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We know that monetary policy alone cannot create a sustainable recovery. Restarting growth ultimately depends on governments, business leaders and social partners working together. Governments need to create the conditions that allow entrepreneurs to generate growth.
There is no short cut to growth through debt. Growth ultimately has to come from increasing the productive capacity of the economy – that is, through raising competitiveness and productivity.
Abraham Lincoln famously said that “you cannot make the weak stronger by making the strong weaker”. Similarly, the answer to the problems of the euro area is not to weaken its stronger economies. Rather, it is to strengthen its weaker economies. And in fact, this is what we are seeing in the euro area today. Most countries that lost competitiveness are regaining it. They are converging towards the most competitive countries, not vice versa. They have learned the fundamental lesson – for which Germany is the model – that in a monetary union, wages have to reflect productivity to maintain price competitiveness.
The challenge ahead
The task of restoring sustainable growth is still far from complete. Regaining competitiveness is only one part of the challenge. Another essential component is to reverse the damage to the economy caused by the crisis. It has reduced the euro area’s output level and perhaps also its growth rate.
To turn that around requires higher investment in human and physical capital – and in all euro area countries. In Germany, for example, investment is still around 1 percentage point of GDP lower than it was in 2007, and in that year it already had the lowest investment ratio in the euro area.
Both the public and private sectors have a role to play here. Generating higher investment is ultimately the job of the private sector. But public authorities have to create the conditions that facilitate and encourage this process.
I see three conditions as crucial: a stable macro-economic environment; growth-enhancing structural reforms; and a healthy banking sector.
First, a stable macro-economic environment provides the certainty that is so important for investment. That entails medium-term price stability, which the ECB is providing. And it entails medium-term economic stability, which governments have to ensure through sustainable fiscal and economic policies and adhering to the euro area rules.
Second, structural reforms are vital to raise growth potential and make new investment attractive – especially in the current environment where firms may have become less optimistic as a result of the crisis. Of particular importance are reforms that increase competition, which in turn drives innovation, efficiency and productivity growth. Such reforms include opening up protected sectors and removing barriers for new firms to enter the market.
Third, we need a healthy banking sector to ensure that capital can be allocated where productive investment is needed. Bank lending in the euro area is currently very weak, having fallen for 16 straight months. This in part reflects the state of the economy; in part it reflects balance sheet constraints in the banking sector.
But as the economy picks up next year, we need to ensure that those balance sheet constraints do not hinder the recovery. This is why the rigorous and comprehensive assessment of banks’ balance sheets currently being undertaken by the ECB is so important. Prompt corrective actions by banks themselves are welcome.
Taken together, these three conditions will provide firms with the certainty, optimism and financing they need to restart investing – and hence to get the euro area back to a higher growth trajectory.