michael burda. the threat of european disintegration

1

The Threat of European Disintegration

Prof. Dr. h.c. Michael Burda, PhDHumboldt-Universität zu Berlin

Public Lecture, Eesti Pank18 August 2016

The Threat of European Disintegration 2

Overview• 2016 has been a difficult year for economic policy – but not

necessarily a bad year for the European economy • The danger of deterioration or even disintegration of the EU:

A bird´s eye view• The shadow of secular stagnation and the north-south divide • Points of light – and possible solutions


The Problem• My bachelor-level course „European Integration“ at Humboldt University

stresses economic forces behind European integration…- Autonomous capital accumulation and convergence to a common European norm- Capital mobility- Labor mobility- Trade in goods and services- Convergence of institutions, rule of law, harmonization of both macroeconomic

disturbances and fiscal policy- Political convergence in general and the free flow of ideas• …all have been thrown into reverse gear over the past year!


The ProblemEconomic Growth: • Growth has not been so low for a long time: D 2015: 1.5% • Not just central Europe – around the world, at the same time • Moveover, divergence in Europe is emerging (2015)

• Italy 0.8%• France 1.1% • Greece -0.2%• Germany 1.5%• Spain 3.2%• Ireland 7.8%

• Life-threatening in a monetary union – a persistent problem


Quelle: World Bank

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 201410000

15000

20000

25000

30000

35000

40000

45000

50000

55000

60000

Pro-Kopf BIP (Niveau), USD von 2005

France Germany Greece ItalyUnited Kingdom Spain Ireland

European Divergence: Real GDP per capita (2005 USD)


1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 201420000

25000

30000

35000

40000

45000

50000

55000

Pro-Kopf BIP (Niveau), Int.USD von 2011

France Germany Greece ItalyUnited Kingdom Spain Ireland

Quelle: Weltbank

European Divergence: GDP per capita (USD int.2011)


Quelle: Weltbank

European Divergence: Real GDP per capita (2005 USD)


The ProblemCapital mobility: • In the course of the sovereign debt crisis at the Euro-periphery

and half-hearted reforms in these countries, investment has ground to a halt – investment, that could stimulate demand and supply

• Capital flight from the crisis countries continues• Mixed with nationalist/nativist tendencies, opposition to foreign

capital is growing


European Divergence: Target-2 Balances


The ProblemLabor mobility: • The Schengen agreement was supposed to facilitate a slower

process of wage convergence, and suppress migration for all but the poorest countries

• After in-migration of more than 1,2 million people to Germany, the free mobility of labor is threatened by the reimposition of border controls

• The deployment of migrants in Germany is occurring, but only slowly


The ProblemTrade: • Intra-European trade has suffered from the crisis• The voices of protectionism have grown louder – as the

discussion of TTIP and Brexit have shown• The EU-referendum outcome in June shows potential dangers

of populist sentiment – and may follow if the UK has a soft „Brexit“


The ProblemConvergence of institutions and policies • Background: The financial and sovereign debt crises have

focused our attention once again on sovereign solvency • Focus on government debt relative to GDP – not debt levels• Facts: Public budget balances, consolidated, 2012 (% des BIP)

Country Fiscal Balance Interest service Primary balance Debt / GDP

D 0,1 2,4 2.5 81,0

F -4,8 2,6 -2,3 90,2

PL -3,9 2,8 -1,1 55,6

GR -9,0 5,0 -4,0 156,9

IRL -8,0 3,2 -4,8 120,2Source: IW Köln


The ProblemConvergence of institutions and policies • Background: The financial and sovereign debt crises have

focused our attention once again on sovereign solvency • Focus on government debt relative to GDP – not debt levels• Facts: Public budget balances, consolidated, 2014 (% des BIP)

Source: IW Köln

Country Fiscal Balance Interest service Primary balance Debt / GDP

D 0,3 1,4 1,7 74,0

F -3,9 2,0 -1,9 95,6

PL -3,3 1,9 -1,4 51,6

GR -3,9 3,9 0,0 178,4

IRL -3,9 3,5 -0.4 107,5


Recall the dynamics of sovereign debt

• The dynamics of debt are simple: Debt = - Consolidated government balance= Spending – Income= Government consumption + transfer payments+ government investment+ interest payments- revenues- debt repayment


• Market interest rates reflect aggregated trust of creditors - and the reputation of the borrowers

• Income normally grows, tax revenues should grow at the same time – assuming there is growth

• The relevant number is therefore the debt-GDP ratio! • The central formula for a stabilized and sustainable fiscal stance:

Primary surplus/GDP = (r–g)(Total government debt/GDP) where r=interest rate on government debt and g=growth rate

Recall the dynamics of sovereign debt


The Dynamic of Government Debt• Primary versus total „headline“ Deficit – latter includes

interest payment• At the moment interest rates are at lowest levels in a century,

lower than 7 decades ago• … but growth has also slowed considerably• Causal for the debt crisis: Chronic primary deficits in a time

when g was greater than r, then collapse of growth (g)


Sovereign debt, Euro-Länder (ESA95 Basis)% of GDP, 1990-2015

18

Yields on Eurozone government debt,10 year bonds, % p.a., 1990-2016

19

Monetary policy appears helpless

19991999

19992000

20002001

20012001

20022002

20032003

20042004

20042005

20052006

20062006

20072007

20082008

20092009

20092010

20102011

20112011

20122012

20132013

20142014

20142015

20152016

20160

500

1000

1500

2000

2500

3000

3500

Total ECB assets and unconventional policy measures

Size of the ECB's balance sheet Securities held for monetary purposes LTRO

EUR

billi

ons


The ProblemRegional divergence is poison for a monetary union: • Mundell (1961)• Nominal wage growth 1999-2015:

Germany

Italy

France

Netherlands

Portugal

Spain

Ireland

Greece

Euro area (12 co

untries)

020406080

100120140160180200

2008

Germany

Italy

France

Netherlands

Portugal

Spain

Ireland

Greece

Euro area (12 co

untries)

020406080

100120140160180200

2016

Quelle: Eurostat/AMECO


SolutionsGrowth – and productivity growth – is the key • But the key is lost! How to find it? Look under the right lamppost• Is Germany part of the problem? Or a key to the solution?• More austerity? More spending? Tax cuts? • Infrastructure? • Human capital program for migrants?


Austerity as priority?• Solution: Does „Schulden“ mean „guilt“?• Many have expressed strong views on this point, also in

Germany• Negative demand effects in the short run – Greece, Italy,

Portugal, Spain, Ireland• But the long run is a string of short runs• Ireland v. Greece• Is hope in sight in Ireland? Spain? Greece?


The growth solution• What can policy do about the situation?• Growth, growth, growth! Europe must „grow up“ - to the

leading countries at the technological frontier • More reforms are necessary: Labor reforms: Learn from the German success story Product market reforms: Learn from Scandinavia and the UK Infrastructure program: The „Summers No-brainer“


Ray of hope, I: Labor market reforms


The price of labor market success: Wage inequality

Quelle: Dustmann, Fitzenberger, Schönberg, and Spitz-Oener (2014)

Reallöhne, Vollzeit, Westdeutschland


…in particular for part-time and marginal jobs

Real wages, part-time, western Germany

Source: Burda and Seele (2015)

Inde

xed

wag

e gr

owth


1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

1.2

1.7

2.2

2.7

3.2

3.7

90-10 Percentile ratios, full-time workers

Germany Sweden FranceSource: OECD

Evident in international comparisons


Personal inequality has not increased more in Germany than in other OECD countries


Ray of hope, II: Demand boom in Germany

The massive influx of refugees in the past year – of more than one million people – will trigger new economic impulses, that might help mend the situation: It will induce 1) A Keynesian demand stimulus, possibly €20-30b. per annum2) A reversal of the still-rising current account surpluses of

Germany with southern Europe, similar to the fashion they were reduced after German unification 1990-1995

3) Nominal wages are finally rising in Germany, especially at thelow end, which will help take the edge off German „über-competitiveness“


Ray of hope, III: Growth is possible• It has become fashionable among scholars of macroeconomics

to talk of „secular stagnation“ again (Alvin Hansen 1939)• Protagonists: Lawrence Summers, Paul Krugman, as well as

Robert Gordon und Martin Wolf • Growth in the past two decades has indeed been remarkably

modest, even in the USA since the Great Recession• Despite this, there are points of strong growth today: Ireland,

Poland, Nordic countries – and Estonia• Extensive economic growth as an alternative: Why not?


Real per capita GDP growth, 1980-2015


US growth took a hit after the crisis

Quelle: Fernald (2015)


…but US labor productivity continues to grow… Value added per hour, cumlative relative to value in 1973 (%)

Source: Fernald (2015)

34Source: Fernald (2015)

…while the rest of the world is falling behind Value added per hour, relative to US value (%)

35

World Bank Ease of Doing Business Indicator, 2013

Source: www.doingbusiness.org The Threat of European Disintegration

http://www.doingbusiness.org/

36Source: www.doingbusiness.org The Threat of European Disintegration 72

(2011: 87)

(2011: 100)

World Bank Ease of Doing Business Indicator, 2013

http://www.doingbusiness.org/


Infrastructure investment• What can policy do about the situation?• For Europe to „grow up“ - to the leading countries at the technological

frontier – it needs to modernize its infrastructure• Facts (% of GDP):

1991 2002 2013D: 2,6 1,8 1,6F: 3,6 2,9 3,2PL: - 3,4 3,9

• Infrastructure investment has been week for more than a decade• Summers‘ logic – the rate of return is certainly high enough


Conclusions• 2016 will be a year of tectonic (not only teutonic) challenges –

„meta challenges – for the EU“: Migration, Euro, reforms, Brexit• The outcome may depend more on the politics than economics• Brexit is only the beginning • The survival of the Euro, low interest rates of ECB and non-

reforms in F, I, P, S and GR mean further divergence • I don´t dare make a forecast – but am happy to speculate!


The Threat of European Disintegration

Prof. Dr. h.c. Michael Burda, PhDHumboldt-Universität zu Berlin

Public Lecture, Eesti Pank18 August 2016

michael burda. the threat of european disintegration

Economy & Finance