Prof. Dr. h.c. Michael Burda, PhD Humboldt-Universität zu Berlin Public Lecture, Eesti Pank 18 August 2016

1. The Threat of European
Disintegration
Prof. Dr. h.c. Michael Burda, PhD
Humboldt-Universität zu Berlin
Public Lecture, Eesti Pank
18 August 2016
1

2. Overview
• 2016 has been a difficult year for economic policy – but not
necessarily a bad year for the European economy
• The danger of deterioration or even disintegration of the EU:
A bird´s eye view
• The shadow of secular stagnation and the north-south divide
• Points of light – and possible solutions
The Threat of European Disintegration 2

3. The Problem
• My bachelor-level course „European Integration“ at Humboldt University
stresses economic forces behind European integration…
Autonomous capital accumulation and convergence to a common European norm
Capital mobility
Labor mobility
Trade in goods and services
Convergence of institutions, rule of law, harmonization of both macroeconomic
disturbances and fiscal policy
Political convergence in general and the free flow of ideas
• …all have been thrown into reverse gear over the past year!
The Threat of European Disintegration 3

4. The Problem
Economic Growth:
• Growth has not been so low for a long time: D 2015: 1.5%
• Not just central Europe – around the world, at the same time
• Moveover, divergence in Europe is emerging (2015)
• Italy 0.8%
• France 1.1%
• Greece -0.2%
• Germany 1.5%
• Spain 3.2%
• Ireland 7.8%
• Life-threatening in a monetary union – a persistent problem
The Threat of European Disintegration 4

5. Quelle: World Bank
10000
15000
20000
25000
30000
35000
40000
45000
50000
55000
60000
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Pro-Kopf BIP (Niveau), USD von 2005
France Germany Greece Italy United Kingdom Spain Ireland
European Divergence: Real
GDP per capita (2005 USD)
The Threat of European Disintegration 5

6. 20000
25000
30000
35000
40000
45000
50000
55000
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Pro-Kopf BIP (Niveau), Int.USD von 2011
France Germany Greece Italy United Kingdom Spain Ireland
Quelle: Weltbank
European Divergence: GDP per
capita (USD int.2011)
The Threat of European Disintegration 6

7. Quelle: Weltbank
The Threat of European Disintegration 7
European Divergence: Real
GDP per capita (2005 USD)

8. The Problem
Capital mobility:
• In the course of the sovereign debt crisis at the Euro-periphery
and half-hearted reforms in these countries, investment has
ground to a halt – investment, that could stimulate demand and
supply
• Capital flight from the crisis countries continues
• Mixed with nationalist/nativist tendencies, opposition to foreign
capital is growing
The Threat of European Disintegration 8

9. European Divergence:
Target-2 Balances
The Threat of European Disintegration 9

10. The Problem
Labor mobility:
• The Schengen agreement was supposed to facilitate a slower
process of wage convergence, and suppress migration for all but
the poorest countries
• After in-migration of more than 1,2 million people to Germany,
the free mobility of labor is threatened by the reimposition of
border controls
• The deployment of migrants in Germany is occurring, but only
slowly
The Threat of European Disintegration 10

11. The Problem
Trade:
• Intra-European trade has suffered from the crisis
• The voices of protectionism have grown louder – as the
discussion of TTIP and Brexit have shown
• The EU-referendum outcome in June shows potential dangers
of populist sentiment – and may follow if the UK has a soft
„Brexit“
The Threat of European Disintegration 11

12. The Problem
Convergence of institutions and policies
• Background: The financial and sovereign debt crises have
focused our attention once again on sovereign solvency
• Focus on government debt relative to GDP – not debt levels
• Facts: Public budget balances, consolidated, 2012 (% des BIP)
Country Fiscal Balance Interest service Primary balance Debt / GDP
D 0,1 2,4 2.5 81,0
F -4,8 2,6 -2,3 90,2
PL -3,9 2,8 -1,1 55,6
GR -9,0 5,0 -4,0 156,9
IRL -8,0 3,2 -4,8 120,2
Source: IW Köln
The Threat of European Disintegration 12

13. The Problem
Convergence of institutions and policies
• Background: The financial and sovereign debt crises have
focused our attention once again on sovereign solvency
• Focus on government debt relative to GDP – not debt levels
• Facts: Public budget balances, consolidated, 2014 (% des BIP)
Source: IW Köln
Country Fiscal Balance Interest service Primary balance Debt / GDP
D 0,3 1,4 1,7 74,0
F -3,9 2,0 -1,9 95,6
PL -3,3 1,9 -1,4 51,6
GR -3,9 3,9 0,0 178,4
IRL -3,9 3,5 -0.4 107,5
The Threat of European Disintegration 13

14. Recall the dynamics of sovereign debt
• The dynamics of debt are simple:
 Debt = - Consolidated government balance
= Spending – Income
= Government consumption
+ transfer payments
+ government investment
+ interest payments
- revenues
- debt repayment
The Threat of European Disintegration 14

15. • Market interest rates reflect aggregated trust of creditors - and
the reputation of the borrowers
• Income normally grows, tax revenues should grow at the same
time – assuming there is growth
• The relevant number is therefore the debt-GDP ratio!
• The central formula for a stabilized and sustainable fiscal stance:
Primary surplus/GDP = (r–g)(Total government debt/GDP)
where r=interest rate on government debt and g=growth rate
The Threat of European Disintegration 15
Recall the dynamics of sovereign debt

16. The Dynamic of Government Debt
• Primary versus total „headline“ Deficit – latter includes
interest payment
• At the moment interest rates are at lowest levels in a century,
lower than 7 decades ago
• … but growth has also slowed considerably
• Causal for the debt crisis: Chronic primary deficits in a time
when g was greater than r, then collapse of growth (g)
The Threat of European Disintegration 16

17. Sovereign debt, Euro-Länder (ESA95 Basis)
% of GDP, 1990-2015
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18. 18
Yields on Eurozone government debt,
10 year bonds, % p.a., 1990-2016

19. 19
Monetary policy appears helpless
0
500
1000
1500
2000
2500
3000
3500
1999
1999
1999
2000
2000
2001
2001
2001
2002
2002
2003
2003
2004
2004
2004
2005
2005
2006
2006
2006
2007
2007
2008
2008
2009
2009
2009
2010
2010
2011
2011
2011
2012
2012
2013
2013
2014
2014
2014
2015
2015
2016
2016
EURbillions
Total ECB assets and unconventional policy measures
Size of the ECB's balance sheet Securities held for monetary purposes LTRO

20. The Problem
Regional divergence is poison for a monetary union:
• Mundell (1961)
• Nominal wage growth 1999-2015:
0
20
40
60
80
100
120
140
160
180
200
2008
0
20
40
60
80
100
120
140
160
180
200
2016
Quelle: Eurostat/AMECO The Threat of European Disintegration 20

21. Solutions
Growth – and productivity growth – is the key
• But the key is lost! How to find it? Look under the right lamppost
• Is Germany part of the problem? Or a key to the solution?
• More austerity? More spending? Tax cuts?
• Infrastructure?
• Human capital program for migrants?
The Threat of European Disintegration 21

22. Austerity as priority?
• Solution: Does „Schulden“ mean „guilt“?
• Many have expressed strong views on this point, also in
Germany
• Negative demand effects in the short run – Greece, Italy,
Portugal, Spain, Ireland
• But the long run is a string of short runs
• Ireland v. Greece
• Is hope in sight in Ireland? Spain? Greece?
The Threat of European Disintegration 22

23. The growth solution
• What can policy do about the situation?
• Growth, growth, growth! Europe must „grow up“ - to the
leading countries at the technological frontier
• More reforms are necessary:
 Labor reforms: Learn from the German success story
 Product market reforms: Learn from Scandinavia and the UK
 Infrastructure program: The „Summers No-brainer“
The Threat of European Disintegration 23

24. Ray of hope, I: Labor market reforms
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25. 25
The price of labor market success: Wage inequality
Quelle: Dustmann, Fitzenberger, Schönberg, and Spitz-Oener (2014)
Reallöhne, Vollzeit, Westdeutschland
The Threat of European Disintegration

26. 26
…in particular for part-time and marginal jobs
Real wages, part-time, western Germany
Source: Burda and Seele (2015)
Indexedwagegrowth
The Threat of European Disintegration

27. 27
1.2
1.7
2.2
2.7
3.2
3.7
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
90-10 Percentile ratios, full-time workers
Germany Sweden FranceSource: OECD
Evident in international comparisons
The Threat of European Disintegration

28. Personal inequality has not increased more in
Germany than in other OECD countries
The Threat of European Disintegration 28

29. Ray of hope, II: Demand boom in Germany
The massive influx of refugees in the past year – of more than
one million people – will trigger new economic impulses, that
might help mend the situation: It will induce
1) A Keynesian demand stimulus, possibly €20-30b. per annum
2) A reversal of the still-rising current account surpluses of
Germany with southern Europe, similar to the fashion they
were reduced after German unification 1990-1995
3) Nominal wages are finally rising in Germany, especially at
thelow end, which will help take the edge off German „über-
competitiveness“
The Threat of European Disintegration 29

30. Ray of hope, III: Growth is possible
• It has become fashionable among scholars of
macroeconomics to talk of „secular stagnation“ again (Alvin
Hansen 1939)
• Protagonists: Lawrence Summers, Paul Krugman, as well as
Robert Gordon und Martin Wolf
• Growth in the past two decades has indeed been remarkably
modest, even in the USA since the Great Recession
• Despite this, there are points of strong growth today: Ireland,
Poland, Nordic countries – and Estonia
• Extensive economic growth as an alternative: Why not?
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31. Real per capita GDP growth, 1980-2015
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32. US growth took a hit after the crisis
Quelle: Fernald (2015) The Threat of European Disintegration 32

33. …but US labor productivity continues to grow…
Value added per hour, cumlative relative to value in 1973 (%)
Source: Fernald (2015)
The Threat of European Disintegration 33

34. 34
Source: Fernald (2015)
…while the rest of the world is falling behind
Value added per hour, relative to US value (%)

35. 35
World Bank Ease of Doing Business Indicator, 2013
Source: www.doingbusiness.org
The Threat of European Disintegration

36. 36Source: www.doingbusiness.org The Threat of European Disintegration
72
(2011: 87)
(2011: 100)
World Bank Ease of Doing Business Indicator, 2013

37. Infrastructure investment
• What can policy do about the situation?
• For Europe to „grow up“ - to the leading countries at the
technological frontier – it needs to modernize its infrastructure
• Facts (% of GDP):
1991 2002 2013
D: 2,6 1,8 1,6
F: 3,6 2,9 3,2
PL: - 3,4 3,9
• Infrastructure investment has been week for more than a decade
• Summers‘ logic – the rate of return is certainly high enough
The Threat of European Disintegration 37

38. Conclusions
• 2016 will be a year of tectonic (not only teutonic) challenges –
„meta challenges – for the EU“: Migration, Euro, reforms, Brexit
• The outcome may depend more on the politics than economics
• Brexit is only the beginning
• The survival of the Euro, low interest rates of ECB and non-
reforms in F, I, P, S and GR mean further divergence
• I don´t dare make a forecast – but am happy to speculate!
The Threat of European Disintegration 38

39. The Threat of European
Disintegration
Prof. Dr. h.c. Michael Burda, PhD
Humboldt-Universität zu Berlin
Public Lecture, Eesti Pank
18 August 2016
The Threat of European Disintegration 39