Group Members. Giuseppe Bertola. John Driffill. Harold James. Princeton University. Hans-Werner Sinn. Jan-Egbert Sturm (Chairman) Akos Valentinyi

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2 Group Members Giuseppe Bertola Edhec Business School, CEPR, Università di Torino John Driffill Birkbeck College, University of London Harold James Princeton University Hans-Werner Sinn Ifo Institute and University of Munich Jan-Egbert Sturm (Chairman) KOF Swiss Economic Institute, ETH Zurich Akos Valentinyi Cardiff University

3 Rebalancing Europe Macroeconomic Outlook European Imbalances Labour Market Reforms and Youth Unemployment US Precedents for Europe

4 Macroeconomic Outlook

5 Regional contributions to world trade growth Index (2008Q1=100) Emerging and developing countries b) (right- hand scale) % Advanced economies b) (right- hand scale) World trade a) (left- hand scale) a) Three month moving average level. b) Contribution to annualised monthly growth rate thereof. Source: CPB Netherlands Bureau for Economic Policy Analysis, World Trade Monitor: December 2012.

6 World economic growth and the Ifo World Economic Climate 6 % Index (2005=100) Real GDP growth (left - hand scale) a) Ifo World Economic Climate (right- hand scale) a) Arithmetic mean of judgements of the present and expected economic situation. Source: IMF, World Economic Outlook, January 2013; GDP 2012 and 2013: EEAG forecast; Ifo World Economic Survey I/2013.

7 5 % Regional contributions to world GDP growth a) % 5 4 Forecast period Other countries Latin America and Russia Asia North America Western and Central Europe World GDP growth a) Based on market weights. Source: IMF; calculations by the EEAG; 2012 and 2013: EEAG forecast. 2.3% 2.5%

8 0 % of GDP Government structural budget balances % of GDP Japan -2-3 Euro area United Kingdom United States Forecast period Source: OECD, Economic Outlook 92, December 2012.

9 Changes in the primary fiscal balances relative to pre - crisis GDP a) 10 % of GDP in 2007 % of GDP in /2009 Total improvement during a) To circumvent strong jumps caused by extraordinary events, in the cases of Ireland and Hungary the changes are aggregated for the years 2010/2011 and 2011/2012, respectively. Source: European Commission, DG ECFIN, General Government Data, Autumn 2012.

10 Contributions to GDP growth a) in the European Union 6 % Seasonally adjusted data % Change in inventories Foreign balance Real GDP growth -6-9 Final domestic demand (excl. inventories) a) Annualised quarterly growth. Source: Eurostat, last accessed on 24 February 2013; EEAG calculations.

11 Billion euros Foreign trade a) in the European Union Seasonally adjusted data Exports (left- hand scale) Billion euros Imports (left - hand scale) Trade balance (right - hand scale) a) In constant prices, seasonally adjusted and work - day adjusted. Source: Eurostat, last accessed on 24 February 2013; EEAG calculations.

12 Trade balances a) in the euro area % of euro area GDP % of euro area GDP Germany Benelux+Austria+Finland Greece+Ireland+Portugal New euro area countries Italy Spain France Euro area a) Four quarter moving averages. Source: Eurostat, last accessed on 31 January 2013; 2012Q4: EEAG forecast.

13 4 3 2 Demand contributions to GDP growth in the European Union a) % Forecast period % External balance Changes in inventories Gross fixed capital formation Government consumption Private consumption GDP growth a) Gross domestic product at market prices (prices of the previous year). Annual percentage change. Source: Eurostat; EEAG calculations and forecast. -0.3% 0.1%

14 European Imbalances

15 European Imbalances There is no quick-fix solution for countries that have lost their competitiveness. These countries need a realignment of prices. An internal devaluation through falling prices is usually accompanied by mass unemployment and deep recession, which can potentially stoke social unrest. An external devaluation, achieved via exiting the euro, is likely to create capital flight before the event, and uncertainty afterwards as a result of ensuing legal challenges, particularly from non-residents. An internal devaluation by inflating the core countries may generate political resistance and violate the ECB's mandate of maintaining price stability. However, countries struggling to restore competitiveness can: Try a fiscal devaluation. Increasing VAT while cutting direct taxes might be a way to slightly improve the competitiveness of uncompetitive euro countries. Cut expenditure rather than raising taxes during fiscal consolidation. The empirical evidence shows that tax-based fiscal adjustments tend to be less successful than expenditure-based ones. The periphery countries should therefore focus more on cutting expenditure, rather than raising taxes to reduce their deficits. Ireland and Spain, for instance, relied more on cutting expenditure and seem far more on track with their internal adjustment than Greece and Portugal, which raised taxes. Reduce the Greek debt overhang. Policy-makers should deal with Greece s debt overhang in a credible way that does not require hard-fought political renegotiation every few months. Writingoff a significant amount of Greek debt under strict conditionality and surveillance would be one way forward.

16 Current account balances by country group % of euro area GDP 2 1 Rest of euro area Germany GIIPS countries Source: Eurostat, last accessed 10 December 2012.

17 Current account balances by country 10 % of GDP NLD LUX 5 DEU Average over EST AUT SVN SVK MLT ESP CYP IRL FRA ITA BEL FIN 10 PRT GRC Average over % of GDP Source: Eurostat, last accessed 10 December 2012.

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19 International investment position 10 % of euro area GDP Germany 0 Rest of euro area GIIPS countries Source: Eurostat, last accessed 10 December 2012.

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21 10 % of GDP Convergence and the current account 5 FIN NLD DEU Current account balances average over SVK PRT SVN CYP MLT GRC ESP IRL FRA BEL ITA AUT EST GDP per capita relative to GDP per capita of EA12 countries a) in 1995 a) Countries which adopted the euro by 1 January Source: Eurostat, last accessed 10 December 2012, and EEAG calculations.

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24 Price and productivity changes, and the current account 10 % of GDP LUX Current account balances average over FIN AUT DEU FRA BEL IRL SVK Change in price level relative to change in labour productivity a) , Germany=100 a) Measured with GDP per employee. Source: Eurostat, last accessed 10 December NLD EST GRC CYP SVN PRT ITA ESP

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29 Ireland Changes in general government expenditures and revenues relative to GDP, % points of GDP Portugal Spain Italy Expenditure Revenues Greece Source: Eurostat, last accessed 10 December 2012.

30 Labour Market Reforms and Youth Unemployment

31 Labour Market Reforms and Youth Unemployment Two-tier labour markets should be eliminated. They are characterised by a marked distinction between temporary and permanent jobs. The burden of adjusting to change falls heavily on those in temporary jobs, while those in permanent jobs are shielded from it. They tend to make the position of younger workers, among others, more precarious. Efforts to reduce these differences should be kept up. Make dismissal costs for firms modest and predictable. Long drawn-out legal proceedings with highly uncertain and costly outcomes must be avoided. Where they do not already exist, it may be worthwhile to establish employment tribunals or an arbitration service to resolve labour disputes quickly and cheaply. Severance payments should depend on the length of time a worker has been employed. Reconsider the automatic, legally binding extension of wage bargains across sectors. Wage bargains should not be imposed on firms where unions do not represent a large enough fraction of the labour force. There should be further moves towards firm-level bargaining. In cases where industry-wide agreements exist, firms and their workers should be able to deviate from them, as local conditions dictate. Vocational education, training and apprenticeships need to be improved in most European countries.

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37 Is this a good time for labour market reform? Pressed on borrowers by the Troika ECB, Commission, IMF among conditions for loans No pressure, no reform?? Unemployment is part demand-deficient and part structural Reforms may worsen unemployment in the short run (e.g., weaken employment protection legislation) European Economic Advisory Group

38 Motivations for reform Immediate need to cut public borrowing Some supply-friendly reforms save public money (though they often hit the poor) Cuts in public sector employment & pay, higher public pension ages; benefit cuts Some are expensive: more ALMPs; better VET Medium term: make wages and prices more flexible and responsive to state of economy Achieve real adjustment more rapidly within the monetary union Long term aim of improving supply side: efficiency, lower structural unemployment rate More resilience? European Economic Advisory Group

39 European Economic Advisory Group

40 No free lunch Reforms come with costs Greater inequality? Hartz reforms in Germany may have increased employment but they also widened wage distribution Lower benefits, shorter duration However higher inequality maybe due to changes in technology Mixed picture across countries European Economic Advisory Group

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45 Youth Unemployment Problem of min wages Bargaining arrangements Two-tier labour mkts Vocational Education & Training European Economic Advisory Group

46 Apprenticeships Highly successful system in Germany, Austria, Switzerland, Denmark Supported by social partners (employers, local chambers of commerce, unions, government, colleges, legal framework (required licence to practice in many occupations ~ 400 in Germany) Dual system on-the-job & college Mostly 3 yr apprenticeships Somewhat rigid European Economic Advisory Group

47 Lessons for other countries Institutions hard to transplant Importance of involving employers German-style apprenticeships held in high esteem compare e.g. UK cheap labour; too little training; fear of free-riding undermines willingness to train More public spending on further education and training (VET); and less on higher education European Economic Advisory Group

48 Dual labour Markets Large fringe of temporary workers, little or no employment protection V strong EPL of regular jobs insulates against labour mkt pressures Lowers sensitivity of wage growth to unemployment Needs proportionate employment protection Ideally supported by good ALMPs to get unemployed back into work End distinction between temporary and regular jobs European Economic Advisory Group

49 US Precedents for Europe

50 US Precedents for Europe Establish a common state before federalising debt. In the United States, the federalisation or mutualisation of state debt depended on the creation of a fiscal mechanism that produced a stream of revenue to service the debt. Debt was only mutualised after the foundation of a common state. Limit liabilities. The 1790 US compromise might be seen as a precedent for limiting the liabilities of the northern European surplus countries in the case a common European bond, or Eurobond, is created. Fiscal Equity. The choice of the fiscal mechanism to service a federalised debt potentially raises deeply divisive issues about the distributive effects of the tax or tariff on the constituent states. Ensure that Europe's central bank is flexible and strictly governed: Designing a central bank for a very large area is complicated, and requires some measure of flexibility (such as differing collateral requirements) to respond to local or regional circumstances, as well as checks and balances in its governance structure. Set up a US-style settlement mechanism in Europe. Europe needs a US-style settlement mechanism that requires a securitisation of balances to keep outstanding debts small; and even creates incentives to take countervailing local policy measures to avoid the build-up of balances in the first place. A settlement system would protect the European creditor countries against losses arising from a break-up of the currency union, while making them more resistant to pressure to participate in bail-out activities.

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