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New strategic approach to growth in Europe

Eugene Eteris, European Studies Faculty , RSU, Riga , 22.11.2011.Print version
At a recent research conference, Olli Rehn, Vice-President of the European Commission and member of the Commission responsible for Economic and Monetary Affairs and the Euro delivered a speech “Europe's quest for growth: which way forward” (Brussels, 21 November 2011, SPEECH/ 11/772). The Commissioner underlined some new growth perspectives for the European Union and the member states.

In discussing new growth models for Europe, the Commissioner pointed out both at the necessity and urgency of crisis management, as well as at more important issues, i.e. designing and pursuing policies to lift sustainable economic growth in Europe.


New strategic policy points

The steady although modest economic recovery experienced since around mid-2009 has recently stalled in the EU. The proximate cause has been the turbulence in the euro area sovereign debt market, contributed with the global slowdown activity. As a result, no real improvement is projected to take place next year in the labour markets, and the economic standstill is also bound to slow down the improvement of public finances.

 

Some tend to interpret the slowdown as evidence of misguided macroeconomic policy: the EU has pursued excessive austerity which is now hitting back; the Commissioner disagrees with this diagnosis.

 

The EU fiscal strategy has been gradual with differentiated consolidation across European states; fast consolidation has been demanded only from the states under market pressure.

 

“The fundamental reason for the turbulence in the sovereign debt market is that there is not trust in the market that some highly indebted member states can service their debt. The centre of the turbulence is Greece, but some other member states have been affected too”, said the Commissioner.

 

If a country is excluded from the bond market or is required to pay unsustainable interest rates for its borrowing because of high debt, there is no real alternative to fiscal consolidation.

 

The Commissioner underlined three main aspects in the “new approaches to growth”:


First, elaborating perspectives for robust growth in order to solve the current sovereign debt problems in a lasting and durable way.

 

Second, growth is a paramount factor for the EU citizens’ needs; in particular, the most vulnerable people depend most strongly on what only sustained, healthy growth can provide: jobs, essential public services, and social security.  

 

Third, dynamic and growing economy is needed for Europe, otherwise the region would be subject to global risks, which would lead and further amplify economic decline.  

 

One simply cannot build growth strategy on accumulating more debt, when the capacity to service the current debt is questioned by the markets. One cannot force foreign creditors to lend more money, if they don’t have the confidence to do it.

 

Greece's dire situation is not due to excessive consolidation. At around 15 % of GDP so far, the fiscal effort is big, but no bigger than that of Latvia (16 %) and only slightly bigger than the Irish effort (12 %). Both Latvia and Ireland are on the path of recovery. It is also instructive to note that the bulk of Latvia's GDP decline of 22 % from the peak took place in the spring of 2009, i.e. before the major budget cuts.

Reference:  SPEECH/11/772, Date: 21/11/2011

 

In addition to the high debt level to start with, the key problem of the Greek economy is its currently limited capacity to create a strong prospect of medium-to-long-term growth. In the package of 26/27 October 2011, the debt challenge is being addressed quite decisively. The focus must now be on both continuing the fiscal effort and intensifying the implementation of such structural reforms that can boost higher growth and job creation. The Commission’s Task Force is coordinating technical assistance for Greece with these objectives in mind.

 

Improving the growth potential is a key to solving the economic and social challenges in most EU member states that are currently under market pressure. It is not a substitute for fiscal consolidation, but a necessary complement, the Commissioner added.


Conditions for sustainable growth

Given the need to consolidate public finances and – in several countries – the continuing deleveraging in the private sector, short-term growth depends essentially on the prospects of exports and productive investment. The immediate questions thus would seem to be how to boost exports and improve the investment climate; therefore, according to the Commission, throwing a lot of public money at the problem is not an alternative.

 

A proper answer to this will be pretty much the same as to the question of how can we in general create the right framework conditions for sustained growth and competitiveness, irrespective of which demand components are making growth to materialise.

 

A basic equation of national accounting in the dismal science tells us that GDP growth is the sum of the growth of labour input and the growth of labour productivity. Given that per capital labour input is bounded from above, and with our demographic trends very strictly bounded as well, in the long term all growth must come from improved productivity.

 

Therefore, the discussion about our medium-to-long-term growth is obviously a discussion about improving productivity.

 

“But this should not lead us, argued the Commissioner, to think that labour input, and in particular the employment rate, would be unimportant. Given the low level of employment in many EU member states, there obviously is large potential for a level jump in GDP per capita, if we only can mobilise the unused labour resources”.

 

Attention to employment is important also for another and very obvious reason: it is very difficult to see how the fruits of stronger economic activity could be fairly distributed without a high employment rate. While a decent and fair distribution of income could be a valuable objective as such, the perception that all get a fair and decent share of the bigger cake is also essential for the political support, which is necessary for growth-enhancing policies, the Commissioner added.


Achieving high labour utilisation rates and high productivity growth

The recent turmoil in Europe underlines the importance of stable macro-financial conditions. It is clear that in the current environment making long-term commitments is unattractive, be it hiring or investment decisions by firms, big-ticket purchases of households, or education efforts by individuals.

 

Therefore, restoring stability is a sine qua non for any meaningful policy for growth; it is encouraging to see that restoring stability is on the way to succeed in some of the most badly hit EU economies, which is also showing up in growth performance, e.g. in Ireland, Latvia and Estonia.

 

But, in parallel, the EU has to work on the key growth drivers. It is pretty well know what is needed with regard to the labour input: flexible wage formation, mobility of labour across sectors, occupations and regions, good basic education combined with life-long learning, avoidance of excessive tax wedge, sufficient incentives for the unemployed to seek employment, pension systems that discourage early retirement etc.

 

Many of the reforms needed in this area are politically difficult. For the sake of fairness, it is important to limit the distributional impacts; The EU member states need flexicurity, in one form or another, assessed the Commissioner.  

 


Good examples

Moreover, it is essential to be able to demonstrate that the medicine helps: there are good examples in this area as well.

 

The improvement of the Dutch labour market since the mid-1980s can rather directly be linked to changes in policy: wage moderation, and reforms to add flexibility in many dimensions of the labour market, preceded the reduction of the unemployment rate down by 7,5 percentage points from 1982 to 2000.

 

More recently, the strong employment and growth performance in Germany, following the labour market reforms and enhanced wage moderation initiated a decade ago, tells a similar story. Interestingly, the positive trends in German employment have not been associated with a weaker productivity performance.

 

As far as product markets are concerned, the literature underlines the importance of competition to eliminate inefficient production and to spur innovation. According to DG ECFIN model simulations, implementing a list of specific single market reforms would increase EU GDP by over 3 % by 2020. About half of that would come from the completion of the implementation of the Services Directive.

 

Capitalising on the EU large internal market potential is particularly attractive in the current context, as it will not require additional public expenditure, but rather produces savings, e.g. by making better use of the EU-wide markets in public procurement.

 

A determined push to complete the single market agenda remains a Commission’s priority. At the initiative of Michel Barnier (Internal Market), the Commission adopted in April 2011 the "Single Market Act", which spells out 12 concrete policy initiatives to that effect. The Commission works presently on making sure that these initiatives are turned into reality.


Enhanced innovation

While considerable potential for further catching up remains Europe’s headache, pushing the technological frontier further is important too. Increased competition, education in world-class universities, and strong R&D investment especially in the private sector, all these play a vital role to close the innovation gap vis-à-vis Europe's leading global competitors.

 

It seems that in many cases an overhaul of the innovation system as a whole is required for better results, added the Commissioner.

 

Fragmented markets are a barrier in this area as well. Moreover, while some of Europe's "ollies" appear to be doing fine ("ollies" means old leading innovators in established sectors) to nurture the "yollies" in innovation (means new or “young” sectors such as ICT, bio-technology or medical services) is of particular importance. In this sphere the EU is badly lagging behind the US.

 

However, encouraging and enhancing innovation is not enough. It is also essential to ensure that innovation can be brought to the market by providing an environment that not only enables entrepreneurial risk-taking, but also rewards it better. Creating such an environment calls for continuous efforts to make business regulations as lean as possible, without sacrificing their legitimate societal objectives. It also calls for overcoming the hurdles that start-ups face in accessing adequate finance.

 

In the “growth drivers”, the Commission’s emphasis is on improving the functioning of the markets, on the provision of public goods like stable macro-financial environment, and on inputs into the innovation process, mainly by financing and organising education and research.

 

Industrial policy in the sense of the government favouring certain "strategic" sectors by subsidies and/or regulatory measures has been out fashion for quite some time, argued the Commissioner, as trying to "pick winners" has not given good results. And, of course, the dire budgetary situation limits the possibility of subsidisation.


However, it seems that there is some new interest in the concept of industrial policy. The Commissioner mentioned the research entitled “Rethinking industrial policy" by Philippe Aghion and his colleagues (Bruegel Policy Brief, June 2011).


Conclusion

It is to be noted, said the Commissioner that “we are still very much in the mode of crisis management in Europe. Restoring macro-financial stability is the first priority, and fiscal consolidation is a key element of that policy. But, at the same time, we must push for measures that enhance our growth potential. That will be the underlying theme in the second Annual Growth Survey, which the Commission will adopt on 23 November.

 

For the Commission to succeed in these efforts, the contribution of the research community is very important. Evidence-based analysis – whether it confirms the received wisdom or challenges it – is most welcome in developing appropriate policy designs and responses. 






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