Benoît Cœuré, Member of the Executive Board of the ECB, argues that lawmakers need to both strengthen the institutional framework to make the currency union more resilient and implement the right policies to boost the growth potential of European economies.
The first line of defence: integrated and flexible markets
No euro area country features in the top 10 of the World Bank’s ease of doing business index. Many are not even in the top 30.
A consequence of a less business-friendly environment is that business dynamism in Europe is weak. Compared with the United States, European countries have, on average, larger shares of “static” firms and smaller shares of both growing and shrinking firms.[5]
Low business dynamism feeds and reinforces the misallocation of resources across firms in the euro area.[6]
Empirical evidence shows that an increasing proportion of capital is concentrated in firms that are less productive. In Italy and Spain misallocation is currently higher than at any point in time before the crisis.[7]
The absence of a Schumpeterian process of creative destruction weighs on innovation and growth.
There is overwhelming evidence that new firms are more likely to adopt new technologies. There is a significant link between business entry rates, technology creation and diffusion, and productivity growth.[8] New and young firms also contribute disproportionally to job creation relative to their share in employment.[9]
Unclogging the innovation channel requires us to improve the ways in which our markets allocate resources, both within and across countries.
In my view, there are three areas which need particular attention.
Efficient allocation of resources
First, we need to reduce the barriers to entry faced by firms, particularly in the services sector, and we need to improve the quality of insolvency frameworks.
Several euro area countries lack an effective framework for early private debt restructuring. In Portugal, Greece and Slovakia, for example, it takes more than three years to resolve insolvency. It takes less than one year in Japan, Norway and Canada.[10]
The absence of effective insolvency frameworks also makes it harder to deal with non-performing loans. It constrains collateral enforcement and raises the risk of banks granting forbearance to “zombie” firms.[11]
Our economic governance framework, the European Semester, has been effective in informing and exchanging views on our economies.
But member states don’t walk the talk. The macroeconomic imbalance procedure always lacked teeth and none of the 2018 recommendations for euro area countries have been fully implemented.
In this context, national productivity boards are useful complements that could strengthen the European Semester discussion.
Completing the Single Market
Second, we must make better use of the economies of scale offered by the Single Market.
20 years after the introduction of the euro, we are faced with a paradox. While the single currency was originally conceived as a complement to the Single Market, lack of progress towards the completion of the Single Market now hampers the deepening of EMU.
The Single Market was initially established with free cross-border trade in goods in mind. But the structure of our economies has changed fundamentally since then. The services sector today accounts for more than 75% of European employment, compared with 45% in 1970.[12]
As value added and employment shift from the manufacturing to the services sector, the Single Market is increasingly losing traction as an engine of growth. Despite the Services Package, there are still 5,000 national regulations protecting the delivery of different types of services across Member States.[13]
These barriers stand in the way of European services firms achieving scale and profitability. As a result, there are about three times as many services firms in the EU as in the United States, despite the economies being of broadly similar size.[14]
Fragmentation perpetuates a lack of competition and blocks a healthy consolidation around the most efficient firms. And larger firms generally invest more in human and brand capital as well as in intangible assets, such as intellectual property rights, software and databases.[15] They are also more likely to export than smaller firms.
Completing the Single Market, in particular for services, is therefore a central pillar in our efforts to boost weak productivity growth.
It will make our monetary union more resilient and support the normalisation of real interest rates towards higher, positive levels.
Launching a capital markets union
Third, if firms are to expand and grow, we need to broaden and deepen the funding mix available for productive investments.[16]
Firms in the euro area primarily rely on bank lending to finance their debt.
This raises two broad concerns.
The first is that over 80% of euro area bank lending remains domestic.[17] This constrains competition for good credit and amplifies the doom loop between sovereign and bank creditworthiness, which we have failed to eradicate.
And, second, banks often hesitate to finance investments in intangible assets for which collateral values are hard to quantify, or in new sustainable technologies with highly uncertain future payment streams.
New ECB research shows that stock markets are better than banks at reallocating investment toward “greener” sectors, and that innovative sectors with fewer tangible assets grow faster in countries with deeper stock markets.[18]
In the euro area, however, stock market capitalisation – at less than a fifth of that in the United States – is too low to serve as a catalyst in this way. Cross-border integration is similarly low.[19]
Our capital markets must become deeper and, at the same time, more accessible for start-ups and small and medium-sized firms.
Achieving truly integrated capital markets is the only way to find the collective response required in the face of enormous global challenges, such as climate change or digitalisation.
Another reason why a capital markets union is urgently needed is that capital markets help in better sharing economic risks across countries.
In the United States, for example, around 70% of a shock to a state’s GDP is cushioned by financial markets, whereas in the euro area the share is closer to 20%. A capital markets union could significantly help to diversify and reduce risk.
Of course, it would be naïve to assume that a capital markets union can be achieved without investing political capital. Improving and harmonising national insolvency laws, for example, goes to the very heart of our legal systems. But it is capital well invested.
Risk sharing by private investors reduces the need for public risk sharing and for the protracted and acrimonious discussions that often ensue.
A capital markets union can’t function without European-level supervision of systemic intermediaries and infrastructures.
There are large cross-border spillovers and, if things go wrong, the banks that are directly supervised by the ECB would be left bearing most of the financial risk. Recent reforms of the European supervisory authorities and of the European market and infrastructure regulation (EMIR) were missed opportunities.
The United Kingdom's departure from the EU will have a lasting impact on the architecture of European financial markets. This reinforces the need to react and complete the capital markets union.
The second line of defence: sound national fiscal policies
National fiscal policies fulfil two key roles in a currency union.
The first is to support convergence, growth and the efficient allocation of resources.
In many euro area countries, however, the labour tax wedge, in particular for low and second earners, remains too high, discouraging both labour supply and demand.
Many euro area countries have space to reduce the distortionary impact of their tax systems in a revenue-neutral way, by shifting taxes away from labour and towards environmental externalities or property.[20]
Such national efforts should be complemented by closer tax cooperation. Agreeing and enforcing minimum tax rates for capital income at the EU level would help countries to regain space to reduce labour income taxes, thereby fostering employment growth.
Supporting growth also means spending more wisely.
Public investment in the euro area fell from 3.7% of GDP in 2009 to 2.7% in 2018. At the same time, large parts of the public infrastructure, including schools, hospitals and roads, are in urgent need of repair and modernisation.
The current interest rate environment provides a unique opportunity to close public investment gaps and to strengthen Europe’s capacity to innovate by mobilising investment to support digitalisation and to accelerate the transition to a low-carbon economy.
This also entails reviewing and boosting spending in intangible assets.
For the past 20 years or so, spending on research and development (R&D) in the EU has stagnated at around 2% of GDP. In the largest euro area countries, public expenditure on R&D, education and transport accounts for around 15% or less of total primary expenditure.[21]
Equally concerning is that environment-related public R&D spending accounts for just 1.6% of total R&D spending across OECD countries. Given that the market does not invest sufficiently in environmental R&D, and that climate change is a deepening emergency, the public sector urgently needs to step in.
The second role of fiscal policy in a currency union relates to stabilisation and resilience.
The Stability and Growth Pact has largely failed on both counts.
It proved toothless in good times when the need to build up sufficient fiscal buffers for bad times was ignored. And it amplified procyclicality in bad times. From 2009 to 2018, the average cyclically adjusted government primary balance was -5.7% for Japan and -3.6% for the United States, but 0.5% for the euro area.
And even when the euro area aggregate fiscal stance was considered broadly appropriate, such as in the most recent years, it was wrongly distributed across countries. Countries with fiscal space were not using it and those without fiscal space were trying to invent some.[22]
As a result, monetary policy had to pick up the slack, quite literally.
Hypotheses are easily made in the absence of true counterfactuals. But I am fairly convinced that some of the measures which the ECB had to take in recent years to stabilise the euro area economy, and which have made it the target of criticism in some Member States, could have been avoided if the recommendations of the European Semester had been more effectively implemented by national governments.
The increasing complexity of the Stability and Growth Pact and the politicisation of its enforcement have not served us well.
We thus need to review both the rules and their enforcement. We need to simplify them, depoliticise them and improve national ownership.[23] Governments should no longer have the option of using loopholes or blaming technocrats in Brussels to hide their responsibility.
National governments are accountable to their voters. Strong and independent national fiscal councils should clearly explain to the public the potential consequences of imprudent fiscal behaviour for the stability of the country and the euro area as a whole. Unfortunately, we no longer have a lack of examples.
The third line of defence: effective area-wide instruments
The crisis revealed that systemic shocks can go beyond the capacity of national fiscal budgets to provide effective stabilisation.
The European Stability Mechanism (ESM) has been a resounding operational success. It is a crisis management instrument and its role as such will be further strengthened by the welcome decision to make it a backstop to the Single Resolution Fund and the introduction of new precautionary facilities.
But the ESM should be able to act decisively in a crisis by deciding with qualified majority, and it should be accountable to the people of Europe under Community law – two objectives which are not covered under the current reform proposal.
Let me repeat: intergovernmental decision-making may be politically convenient in the short term, but it carries a high economic cost in the longer run. It favours procrastination and turns every decision into a zero-sum game.
Intergovernmental crisis management increased the cost of the crisis for the Greek people – in terms of the burden of adjustment –, for Greece’s creditors – in terms of exposure and potential losses –, and for Europe as a whole, in terms of trust and unity. This cannot be the way forward. If we don’t learn from past crises, we condemn ourselves to repeat them.
This is why the current proposals can only be a first step. What we are missing, are three complementary instruments.
A common European deposit insurance scheme
The first is a common European deposit insurance scheme, which is a precondition for a truly integrated banking system and single money. I welcome the progress currently being made towards starting political negotiations on such a scheme.
Progress should be made in parallel in two complementary directions. First, to eliminate the bank-sovereign doom loop by incentivising banks to diversify their sovereign exposures in a way that does not disrupt the functioning of government bond markets.
And second, to strengthen our resolution framework. Today, only a handful of banks are deemed of public interest and subject to European resolution, leaving most bank failures to be addressed in nineteen different ways. This is untenable. Creating a single administrative tool for bank liquidation, as proposed by the International Monetary Fund, would be an important first step.
A common fiscal capacity
The second missing instrument is a common fiscal capacity that provides macroeconomic stabilisation with a view to preventing, or mitigating, systemic shocks – that is, before they turn into a full-blown crisis.
The budgetary instrument that is currently being operationalised has a different aim, namely to foster competitiveness and convergence, which is an important aim in itself, albeit already largely addressed by existing instruments. But it is not designed to provide macroeconomic stabilisation. And even if it were, it would not be large enough to do so effectively.
We have also learned the hard way that coordination of national fiscal policies will not lead to an adequate fiscal stance for the euro area as a whole. The current period of weak growth is a case in point.
And even if governments improved their coordination, the cross-border spillovers would likely be too small to be effective. ECB research, for example, suggests that cross-border spillovers could be less than 10% of initial spending.[24]
For all these reasons, the euro area needs a common fiscal instrument. Such an instrument would support monetary policy and prevent a procyclical tightening in bad times. And it would boost confidence in national automatic stabilisers, thereby protecting jobs and minimising output losses.
All successful and stable monetary unions have genuine fiscal instruments, built on strong legal and market-based mechanisms ensuring fiscal discipline at the state level. Such an instrument should not replace national policies, but it will need to be large enough to complement them effectively.
A common safe asset
The third instrument required is a common safe asset.
A joint fiscal capacity and a safe asset can go hand-in-hand. But they do not need to.
A safe asset would fix many of the remaining euro area faultlines. It would help break the doom loop between banks and sovereigns; support the design and transmission of monetary policy; strengthen the international role of the euro in an environment in which global governance is under threat; and buttress efforts to deepen and integrate our capital markets.
Full speech
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