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News : EU Economy Last Updated: Feb 9, 2010 - 5:16:28 AM


Competitiveness of Eurozone economies: Long tradition of tensions
By Michael Hennigan, Founder and Editor of Finfacts
Feb 8, 2010 - 12:42:55 AM

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BusinessEurope President Jürgen Thumann and President of the Spanish business confederation, Díaz Ferrán, met Spanish Prime Minister Zapatero, Second Vice Prime Minister and Minister of Economy and Financial Affairs Salgado Méndez, and Minister of Work and Immigration Corbacho Chaves in Madrid on February 02, 2010. Spain currently holds the EU council presidency.
Deutsche Bank Research says that in recent months, soaring government debt has shaped public debate over economic policy in the Eurozone. One often overlooked aspect is that the deficits of some countries are not only attributable to crisis-related revenue shortfalls and higher spending or poor budget policy. They are partly also due to reduced growth prospects resulting from a country’s lack of competitiveness. The differences in competitiveness are increasingly becoming a problem for EMU (European Monetary Union), especially since the gaps between the member states have grown over the past few years. Meanwhile last week, BusinessEurope, the pan-European business group representing 40 national business organisations in 34 countries, slammed governments for paying lip service to the goal of completing the European Union’s single market and for an EU budget that gives undue weight to agriculture over economic competitiveness.

On Thursday, EU leaders meet for a  special economic summit and three years after the so-called EU services directive was passed, only nine member states had made “good” progress on implementation by the December 28th deadline last year, according to Eurochambers, the association of European Chambers of Commerce. The services directive aims to make it easier for services businesses to set up in other countries: for example, by establishing a single point of contact for necessary paperwork and allowing form-filling to be done electronically. The Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, The Netherlands, Sweden and the UK have made most progress in implementation while Ireland is among the laggards with Bulgaria, Greece, Italy, Latvia, Poland, Slovakia and Slovenia. There were no data for Lithuania..

On the current problems in the Eurozone, Prof. David Cameron of Yale University, writing in the Financial Times last week, said there is nothing in the Treaty of Lisbon that gives the Eurogroup, the grouping of Eurozone finance ministers, the power to issue binding policies. And judging by the European Union’s feeble response to the current economic crisis, there is little reason to think it will be able to reduce the imbalances by co-ordinating those policies on a non-binding basis.

Cameron said the magnitude, distribution and duration of the imbalances suggest a more profound problem than the absence of co-ordination and binding policy. From 1999, when the exchange rates of the original 11 members of the Eurozone were frozen, through 2008, Germany had a cumulative surplus in intra-EU trade of more than €800bn. The Netherlands had a cumulative surplus of more than €1,000bn. Ireland and Belgium had cumulative surpluses of roughly €200bn. Those four had surpluses in intra-EU trade every year between 1999 and 2008. Spain and France, on the other hand, had cumulative deficits of roughly €300bn. Greece, which entered the Eurozone in 2001, had a cumulative deficit of €170bn. And Portugal had a cumulative deficit of €125bn. The latter four had deficits in intra-EU trade every year between 1999 and 2008.

He said the fact that the imbalances that exist today in the Eurozone have existed since 1999 suggests that, notwithstanding the decisions that they satisfied the “convergence criteria” for entering the third and final stage of economic and monetary union, the 11 original members (plus Greece) had not achieved then and still have not achieved the “high degree of sustainable convergence” required of those participating in that stage. It also suggests that the irrevocable locking of exchange rates in 1999 locked in substantial advantages in trade for some member states and substantial disadvantages for other member states.

Source: Deutsche Bank Research
Deutsche Bank economist, Nicolaus Heinen, says in a commentary published last Friday that the nominal exchange rates between the EMU member states are fixed. If individual countries want to boost their price competitiveness they cannot do so via a nominal devaluation of the currency. The alternative, at best, is via a reduction of real wages and non-wage labour costs (thereby achieving devaluation in real terms). In terms of (wage) policy, this is not always the easiest task. The elimination of the exchange-rate channel has increased the importance of non-price competitiveness. By strategically promoting technological progress and enhancing economic structures towards the production of knowledge-intensive goods and services it is possible to make export demand in key sectors less sensitive to price movements.

A third way of smoothing out differences in a monetary union is to improve the cross-border use of production factors. Supply, demand and market price could then neutralise the differing levels of competitiveness between the member states. Unfortunately, particularly the cross-border labour market in EMU is still marked by an inadequate degree of flexibility - - despite liberalisation. The lack of worker mobility, due not least to language differences, causes considerable inefficiencies.

As a result, macroeconomic tensions remain prominent. As can be seen in the chart above, the differences in competitiveness between the EMU states -- as measured by their average balance on current account - - continued to widen in the first 11 years of the Eurozone’s existence. The reason is the differing growth models in the member states which can be classified in three groups.

First of all there are countries with a high degree of competitiveness that went hand in hand in recent years with strong export-driven growth and sizeable current account surpluses. Examples include Germany, the Netherlands and Austria. With the crisis-induced slump in the world markets petering out, the outlook for these countries is positive again.

A second group is composed of countries with robust demand at home but a decline in net exports, examples being Belgium, France and Italy. Growth has been driven mainly by consumption, so the strong internal demand has cushioned the impact of the crisis. However, high wage settlements in the past have limited the ability of these countries to compete on price.

The countries in the third group are under particularly heavy pressure: they initially enjoyed a huge growth boost thanks to their accession to the single European market, but they failed to implement necessary structural reforms with the same gusto. Their growth was primarily nurtured by high capital inflows and low interest rates. However, inward investment was not always channelled into projects with the highest productivity, and high wage settlements led to a decline in competitiveness. Greece, Spain and Portugal are cases in point.

In some cases the different growth models developed over time, in others they are attributable to political errors and omissions of the past few years. Heinen says these must soon be rectified via structural reforms. However, to do so in the EMU requires a coordinated approach which includes the option of imposing sanctions. The reason is that the willingness of member states to launch reforms still varies considerably. Moreover, care must be taken to prevent negative spillovers from one country to the next.

In efforts to achieve a coordinated approach within EMU, EU legislation provides for the following possibilities:

  • The Broad Economic Policy Guidelines, established and updated annually by the Commission and Council for a period of three years, set out the priorities of economic policy for the European Union. Besides listing general priorities for the EU-27, they also define country-specific reform priorities. Member states transpose these targets into national reform programmes which they have to report on once a year.
  • The Stability and Growth Pact enables economic policy to be coordinated via two mechanisms. First, the multilateral surveillance framework ensures that eurozone countries give an account of their reform projects in national stability programmes (the other EU states table convergence programmes). If an EU member runs up an excessive government deficit it is subjected to an excessive deficit procedure that, for EMU members, may result in the imposition of sanctions. Deficit procedures are currently under way against 12 of the 16 EMU states - - in Greece’s case at an advanced stage.
  • Furthermore, the Treaty of Lisbon has created the option of tighter, sanctions-linked coordination of the Eurogroup within the framework of the Broad Economic Policy Guidelines. However, this option must still be fleshed out under secondary European law.

In the years ahead the gaps between the EU economies will need to be narrowed. This convergence in competitiveness should naturally be based on the laggards catching up with the leaders. Only then is it likely to be in the interest of all parties involved. The countries in the leading group certainly have an interest in the competitiveness gap closing again. The fear of competition is more than outweighed by the dislike and rejection of permanently higher transfers and aid for the laggards which would loom if no further action were taken. And, for the laggards too, a lack of competitiveness would mean that their growth opportunities would be limited in the long run - - and thus their ability to get to grips with the crisis-driven ballooning of government debt.

In coming weeks, DB Research plans to focus on the causes of differing competitiveness levels and their implications for the fiscal situation of the Eurozone members; in addition, it will outline potential economic policy responses.

SEE: Finfacts article, Jan 2010: Irish and Eurozone Competitiveness Indicators 1999 - 2009

BusinessEurope

Last week, BusinessEurope published its Go for Growth report.

Jürgen Thumann, president of BusinessEurope, said the EU could gain an extra €275bn-350bn a year in wealth by removing the remaining barriers in the single market. Efforts should focus on six sectors - - energy, transport, telecommunications, financial services, public procurement and restrictions on the movement of citizens from new EU member-states.

“The single market is not delivering at its full potential today,” Signhild Arnegard Hansen, head of Sweden’s business confederation, told reporters. “In the area of services, I would say the single market is not operational at all yet.”

She said business was unhappy with differences in quality between one country and another in how EU single market legislation is converted into laws at national level.

The business group said 40% of the EU's annual €140bn is spent on agriculture and only 8% on competitiveness-related projects.

Post-financial crisis economic growth rate is estimated at about 1% a year, at least half the level required to maintain the EU’s present living standards and support its welfare state.

The difference between a European economy growing at 2% instead of 1% amounts to 6.5 million additional jobs and a public debt consolidation effort of €450bn or 7% of GDP by 2014.

Jürgen Thumann said: “Go for growth is more than a slogan. It should inspire every policy decision of the European Union. Growth is a fundamental pre-condition to maintain our living standards and strengthen Europe’s position in the world.”

The report says it will not be business as usual in 2010-2014. The post-crisis world will be very different!

  • Global economic growth will no longer be mainly driven by developed countries. Emerging economies will play an increasingly important role. They will be partners but also strong competitors, even in high value-added products.
  • Supporting innovation is absolutely essential because it is the key to economic recovery, the motor to revitalise the single market and the best way to create new jobs.
  • The fight against climate change will remain at the highest level of priorities. European business has made great efforts to reduce CO2 emissions under the Kyoto protocol rules. It is committed to continue doing so. Climate change will not be solved by EU unilateral actions
    and cannot be driven only by rules. If the European Union wants to lead in the fight against climate change, it should put a much greater emphasis on technology. European companies have a lot to offer! But much more could be done with appropriate policies to address
    obstacles to innovation, skills shortages, lack of venture capital, and under-development of entrepreneurship.
  • More secure access to energy through the diversification of energy sources and consumption efficiency is also indispensable. Nuclear power, renewable energies, carbon capture and storage and other new technologies are essential to meet this challenge.

The EU Competitiveness Council said it in May 2009: Europe must develop a truly integrated industrial policy. This should be the European Commission’s priority.

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© Copyright 2009 by Finfacts.com

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