Stagnation Versus Growth in Europe

The debate on the future of monetary union is a great opportunity to strengthen the resilience of the European economy and of the European project at large. How we move forward in this new challenge should be guided by a few key principles: the link between short term and long term issues should be strengthened and based on a common vision.

The distinction between measures that require Treaty changes and those that do not should not be an obstacle to ambitious policy goals. Much can be done with the current treaty. Economic union is a multidimensional project: strengthening monetary and financial integration should go hand in hand with measures to boost growth and jobs. Strengthening EMU should be an opportunity to strengthen the relationship between EMU and non EMU member states, with reciprocal benefits for all of us and Europe as a whole.

Using national household income shares for deciles of household of countries belonging to the European Union, and their corresponding per capita GDP, projections of the share of the total household income flowing to the richest (top 20) quintile and the poorest (bottom 40) quintiles were projected based on the income distribution trends that were prevailing from 2003 to 2011. The decile data are the published estimates made by Eurostat from the EU-SILC survey and the per capita data are estimates made by the United Nations Statistical Office. The projections model is based upon the World Bank model developed by Ahluwalia, Carter and Chenery in 1979. That model was in turn based on the Kuznets’ hypothesis (1955) which postulated that income equality and socio/economic development have a quadratic relationship. The purpose of the exercise was to ascertain whether the shares between the richest and the poorest quintiles are diverging or converging. Our results for the European Union indicate that they are slightly converging, but at least there is no indication that they are diverging.

The spectre of “secular stagnation” has been haunting both pundits and policymakers for some time. In weighing the question of whether slow growth in Europe and other advanced countries reflects some kind of ongoing stagnation problem, it’s important to be clear on the concept. Moreover, in view of the hotly debated bi-causal interaction between lacklustre economic growth and growing inequalities in the distribution of income and wealth fuelled by Piketty’s recent bestseller, it may be useful to recall some of the fundamental insights about capital accumulation, growth and distribution in order to take a look at the secular stagnation hypothesis from this angle as well. Against that background, the paper first reviews the secular stagnation hypothesis and variants thereof, discussing its plausibility and confronting it with the empirical evidence from a European perspective. It then looks into the nexus between growth patterns and the trends in the distribution of income and wealth. Finally, it offers some policy conclusions that can be derived from the analysis.

The current transitional paths of the Euro Area countries can be seen as a turning point between two alternative scenarios: (i) a low decline path (although no secular stagnation), where markets saturation features and trends dynamically interact with a growing share of finance disentangled from the real economy; (ii) an evolution towards self -sustained growth trajectories bundles, where feasible economic and institutional improvements are set in place. In order to capture such a turning point, we adopt a new approach to understand the Saving-Investment Feldstein–Horioka puzzle, developing a model based on the investigation on the time-growth varying surfaces of the Average Propensity to Save (APS) and the Average Propensity to Invest (API). The related specification econometrics, a sort of Colander “Craftsmen’s approach” that includes à la MIMIC estimates of the real rate of depreciation of social overhead capital stock, requires only the hypotheses of adaptive behaviour and stock-flow feedback loops. The results are consistent with the current instability of the Euro Area and show (and measure) to what extent small institutional changes and a limited set of operators can shift the overall trajectories of the EU system.

The euro area is slowly exiting a deep and prolonged economic, financial, institutional and confidence crisis. Several reforms and adjustment processes are underway. An aspect that is often neglected in this difficult period is that European integration has an “engine” which has withstood the crisis: over the last 60 years there has been a continuing deepening of trade in goods and services, foreign direct investment and financial links across EU countries. Such EU Internal Market is a diffused process advancing slowly but steadily, while generating a stream of benefits (with a caveat during the crisis). Four new components of the internal market are under way and are briefly introduced in this chapter. They are: the EU’s Digital Agenda, the Capital Market Union (CMU), the Payment System Directive (PSD), and Target-to-Securities (T2S). These elements are quite ambitious in their respective domains and need to be completed, understood, and widely adopted to exert their benefits, and boost the benefits from the euro. This is a big change in culture that is also supporting the change in EMU governance and political economy under way.

We derive an overlapping-generations model where the creativity of individuals is age dependent. The model implies that lower population growth and the ageing of the population may bring lower productivity growth and investment levels. Using a panel of OECD countries from 1950 to 2011 we find evidence for the negative effect of lower population growth on investment and the effect of the ageing of the population on both investment and productivity growth. However, we find no evidence on the effect of population growth on productivity growth. We conclude that Europe should welcome immigrants and promote higher birth rates among its population.

The Juncker Plan, along with other measures of economic policy, is an attempt to rectify the fall in demand of European investment, raising investment and innovation capacity of enterprises, in a framework of perceived excess of austerity policies and some progress towards a new European industrial (and fiscal) policy. The Plan indicates the need to reconstitute investment profitability and the importance of environmental policies. Green growth policies have become particularly popular in the last decade, but their effects could be much greater because of the growing importance of intangible investment and the industrial changes, such as those expected from the EU program “Industry 4.0”, the growing e change as market failure “global”, and because the green technologies seem to offer the prospect of a new technological, industrial, and research-driven paradigm. The UN Report “Better Growth”, “Better Climate” main thesis is that climate mitigation policies may not have a negative impact, but can even represent a stimulus for economic growth. The idea is that it is possible to combine growth and climate objectives by increasing resource efficiency, by investing in infrastructure and promoting innovation in urban policies, land use and energy sources.

The concept of sustainable development appears to be one of the drivers of green financing, with a growing influence on public awareness of a broad accountability set of criteria to judge governments and corporations on ethical grounds. In many cases, green projects lack an articulated financial structure that allows them to be competitive in attracting financial resources: they may be too small, too specialized, dependent on very specific and risky sources of income, or, due to their public or quasi public nature, not capable to generate appropriable cash flows that may permit risk sharing through concessions or similar private public partnerships. The role of the government in improving this situation is thus expandable on a number of fronts and may prove to be decisive.

The Investment Plan proposed by the European Commission is a policy response to the long-term decline in the global competitiveness of the EU, which is vital for maintaining economic growth potential and our future well-being. The European Fund for Strategic Investments (EFSI) is an important element of this plan and aims at addressing structural investment needs. This note briefly discusses the view on the competitiveness challenge facing Europe, the specific, structural investment gaps and how the EFSI aims at contributing to addressing them.

The purpose of the European internal market is to allow all firms in the Union to compete freely, without artificial barriers built up to protect them. The Treaty provisions and the subsequent case law are quite comprehensive and they are meant to eliminate restrictive regulatory barriers, anticompetitive practices by firms and anticompetitive subsidies. However, especially with respect to State measures (restrictive regulatory provisions and State aid) the results that are achieved by the Union depend strictly on the follow on policies that are adopted by Member States. For example in public procurement European law deals mainly with adjudication (and only above a given threshold), while Member States are responsible for execution and sanctioning (and also adjudication below the threshold). Furthermore, in the process of reform of public utilities, liberalizations decided at the European level have to be followed up by coherent decisions at the Member State level. If such Member State interventions are not well thought out, the whole purpose of the reforms collapses. And indeed in public utilities, the European Union started in the 1990s by providing some very general indications to Member States and eventually, having recognized that markets were not sufficiently opened up, making its indications more and more stringent (but still leaving most of the responsibility of reform to Member States). Recently the Service Directive has extended this approach to liberalization to the general category of service activities. The Directive identified regulatory provisions that were prohibited and those that had to be justified by Member States. However the Directive did not introduce general categories of regulatory restriction to be justified, and instead chose to identify them precisely, falling short of providing an all-comprehensive list. A very effective revision of the Directive would be to introduce explicitly in the text the general categories of regulatory restrictions contained in the OECD Toolkit for Competition impact assessment (is the number of players restricted? Is their possibility to compete restricted? Are their incentives to compete restricted?). Should regulations have these effects, Member States would have to justify them. The regulatory reform that would be initiated in this way would promote the introduction of an innovation friendly regulatory structure.

This paper looks into the recent experience of Greece and addresses why Greece has so far failed to put in place the social and economic changes necessary to resume growth. Economic and institutional features of the country as well as social values and cultural factors play a role in the judgement about such failure. Each of them needs to be considered and addressed in order to shape a different future for the country, but most have received only limited attention. This helps to explain why the internal devaluation that came along with the adjustment programmes (and the financial support) did not on its own deliver a rapid return to growth. The comparison between the southern regions of Italy (the “Mezzogiorno”) and Greece suggests some stunning similarities. The experience and perverse effects of certain policies adopted in the Mezzogiorno serve as a warning that risks could arise in the relationship between Greece and the EU should serious and far-reaching reforms not be implemented soon.

The Greek paradox of falling wages that do not lead to increased exports can be reconciled with standard economic theory, once a number of facts are taken into account. Actually, exports of goods that have not been facing the additional adverse effect of highly increased after tax energy prices for industrial users have been increasing steadily during the crisis. In addition, once the collapse of the economy was well under way, labour market reforms in Greece introduced flexibility that stabilized employment, especially among SME’s. At the same time in spite of modest product market reforms the increasing distortions of a tax system that overtaxes honest productive individuals and businesses, which are by definition more likely to be engaged in businesses that offer higher value tradable goods, further undermined growth and export prospects. Finally, real interest rates on corporate loans, wages and the efficiency of product markets are found to have an important impact on manufacturing employment. Product market reforms and reducing uncertainty thus emerge as key policy priorities if the increase in employment, export performance and wages are a desired policy priority.

We argue that sustainable development is at its essence the destruction and creation of expansion options under the shroud of uncertainty. Without this options approach, the future is undervalued because of uncertainty and the opportunity to stage investment. As a result of this undervaluation, protecting the environment, in particular combatting climate change, is underinvested in favor of short-term returns. We extend this argument to income and wealth distribution arguing that public policy should favor longer-term investment and suppress returns on shorter-term capital. That is, policy should favor the future. In making this argument, we extend the analysis of the influential book by Piketty to real options analysis of investment under uncertainty. We find that taking into account the term structure of investment is more important than the average rate of return on capital in income and wealth distribution. Valuing the future not only benefits the environment but also results in a more equitable income distribution. Both are at the heart of sustainable development.

This paper explores the causes of the tensions that are affecting the international monetary system, in the current situation of the world economy. International monetary spillovers, financial cycles and exchange rate disturbances are posing policy challenges that have been addressed with divergent strategies by the main industrial and emerging countries. There is the risk that this generates trade protectionism and fragmentation with negative implication for world economic growth.