The euro and a social Europe
Speech delivered by Dr. Willem F. Duisenberg, President of the European Central Bank, at the congress of the Bundesvereinigung der deutschen Arbeitgeberverbände (BDA) [Confederation of German Employer Associations] in Berlin on 23 November 1999
Ladies and gentlemen,
It is a great pleasure for me to be here in Berlin today and I should like to congratulate the BDA on its fiftieth anniversary. The BDA has, for the past fifty years, played a leading role in German and European politics, and not only with regard to wage policy. I am convinced that the BDA will, and should play an equally important role over the next fifty years and beyond, for the benefit of employers and employees. I should like to wish Dieter Hundt and all the members of this association every success.
On 1 January 1999 the euro became a reality. This was a historic moment, as it was the first time in monetary history that sovereign states had replaced their national currencies with a common currency and transferred their monetary authority to a newly established supranational institution. However, the launch of the euro, historic as it was, did not constitute a one-off event. In fact, it is the longer-term dynamics of Economic and Monetary Union (EMU) which represent the great challenge for the years to come. The reduction in unemployment is the major challenge currently, and for the foreseeable future, facing most euro area Member States, and the larger ones in particular. A significant and lasting reduction in unemployment would clearly be a major economic milestone for a social Europe. Unemployment is a waste of resources, leaves human potential unused, is a source of frustration and ultimately undermines the stability of our societies. In a narrower vein, the existence of a high level of unemployment may also hamper the conduct of monetary policy. It can all too easily lead to calls for an expansionary monetary policy as a solution to a problem which monetary policy cannot solve. The central bank can become the scapegoat for failure to take action in areas where it is, in fact, others who need to take action. Making markets more adaptable is also necessary for the success of EMU. Only flexible markets will be able to cope with the asymmetric shocks which can sometimes affect the individual members of a monetary union. The policies needed to make EMU work are, at the same time, essential for reducing unemployment.
In my comments today, I shall first briefly elaborate on the short-term prospects and medium to long-term challenges facing the labour market in the euro area. I should then like to deal with the role of monetary policy, and subsequently with the policies other economic agents need to pursue to enable Europe to exploit its full economic potential for the benefit of its citizens.
2. The labour market in the euro area: prospects and challenges
Net employment growth in the euro area has, over a longer period of time, been insufficient to bring about a significant and lasting reduction in unemployment. Unfortunately, the 1990s have been no exception to this rule. Employment in the euro area declined sharply in the early 1990s, and increased only moderately during the mid-1990s. The acceleration in employment growth seen in 1997 and 1998 is generally thought to have been losing some of its momentum since the beginning of this year owing to the slowdown in economic growth in the euro area in the aftermath of the emerging markets crises. Today, in the EMU Member States, an estimated 13.1 million people are looking for employment. This represents about 10.2% of the workforce and does not even include anyone who may have given up looking for a job or who never tried.
Fortunately, a recovery is now under way. Many leading indicators point towards an acceleration in growth in the euro area during the remainder of this year and into 2000. Forecasters in both private institutions as well as institutions like the IMF and the OECD have recently been revising their growth forecasts upwards, and the consensus now seems to be that real GDP growth in the euro area will increase from around 2% this year to almost 3% in the year 2000. This should also lead to a cyclical increase in employment growth in the euro area. The challenge faced by policy-makers, but also by entrepreneurs, at this juncture, is to ensure that the cyclical recovery is the beginning of a long period of growth without inflation, thereby creating many more jobs and effectively tackling the unemployment problem.
As you all know, for a realistic assessment of the labour market situation, it is important to bear in mind that unemployment in the euro area is, predominantly, of a structural rather than a conjunctural nature. While there has been some cyclical variation in the average European unemployment rate, there has also been an upward trend, and the rate appears to have risen with each passing cycle. Moreover, if one examines the duration of unemployment, it is immediately apparent that Europe's unemployment problem is principally one of long-term unemployment. Long periods of unemployment are often associated with a loss of skills and thus a severe decline in re-employment prospects. According to OECD figures, around half of the unemployed in Europe have been out of work for at least a year, while the corresponding proportion in the United States is less than 10%.
This is a fiftieth anniversary, and I do not want to sound pessimistic on such an occasion. Europe can achieve a lasting and significant reduction in unemployment, and become a dynamic economy while remaining a social economy. The root causes of the unemployment problem need to be addressed, and not only the symptoms. The root causes of high unemployment in the euro area are structural rigidities in the labour and product markets as well as tax and public transfer policies. A good dose of, by now, well-known remedies to get rid of these recurring illnesses could improve the conditions for entrepreneurs and enable them to do what they are really good at: enterprise. Policies have to create the right conditions, but real growth and new jobs have to come from entrepreneurial activities.
3. The role of monetary policy: maintaining price stability
There are a number of benefits associated with the introduction of the euro, which should help the euro area achieve higher growth and lower unemployment. EMU has eliminated nominal exchange rate volatility, exchange risks and the transaction costs for exchanging different currencies within the euro area. This prevents a misallocation of resources, and hence fosters growth. The single currency will make prices across the euro area directly comparable, which should increase competition and therefore efficiency and growth. Yet another benefit is the potential for the reduction of risk premia built into real interest rates and for the elimination of premia resulting from less liquid markets. This will stimulate investment, and again foster growth. However, the euro is not and cannot be a cure for structural problems facing Europe. In particular, the introduction of the euro alone will not solve the unemployment problem and automatically increase the long-term growth potential. The degree to which the economic potential of the euro is exploited indeed depends first and foremost on stability-oriented fiscal policies and appropriate labour market policies, as well as on decisive and comprehensive efforts to eliminate structural rigidities in labour and product markets. The single monetary policy can, however, provide a sound basis for economic growth and employment. Let me start by dealing with monetary policy.
Among central bankers and economists, the overwhelming consensus is that there is no long-run trade-off between real activity and inflation. Attempts to use monetary policy to raise real economic activity above its sustainable level will, in the long run, simply lead to ever higher inflation, and not faster economic growth. The best contribution which monetary policy can make to sustainable growth and employment in the euro area is to maintain price stability in a credible and lasting manner, thereby allowing the considerable benefits of price stability to be reaped over the medium term.
A recent study published in the November issue of the ECB Monthly Bulletin once again confirmed that price stability is essential as a foundation for strengthening output and employment prospects and thereby creating lasting improvements in living standards for Europe's citizens. When price stability prevails over the medium term, the relative price signals upon which the market mechanism relies are not obscured by changes in the general price level. The market is, therefore, able to allocate scarce resources more efficiently to their most productive uses. The costs that inflation would otherwise give rise to, by exacerbating the distortions in tax and welfare systems, are avoided. As has been seen since the mid-1990s, the credible creation of price stability throughout the euro area has helped to reduce uncertainty with regard to future price developments, and has thereby reduced the inflation risk premium in long-term interest rates. This, in turn, improves the financing conditions for investment, helping to avoid arbitrary redistribution of wealth and income, and thereby improving overall economic welfare. Through these and other channels, the current environment of price stability is contributing to the growth and employment potential of the euro area. I should like to mention the fact that price stability, apart from its effects on growth, also has a direct social impact. Low-income households gain more from price stability in relative terms, because they tend to have a higher consumption-to-income ratio than high-income households, and because they have less potential for protecting themselves against future inflation risks.
It is also generally acknowledged that monetary policy does, indeed, affect real activity in the short run. Although the focus must always be on price stability, in many cases, the policy measures required to maintain price stability also help to sustain short-run economic and employment prospects. This is the case when inflation, on the one hand, and economic growth and employment growth, on the other, move in the same direction, i.e. they all increase or decrease. However, in situations where monetary policy faces a short-term trade-off between adverse developments in real activity and deviations from price stability, the overriding priority assigned to maintaining price stability must be made absolutely clear. Any ambiguity on this point will simply jeopardise the credibility and, therefore, the effectiveness of the monetary policy response.
The interest rate changes in the Eurosystem during the course of this year are cases in point. Let me start with the reduction in the Eurosystem's main refinancing rate on 8 April. Following the Asian and Russian financial crises last year, global demand weakened. Weaker external demand led to a shift in the risks to price stability in the euro area towards the downside, as demand pressures abated. At that time, the latest three-month moving average of annual M3 growth (for the period December 1998 to February 1999) stood at 5.1%. As this figure may have been affected by the unusual environment at the start of Stage Three of EMU and as it was still close to the reference value for M3 growth of 4.5%, the Governing Council did not see any inflationary risks in monetary developments in April. Therefore, with both pillars of the ECB's strategy in mind, in April the Governing Council of the ECB concluded that a rate cut of 50 basis points in the main refinancing rate would best serve the maintenance of price stability, thereby also supporting employment and growth.
The main argument for the Governing Council's decision to increase interest rates on 4 November was the fact that since around the beginning of the summer the balance of risks to future price stability had gradually been moving towards the upside. In fact, the economic situation is now far more favourable than in the spring. Moreover, the steadily increasing deviation of M3 growth from the reference value, the strong demand for the most liquid components of M3 and a continuing rapid expansion of credit to the private sector indicate a generous liquidity situation in the euro area. Inflation rates are expected to increase gradually in the months ahead, mainly as a result of the increase in energy prices earlier this year working its way through to consumer prices. The latest data on industrial prices confirm this pattern. Over the medium term, however, it is important to prevent the availability of ample liquidity from translating into upward pressure on prices. In particular, an increase in interest rates now should help to counteract further liquidity growth over the medium term, and contribute to maintaining inflation expectations safely below 2%. This increase in interest rates will not jeopardise the acceleration of economic growth. By contrast, a timely increase in interest rates will prevent the need for a greater increase in interest rates later on, and will hence contribute to stronger growth over an extended period of time.
4. The role of national governments: heading towards stability and structural reform
The full benefits of the single currency will only develop if there is appropriate support from a variety of other policy areas, above all national fiscal and labour market policies, and if structural reforms are carried out in these areas. Price stability is a necessary, but not a sufficient condition for exploiting the full potential of EMU.
What role can national governments play in responding to short-term imbalances, now that monetary policy has been centralised? A very important one. In fact, I am convinced their role has even become more important since monetary policy and the exchange rate are no longer conducted at the national level. It is of the utmost importance that national governments continue to implement fiscal policies which aim for a budgetary position close to balance or in surplus, as stipulated in the Stability and Growth Pact. If governments achieve balanced budgets or surpluses during normal periods of the cycle, they create a safety margin which is sufficient to enable automatic stabilisers to operate in the event of fluctuations in growth without generating a risk of excessive deficits. Moreover, sound government finances are important for improving the conditions for price stability and for the strong and sustainable growth needed to support employment growth.
The problem, at this juncture, is that in the euro area as a whole we have not yet reached the target of balanced budgets under normal cyclical conditions. In a number of countries, and again the larger ones, in particular, deficit-to-GDP ratios remain too close to the 3% threshold laid down in the Treaty as a reference value for excessive deficits. The need for sustained fiscal consolidation seems to have been acknowledged across the euro area. On average, however, recent fiscal consolidation in the euro area has been rather disappointing. A significant increase in overall deficits, for instance in response to a decline in real GDP growth rates, could reverse the progress we have seen in recent years in reducing deficit-to-GDP ratios across the euro area. Moreover, in the case of a prolonged slowdown in growth, it is quite possible that deficits could rapidly reach excessive levels, at least in some countries.
Fiscal consolidation would not only contribute to achieving a social Europe as a result of the effects on price developments and growth. Fiscal consolidation could also provide scope for reassessing the role of government and changing the structure of public expenditures. At this point, it is important to note that a social Europe is not synonymous with increased welfare state expenditure. A social Europe would enhance equality of opportunity and the productive potential of all Europeans. In addition to a social safety net, this means a well-functioning infrastructure and high quality education systems. Unfortunately, the increase in public debt has often crowded out precisely this type of expenditure. In addition, high debt and less productive spending has resulted in high taxes, which often affect even very modest incomes in view of high marginal tax rates. A more social Europe would also address this dimension of fiscal consolidation.
Another extremely important area where national flexibility is needed is in relation to structural policies. In fact, many of the major challenges which the euro area countries currently face, can only be addressed by national policies. In particular, this is true for the high and persistent level of unemployment. The need for structural reform is widely recognised, and some progress has already been achieved in certain Member States.
There are many examples of what can be done. First, there are measures to ensure that low-productivity employees are not forced out of the labour market. To this end, the burden of taxes and non-wage labour costs could be reduced in respect of low-paid workers. In addition, minimum wage schemes could be adjusted to take account of the need to preserve jobs for low-productivity workers. Second, there are "active labour market measures" which provide programmes of education, training and work experience targeted at the long-term unemployed. Third, reforms of the tax and benefit systems could be implemented to ensure that people are significantly better off in work than out of work.
I should like to emphasise the fact that the structural reform agenda available to national governments to promote economic development goes well beyond the reform of labour markets. For example, national governments can take steps to promote entrepreneurship and make it easier for people to start and run businesses and thus create new jobs. This could involve encouraging competition through measures to promote the establishment of new firms, such as reducing the administrative burdens they face and making markets more competitive. Governments can also liberalise sectors which used to be highly regulated, such as utilities, to increase efficiency and reduce prices for the benefit of industrial and household users of these services. National governments may also wish to take steps to raise productive investment in research and development so as to increase growth in expanding high-tech industries.
5. The role of social partners
While addressing this audience, I should also like to elaborate, from a central banker's point of view, on the role social partners can and must play in EMU in order to foster growth, improve employment prospects, and hence achieve a more social Europe. Social partners are responsible for reconciling high employment with appropriate wage settlements and for setting up a suitable institutional framework for the wage formation process, supported, where appropriate, by public authorities. I should like to emphasise the fact that the role of social partners within EMU will be even more important than before, because the link between wages and employment will become even more apparent and even closer.
Generally speaking, it is of the utmost importance that wage cost developments in Member States are allowed to reflect different economic and employment situations. The current situation with regard to growth, unemployment and inflation differs, indeed, within the euro area. But while this is not in itself a problem, it should be clear that a "one-size-fits-all" wage policy would be fatal. Moreover, social partners should take into account the needs of both "insiders" and "outsiders"; wage settlements which only reflect the interests of the employed may result in a wage level which is too high to enable the unemployed to find work. In order for wage developments to contribute to employment-friendly policy-making in the euro area, the social partners would be well advised to pursue a course which is in line with the following general principles as discussed extensively in the "Broad guidelines of the economic policies of the Member States and the Community".
To start with, nominal wage increases in euro area Member States must be consistent with price stability, so that in the euro area aggregate wage increases will be consistent with keeping price increases in line with the price stability objective of the ECB. The Governing Council of the ECB defines price stability as a year-on-year increase in the Harmonised Index of Consumer Prices for the euro area of below 2%, and this should serve as the benchmark for social partners. Second, real wage increases in relation to labour productivity growth should take into account the need to strengthen, where necessary, and subsequently maintain the profitability of capacity-enhancing and employment-creating investment. In principle, real wage increases in line with productivity gains would ensure that there would be no upward pressure on unit labour costs. Third, in order to improve employability, wage agreements should take into account differentials in productivity levels and growth rates according to qualifications, skills and geographical areas. Finally, it will be of crucial importance to avoid a convergence of nominal and real wages across countries and regions in advance of productivity; therefore, wage imitation effects should be avoided. Labour cost differences between Member States should continue to reflect discrepancies in labour productivity.
The introduction of the euro and a common monetary policy have certainly not rendered national governments impotent. With scope to vary fiscal policy and undertake structural reforms, national governments still have the key powers to improve the performance of their economies. If the terms of the Stability and Growth Pact are adhered to, there will be sufficient flexibility to allow automatic stabilisers to work in the event of cyclical fluctuations.
Together with the social partners, governments have a key responsibility to act decisively in order to ease the unemployment problem in Europe. Structural reforms provide the only means of achieving lasting reductions in unemployment, of preparing for the ageing of the population and reducing the burden of government debt. The social partners will remain, principally, responsible for achieving and maintaining high rates of employment, and the link between wage settlements and employment will become even tighter.
I recognise the fact that balanced budgets, structural reforms, and appropriate wage policies are not always easy to implement. The benefits are often enjoyed in the medium term, while short-term costs affecting some groups may mean that reforms are vigorously opposed. However, experience within and outside the euro area shows that reform programmes coupled with appropriate wage policies do have the potential to substantially improve the labour market situation. Some euro area Member States, so far notably the "smaller" Member States, and particularly those with more flexible labour markets, more moderate wage increases and better tax and social security policies, have managed to avoid the trend of ever-increasing unemployment. There are also examples of other countries with higher unemployment rates which have begun to take steps to reform their labour markets and are now beginning to see tangible results. Some of the non-participating EU Member States have also demonstrated that high unemployment can be reduced through radical reforms.
To conclude, I am convinced that EMU provides a great opportunity to create and maintain a large area of price stability and economic prosperity in Europe, as well as a substantial reduction in unemployment. However, while price stability is a necessary condition in order to fully exploit the opportunities of EMU, it is not sufficient. Stability-oriented polices on the development of national fiscal positions and structural changes to improve the functioning of markets are of crucial importance as well. Policy-makers in all areas must take the new environment facing EMU and its consequences into account accordingly when formulating their policies. Only then will the euro be able to function as a true accelerator of economic growth, and thereby contribute to a social Europe.