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Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies www.wiiw.ac.at IDEAS Tenth Anniversary.

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Presentation on theme: "Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies www.wiiw.ac.at IDEAS Tenth Anniversary."— Presentation transcript:

1 Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies IDEAS Tenth Anniversary Conference, Chennai, January 2012 Can the Euro Hold? Michael A Landesmann

2  wiiw 2 Main Issues  Why has the crisis in the Eurozone escalated that much?  Where are we at the moment? Is there a policy master-plan?  Is the Euro-zone going to pull through? In which shape?  What is the predicament of Europe’s ‘periphery’?

3  wiiw 3 Why has the crisis in the Eurozone escalated that much?  Pronounced developments of external imbalances within the Euro-zone, driven by financial market integration and – mostly – fast private sector debt accumulation  Policy-mechanisms to deal with these imbalances non-existent or in-effective: financial markets insufficiently (and nationally) regulated; real exchange rates diverge persistently driven by capital inflows (interest rate convergence before the crisis); relative price adjustment very slow – hence rebalancing through incomes; no established crisis management mechanism at EU/Euro level (ECB mandate, no pooling of debt responsibility; no fiscal stabilisation function)  Banks very weak; no effective re-capitalisation; implicit liability of states – sovereign debt problem and feed-back processes; national segmentation of responsibility  Fiscal policies, deleveraging and weak banks generate stagnation; sustainability of debt of both private and public sectors judged (by markets) as unresolved

4  wiiw 4 Public and private debt in % of GDP Source: wiiw Annual Database incorporating Eurostat statistics. Public debt Private debt Corporations Banks Households

5  wiiw 5 Public and private debt in % of GDP Source: wiiw Annual Database incorporating Eurostat statistics. Public debt Private debt Corporations Banks Households

6  wiiw 6 Where are we at the moment? Is there a policy master-plan?  Exclusive focus on fiscal consolidation: Germany sees this as a pre- condition for any move towards joint action/mutualisation on the debt problem and widening ECB’s mandate – focus to bring long-term public debt ratios down (constitutional amendments; tightening of fiscal control)  Recapitalisation of banks asked for, but happens through shrinkage of balance sheets – credit crunch  Some moves towards EU-wide regulatory and supervisory bodies; but lacking teeth so far; in the short-run more national segmentation of banking  Measures to monitor development of competitiveness in the future; details to be worked out; unlikely to be very effective  No growth strategy, except lip-service to change revenue and expenditure structures in ‘growth enhancing’ manner; plus liberalisation

7  wiiw 7 Is the Euro-zone going to pull through? In which shape?  Economic issues: - recession(s) 2012/13; then medium-term stagnation/low growth - unfolding of fiscal consolidation; widening of ECB activity – important transitory role; slow build-up of EFSF/ESM (role vis-a-vis banking system and sovereign debt); Greek default – contagion effects – ‘ring-fencing’; access to capital markets will remain/become very problematic for a range of countries (IT,SP,PO,GR,HU, Ro,...)  Political issues: - How are polities going to react? espec. in high austerity countries - Technocratic handling of the crisis; reaction against MerkMontozy; tensions in and towards inter-governmental processes; reactions in national parliaments/polities; field for populist/nationalist parties; little debate on alternative strategies

8  wiiw 8 What is the predicament of Europe’s ‘periphery’?  In many countries (Southern and Eastern periphery) high debt levels of private sectors (corporate and household sectors) – deleveraging processes; public sector debt has significantly increased  Foreign banks in retrenchment – credit constraints severe; cross-border banking goes through a process of re-nationalisation  Current accounts adjust strongly – mechanisms different in fix- and flex-exchange rate countries; big differences across countries in underlying strength of export sector; in a range of economies strong legacy of distorted tradable/non- tradable sector structures  The strong slowing down/contraction of German, Italian etc. growth affects peripheral region strongly  FDI and inward capital flows sharply down – ‘catching-up model’ (‘downhill capital flows’) will have to be significantly rethought (stronger focus on industrial policy; emphasis on tradable sector; less reliance on fixed exch. regimes; EMU?)

9  wiiw 9 Composition of the current account of the balance of payments, Note: ASIA-6 excl. Taiwan. Source: IMF International Financial Statistics and IMF WEO October 2010.

10  wiiw 10 Net private financial flows in % of GDP, Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan. LATAM-8 ASIA-6MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR

11  wiiw 11 Is the Eurozone/the EU likely to disintegrate?  Analytical approaches to this question: Bolton/Roland; Alesina et al; Rodrik - heterogeneity issues; impact of international liberalisation; importance of EU wide public goods (and scale effects in their supply); problems with transfer Union; role of mobility  crisis is an historical threshold event for the EU: - weakness of the institutional/policy set-up has become very apparent - a large number of institutional reforms are emerging: fiscal policy frameworks (‘fiscal compact’; six-pack); EU wide regulation and supervision; increased tax base of EU?; evolution of crisis and risk management (EFSF/ESM; Bank Risk Fund?; sovereign default procedures); widening of ECB mandate also de jure?  Political commitment of European elites (is it changing?); popular resentment towards crisis management/technocratic/legitimacy issues

12  wiiw 12 ‘... As it is, men have devised ways to impoverish themselves and one another; and prefer collective animosities to individual happiness.’ J.M. Keynes: The Economic Consequences of the Peace, 1920

13  wiiw 13 Economic Integration and Emerging Economies: Pitfalls revealed in Repeated Crises ISSUES COVERED:  The role of (deep) financial market integration  The nature of external and internal imbalances  The crucial role of exchange rate regimes  European and other emerging economies – do they differ?  The European integration model of catching-up  Constrained policy choices in different environments

14  wiiw 14 Economic Integration and Emerging Economies: Main lines of the argument  International financial markets integration can strongly accentuate the possibility of external and internal imbalances  Exchange rate regimes are very important in this context  Catching-up processes can be seriously derailed due to the build- up of imbalances  Impact on distorting economic structures (domestic savings behaviour, capital allocations across tradable/non-tradable sectors, asset prices, competitiveness, etc.)  The setting for catching-up economies in (EU)rope is special: affects not only EU members but also economies in the neighbourhood (e.g. Balkans)

15  wiiw 15 Comparing emerging market economies (EMEs)  European EMEs: CE-5; B-SEE (B-3, SEE-2; WB-6); EU-COH; Turkey  Non-European EMEs: ASIA-6 (w/o China, India); LATAM-8; MENA-6 (non-oil)  Focus areas: specific characteristics of European integration; European vs. global capital market integration; evolution of disequilibria; policy environment and policy choices

16  wiiw 16 Comparing emerging market economies (EMEs)  CE-5: Czech Republic, Hungary, Poland, Slovakia, Slovenia  B-3: Estonia, Latvia, Lithuania  SEE-2: Bulgaria, Romania  WB-6: Albania, Bosnia and Herzegovina, Croatia, Former Yugoslav Republic of Macedonia, Montenegro, Serbia  B-SEE: B-3 + SEE-2 + WB-6  EU-COH: Greece, Portugal, Spain, Ireland  Turkey  ASIA-6: Indonesia, Korea, Malaysia, Philippines, Taiwan, Thailand  LATAM-8: Argentina, Brazil, Chile, Columbia, Ecuador, Mexico, Peru, Uruguay  MENA-6: Egypt, Jordan, Lebanon, Morocco, Syria, Tunisia

17  wiiw 17 Capital market integration and emerging economies  The question of ‘downhill’ vs. ‘uphill’ capital flows in the global economy (see e.g. Prasad/Rajan/Subramanian, 2006; Gourinchas/Jeanne, 2009; Abiad/Leigh/Mody, 2009)  The issue of financial and monetary integration and catching-up economies (‘threshold’ effects, ‘institutional anchoring’)  The nature of external disequilibria and the composition of capital (in)flows; role of exchange rate regimes  Which disequilibria are ‘sustainable’ and under which external circumstances?  The available spaces for policy choices

18  wiiw 18 The European integration model of catching-up  targeted at integration with the EU/Euro area  associated with very far-reaching internal and external liberalization (trade, capital transactions, financial market integration, labour mobility)  benefits: ‘downhill’ capital inflows, trade integration, ‘technology’ transfer; institutional convergence  the model worked - ‘convergence process’ – but emergence of severe structural imbalances in important groups of European EMEs; heterogeneity of pre- and post-crisis experience of European EMEs

19  wiiw 19 Growth - GDP at constant prices Average annual growth rates, , in % Source: IMF World Economic Outlook, October EBRD and wiiw Annual Database incorporating national statistics, Eurostat..

20  wiiw 20 Growth - GDP at constant prices Average annual growth rates, in % Source: IMF World Economic Outlook, October EBRD and wiiw Annual Database incorporating national statistics, Eurostat.

21  wiiw 21 Quarterly GDP developments 3rd quarter 2008 = 100 Source: Eurostat, wiiw calculations. B-3 SEE-2 + HR EU-COH CE-5 LATAM-8 ASIA-6

22  wiiw 22 Quarterly GDP developments 3rd quarter 2008 = 100 Source: Eurostat, wiiw calculations. B-3 SEE-2 + HR EU-COH CE-5 LATAM-8 ASIA-6

23  wiiw 23 Differentiating features of EMEs  Degree of openness: - trade integration; financial market integration  Private sector borrowing and debt  External disequilibria: current accounts, composition of capital flows; real exchange rate developments  Sectoral ‘distortions’ (tradable/non-tradable sectors); FDI allocation  Fiscal policy during the crisis; public debt development  Recovery from the crisis: level and trend effects

24  wiiw 24 Openness indicators: trade and financial integration, 2007 in % of GDP Note: Assets and liabilities: EU-COH: 618.1%; ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon. Source: IMF International Financial Statistics.

25  wiiw 25 Financial integration - Changes in: (i) assets plus liabilities; (ii) credit to private sector in % of GDP (percentage point change), Note: Assets and liabilities: EU-COH: %; WB-6: %. Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon.

26  wiiw 26 Foreign bank ownership, (assets owned by foreign banks as % of banking system assets) Note: ASIA-6 excl. Taiwan, MENA-6 excl. Syria. Source: from Claessens et al (2008). B-3 SEE-2 WB-6 CE-2 LATAM-8 MENA-6 Turkey ASIA-6

27  wiiw 27 Industrial Production - Index 1993=100, 2000, 2008 Note: ASIA-6 excl. Taiwan. B-SEE excl. Bosnia and Herzegovina, Montenegro and Serbia. Source: World Bank.

28  wiiw 28 Change in openness to trade, in % of GDP (percentage point change) Source: IMF International Financial Statistics.

29  wiiw 29 Summarizing some of the features of European EMEs compared to other EMEs  High growth prior to the crisis  High indicators for openness: trade and particularly strong growth in international financial integration  Much greater role of foreign banks in European EMEs compared to other EMEs  Fast growth of credit to private sector in many European EMEs  Differences in industrial production growth and the build-up of export capacity in different EMEs  Next: the build-up of significant disequilibria before the crisis

30  wiiw 30 Composition of the current account of the balance of payments, Note: ASIA-6 excl. Taiwan. Source: IMF International Financial Statistics and IMF WEO October 2010.

31  wiiw 31 Net private financial flows in % of GDP, Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan. LATAM-8 ASIA-6MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR

32  wiiw 32 Real exchange rate developments, 1995 to 2010 Appreciation hand-in- hand with catching-up in Central Europe Misalignment in the Baltics/Balkans Stable real X-rate in Asia post crisis

33  wiiw 33 Real exchange rate developments 2003=100, CPI deflated Source: IMF: International Financial Statistics, wiiw calculation.

34  wiiw 34 Credit to the private sector (%GDP, )

35  wiiw 35 Differences in the composition of FDI 35 Large part in manufacturing, infrastructure, trade in central Europe Large part in real estate, finance in Baltic region

36  wiiw 36 Relationship between pre-crisis credit growth and current account balances Source: IMF World Economic Outlook. average CA/GDP Change in credit/GDP

37  wiiw 37 Real lending NB/ECB interest rates, CPI-deflated, in % p.a. Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon. B-3 SEE-2 EU-COH

38  wiiw 38 Gross private and public debt in % of GDP, 2008 Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon.

39  wiiw 39 Debt in % of GDP Gross external debtPublic debtPrivate debt Source: wiiw Annual Database incorporating Eurostat statistics.

40  wiiw 40 Debt in % of GDP Gross external debtPublic debtPrivate debt Source: wiiw Annual Database incorporating Eurostat statistics.

41  wiiw 41 Debt in % of GDP Gross external debtPublic debtPrivate debt Source: wiiw Annual Database incorporating Eurostat statistics.

42  wiiw 42 Public and private debt in % of GDP Source: wiiw Annual Database incorporating Eurostat statistics. Public debt Private debt Corporations Banks Households

43  wiiw 43 Public and private debt in % of GDP Source: wiiw Annual Database incorporating Eurostat statistics. Public debt Private debt Corporations Banks Households

44  wiiw 44 Public and private debt in % of GDP Source: wiiw Annual Database incorporating Eurostat statistics. Public debt Private debt Corporations Banks Households

45  wiiw 45 CESEE: GDP growth was well above the interest rate before the crisis Nominal interest rate on government debt and nominal GDP growth (%), Note: Interest rate = government interest expenditures / previous year gross debt.

46  wiiw 46 General government balance and gross debt (% GDP), CESEE: low debt (on average), even after the crisis

47  wiiw 47 External debt: public and private (% of GDP), 2008 Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS. Source: World Bank, World Databank.

48  wiiw 48 External debt: public and private (% of GDP), 2008 Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS. Source: World Bank, World Databank.

49  wiiw 49 Structural features: European and other EMEs LATAM-8ASIA-6MENA-6CE-5EU-COHB-SEE Credit/GDP, change from 2004 to 2008 (percentage points) Real interest rate average, Current account balance/GDP, 2007 (%) Gross external debt, 2009 (% of GDP) GDP growth, Source: wiiw calculations.

50  wiiw 50 Summarizing the build-up to the crisis – differentiated patterns in the EMEs  Different developments amongst European EMEs EU-Coh, CE-5, B-SEE and compared to other EMEs  Current account developments; real exchange rate appreciation  Composition of net capital inflows (credits, portfolio, FDI)  Credit growth to the private sector; low (partly negative) real interest rates  Public debt situation not that different between European EMEs and other EMEs  Clear link between private credit growth and current account deterioration; and hence foreign debt positions

51  wiiw 51 The impact of the crisis and patterns of recovery

52  wiiw 52 Pre-crisis credit growth and GDP growth in 2009 Source: IMF World Economic Outlook. GDP growth in 2009 Change in credit/GDP

53  wiiw 53 Pre-crisis credit growth and GDP growth in 2010 Source: IMF World Economic Outlook. GDP growth in 2010 Change in credit/GDP

54  wiiw 54 Structural features: the role of exchange rate regimes ‘Fixers’ and ‘floaters’ amongst the CESEEs CESEE floatCESEE fix Credit/GDP, change from 2004 to 2008 (percentage points) Real interest rate average, Current account balance/GDP, 2007 (%) Gross external debt, 2009 (% of GDP) GDP-growth, FDI to finance and real estate sectors, 2007 (per cent of total FDI stock) Change in unemployment rate from 2007 to 2010 (percentage points) Source: wiiw calculations.

55  wiiw 55 Fiscal policy reaction: huge adjustment in CESEE Average annual changes in total general government expenditures, Note: Nominal from data in EUR. Source: IMF World Economic Outlook, wiiw Database and Eurostat. Nominal per cent changeReal per cent change CE B SEE WB EU ASIA LATAM

56  wiiw 56 GDP development, =100 Source: wiiw forecast and IMF World Economic Outlook, October WB-6 CE-5 SEE-2 B-3 EU-COH LATAM-8 ASIA-6 TR

57  wiiw 57 GDP development, =100 Source: wiiw forecast and IMF World Economic Outlook, October WB-6 CE-5 SEE-2 B-3 EU-COH LATAM-8 ASIA-6 TR MENA-6

58  wiiw 58 Summarizing the crisis impact  Stronger impact of the crisis on European EMEs than on other EMEs (level and – medium-term – trend effect)  Countries with high current account deficits and high credit growth prior to the crisis have stronger downturn  Significant differences between ‘fixers’ and ‘floaters’ amongst European EMEs  Substantial pro-cyclical contraction of real government spending in European EMEs during the downturn

59  wiiw 59 The aftermath of the crisis: - Recovery patterns - Socialisation of private debt (internal vs. external)

60  wiiw 60 Crucial question: output prospects Three options: 1. downturn is purely cyclical and GDP will return to the pre-crisis trendline 2. part of the downturn is permanent, but the potential growth rate is unaffected 3. part of the downturn is permanent and the potential growth rate is also reduced  1 may characterize Asia, CESEE will likely follow 2 or 3

61  wiiw 61 GDP development, =100 Source: wiiw forecast and IMF World Economic Outlook, October WB-6 CE-5 SEE-2 B-3 EU-COH LATAM-8 ASIA-6 TR

62  wiiw 62 General government gross debt (% of GDP), Source: IMF World Economic Outlook.

63  wiiw 63 Unemployment at high levels registered unemployment rates in % Source: wiiw Monthly Database. Latvia Lithuania Romania

64  wiiw 64 Summary: Specific features of European EMEs  Opening of the capital account: a rule of the game in the EU; deep financial integration  Reliance on massive imports of capital; only 4 CESEE-countries could avoid skyrocketing external (private) debt  Bank credit: the overwhelming source of external funding  Financial integration: major channel for transmitting shocks (EU- Coh, B-SEE regions hit hardest by the crisis)  In general no meltdown of financial systems in CESEE (advantage of the presence of foreign banks? Implies also less socialization of private debt in CESEE – i.e. lower public debt effects); difference to EU-Coh in which there was massive nationalisation of private sector debt

65  wiiw 65 The outlook on recovery after the crisis  Which pattern of recovery after the crisis? European EMEs show level and trend effect of crisis impact  Fiscal policy: less room for manoeuvre because of reduced growth expectations and higher interest rates; in EU-Coh socialisation of private debt; full blown sovereign debt crisis  Household deleveraging process and fragile banks (lasting credit constraint); some countries banking system on the brink  Capital flows to European vs. non-European EMEs: pattern reversed from before the crisis; depending on built-up debt positions and (revised) growth expectations

66  wiiw 66 Policy space in different environments:  Specific policy environment for European EMEs: - no capital controls - highly integrated financial markets; Euro-zone members or Eur anchorage - compliance with Single Market regulations - Maastricht criteria and Growth and Stability Pact (GSP) set fiscal criteria  Advantages of this policy environment: - institutional and policy anchorage for trade and production networks and for fast growth of financial intermediation - fast institutional and behavioural convergence  Disadvantages: - De facto no independent monetary policy; use of exchange rate as policy instrument severely restricted; prone to credit/asset bubbles - use of industrial policy restricted; other supply side policies (education/training, labour mobility, R&D, regional) encouraged

67  wiiw 67 Principal policy lessons:  In national and EU policy frameworks: neglect of private sector debt build-up relative to public sector  Financial market regulation severely underdeveloped; but very high degree of financial market integration; specific issue in CESEE region: high level of cross-border banking  Fixed exchange rate regimes bear high risks; but what are the options of highly euroized EU members and candidates?  Scope for counter-cyclical fiscal policy was used much less in European CE-EMEs during crisis; post-crisis: task to restructure public finance in growth-enhancing manner  Current situation characterised by very fragile banking system; protracted deleveraging processes; severe drag on recovery

68  wiiw 68 Indicators - country groups: Pop, GDP, GDP per capita 2008 Population, total (mn) GDP (USD bn) GDP, PPP (USD bn) GDP per capita (USD) GDP, PPP per capita (USD) 2008 LATAM ASIA MENA EU-COH CE SEE B WB Turkey B-SEE Source: World Bank, World Databank, wiiw calculation.

69  wiiw 69 Indicators: Pop, GDP, GDP (per capita) averages per country in group, 2008 Population, total (mn) GDP (USD bn) GDP, PPP (USD bn) GDP per capita (USD) GDP, PPP per capita (USD) 2008 LATAM ASIA MENA EU-COH CE SEE B WB Turkey B-SEE Source: World Bank, World Databank, wiiw calculation.

70  wiiw 70 Source: IMF International Financial Statistics, World Bank, World Databank, wiiw calculation. GDP, PPP and Exports plus Imports in % of GDP, 2007 Exports and Imports in % of GDP, 2007 GDP, PPP (USD bn), 2007

71  wiiw 71 GDP, PPP and Assets plus liabilities in % of GDP, 2007 Source: IMF International Financial Statistics, World Bank, World Databank, wiiw calculation. GDP, PPP (USD bn), 2007 Assets and liablities in % of GDP, 2007


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