Europe in the World Economy: Economic Recovery and Europe 2020

Europe in the World Economy: Economic Recovery and Europe 2020 Rafael Doménech Economic recovery and Europe 2020: Towards smart, sustainable and inclusive growth Wilton Park, October 24, 2012

Main messages 1 2 3 4 5 In 2020 Europe will be a smaller region in the world economy due to (1) lower population growth and (2) lower GDP per capita growth than emerging economies. The challenge is to increase productivity and employment growth. Needed: a recovery strategy and a long-run strategy: convergence with the US. Recovery strategy: (1) a road map to a genuine EMU (four pillars), (2) correction of internal imbalances, and (3) a balance between growth and austerity. Long-run strategy: (1) economic integration to ensure internal convergence (at national and European levels), (2) improve institutional quality, human capital, R&D and infrastructures. Page 2

Relative position of Europe in the world economy Shares in world GDP and in world population Source: BBVA Research 60 50 40 30 20 10 53.7 7.7 23.5 22.4 37.5 4.8 17.9 14.8 12.8 2.1 4.6 6.1 11.4 1.6 4.4 5.3 14 12 10 8 6 4 2 In 2020 Europe (EU15) will be a smaller region in the world economy due to: (1) lower population growth and (2) lower GDP per capita growth than emerging economies 0 2000 2017 2000 2020 0 Demographics are difficult to change, but GDP per capita is more sensitive to policy changes Share in world in economy in PPP Share world population UE-15 USA Japan Page 3

The European growth challenge A useful decomposition GDP = GDP L 15-64 L 15 64 = GDP L d GDP growth = productivity growth + L d L 15-64 L 15-64 employment growth bonus + working-age population growth As stated before, working-age population growth in the next 10 years will be low The challenge is to increase (1) productivity growth and (2) employment growth above working-age population growth This requires first to close the cyclical gap and, second, to increase potential growth, closing the gap with the USA Page 4

The European growth challenge GDP per working-age population Source: BBVA Research 1 1 USA 1 0. 9 GDP per WAP gap EU15 cyclical gap with the 1970-2012 trend: around 5% 1 0. 8 1 0. 7 Average growth = 1.83 Cyclical gap EU15 trend gap with the USA: around 25% 1 0. 6 1 0. 5 EU = 15 Needed: (1) a recovery strategy in the short run, and (2) a long-run growth strategy: convergence with the USA 1 0. 4 Average growth = 2.01 1 9 9 4 1 9 9 8 2 0 0 2 2 0 0 6 2 0 1 0 Trend components estimated from 1970 to 2012 Page 5

A recovery strategy 1. A road map to a genuine EMU 2. Correction of imbalances in a very heterogeneous Europe 3. Balance between growth and austerity: Focus on structural deficits as the Stability Treaty proposes Short-term objective: to avoid the risk of an austerity-recession vicious circle and the doubts regarding sovereign debt solvency Page 6

A recovery strategy (1): a road map to a genuine EMU J. Andrés and R. Doménech (2012): The solution to the Euro crisis: Back From the Future. Vox EU. Page 7

A recovery strategy (2): internal imbalances in EMU Debt and deficits in the EMU, USA and the UK (% of GDP) Source: AMECO, Haver, IMF, national sources and BBVA Research Page 8

A recovery strategy (2): internal imbalances in EMU Macroeconomic imbalances in the European periphery (six pack) Index. Units of standard deviations with respect to the average in the Eurozone (Euro zone average= 0) Source: BBVA Research, Eurostat and Haver Export Market share loss General Government Deficit (% of GDP) Unit Labor costs growth General Government Debt (%GDP) 2,5 2,0 1,5 1,0 0,5 0,0-0,5-1,0-1,5-2,0 Private sector debt Debt (% of GDP) % change on credit to the private sector (% of GDP) Housing market developments REER growth Net International Debtor Position (% of GDP) Unemployment rate Current Account (% of GDP) DEU FRA ITA ESP GRC PRT eurozone average Page 9

Europe in the World Economy: Economic Recovery and Europe 2020 A recovery strategy (2): internal imbalances in EMU Unemployment rates Source: BBVA Research, Haver 30 25 20 15 10 The challenge: from adjustment to growth Short-term goal: prevent further job losses adjust working hours + wage flexibility and effective organisation Reallocation of productive factors to more dynamic firms and sectors (external competitiveness) 5 0 Eliminate internal growth barriers through a more favourable regulatory environment 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Ireland Portugal Spain Greece France Germany Italy Page 10

A recovery strategy (2): internal imbalances in EMU Household debt Source: Haver and BBVA Research Non-financial corporations de Source: Haver and BBVA Research 180 350 160 Denmark 300 Ireland 140 120 250 100 200 80 150 60 40 Italy Austria 20 0 20003 20014 20031 20042 20053 20064 20081 20092 20103 20114 USA EA-17 Japan UE-15 100 50 Greece/ Germany 0 20003 20014 20031 20042 20053 20064 20081 20092 20103 20114 USA EA-17 Japan UE-15 Page 11

A recovery strategy (2): internal imbalances in EMU Domestic credit (% of GDP) Source: Haver and BBVA Research 250 200 150 100 50 Ireland Belgium Current account deficits Source: Eurostat, National Sources, IMF BOP and BBVA Research 20 15 10 5 0-5 -10-15 0 20003 20014 20031 20042 20053 20064 20081 20092 USA EA-17 Japan UE-15 (Excl. Sweden) -20 20004 20021 20032 20043 20054 20071 20082 20093 20104 USA UE-15 Japan EA-17 UK Page 12

A recovery strategy (2): internal imbalances in EMU General government debt Source: Eurostat and BBVA Research 250 200 A slow but steady fiscal consolidation Public debt is increasing due to fiscal deficits and bank recapitalizations 150 Weak fiscal position of some countries that need a deep and low restructuring of public administrations 100 50 Evaluate fiscal consolidation in structural terms 0 20003 20014 20031 20042 20053 20064 20081 20092 20103 20114 USA EA-17 Japan UE-15 Page 13

10-Y bonds interest rate Europe in the World Economy: Economic Recovery and Europe 2020 A recovery strategy (2): internal imbalances in EMU Interest rate and TARGET2 Source: ECB and BBVA Research 30,0 GRE 10,0 IRL POR CHI SPA ITA SLV 4,0 SLK MNT BEL FRA NED FIN LUX AUT (209%) GER 1,0-80% -60% -40% -20% 0% 20% 40% Target 2 (in GDP%) Differences in interest rates and in ECB dependence: two sides of the same coin Reduction in financial stress: a precondition for the success of fiscal adjustment and structural reforms A political arrangement needed Page 14

A long-run growth strategy Structural capacity in developed economies Source: IMF and BBVA Research Varieties of Capitalism and Comparative Advantage (Hall and Soskice, 2001) Liberal Market Coordinated Market Economies Mixed market Economies Economies Avge. Medium Term UK USA IRL GER FRA NLD BEL AUT FIN DEN SWE JAP SPA ITA POR GRE Labour market 1 1 1 2 3 2 2 2 1 1 2 1 2 3 3 3 1.9 Corporate regulations 1 1 1 2 2 1 3 2 2 1 1 2 3 2 2 3 1.8 TIC regulations 1 1 3 1 2 1 1 1 2 1 1 2 1 2 2 3 1.6 Retail regulations 1 1 1 1 2 1 3 3 2 2 1 1 2 2 2 3 1.8 Professional services reg. 1 1 1 3 2 1 2 2 1 1 1 1 2 3 2 3 1.7 Long term Institutions and contracts 1 2 2 1 2 1 2 1 1 1 2 2 2 3 3 3 1.8 Human capital 2 2 1 2 2 1 1 2 1 1 1 1 3 3 3 3 1.8 Infraestructure 1 1 3 1 1 1 2 2 2 1 1 1 1 3 2 3 1.6 R&D 1 1 2 1 1 1 1 2 2 1 1 1 3 2 3 3 1.6 Average 1.1 1.3 1.7 1.6 1.9 1.1 1.9 1.9 1.6 1.1 1.2 1.3 2.1 2.6 2.4 3.0 1.7 Page 15

A long-run growth strategy Doing Business and structural unemployment Source: BBVA Research based on OECD and Doing Business 1 1 1 0 9 ESP GRE Institutions are crucial for long-term growth (e.g., Acemoglu and Robinson, 2012) 8 FIN FRA 7 CAN DEU BEL ITA Huge differences among European countries 6 5 4 AUS G BR IRE SWE DNL NZL USA NOR JAP AUT POR Interaction with other economic long-run determinants. 3 NLD 0,0 0,1 0,2 0,3 0.4 0,5 0,6 0,7 0,8 0,9 Doing Busines, 2007 Page 16

G D P p e r W A P, 2 0 1 ( i n l o g s ) Europe in the World Economy: Economic Recovery and Europe 2020 A long-run growth strategy Schooling of adult population and GDP per WAP Source: de la Fuente and Doménech (2012) 11.3 11.2 11.1 11.0 10.9 10.8 R ² = 0.81 7 68 IT A IRL NLD A UT BEL DNK DEU GBR FIN FRA US A S WE Human capital is one of the main determinants of GDP per working-age population and other economic variables (U, R&D, etc.) Huge differences among European countries 10.7 10.6 E SP GR C Increasing human capital levels in some countries will be a very slow process (demographics) -> onthe-job training (labour markets reforms) 10.5 PR T 10.4 7 8 9 10 11 12 13 14 Years of schooling of adult population, 2010 Page 17

R&D investment over GDP (%), 2007 Europe in the World Economy: Economic Recovery and Europe 2020 A long-run growth strategy Human capital and R&D Source: BBVA Research based on OCDE The black-box growth Human capital and R&D activities are deeply correlated. Human capital is the basic input of R&D activities Again, huge differences in R&D investment across European countries Coordination of national and European policies to favour innovation in areas in which each country has its own comparative advantage Number of researchers per 1,000 workers, 2007 Page 18

C h a n g e i n r e l a t i v e e x p o r t s p r i c e s ( % ), 1 9 9 9-2 0 1 1 Europe in the World Economy: Economic Recovery and Europe 2020 A long-run growth strategy C AN 30 Heterogeneity in international competitiveness FR R U JP IT US FIN GR SPA DIN P T IRL SUE A T GER NED 20 10 0-10 - 20 Exports prices have not been the main determinant of exports shares. And aggregate ULCs even less Not clear pattern between the determinants of aggregate productivity and exports competitiveness -> significant internal duality in many countries In a globalized economy, a long-run strategy in terms of international competitiveness is crucial - 45-40 - 3 5-30 - 2 5-20 - 15-10 -5 0 Change in the shar e of w orld e xpor t s (%), 19 9 9-2011 w x x w (ex t ex t ) = s t - (p t p t ) - 30 Page 19

Main messages 1 2 3 4 5 In 2020 Europe will be a smaller region in the world economy due to (1) lower population growth and (2) lower GDP per capita growth than emerging economies. The challenge is to increase productivity and employment growth. Needed: a recovery strategy and a long-run strategy: convergence with the US. Recovery strategy: (1) a road map to a genuine EMU (four pillars), (2) correction of internal imbalances, and (3) a balance between growth and austerity. Long-run strategy: (1) economic integration to ensure internal convergence (at national and European levels), (2) improve institutional quality, human capital, R&D and infrastructures. Page 20

Europe in the World Economy: Economic Recovery and Europe 2020 Rafael Doménech Economic recovery and Europe 2020: Towards smart, sustainable and inclusive growth Wilton Park, October 24, 2012