crisis, Europeans tended to blame the US whereas more recently the finger-pointing has been directed at Europe. “The truth is, however, that the global financial system as a whole was swimming naked,” the Commission President noted.

European recovery: slow and steady

For its part, Europe is putting on its clothes again. According to Olli Rehn, European Commissioner for Economic and Monetary Affairs, quoting recent economic data, the economic recovery in Europe is maintaining its momentum, and the EU will reach its pre-crisis level of production next year. The recovery is also becoming more broad-based as it’s increasingly driven by domestic demand rather than exports.

Rehn pointed out that these improvements are taking place despite the uncertainty resulting from the political changes in the Middle East and North Africa, the nuclear crisis in Japan and the ongoing tensions in the sovereign debt markets of certain Member States. Moreover, those countries which have undertaken the most far reaching economic structural reforms are now the best placed to take advantage of economic recovery.

A two-speed Europe

Challenges remain, however. “Unfortunately, we are living in a two-speed Europe,” Rehn admits. “While some Member States are rebounding and creating jobs, other Member States are still struggling.” Moreover, despite the recovery, employment is recovering at a painfully slow pace.

“Nonetheless, you should not lose perspective,” said Rehn. “We have managed to preserve financial stability and prevent a meltdown of our financial system. All Member States have engaged in fiscal reforms and most in structural reforms.”

Reforming economic governance

The next step is to move away from firefighting to address the underlying vulnerabilities. According to Rehn, financial institutions and markets must be regulated, public debt consolidated and structural reforms implemented to ensure growth. Improving economic coordination will play a major role. Rehn noted the shortcomings of economic policy coordination in the past: not paying sufficient attention to debt and deficits, rules that lacked teeth, ignoring macroeconomic imbalances and underestimating spillover effects in an integrated economy.

While mistakes were made, Europe now has the chance to put on a fresh set of clothes. "Reforms that we would have thought impossible two years ago are today a reality. And why? Because the EU and its Member States have understood how interdependent our economies are". said Barroso. The crisis has shown that if we want our common monetary system to be a success, we cannot have a single currency trying to run on its own, without coordinated budgetary and economic policies Priority must be given to decisively implementing what was agreed – sticking to the course is a virtue.”

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Delivering the keynote address at the Forum, Angel Gurría urged Europe to fix its persistent unemployment problem and tackle its sovereign debt crisis. He advocated environmental taxes and structural reforms as one possible way forward.

Angel Gurría’s first contact with European currency came when as an official in the Mexican government he attempted to float a bond issue in European units of account. Back then, he and his colleagues had to calculate 14 different currency weights to determine the correct interest rates to use. Not surprisingly, Gurría, who is now Secretary-General of the Organisation for Economic Co-operation and Development (OECD) is a true euro-phile.

Gurría is concerned about Europe, however. “If nothing is done, the pace of growth in the euro area over the next 15 years will be about half of what it has been, since 1995,” he notes. Delivering the keynote address at the Forum, Gurría urged Europe to take steps to deal with the sovereign debt crisis in the periphery of the euro area and address stubbornly high unemployment. So he sees Europe 2020 as a good step in this direction as it provides a concrete strategy to meet such challenges.

Fixing unemployment

“When we have 10 percent unemployment and sometimes 20, 30 or even 40 percent unemployment for youth, we cannot say that the crisis is over,” he asserted.

Gurría recommended measures such as more effective training, work-sharing and temporarily reducing labour taxation as ways to prevent cyclical unemployment from becoming permanent. He noted that a return to work would also contribute to growth.

Solving the sovereign debt crisis

Gurría is particularly concerned about countries’ fiscal positions. Government debt is set to rise to close to 96% in the euro area, he noted, and just above 100% in the OECD as a whole. This is 30 percentage points above the pre-crisis level and continues a trend since the early 1970s.

“We are going to end up in a level of debt where it is going to be like Everest,” said Gurría. “The oxygen level will make it uncomfortable to breathe. And it will take a big push to bring it down to a more comfortable level.” Gurría added that this debt ‘mountain’ will be further exacerbated by demographic ageing. To solve the problem, Gurría advocated novel solutions such as greater recourse to environmental taxes. He also stressed the importance of structural reforms.

“We ran out of money on the fiscal side and room on the monetary side,” he said. “What is left? We have structural reforms.”

Go green, go social

Gurría noted that the global economy is exiting the crisis but is not returning to business as usual. Future growth will need to be green, sustainable and more inclusive.

“Go structural, but also go social,” he said. “There were many groups that were left vulnerable by the crisis.”

Gurría called for greater international cooperation both in dealing with the emergency but also in shaping the way forward, but acknowledged that it won’t be easy.

During the crisis, “the house was on fire and everybody had to get a hose. Now there are options and it’s more difficult to coordinate policies and set common rules.”

Gurría welcomed the “impressive effort” by the euro area authorities in terms of strengthening institutions. “Europe can learn from its difficulties and transform a crisis into an opportunity,” he said. Acknowledging the possibility of insolvency puts pressure on national governments to manage their public finances prudently, he continued, adding: “The reform of the SGP contains important measures, including a system of ex ante fines and a quantitative structure for debt reduction.”

Reversing the voting majority for Council decisions would be an “important signal”, underlining that European governments are no longer willing to accept risks from bad policies in other countries.

Despite issuing some stern warnings, Gurría remains at heart a euro-phile. “You are building a huge safety net and more importantly making sure you don’t have to use the safety net,” he said. “I think you’re going about it in the right way.”

Delivering the First Annual Tommaso Padoa-Schioppa Lecture, Wolfgang Schäuble Federal Minister of Finance in Germany, said that the sovereign debt crisis was a fiscal crisis rather than a currency crisis. He argued against bailouts and other income transfers but recognised the vital role that economic coordination has to play.

“The euro, one day, will be perceived as the father of all things European. The euro compels us to engage with European issues at an existential level, to steer them into the right channels.” Wolfgang Schäuble, Federal Minister of Finance in Germany, used this prediction to illustrate his belief in the single currency in the First Annual Tommaso Padoa-Schioppa Lecture in Brussels.

The words have become something of a rallying call for euro-enthusiasts. Jean-Claude Juncker used them on the eve of the euro’s introduction on 1 January 2002.

“There is one basic principle which directed – and still directs - European integration,” said Schäuble. “The principle that economic unity precedes political unity, but is intended to lead to political unity..” And like Padoa-Schioppa, Schäuble also takes a nuanced view. “On the one hand, the nation state has indisputably lost its monopoly on regulation,” he said, “ On the other hand, no one wants a European super-state. And that is why we need something unique.”

While supporting the euro, Schäuble gave a frank – and sometimes pointed – assessment of what ails the euro area., “At the heart of the matter, we are not experiencing a crisis of the euro, but various crises in individual countries that belong to the euro area. These crises were caused by the individual countries’ erroneous economic and fiscal policies,” he stated. “The inconvenient truth is that a number of European countries lived well beyond their means over the past decades.”

A fiscal crisis, not a currency crisis

According to Schäuble, we are now faced with a fiscal crisis, not with a currency crisis. Both the internal and external values of the euro are very high, he noted. Schäuble praised the euro for protecting Europe from excessive exchange rate fluctuations.

But he expressed a measure of disappointment with the workings of the euro area. “We used to believe that the different rates of interest paid by the single currency’s members would be a sufficient incentive for prudent fiscal policies by countries within the euro zone,” he said. However, "the truth is that markets work well but they do not always react rationally since human beings do not always act rationally.” It was a mistake to de-regulate financial markets as much as possible, said Schäuble.

Solidarity but ‘tough love’

Apart from this critique, Schäuble said that it was right to shore up the system because the financial, political and economic consequences of a debt crisis would have been severe. But Schäuble also leveled some criticism at the way in which the system has been repaired.

“No, throwing other countries’ money at the problem is not the answer,” he said. “We can help them, but we cannot do their job. Besides, one does not resolve one’s own problems of competitiveness by asking others to become less competitive", nor is it possible to "permanently close the gap between expenditure and income by asking others for more money.”

Continuing in the same vein, Schäuble stated that “EMU was not intended to be a quick fix for euro zone members, or – for that matter - a get-rich scheme for financial speculators. It was not meant to be a system of redistribution from richer to poorer countries via cheaper borrowing for governments.”

To solve the EU’s problems, Schäuble offered several words of advice. Don’t only listen to markets, also listen to citizens, he said. He also warned that only calling for more budgetary austerity is insufficient. “We must consider an individual Members’ economic performance too and better co-ordinate economic policy..”

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How can the EU ward off the next financial crisis? The Brussels Economic Forum heard views from the institutions, the private sector, and academia.

Europe’s new financial infrastructure was the subject of intense debate during the first session of the Brussels Economic Forum.

Panelists from the European Union institutions outlined proposals for broadening and deepening economic governance, measures they said were crucial for avoiding another crisis.

Servaas Deroose, Deputy Director-General of the European Commission’s DG for Economic and Financial Affairs, said he hoped the Commission’s package of measures would receive the blessing of the European Council of Ministers in June. The package was based on three main “building blocks”, he said: sound fiscal polices, balanced growth and crisis resolution mechanisms.

An eye-opener

“The crisis has worked as an eye-opener,” he told the Forum. There would be an increased focus on reducing government deficits during periods of economic expansion, new debt benchmarking and tougher sanctions for transgressors.

The proposed governance package “goes well beyond the six legislative initiatives of the Commission,” added Vítor Constâncio, Vice President of the European Central Bank. European banking needed a “stronger European perspective” he said. There was a need for a “quantum leap” in terms of strengthening the Stability and Growth Pact.

Mr Constâncio stressed governments should in the future have less room for manoeuvre when faced with fines: “Discretion to reduce or suspend financial sanctions is undesirable as it strongly reduces effectiveness and sets the wrong incentives.”

Klaus Regling, chief executive officer of the European Financial Stability Facility, gave his whole-hearted support to the package. “If all the European Commission proposals are implemented we will have a better system,” he said.

No crisis mechanism was foreseen

There was at the same time an admission that the institutional arrangements of the past had been incomplete. “The founding fathers of EMU [Economic and Monetary Union] did not foresee the need for a crisis mechanism,” Mr Regling pointed out. The need for a central institution for overcoming liquidity crises had emerged, though it should only be used in “extreme circumstances".

He asked if with the creation of bodies such as the European Stability Mechanism, Europe was moving towards its own European Monetary Fund – mirroring the International Monetary Fund. He then answered his own question: “I don’t think so”. The EU already had institutions – the European Commission and the European Central Bank – capable of negotiating with Member States and boasting the necessary expertise. There was no need to duplicate this expertise, he said.

Thomas Mayer, chief economist of the Deutsche Bank Group, agreed that the current system was “too focused on fiscal policy” and that the sanction mechanism was “far too weak”. But Mr Mayer warned regulators against thinking they knew better than the markets. “You need to make markets work to enforce discipline in the euro area,” he said. Markets can themselves help regulate excess if allowed to correct, it was argued. If markets were not allowed to do their worst there was a danger of introducing “moral hazard”. He noted: “We need to make it possible for banks to fail…and for governments to fail.”

Fiscal policy is more political

Alberto Alesina, Nathaniel Ropes Professor of Political Economics at Harvard University, drew a key distinction between monetary policy and fiscal policy. Why can the EU boast monetary union but no fiscal union, he asked? The answer, which he also provided, was that “monetary policy is less directly political than fiscal policy.”

This was said to have significant implications. If the new system of economic governance is approved, will Member States abide by the rules, even if it is politically inconvenient? “I am skeptical that national governments will want to delegate much to the EU in terms of fiscal policy,” said Mr Alesina “It is very easy to be tough on small countries but when large countries want to violate rules, they can.”

The panel also debated one of the most sensitive economic subjects of the day – debt restructuring.

There was no question that restructuring should be a “last resort,” said Mr Constâncio. Debt restructuring would trigger “enormous consequences” for any country, he warned.

In the case of Greece, which has received much media coverage, the EU institutions were not of the belief that debt levels were unsustainable, the Brussels Economic Forum heard. “There is an adjustment path that Greece can follow to avoid the worst,” he underlined. While Mr Mayer agreed that Greece should be given “a chance” to put itself back on the right path, he said that policy-makers should take some of the blame for today’s problems. Market failures of the past have been accompanied by “policy failures”, he said: “no-one on the policy side took active measures”.

Panelists finally addressed the ‘too-big-to-fail’ issue. “All countries must have resolution regimes that allow banks to fail even if they are big,” said the Vice President of the European Central Bank.

The difficulty, he pointed out, was that failures were unlikely to be confined to a single country.

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Participants in Session II of the Forum: “the EU economic governance framework in practice – ensuring its robustness”, felt that the EU needs to increase transparency and engagement at the national level in order to ensure that reforms to economic governance are successfully implemented.

“The devil is in the detail and you need to get the devil right from the start or you get into a lot of problems,” said Martin Dickson, quoting Olli Rehn, European Commissioner for Economic and Monetary Affairs. Dickson is Deputy Editor of the Financial Times and was moderator of Session II of the Forum: “the EU economic governance framework in practice – ensuring its robustness”. As its name suggests, the session aimed to dig into the details to see how economic governance could work in reality.

Elena Flores, Director of Policy Strategy, Co-ordination and Communication at DG ECFIN, kicked off with the acknowledgement that “all these things are in the making and not yet finally decided; so we don’t have much experience with how to make these things work.” With this spirit of openness, Flores described some aspects of the new framework of the European Semester. The clear aim of Commission proposals was to have a more integrated approach to policies. She noted that the three challenges identified in the Annual Growth Survey are fiscal and financial stability, increasing the efficiency of labour markets and frontloading growth-enhancing structural measures.

Flores also noted that the new economic governance framework currently being negotiated needs to be applied intelligently. “We need to ensure that fiscal consolidation is not undermining growth,” she said, and observed that “not everything will be tackled with this legislation”.

Transparency and democracy

On the issue of structural reforms, Dickson raised the question of how to gain acceptance at the national level - an essential step. “How are stakeholders involved at the national level? We have to explain the policies. Otherwise citizens are looking at them through their own glasses,” Flores said.

Transparency and democracy was a theme echoed by several other speakers. Sharon Bowles, Chair of the Economic and Monetary Affairs Committee (ECON) of the European Parliament said that Parliament has been trying to increase transparency by having an annual meeting with national parliaments.

With a view to the proposals on economic governance currently being negotiated, Bowles underlined that the European Parliament wants to establish a robust and measurable framework. She noted a discontinuity not just between the European and national levels, but also within the national level. “For far too long there has been a lack of disclosure about what ministers are doing in the name of their citizens in Europe,” she said.

She also called for an ‘economic dialogue’ like the monetary dialogue which ECON has with the ECB every quarter.

Pier Carlo Padoan, Deputy Secretary-General and Chief Economist of the Organisation for Economic Cooperation and Development (OECD) took the issue of democracy a step further. “You have to explain the distributional impacts of reforms,” he said. “If you don’t do that, then the likelihood of failure is high.” He said that structural reforms are beneficial for the countries but they should be much more specific depending upon the country. Deficit countries, for example, might wish to increase competitiveness in tradable sectors by examining wage formation. Padoan also thought it possible for surplus countries to adjust not by decreasing competitiveness but by increasing investment, for example in their own services sector. Padoan stated that it was even possible to have structural reforms without a crisis, citing ‘shadow reforms’ at an industrial level in Germany.

Ignazio Visco, Deputy Director-General of the Banca d’Italia had a different perspective. “We are having so many problems because we have an election every other week in Europe,” he said. “This is democracy but it delays reforms.”

Market discipline

Another major issue which roundtable participants discussed was the role of markets. Visco noted that markets have been criticised as too slow and weak, or too sudden and disruptive. His solution was greater market discipline. Visco would impose stricter market oversight and organise procedures to make re-structuring more likely and quicker. He also pointed to the link between sovereign risk and bank risk since the interconnection between the two is what really makes the crisis potentially disruptive.

Bowles pointed out, however, that every single measure that has been taken to address the sovereign debt crisis was forced by the markets. “Instead of regarding the market as an enemy, we should harness market discipline for the good,” she said. “We did so at the last minute whereas it would have been better to take these actions earlier.”

Participants noted the tendency of markets to overreact or overshoot, however. Padoan put it down to rapid change. “Discipline works in normal times,” he said. “It doesn’t work when times change and there’s an acceleration that markets don’t understand.” Padoan wondered whether there might be scope for putting firewalls in financial markets that “do too many things under the same chapeau”. He noted that conflicting national interests might make this difficult, however.

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The country’s low debt levels were a blessing when the financial crisis hit.

“If in debt you are not free,” is an expression attributed to Göran Persson, Sweden’s former prime minister, though Stefan Ingves, Governor, Sveriges Riksbank, Sweden’s central bank, used it to open his keynote speech to the Brussels Economic Forum.

He wanted to emphasis the hard work undertaken by Sweden over the last decade – a sustained effort that helped reduce the debt to GDP ratio from 56% in 2000 to 35% today.

GDP fell more than 5%

Sweden’s open economy was susceptible to external shocks and therefore suffered as much or even more than most when the financial whirlwind hit in 2008. The following year, GDP fell by more than 5%, the largest fall since the 1930s. Sweden is a “small open economy that exports roughly 50% of GDP,” said Mr Ingves. “Whatever is flying around outside shows up on your doorstep.”

But the low debt ratio helped the country rebound just as quickly. Robust exports helped stablise the economy when world trade recovered. “If you look at the bounce back you will see it has been remarkable,” said the governor.

More importantly, the country’s strong finances meant there was less need for belt-tightening after the crisis hit. In the lead-up to the crisis, while many governments in the euro area were running budget deficits of 2% on average every year, Sweden was running a surplus of over 1%.

No boom-bust housing cycle

Sweden had other advantages too. There was a high level of household saving and no boom-bust cycle in the housing market - the crashes in property prices that took place in other countries ended up weakening public finances further.

“But that doesn’t mean there was nothing to learn,” Mr Ingves said.

There was a realisation that Sweden’s banks were heavily reliant on international funding. “Whatever Sweden’s banks do in other parts of the world – that will affect the entire economy.” This was made apparent by the exposure of Swedish banks to economies in the Baltic, where “things were going wrong”. This has left the impression that the Swedish banking system should have discouraged the tendency in the Baltic to take out loans in foreign currency. “We could have done better if we had stepped in earlier,” said Mr Ingves.

Sweden has nevertheless pulled through. “The exit has been executed. It’s done. It’s doable.” said Mr Ingves.

In retrospect of course, things could have gone better. The legislative measures Sweden had put in place after the previous crisis of the 1990s had all expired. “This was no good,” the governor told the Forum. Fortunately, “there were a few old-timers around like myself so we knew where to start.”

There was also a realisation that the Swedish deposit insurance scheme had been “dysfunctional” because it took “nine months for people to get their money”.

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Panelists analysed the impact of the crisis and the proposed reforms on EU citizens.

The final panel discussion of the 2011 edition of the Brussels Economic Forum focused to a large degree on the political legitimacy of the proposed economic governance package.

Panelists, on occasion encouraged by lively questions from the forum floor, asked hard-hitting questions to policy-makers and questioned the very premises of long-established EU principles such as solidarity among Member States.

A somewhat speculative venture

Geoffrey Heal, Professor of Finance & Economics at Columbia University, started out on a controversial note: “The eurozone was a somewhat speculative venture,” he said. In setting up the common currency with a common bank but no common fiscal policy, the EU was “taking a risky step”.

Professor Heal’s main point concerned the public reaction to the proposed economic package, which will undoubtedly lead to deeper European integration. “Will it be politically acceptable in the Member States?” he asked. “It will lead to much greater intervention. There is already a certain degree of resentment at the reach of the European Commission.” He continued: “We are being told that to make economic integration work we need political integration – but are eurozone members ready?’

The new emphasis on balancing Member States’ budgets over the economic cycle was laudable, but would it work? Similar polices were applied the UK without success, he said: “there is a temptation to look at upswing as the trend and the downswing as the cycle”.

Doubts were also expressed over the proposed reverse qualified majority vote (QMV) requirement that, according to the proposal, would help the European Commission apply strict sanctions to transgressors even when faced with opposition from national capitals.

Euro-skeptics could take advantage

The proposal could be interpreted the wrong way, as a means to stifle debate, it was claimed: “what is wanted from EU citizens is more discussion not less”. Euro-skeptic politicians could take advantage of such proposals by putting a “reverse slant” on them.

European Commission director Lucio Pench defended the reversed QMV proposal. It was a “simple device to make sure rules that in principle have already been agreed – are applied”, he said.

David Begg, General Secretary, Irish Congress of Trade Unions, reminded the Forum of the human toll the crisis had taken.

“For most people the consequence is a loss of personal economic security,” Mr Begg said. “People are afraid of losing their jobs, afraid of losing their homes, afraid of losing their pensions.” He continued: “And despite the hardship they are enduring they see little by way of real reform of the European financial system.”

Panelists tackled the issue of blame. “There were very serious policy failures in Ireland and the last Government paid a high electoral price for that,” said Mr Begg. But he wanted at the same time to lay some responsibility at the door of the EU institutions. With monetary policy dominating, interest rate policy that suited France and Germany proved pro-cyclical for Ireland and unsuitable.

The EU and the ECB, who were together “dictating the terms of our existence”, were “not without responsibility”, he said.

As far as Ireland and other troubled EU periphery Member States are concerned, these claims begged the question: what next?

A debate over Ireland animated the audience. To what extent had EU structural funds contributed to the Irish economic boom? Are interest rates charged to Ireland for its financial bailout fair?

The US perspective

There was also a US perspective. Mickey Levy, Bank of America’s chief economist, said it was “very important to distinguish between bad policy and under-regulation.” This was a reference to the US housing crash that precipitated the financial crisis.

“Watch out for seemingly unsustainable trends. They’ll eventually end,” he warned, while admitting that it was not always easy to spot such trends. “With very few exceptions executive management in the US did not understand the risks” they were taking or even in some cases the acronyms of the financial products they were using, Mr Levy reported. He stressed the importance of sound fiscal policies at the national level. Fiscal austerity was imperative, but this could be combined with growth-enhancing structural mesures such as encouraging foreign investments. His advise to Europe was practical and no-nonsense: “economic policy must be sound”; “losses have to be absorbed”; “regulatory apparatus must be appropriately structured”.

Mr Pench said humility was one of the main lessons he took from the crisis. “One should learn humility,” he said. “You cannot avoid crises. What you can do is to increase resilience of your economy to crises so that you avoid the worst.”

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