The New Economy - a European view
Speech by Professor Otmar Issing, Member of the Executive Board of the European Central Bank, National Conference CBI 2000, Birmingham, 7 November 2000
I am very pleased to have the opportunity to speak here in Birmingham today. It is a pleasure to address so many of the business leaders operating in the British - and, of course, by implication the European - economy.
At the start of a new century, we are all witnesses to remarkable, ongoing and apparently accelerating economic change. The economic landscape in Europe has been transformed by the introduction of the single currency and the creation of a new European Central Bank (ECB), firmly oriented towards the maintenance of price stability. This development has acted as the catalyst for a further round of institutional and economic change, with profound implications for the business environment. At the same time, I - and I am sure many of you - continue to be astounded by the pace and depth of technological change, which - although perhaps not as evident yet in Europe as in the United States - has the potential to transform many aspects of economic and business performance.
In my remarks today, I would like to discuss the new economic opportunities being created in the euro area by these ongoing developments. I will distinguish two aspects. On the one hand, the implications of technological advances in information and communication technology - in other words, the potential emergence in the euro area of a New Economy as the term is conventionally understood. On the other hand, the powerful dynamic forces unleashed by Monetary Union - effects, which one could label a new European playing field. While hard evidence of the former is, as yet, relatively modest in the euro area, there can be no doubt that the impact of the latter has been - and continues to be - profound.
The new European playing field
Information technologies have fostered an enormous and quite unprecedented capacity for businesses and individuals to capture, harness and disseminate information. This has bred many new opportunities for businesses to expand both the range and the value of their products. When evaluating the impact of these developments on economic performance, even the most cautious commentators have reached the conclusion that the implications are - potentially at least - profound. Overcome with enthusiasm, other observers have even entertained theories of a new economic and social paradigm, announcing the dawn of a new era.
While we should be careful not to succumb to such hyperbole, nobody among us, I believe, can afford to turn a blind eye to what is happening. This immediately raises the question of whether the European economy - and Europe's society in general - is prepared to exploit and benefit from these new emerging technological, economic and social trends. Is Europe equipped to address the challenge posed by such continuous - and sometimes fundamental - change? Will European institutions be flexible enough to accommodate the new developments and foster the innovative energies in Europe? Will policy makers - often accustomed to an environment of regulation and protection - be able to create the framework within which a New Economy can become a powerful engine for economic growth?
I often hear the answer "NO" to the questions I have just raised, in particular with regard to the euro area. After all, statistics indicate that Europe is trailing somewhat behind the best performer - the US - in the production and adoption of new technologies, although the pace of advance in several euro area countries is impressive. On average, there is as yet little hard evidence that Europe's economy is already shifting into an extended period of more rapid expansion. Although it might be the case that the forces of change are already discretely operating in the background, it is still unclear whether a genuinely New Economy - as the term is understood on the other side of the Atlantic - has emerged in the euro area.
This notwithstanding, I am nevertheless increasingly optimistic about long-term economic prospects within the euro area. The euro area has the potential to grow faster than in the past, although perhaps in part for reasons other than those typically attributed to the so-called New Economy. My optimism is grounded in the transformations I have seen during recent years, following the creation of the single market. The successful establishment of a new single currency and of a new Central Bank - which together have created a new economic entity comprising some 300 million people - are, I maintain, compelling testimony of the ability not only to face, but rather to embrace and even accelerate change. The euro area has created an entirely new economic environment - often amidst scepticism, criticism and adverse external circumstances. This is a significant contribution to furthering the new economic dynamism. It is an undertaking that is truly historical. It is the essence of what I would like to call a new European playing field, which arrived on 1 January 1999 - the day the euro made its debut as Europe's new single currency.
Regarding the sheer size of the new economic area, it is fair to say that the introduction of the euro has also changed the face of the world economy. The euro area combined output is second only to that of the US. If it is successful in maintaining stability in a broad sense, it delivers also an important contribution to stability on a global scale.
The new institutional environment is built firmly on the principle of stability. In a world of accelerated change and therefore heightened uncertainty, the architects of the Treaty set out to establish a durable anchor to guide economic decisions, and lessen one important - and potentially disruptive - dimension of economic uncertainty, namely that surrounding the value of money. The Treaty entrusts the mandate to maintain price stability in the euro area to the ECB. To facilitate the achievement of this mandate, the Treaty has created one of the most independent central banks in the world. For its part, by assigning overriding importance to achieving this mandate, the ECB provides the environment of stable prices, which is a pre-condition for sustainable growth in activity and employment and within which a New Economy, once it emerges, can thrive and prosper.
The advantages of price stability need no qualifiers or caveats. Since ancient times, stable prices and confidence in the value of money have constituted the roots of a prosperous economy and, indeed, any successful civil society. However, in the emerging knowledge-based society, the interactions between price stability and economic prosperity become tighter.
On the one hand, easier access to real-time information can substantially increase the speed of access to - and thus the transparency of - market prices. This may curtail the pricing leverage available to producers. Overall, these effects are likely to have favourable implications for price moderation. On the other hand, in the world of high-speed communication in which we now operate, competitive forces will become increasingly intense and economic decisions have to be taken at shorter notice. The risk of misperception and misjudgement in making these decisions may rise. In such an environment, ensuring stability of the general price level and maintaining the value of money in a credible and lasting way are particularly important, since they reduce the noise surrounding the transmission and the interpretation of the information conveyed through prices. Transparent information allows the market mechanism to work efficiently and provides the environment in which entrepreneurial, risk-taking and wealth-creating activities can thrive.
Its effects on markets and policies
The introduction of the euro has made - and will continue to make - this interaction between institutions and market mechanisms more fruitful and productive. With a single currency, the forces of competition are felt more strongly. Price transparency across countries has increased, and will do so even more after the introduction of the new coins and banknotes. Both consumers and companies are becoming increasingly aware of any price differences between similar or identical products. These differences will therefore be harder to maintain - even if markets are segmented for reasons such as the particular tax system or different product specifications. Moreover, the escape route of exchange rate devaluations, often turned to in the past to temporarily restore national competitiveness, is no longer available. This adds further to the drive for efficiency at the company level.
To be sure, the increasing competition is felt in all markets - for goods, services and labour. Regarding the labour market, it is increasingly important in wage bargaining to assess the implications of wage developments for competitiveness. There should thus be a natural drive to take account of sectoral and regional differences in productivity and labour market conditions. All this is not to say that things will turn out well automatically. But it is to say that the beneficial forces of competition are being increasingly felt in the euro area.
Politics should be able to benefit from increased competition as well. The start of monetary union has created a historically unique asymmetry. On the one hand, there is a supranational European monetary regime; on the other, predominantly national sovereignty is retained in most policy areas. In this new environment, the nature of further European integration - and the pace at which it will proceed - remain to be seen. Given the importance of these issues, it is vital that this process can unfold in the most fruitful directions.
At present, there can be no doubt that, for the foreseeable future, Monetary Union will have to function without political union. Nevertheless, the introduction of the euro is already prompting Europe's politics to change at the national level.
In a rapidly changing world, implementing a grand political design for Europe as a whole would be difficult. Instead, it may be better to adopt a search process based on competition - something that would allow us to adapt to change while permitting further co-operation or even centralisation in some specific areas and retaining scope for greater decentralisation in others. Such enhanced competitive environment, along with the introduction of the euro, should be seen as fostering the search for best policies and practices.
A remarkable evolution in macroeconomic management can already be seen. The Stability and Growth Pact provides the necessary fiscal discipline. Peer pressure is also helping in this respect. The fiscal position of euro area countries could on average show a substantial improvement this year. In part, this is due to stronger growth and one-off windfall gains from mobile telephone licenses. But it is also the reward for many years of fiscal reform, which started in the run-up to Monetary Union, and which need to be continued with determination. Moreover, political leaders throughout Europe have finally recognised the need for structural measures in taxation and expenditure policies. And they have recognised the need for more encompassing moves towards a deregulation of product and labour markets. The introduction of the euro has been a powerful catalyst in this regard, since it has exposed European economies to greater competition and it has denied the option of using a cyclically-oriented monetary policy as a short-term palliative for deeper structural problems. Although most reforms have yet to be implemented, it cannot be denied that substantial progress has been made.
Of course, every wave of change creates its own powers of resistance. Attempts to harmonise policy instruments and national economic environments across members of the European Union are fruitful insofar as they are geared to preparing a favourable ground on which the creative forces of competition can operate and be fully productive. The concerted removal of certain regulations and government subsidies to businesses and households, to the extent that they can alleviate rigidities and enhance the propensity to undertake economic activities, are to be welcomed.
But attempts to harmonise policies may also be driven by a desire to repress competition. At the euro area level, these attempts seem to be inspired by the idea that policies, which are no longer sustainable in a globalised environment, can still be preserved if competition is stifled at the Community level. In this regard, however, it should be remembered that differences in national policies are needed against the background of country specific developments, institutions, and traditions. Moreover, the euro area is not operating in a world-wide vacuum. Policies have to deal with the forces of globalisation as well, regardless of whether they are at national or at Community level. In this light, one might recall Abraham Lincoln's famous statement:
"You can fool some people all of the time and you can fool all people some of the time. But you cannot fool all of the people all of the time."
Globalisation implies that the time available to policymakers for "fooling" has been shortened substantially, if not eliminated altogether.
New Economy in the euro area
I have been talking about the new European playing field, as I regard it as an important element to foster the development of a New Economy in the - dare I say - traditional sense of the concept. That is when we talk about a lasting increase in productivity growth due to the rapidly evolving Information and Communication Technologies, so-called ICT.
Although the gap with the US seems large, the new technologies are available and are being used and produced in the euro area. Available evidence suggests that investment in ICT has shown annual double-digit growth rates over the 1990s in the euro area as well, although levels are still lower than in the US. Internet use has been rapidly spreading throughout the economy in recent years. And there are leading producers of semi-conductors, mobile phones, and other ICT goods in the euro area as well. An exploitable potential is thus clearly visible.
But the increased influence of ICT in the euro area has up to now not been reflected in any significant strengthening of measured macroeconomic productivity growth, which continues around the trend displayed since the beginning of the 1980s. Thus, there is as yet no sufficiently convincing macroeconomic evidence pointing to a New Economy emerging in the euro area, although there are some microeconomic signs that the main driving force of a New Economy - namely, the spread of Information and Communication Technologies - is already starting to operate.
I think that as structural rigidities in the euro area economies are being remedied the full benefits of the new technological possibilities can be reaped over time. The introduction of new technology requires flexibility of other factors, including labour, if production processes are to be reorganised most efficiently. If there are limits and restrictions to the adjustment to the most profitable combination of productive factors, the levels of investment in the new technologies will be negatively affected accordingly. Also, euro area economies are still some way short of the standard set by the US, where a relatively large part of potentially innovative start-ups receive funding from so-called "business angels" - venture capital companies specialised in uncollateralised loans to new-comers. Thus there is no doubt that structural reforms are indeed needed to exploit the available potential fully.
There remains extensive work to be done to further improve the structural environment in the euro area. It is my firm belief that the new European playing field is to a large extent the response to the challenges posed in this respect, as it has stimulated the euro area economy towards change and improvement. The immediate challenge now facing the euro area is to continue to move in this direction and translate the current cyclical upswing into a period of sustained non-inflationary growth. This process should be driven by further determined action of various policy makers in the areas for which they are responsible. Appropriate structural reform and fiscal discipline, price stability and continued wage moderation are essential. Each of these factors will permit better exploitation of emerging technologies and economic opportunities. Following its mandate, the ECB's primary focus will remain on price stability.
You might object at this point that the weak external value of the euro stands in sharp contrast to this message. And my answer is: YES, indeed. However, I am convinced that confidence of investors in the internal stability of the euro and the positive outlook for growth - if supported by structural reform - will end the phase of undervaluation and lead to a stronger exchange rate.
A well-designed monetary policy aiming at the maintenance of price stability is the best - and a significant - contribution that we at the ECB can make to Europe's promising future.