Coming together or falling apart?

70 Pages·2017·2.39 MB·English

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Presidente: Vladimiro Giacché

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Comitato scientifico: Paolo Guerrieri Paleotti (presidente), Pierluigi Ciocca, Innocenzo Cipolletta, Ste-
fan Collignon, Giovanni Ferri, Simona Iammarino, Lelio Iapadre, Domenico Lombardi, Mauro Marè,
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Paola Subacchi, Gianni Toniolo

Rapporto CER: pubblicazione periodica a carattere economico. Anno XXXIV
Direttore responsabile: Jacopo Tondelli

Iscrizione n. 59/2016 del 5 aprile 2016 del Registro della Stampa del Tribunale di Roma
Proprietario della testata: Centro Europa Ricerche S.r.l.
C.C.I.A.A. Roma: R.E.A. 480286

Edizione: Centro Europa Ricerche S.r.l.

Printed out at CER – June, 2017
Europe: Coming together
or falling apart?
The following authors have contributed to this report: Stefan Collignon, Piero Esposito,
Giovanna Scarchilli.
R A P P O R T O C E R

Executive summary 7

The end of austerity 9
FISCAL POLICY AND THE SUSTAINABILITY OF PUBLIC DEBT 12
EUROPE’S GROWTH POTENTIAL 18
Box 1. European fiscal rules 20
Box 2. The sustainability of public debt 21
Box 3. Potential output, skill mismatch and public finances 22

Economic convergence in the Monetary Union? 27
INCOME DISTRIBUTION 29
MACROECONOMIC IMBALANCES 29
FLOW OF FUNDS IN THE EURO AREA 33
THE EUROPEAN LABOUR MARKET 37
COMPETITIVENESS AND LABOUR COSTS 40
Box 4. Economic real convergence in the Euro Area 44
Box 5. Sources and availability of data on the international position 47

The EU trade and rising protectionism: divergence in the world 49
THE IMPORTANCE OF TRADE FOR EUROPE 50
THE ROLE OF TARIFFS 56
TRADE ELASTICITIES 58
Box 6. US protectionism and Global Value Chains: impacts on European trade 60

Conclusion 65

55

R A P P O R T O C E R
Executive summary

The Euro Area has gone through a long and painful crisis, but the end is near. Growth
is returning, although its distribution across the EU is very unequal. This divergent eco-
nomic development between member states of the European Union is not sustainable,
both for economic and political reasons.
The most important challenge is now to restore balanced economic growth. This is also
a necessary condition for maintaining stable public finances. We reassess the concept
of sustainable public debt and provide empirical evidence. It turns out that in the long
run the debt/GDP ratio depends on the nominal growth rate, which needs to attain
5% in order to bring the steady state debt ratio down to 60%. Yet, unfortunately no
member state of the European Union is presently achieving nominal growth rate of this
order.
We also find that fiscal policy must adjust in proportion to the growth adjusted interest
rate in order to prevent it from steadily diverging from the long run steady state equi-
librium. Most countries, with the exception of Belgium, Austria, Lithuania and Germany
have satisfied this condition in 2016, but far less countries have done so since the crisis
started in 2009. Yet, in the present economic environment, European public debt is
sustainable.
Given the importance of growth for the long run sustainability of the euro, we question
whether the divergences observed during the crisis years are likely to persist or whether
growth will return towards a long run equilibrium. We find that economic convergence
has taken place among the new eastern member states, but not among the core
countries or the Mediterranean crisis countries. It is largely dependent on catchup from
the poorest regions, while middle income countries diverge. Domestic income distribu-
tion does not seem to affect economic growth.
In a long term perspective we analyze the factors behind the growth of potential out-
put. We find that in nearly all cases, more open trade, more R&D, labour market re-
forms, the de jure index of capital account opening and the rule of law make positive
contributions to the growth of economic potential. The impact of public debt and
deficits on potential growth is more complex. At debt-GDP ratios below 100 percent,
deficits will not impede potential growth, and the effect of fiscal tightening is positive
provided the country is in deficit or has a very small surplus (below 1%). Above this level
further consolidation is insignificant and might even turn negative. Hence, the role of
potential growth must be seen in the context of debt sustainability.
Diverging economic growth can be interpreted as the consequence of macroeco-
nomic imbalances, which are surveilled by the European Macroeconomic Imbalance
procedure. However, the Commission’s focus on current account deficits has contrib-
uted to even greater growth divergences, especially in the southern crisis countries.
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N. 1 - 2 0 1 7
We argue that flow of funds analysis is a better tool for assessing imbalances. Our anal-
ysis shows that the deleveraging process of the corporate sector is the reason for the
slow economic growth in most countries except France, where the balance sheets of
corporations are in better shape. With returning confidence after the election of Em-
manuel Macron, France is likely to become the new growth pole of the Euro Area. In
the UK, economic growth is driven by a consumer boom, which is unsustainable, es-
pecially in the context of Brexit.
Unemployment is coming down as well, although the impact suffers from the diverging
economic performances. Labour costs are above equilibrium levels in several southern
states, but dramatically below that level in the new member states. This is one of the
main reasons for the divergent growth rates in Europe.
With Brexit and the election of Donald Trump, the world has entered a new phase of
development. The era of neoliberalism, which started with Margaret Thatcher and
Ronald Reagan, has come to a close; nationalism and xenophobia are progressing
rapidly and populists seek to close previously open societies. We look at the potential
consequences of this regime change. Assuming a “hard” Brexit, which would imply the
exit from the single market and the customs union and a rise in tariffs, we assess the
importance of trade for Europe and find that while the US market is generally more
important than the UK, both countries are marginal but not insignificant players in Eu-
ropean trade. Nevertheless, a deeper analysis reveals that because the increased re-
gional integration, especially in the European single market, has generated a large
and growing role for global value chains, whereby the production of final goods is a
combination of imports and exports from different countries, a hard Brexit will affect
these countries more severely than American protectionism.
We calculate trade elasticities and estimate the consequences of a general increase
in tariffs on trade with the EU. We find that a rise in protectionism, especially from the
US, would mostly affect the EU Emerging Markets in the new member states and to a
lower extent, core countries like Germany and the Netherlands. Italy and the other
Southern European Countries are not the most penalized economies, although the
high dependence of Italy on the US market put the country in a slightly worse position
than its peers. A generalized trade war between the EU and the United States would
become as devastating as was the Global Financial Crisis in 2008/9.

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