This paper focuses on roots of strain in the European Monetary Union (EMU). It argues that there is need for a thorough reform of the governance structure of the Union in conjunction with radical changes in the regulation and supervision of financial markets. Financial intermediation has gone astray in recent decades and entailed a big bubble in the industrialized world. Waves of financial deregulation have enhanced systemic risks, via speculative behavior and growing inter-connectedness. Moreover, the EMU was sub-optimal from its debut and competitiveness gaps did not diminish against the backdrop of its inadequate policy and institutional design. The euro zone crisis is not related to fiscal negligence only; over-borrowing by the private sector and poor lending by banks, as well as a one-sided monetary policy, also explain this debacle. The EMU needs to complement its common monetary policy with solid fiscal/budget underpinnings. Fiscal rules and sanctions are necessary, but not sufficient. A common treasury (a federal budget) is needed in order to help the EMU absorb shocks and forestall confidence crises. A joint system of regulation and supervision of financial markets should operate. Emergency measures have to be comprehensive and acknowledge the necessity of a lender of last resort; they have to combat vicious circles. Structural reforms and EMU level policies are needed to enhance competitiveness in various countries and foster convergence. The EU has to work closely with the US and other G20 members in order to achieve a less unstable global financial system.
Authored by: Daniel Daianu
Published in 2012
This document provides background on private sector development in developing countries. It discusses trends in privatization revenues globally and by region since 1988. Privatization activity was highest in Latin America in the 1990s and Eastern Europe/Central Asia in the 2000s, while the Middle East/North Africa region saw more modest activity. Research generally finds private ownership outperforms state ownership. However, privatization alone does not guarantee improved performance - competition, strong market institutions, and the type of private owner are also important factors. The document will examine private sector trends in Latin America, post-communist Europe/Asia, and the Middle East/North Africa region.
The The purpose of this paper is to analyze the various challenges facing European integration and the EU institutional architecture as result of the global financial crisis. The European integration process is not yet complete, both in terms of its content and geographical coverage. It can be viewed as a kind of intermediate hybrid between an international organization and a federation, subject to further evolution. This is also true of the Single European Market and the Economic and Monetary Union, which form the core of the EU economic architecture. Certain policy prerogatives (such as external trade, competition, and the Common Agriculture Policy) are delegated to the supranational level while others (such as financial supervision or fiscal policy) remain largely in the hands of national authorities.
Authored by: Marek Dąbrowski
Published in 2009
Emerging market economies were major beneficiaries of the economic boom before 2007. More recently, they have become victims of the global financial crisis. Their future development depends, to a large extent, on global economic prospects. Today the global economy and the European economy are much more integrated and interdependent than they were ten or twenty years ago. Every country must recognize its limited economic sovereignty and must be prepared to deal with the consequences of global macroeconomic fluctuations.
The statistical data for 2009 provides a mixed picture with respect to the impact of the crisison various groups of countries and individual economies. On average, Central and Eastern Europe experienced a smaller output decline than the Euro area and the entire EU while the CIS, especially its European part, contracted more dramatically. However, there was a deep differentiation within each country group. Looking globally, richer countries, which are more open to trade and in which the banking sector plays a larger role and which rely more on external financing, suffered more than less sophisticated economies, which are less dependent on trade and credit (especially from external sources). With some exceptions, the previous good growth performance helped rather than handicapped countries in the CEE and CIS regions in the crisis year of 2009.
The post-crisis recovery has been rather modest and incomplete. It remains vulnerable to new shocks (like the Greek Fiscal crisis), the danger of sovereign default and other uncertainties. Full post-crisis recovery and increasing potential growth will require far going economic and institutional reforms on both national, regional (e.g., EU) and global levels.
Authored by: Marek Dąbrowski
Published in 2010
This document discusses the debate around fiscal integration within the European Union and Eurozone. It argues that while some level of fiscal integration may help support monetary integration, the relationship is complex and not all proposals for closer fiscal integration are necessarily beneficial. The document outlines different definitions and components of a fiscal union. It also examines the interlinkages between monetary and fiscal unions from both a theoretical and empirical perspective, finding the evidence mixed. Overall the paper aims to provide a more nuanced analysis of fiscal integration options within the EU/Eurozone.
The Eurozone crisis mobilises an appreciable amount of the attention of politicians and the public, with calls for a decisive defence of the euro, because the single currency’s demise is said to be the beginning of the end of the EU and Single European Market. In our view, preserving the euro may result in something completely different than expected: the disintegration of the EU and the Single European Market rather than their further strengthening. The fundamental problem with the common currency is individual countries’ inability to correct their external exchange rates, which normally constitutes a fast and efficient adjustment instrument, especially in crisis times.
Europe consists of nation states that constitute the major axes of national identity and major sources of government’s legitimisation. Staying within the euro zone may sentence some countries – which, for whatever reason, have lost or may lose competitiveness – to economic, social and civilizational degradation, and with no way out of this situation. This may disturb social and political cohesion in member countries, give birth to populist tendencies that endanger the democratic order, and hamper peaceful cooperation in Europe. The situation may get out of control and trigger a chaotic break-up of the euro zone,
threatening the future of the whole EU and Single European Market.
In order to return to the origins of European integration and avoid the chaotic break-up of the euro zone, the euro zone should be dismantled in a controlled manner. If a weak country were to leave the euro zone, it would entail panic and a banking system collapse. Therefore we opt for a different scenario, in which the euro area is slowly dismantled in such a way that the most competitive countries or group of such countries leave the euro zone. Such a step would create a new European currency regime based on national currencies or currencies serving groups of homogenous countries, and save EU institutions along with the Single European Market.
This paper has been also published in "German Economic Review" (Volume 14, Issue 1, pages 31–49, February 2013)
Authored by: Stefan Kawalec and Ernest Pytlarczyk
This paper draws on the experience of emerging Europe and argues that foreign capital is an enviable development opportunity with tail risks. Financial integration and foreign savings supported growth in the EU12 and EU candidate countries. We argue that this was possible because of EU membership (actual or potential) and its role as an anchor for expectations. In contrast, the eastern partnership states did not benefit from the foreign savings-growth link. But financial integration also led to a buildup of vulnerabilities and now exposes emerging Europe to prolonged uncertainty and financial deleveraging due to eurozone developments. Nonetheless, we believe that external imbalances should not be eradicated—nor should emerging Europe pursue a policy of self-insurance. Instead, what we refer to as an acyclical fiscal policy stance could serve to counterbalance private sector behavior. Going forward, a more proactive macroprudential policy will also be needed to limit financial system vulnerabilities when external imbalances are large.
This paper build on work presented in a World Bank report titled “Golden Growth: Restoring the Lustre of the European Economic Model” (2012) and on Juan Zalduendo’s presentation on “Financial integration. Lessons from CEE and SEE” delivered at the CASE 2011 International Conference on “Europe 2020: Exploring the Future of European Integration” held in Falenty near Warsaw, November 18-19, 2011.
Authored by: Aleksandra Iwulska, Naotaka Sugawara, Juan Zalduendo
Published in 2012
This paper discusses the global financial crisis of 2008/9 in thirteen countries, the ten new EU members that previously were communist and the three countries of Western former Soviet Union. Their problems were excessive current account deficits and private foreign debt, currency mismatches, and high inflation, while public finances were in good shape. The dominant cause was fixed exchange rates. Many lessons can be drawn from this crisis. A dollar peg makes no sense in this part of the world. The five currency boards in the region have lacked credibility. By contrast, inflation targeting has worked eminently. The euro has proven credible both in the countries that officially adopted it and in the countries that adopted it unilaterally. With the exception of Hungary, all the countries in the region have displayed decent fiscal policies. No government should accept large domestic loans in foreign currency and they can be regulated away. The IMF has successfully returned to the original Washington consensus with relatively few conditions: a reasonable budget balance and a realistic exchange rate policy, while focusing more on bank restructuring. The most controversial issue is the role of the ECB. The ECB should facilitate the accession of willing EU members to the euro by relaxing the ERM II conditions.
Authored by: Anders Aslund
Published in 2009
The current fiscal imbalances and fragilities in the Southern and Eastern Mediterranean countries (SEMC) are the result of decades of instability, but have become more visible since 2008, when a combination of adverse economic and political shocks (the global and European financial crises, Arab Spring) hit the region. In an environment of slower growth and higher public expenditure pressures, fiscal deficits and public debts have increased rapidly. This has led to the deterioration of current accounts, a depletion of official reserves, the depreciation of some currencies and higher inflationary pressure.
To avoid the danger of public debt and a balance-of-payment crisis, comprehensive economic reforms, including fiscal adjustment, are urgently needed. These reforms should involve eliminating energy and food subsidies and replacing them with targeted social assistance, reducing the oversized public administration and privatizing public sector enterprises, improving the business climate, increasing trade and investment openness, and sector diversification. The SEMC may also benefit from a peace dividend if the numerous internal and regional conflicts are resolved.
However, the success of economic reforms will depend on the results of the political transition, i.e., the ability to build stable democratic regimes which can resist populist temptations and rally political support for more rational economic policies.
Authored by: Marek Dąbrowski
Published in 2014
This document provides background on private sector development in developing countries. It discusses trends in privatization revenues globally and by region since 1988. Privatization activity was highest in Latin America in the 1990s and Eastern Europe/Central Asia in the 2000s, while the Middle East/North Africa region saw more modest activity. Research generally finds private ownership outperforms state ownership. However, privatization alone does not guarantee improved performance - competition, strong market institutions, and the type of private owner are also important factors. The document will examine private sector trends in Latin America, post-communist Europe/Asia, and the Middle East/North Africa region.
The The purpose of this paper is to analyze the various challenges facing European integration and the EU institutional architecture as result of the global financial crisis. The European integration process is not yet complete, both in terms of its content and geographical coverage. It can be viewed as a kind of intermediate hybrid between an international organization and a federation, subject to further evolution. This is also true of the Single European Market and the Economic and Monetary Union, which form the core of the EU economic architecture. Certain policy prerogatives (such as external trade, competition, and the Common Agriculture Policy) are delegated to the supranational level while others (such as financial supervision or fiscal policy) remain largely in the hands of national authorities.
Authored by: Marek Dąbrowski
Published in 2009
Emerging market economies were major beneficiaries of the economic boom before 2007. More recently, they have become victims of the global financial crisis. Their future development depends, to a large extent, on global economic prospects. Today the global economy and the European economy are much more integrated and interdependent than they were ten or twenty years ago. Every country must recognize its limited economic sovereignty and must be prepared to deal with the consequences of global macroeconomic fluctuations.
The statistical data for 2009 provides a mixed picture with respect to the impact of the crisison various groups of countries and individual economies. On average, Central and Eastern Europe experienced a smaller output decline than the Euro area and the entire EU while the CIS, especially its European part, contracted more dramatically. However, there was a deep differentiation within each country group. Looking globally, richer countries, which are more open to trade and in which the banking sector plays a larger role and which rely more on external financing, suffered more than less sophisticated economies, which are less dependent on trade and credit (especially from external sources). With some exceptions, the previous good growth performance helped rather than handicapped countries in the CEE and CIS regions in the crisis year of 2009.
The post-crisis recovery has been rather modest and incomplete. It remains vulnerable to new shocks (like the Greek Fiscal crisis), the danger of sovereign default and other uncertainties. Full post-crisis recovery and increasing potential growth will require far going economic and institutional reforms on both national, regional (e.g., EU) and global levels.
Authored by: Marek Dąbrowski
Published in 2010
This document discusses the debate around fiscal integration within the European Union and Eurozone. It argues that while some level of fiscal integration may help support monetary integration, the relationship is complex and not all proposals for closer fiscal integration are necessarily beneficial. The document outlines different definitions and components of a fiscal union. It also examines the interlinkages between monetary and fiscal unions from both a theoretical and empirical perspective, finding the evidence mixed. Overall the paper aims to provide a more nuanced analysis of fiscal integration options within the EU/Eurozone.
The Eurozone crisis mobilises an appreciable amount of the attention of politicians and the public, with calls for a decisive defence of the euro, because the single currency’s demise is said to be the beginning of the end of the EU and Single European Market. In our view, preserving the euro may result in something completely different than expected: the disintegration of the EU and the Single European Market rather than their further strengthening. The fundamental problem with the common currency is individual countries’ inability to correct their external exchange rates, which normally constitutes a fast and efficient adjustment instrument, especially in crisis times.
Europe consists of nation states that constitute the major axes of national identity and major sources of government’s legitimisation. Staying within the euro zone may sentence some countries – which, for whatever reason, have lost or may lose competitiveness – to economic, social and civilizational degradation, and with no way out of this situation. This may disturb social and political cohesion in member countries, give birth to populist tendencies that endanger the democratic order, and hamper peaceful cooperation in Europe. The situation may get out of control and trigger a chaotic break-up of the euro zone,
threatening the future of the whole EU and Single European Market.
In order to return to the origins of European integration and avoid the chaotic break-up of the euro zone, the euro zone should be dismantled in a controlled manner. If a weak country were to leave the euro zone, it would entail panic and a banking system collapse. Therefore we opt for a different scenario, in which the euro area is slowly dismantled in such a way that the most competitive countries or group of such countries leave the euro zone. Such a step would create a new European currency regime based on national currencies or currencies serving groups of homogenous countries, and save EU institutions along with the Single European Market.
This paper has been also published in "German Economic Review" (Volume 14, Issue 1, pages 31–49, February 2013)
Authored by: Stefan Kawalec and Ernest Pytlarczyk
This paper draws on the experience of emerging Europe and argues that foreign capital is an enviable development opportunity with tail risks. Financial integration and foreign savings supported growth in the EU12 and EU candidate countries. We argue that this was possible because of EU membership (actual or potential) and its role as an anchor for expectations. In contrast, the eastern partnership states did not benefit from the foreign savings-growth link. But financial integration also led to a buildup of vulnerabilities and now exposes emerging Europe to prolonged uncertainty and financial deleveraging due to eurozone developments. Nonetheless, we believe that external imbalances should not be eradicated—nor should emerging Europe pursue a policy of self-insurance. Instead, what we refer to as an acyclical fiscal policy stance could serve to counterbalance private sector behavior. Going forward, a more proactive macroprudential policy will also be needed to limit financial system vulnerabilities when external imbalances are large.
This paper build on work presented in a World Bank report titled “Golden Growth: Restoring the Lustre of the European Economic Model” (2012) and on Juan Zalduendo’s presentation on “Financial integration. Lessons from CEE and SEE” delivered at the CASE 2011 International Conference on “Europe 2020: Exploring the Future of European Integration” held in Falenty near Warsaw, November 18-19, 2011.
Authored by: Aleksandra Iwulska, Naotaka Sugawara, Juan Zalduendo
Published in 2012
This paper discusses the global financial crisis of 2008/9 in thirteen countries, the ten new EU members that previously were communist and the three countries of Western former Soviet Union. Their problems were excessive current account deficits and private foreign debt, currency mismatches, and high inflation, while public finances were in good shape. The dominant cause was fixed exchange rates. Many lessons can be drawn from this crisis. A dollar peg makes no sense in this part of the world. The five currency boards in the region have lacked credibility. By contrast, inflation targeting has worked eminently. The euro has proven credible both in the countries that officially adopted it and in the countries that adopted it unilaterally. With the exception of Hungary, all the countries in the region have displayed decent fiscal policies. No government should accept large domestic loans in foreign currency and they can be regulated away. The IMF has successfully returned to the original Washington consensus with relatively few conditions: a reasonable budget balance and a realistic exchange rate policy, while focusing more on bank restructuring. The most controversial issue is the role of the ECB. The ECB should facilitate the accession of willing EU members to the euro by relaxing the ERM II conditions.
Authored by: Anders Aslund
Published in 2009
The current fiscal imbalances and fragilities in the Southern and Eastern Mediterranean countries (SEMC) are the result of decades of instability, but have become more visible since 2008, when a combination of adverse economic and political shocks (the global and European financial crises, Arab Spring) hit the region. In an environment of slower growth and higher public expenditure pressures, fiscal deficits and public debts have increased rapidly. This has led to the deterioration of current accounts, a depletion of official reserves, the depreciation of some currencies and higher inflationary pressure.
To avoid the danger of public debt and a balance-of-payment crisis, comprehensive economic reforms, including fiscal adjustment, are urgently needed. These reforms should involve eliminating energy and food subsidies and replacing them with targeted social assistance, reducing the oversized public administration and privatizing public sector enterprises, improving the business climate, increasing trade and investment openness, and sector diversification. The SEMC may also benefit from a peace dividend if the numerous internal and regional conflicts are resolved.
However, the success of economic reforms will depend on the results of the political transition, i.e., the ability to build stable democratic regimes which can resist populist temptations and rally political support for more rational economic policies.
Authored by: Marek Dąbrowski
Published in 2014
The paper shows that the question that is relevant for the debate on the efficacy of development assistance is not so much as an issue of how much, but rather for what. In view of the growing awareness of ODA’s inefficiency in achieving intended aims, this paper proposes an alternative approach to development assistance policies – economic integration and subsidiarity provides the conditions necessary for ODA to produce higher rates of economic growth on a sustainable basis. Europe is an excellent case in point, in this context. Europe has in the last decades experienced a number of success stories in moving out of poverty and onto sustainable economic growth. The secret of success has been the push towards economic integration, and the adoption of economic reforms at the local, national, and regional level conducive to economic growth. The recipient countries of development assistance have much to learn from the European experience.
We apply Feldstein's (1997, 1999) analysis of the interactions between the tax system and inflation to two transition economies: Poland and Ukraine. We find that the taxrelated costs of inflation in these countries are significantly smaller than in mature market economies. Our analysis points out that the tax system in these two countries is superior to the tax system in developed market economies, as taxes on investment income are lower. It implies that transition countries should avoid replicating other tax systems and, instead, take advantage of the unique opportunity to design and entrench the features of their tax system which are superior to those in mature economies.
Authored by: Monika Blaszkiewicz, Jerzy Konieczny, Anna Myslinska, Przemyslaw Wozniak
Published in 2003
This paper analyses the effect of the EU enlargement process on income convergence among regions in the EU and in the Eastern neighbourhood of the EU. The data used is NUTS II regions in the EU and Oblasts' of Russia over the period 1996-2004. The estimation techniques used take into account both regional and spatial heterogeneity. The main findings are that the regional income differences are reduced within EU15. The income convergence within the EU is mainly driven by reductions in the differences across countries rather than by a reduction in regional differences within countries. When differences in initial conditions in the regions are controlled for by fixed regional effects there are strong evidences of convergence among regions in all studied country groups.
Authored by: Fredrik Wilhelmsson
Published in 2009
Despite significant economic reforms in many Southern Mediterranean EU neighbour countries, their growth performance has on average been subdued. This study analyses the differences in growth performance and macroeconomic stability across Mediterranean countries, to draw lessons for the future. The main findings are that Southern Mediterranean countries should benefit from closer ties with the EU that result in higher levels of trade and FDI inflows, once the turbulence of the ‘Arab Spring’ is resolved, and from the development of financial markets and infrastructure. They will also benefit in keeping inflation under control, which will depend in great part on their ability to maintain fiscal discipline and sustainable current accounts. One of the main challenges for the region will be to implement structural reforms that can help them absorb a large pool of unemployed without creating upward risks to inflation.
Authored by: Leonor Coutinho
Published in 2012
The paper discusses the current and potential role of the European Neighbourhood Policy (ENP) in anchoring economic reforms in the countries of the EU's Eastern Neighbourhood. It claims that it is too early to assess the success of the ENP in this sphere especially given that the actual progress of the ENP agenda has been limited. A review of the empirical evidence on external reform anchors confirms that the ENP shares some features with the EU accession process that has proven to be an effective mechanism supporting major economic, political and social changes in the countries concerned. The eventual ENP economic offer is meaningful and integration with the EU is getting stronger public support in several CIS countries and among their political elites. On the other hand several factors limit the reform anchoring potential of the ENP. This paper offers recommendations on policies that could strengthen this potential.
Authored by: Wojciech Paczynski
Published in 2009
This study reviews monetary policy options that are seemingly viable for adopting the euro by the new Member States of the European Union. A fully autonomous direct inflation targeting is believed to be suboptimal for convergence to the euro as it does not incorporate convergence parameters into the central bank reaction function and instrument rules. In an attempt to correct for such deficiency, this study advocates adopting a framework of relative inflation forecast targeting where a differential between the domestic and the eurozone inflation forecasts becomes the main objective of the central bank's decisions.
At the same time, some attention to the exchange rate stability objective becomes necessary for facilitating the monetary convergence process. Foreign exchange market interventions, rather than interest rate adjustments, are viewed as a preferred way of achieving this objective.
Authored by: Lucjan T. Orlowski
Published in 2005
The IMF staff report discusses Albania's 2010 Article IV consultation. It notes that Albania entered the global crisis in a relatively strong position due to macroeconomic stability, structural reforms, and policy buffers like low debt and high reserves. However, these policy buffers are now depleted. While the economy is recovering from the crisis, downside risks remain from high public debt and regional uncertainties. The report recommends rebuilding fiscal space through consolidation, conducting prudent monetary policy, and improving competitiveness to support sustainable growth.
Since May 1, 2004 the European Union's new member states (NMS) have been subject to the same fiscal rules established in the Treaty on the European Union and Stability and Growth Pact (SGP) as the old member states (OMS). The NMS entered the EU running structural fiscal deficits. More than half of them (including the biggest ones) breach the Treaty's actual deficit limits and are already the subject of the excessive deficit procedure. A high rate of economic growth makes the fiscal situation of most NMS reasonably manageable in the short- to medium-term, but the long term fiscal outlook, mostly connected with the consequences of an aging population, is dramatic. The NMS should therefore prepare themselves now to be able to meet this challenge over the next decades (the same goes for the OMS). In addition, the perspective of EMU entry should provide the NMS with a strong incentive to reduce their deficits now because waiting (and postponing both fiscal adjustment and the adoption of the Euro) will only result in higher cumulative fiscal costs. The additional financial burden connected with EU accession cannot serve as excuse in delaying fiscal consolidation.
In spite of the growing debate on the relevance of the EU's fiscal surveillance rules and not excluding the possibility of their limited modification, they should not be relaxed. Frequent breaching of these rules cannot serve as an argument that they are irrelevant from the point of view of safeguarding fiscal prudence and avoiding fiscal 'free riding' under the umbrella of monetary union. Any version of fiscal surveillance rules (either current or modified) must be solidly anchored in an effective enforcement mechanism (including automatic sanctions) at the EU and national levels.
Authored by: Malgorzata Antczak, Marek Dabrowski, Michal Gorzelak
Published in 2005
This paper confronts the traditional balance-of-payments (BoP) analytical framework (with its dominant focus on the size of a given country’s current account imbalance and its external liabilities) with the contemporary realities of highly integrated international capital markets and cross-country capital mobility. Some key implicit assumptions of the traditional framework like those of a fixed residence of capital owners and home country bias are challenged and an alternative set of assumptions is offered. These reflect the unrestricted character of private capital flows (with no “home country bias” and fixed domicile) determined mostly by the expected rate of return. As a result, the importance of BoP constraints (in their “orthodox” interpretation) diminishes and they disappear completely with respect to individual member states within a highly integrated monetary union. This does not mean, however, immunization from other kinds of macroeconomic risks.
Authored by: Marek Dąbrowski
Published in 2006
This paper evaluates achievements and shortcomings of the Lisbon Strategy launched by the European Union in the spring of 2000 aiming to increase the competitiveness of the European economy within ten years. A careful examination of the Strategy’s pros and cons shows that its general rationale was sound and helpful despite an incorrect and naive political call to economically outperform the rest of the world in such period. The main priorities of the Strategy: promoting growth through creating more and better jobs and developing the knowledge base of the economy, remain valid for today and for the future. However, it has to be underlined that implementing desired changes requires time. At the moment, it is crucial to accomplish structural reforms, which have significant impact on job creation, business performance and growth. Among them, it is essential to complete the Single Market, still limited by many administrative barriers.
The paper shows main areas of necessary improvements to be undertaken by the Community and the member states. To strengthen real ownership of the Lisbon process, politicians must change their thinking from short-term and national to long-term and beneficial for the entire Community. Only such committed leadership can persuade the citizens to support the reforms, aiming to build a common European public good. Exploring these ideas would be a desirable return to the basic concept of the European Community, shaped by its founding fathers short after the World War II.
Authored by: Barbara Blaszczyk
Published in 2005
This study seeks to determine the extent to which countries of the former Soviet Union are "infected" by the Dutch Disease. We take a detailed look at the functioning of the transmission mechanism of the Dutch Disease, i.e. the chains that run from commodity prices to real output in manufacturing. We complement this with two econometric exercises. First, we estimate nominal and real exchange rate models to see whether commodity prices are correlated with the exchange rate. Second, we run growth equations to analyse the possible effects of commodity prices and the dependency of economic growth on natural resources.
Authored by: Balazs Egert
Published in 2009
This report is concerned with the analysis of privatization and private sector development for the eastern and southern Mediterranean countries partnered with the European Union and collectively known as MED-11. Noting that the analysis applies to the situation prior to the dislocations of the Arab Spring, we review the shift in the relative shares of the public and private sectors in these countries, as well as the business climate affecting the development of the private sector, examine a number of cultural factors that may influence the development of the private sector, and discuss some alternative scenarios for future developments. In the last 20 years, efforts have been made in all countries of the MED-11 to encourage private sector development and, to a greater or lesser extent, privatization of stateowned assets. However, there is a great deal of differentiation among the countries in the group. In the MED-11, Israel has not only the most business-friendly policy environment but also the most developed private sector, accounting for almost 80% of employment. The other countries of the region can be divided into two groups: one, including Algeria, Libya, and Syria, where reforms promoting privatization and private sector development have been very limited, and the rest, in which they have been much more extensive (the Palestine Authority is, for obvious reasons, a rather special case). A generally poor business environment makes for a large informal sector in almost every country in the region; however, generally speaking, we do not find the cultural factors we examine to be hostile to private sector development. Optimistic, reference and pessimistic scenarios are discussed; which of these is realized in any particular MED-11 country will depend greatly on the direction of change following the events of 2011’s Arab Spring.
Written by Mehdi Safavi and Richard Woodward. Published in October 2012.
PDF available on our website at: http://www.case-research.eu/en/node/57858
Financial market integration and growth 2011sirio788
This document provides an introduction to a volume on financial market integration and growth in the European Union. It discusses how policy events over the last two decades have influenced the structure of financial markets among original EU members and incentives to invest in new member economies. The volume aims to study relevant European and global dynamics through chapters focusing on topics like the transatlantic banking crisis, financial market integration in the EU15, and the impact of financial development and foreign direct investment in countries like Portugal, Ireland, Greece and Spain as well as new member states. The introduction argues that new member countries represent both a geographical enlargement of the EU and a natural experiment in institutional changes and economic internationalization, providing analytical challenges to understand developments across the EU.
The paper first considers why central European countries wish to join EMU soon. The main reasons are the risk of macroeconomic instability they face outside the euro zone if they wish to grow quickly. At the same time, Central Europe is highly integrated as regards trade with EMU, so it is little exposed to asymmetric shocks that would require a realignment of exchange rates. Finally, it is argued that there is no cost in terms of slower growth from EMU accession, so that there is no trade-off, as has been claimed, between nominal convergence to EMU and real convergence to EU average GDP levels. Second, the paper assesses whether Central European accession to EMU would be disadvantageous to current members. It concludes that accession cannot increase inflationary pressure on existing EMU members, as has been claimed, but that slow growing members of EMU might suffer increased unemployment, unless they increase the flexibility of their labour markets. Incumbent members may also be unwilling to share power with Central Europeans in EMU institutions.
Authored by: Jacek Rostowski
Published in 2003
Press release for the St. Petersburg International Economic Forum (SPIEF), which will be held on 18-20th of June 2015, with support and participation of the President of the Russian Federation Vladimir Putin.
The aim of this study is to undertake an up-to-date assessment of market power in Central and Eastern European banking markets and explore how the global financial crisis has affected market power and what has been the impact of foreign ownership. Three main results emerge. First, while there is some convergence in country-level market power during the pre-crisis period, the onset of the global crisis has put an end to this process. Second, bank-level market power appears to vary significantly with respect to ownership characteristics. Third, asset quality and capitalization affect differently the margins in the pre-crisis and crisis periods. While in the pre-crisis period the impacts are similar for all banks regardless of ownership status, in the crisis period non-performing loans have a negative effect and capitalization a positive effect only for domestically-owned banks.
Authored by: Georgios Efthyvoulou, Canan Yildirim
Published in 2013
This document analyzes the effects of the 2004 EU enlargement, Russia's entry into the WTO, and a potential free trade agreement between Russia and the enlarged EU using a computable general equilibrium model. It finds small positive effects on GDP and trade from EU enlargement. Russia's WTO accession on top of an enlarged EU is estimated to further increase trade somewhat. A free trade agreement between Russia and the EU could significantly boost bilateral trade flows, with overall moderate economic impacts.
This document is a paper analyzing inflation and monetary policy in Russia between 1992-2001. It seeks to identify the main factors driving inflation in Russia during this period through empirical testing and econometric analysis. The paper finds that money expansion and exchange rate depreciation fueled inflation, though the underlying trends changed over time. Until 1999, fiscal policy posed the biggest obstacle to disinflation, while later, attempts to target both money supply and exchange rate simultaneously through monetary policy caused inflationary pressures.
This paper analyses the public finance performance and the dynamics of government expenditures on education and health in the Kyrgyz Republic in 2007-2010, when the country was hit by the global economic crisis and then by an internal political crisis in 2010. Despite these crisis conditions, public health expenditures have increased substantially. In education, recurrent expenditures have been protected, while capital investments have been cut dramatically. Both sectors suffer from chronic under-financing, which results in an insufficient quality of services. The country's fiscal situation in the medium-term is going to be difficult, so efficiency-oriented reforms need to be implemented in health care and especially in education in order to sustain the development of these critical services in Kyrgyzstan.
Authored by: Roman Mogilevsky
Published in 2011
In this paper the authors undertake an ex-post evaluation of whether the special economic zones (SEZs) introduced in Poland in 1994 have been successful in meeting regional development objectives. They evaluate the policy of as many of its objectives as possible: employment creation, business creation (which includes attracting foreign direct investment), income or wage effects, and environmental sustainability. They use different panel data methods to investigate this question at the powiat and gmina levels in Poland during the 1995-2011 period. It is also possible to include numerous controls to reduce the problem of the omitted variables bias such as education level, dependency rates, state ownership, general subsidies and whether the area is urban or rural. The results indicate that SEZs in Poland have been successful in a number of their objectives such as private business creation. The positive effect of the policy however mainly comes through foreign direct investment (FDI), whereas the effects on e.g. investment and employment are small or insignificant. In other areas, such as securing higher income levels and locking firms into the sustainability agenda through the adoption of green technologies and reduced air pollution, the authors find only a small positively moderating effect of the policy on what are traditionally economically disadvantaged areas in Poland that used to be dependent on the socialist production model. Hence, despite high levels of FDI, the zones policy has not managed to overcome the legacy of backwardness or lagging regions. The main policy implication of the paper is that SEZs may be successful in stimulating activity in the short run but the policy must be seen as one of necessary temporality and can therefore not stand alone. Before launching SEZs, policymakers must have plans in place for follow up measures to ensure the longer term competitiveness and sustainability implications of such an initiative. There is a need to understand the connection between the specific incentive schemes used (in this particular case tax incentives were used) and the kinds of firms and activities they attract, including the behavioral models that those incentives promote.
Authored by: Camilla Jensen
Published in 2014
Christine teaching in socially networked classroomScholars Burton
Teachers can harness students' drive to reconnect through social media to expand learning opportunities. When using tools like wikis and blogs, teachers can monitor student work, provide feedback, and better understand individual contributions to group projects. Social networking allows teachers to track student progress and engagement, while helping students learn collaboration skills in a way that is familiar and motivating to today's plugged-in students.
The paper shows that the question that is relevant for the debate on the efficacy of development assistance is not so much as an issue of how much, but rather for what. In view of the growing awareness of ODA’s inefficiency in achieving intended aims, this paper proposes an alternative approach to development assistance policies – economic integration and subsidiarity provides the conditions necessary for ODA to produce higher rates of economic growth on a sustainable basis. Europe is an excellent case in point, in this context. Europe has in the last decades experienced a number of success stories in moving out of poverty and onto sustainable economic growth. The secret of success has been the push towards economic integration, and the adoption of economic reforms at the local, national, and regional level conducive to economic growth. The recipient countries of development assistance have much to learn from the European experience.
We apply Feldstein's (1997, 1999) analysis of the interactions between the tax system and inflation to two transition economies: Poland and Ukraine. We find that the taxrelated costs of inflation in these countries are significantly smaller than in mature market economies. Our analysis points out that the tax system in these two countries is superior to the tax system in developed market economies, as taxes on investment income are lower. It implies that transition countries should avoid replicating other tax systems and, instead, take advantage of the unique opportunity to design and entrench the features of their tax system which are superior to those in mature economies.
Authored by: Monika Blaszkiewicz, Jerzy Konieczny, Anna Myslinska, Przemyslaw Wozniak
Published in 2003
This paper analyses the effect of the EU enlargement process on income convergence among regions in the EU and in the Eastern neighbourhood of the EU. The data used is NUTS II regions in the EU and Oblasts' of Russia over the period 1996-2004. The estimation techniques used take into account both regional and spatial heterogeneity. The main findings are that the regional income differences are reduced within EU15. The income convergence within the EU is mainly driven by reductions in the differences across countries rather than by a reduction in regional differences within countries. When differences in initial conditions in the regions are controlled for by fixed regional effects there are strong evidences of convergence among regions in all studied country groups.
Authored by: Fredrik Wilhelmsson
Published in 2009
Despite significant economic reforms in many Southern Mediterranean EU neighbour countries, their growth performance has on average been subdued. This study analyses the differences in growth performance and macroeconomic stability across Mediterranean countries, to draw lessons for the future. The main findings are that Southern Mediterranean countries should benefit from closer ties with the EU that result in higher levels of trade and FDI inflows, once the turbulence of the ‘Arab Spring’ is resolved, and from the development of financial markets and infrastructure. They will also benefit in keeping inflation under control, which will depend in great part on their ability to maintain fiscal discipline and sustainable current accounts. One of the main challenges for the region will be to implement structural reforms that can help them absorb a large pool of unemployed without creating upward risks to inflation.
Authored by: Leonor Coutinho
Published in 2012
The paper discusses the current and potential role of the European Neighbourhood Policy (ENP) in anchoring economic reforms in the countries of the EU's Eastern Neighbourhood. It claims that it is too early to assess the success of the ENP in this sphere especially given that the actual progress of the ENP agenda has been limited. A review of the empirical evidence on external reform anchors confirms that the ENP shares some features with the EU accession process that has proven to be an effective mechanism supporting major economic, political and social changes in the countries concerned. The eventual ENP economic offer is meaningful and integration with the EU is getting stronger public support in several CIS countries and among their political elites. On the other hand several factors limit the reform anchoring potential of the ENP. This paper offers recommendations on policies that could strengthen this potential.
Authored by: Wojciech Paczynski
Published in 2009
This study reviews monetary policy options that are seemingly viable for adopting the euro by the new Member States of the European Union. A fully autonomous direct inflation targeting is believed to be suboptimal for convergence to the euro as it does not incorporate convergence parameters into the central bank reaction function and instrument rules. In an attempt to correct for such deficiency, this study advocates adopting a framework of relative inflation forecast targeting where a differential between the domestic and the eurozone inflation forecasts becomes the main objective of the central bank's decisions.
At the same time, some attention to the exchange rate stability objective becomes necessary for facilitating the monetary convergence process. Foreign exchange market interventions, rather than interest rate adjustments, are viewed as a preferred way of achieving this objective.
Authored by: Lucjan T. Orlowski
Published in 2005
The IMF staff report discusses Albania's 2010 Article IV consultation. It notes that Albania entered the global crisis in a relatively strong position due to macroeconomic stability, structural reforms, and policy buffers like low debt and high reserves. However, these policy buffers are now depleted. While the economy is recovering from the crisis, downside risks remain from high public debt and regional uncertainties. The report recommends rebuilding fiscal space through consolidation, conducting prudent monetary policy, and improving competitiveness to support sustainable growth.
Since May 1, 2004 the European Union's new member states (NMS) have been subject to the same fiscal rules established in the Treaty on the European Union and Stability and Growth Pact (SGP) as the old member states (OMS). The NMS entered the EU running structural fiscal deficits. More than half of them (including the biggest ones) breach the Treaty's actual deficit limits and are already the subject of the excessive deficit procedure. A high rate of economic growth makes the fiscal situation of most NMS reasonably manageable in the short- to medium-term, but the long term fiscal outlook, mostly connected with the consequences of an aging population, is dramatic. The NMS should therefore prepare themselves now to be able to meet this challenge over the next decades (the same goes for the OMS). In addition, the perspective of EMU entry should provide the NMS with a strong incentive to reduce their deficits now because waiting (and postponing both fiscal adjustment and the adoption of the Euro) will only result in higher cumulative fiscal costs. The additional financial burden connected with EU accession cannot serve as excuse in delaying fiscal consolidation.
In spite of the growing debate on the relevance of the EU's fiscal surveillance rules and not excluding the possibility of their limited modification, they should not be relaxed. Frequent breaching of these rules cannot serve as an argument that they are irrelevant from the point of view of safeguarding fiscal prudence and avoiding fiscal 'free riding' under the umbrella of monetary union. Any version of fiscal surveillance rules (either current or modified) must be solidly anchored in an effective enforcement mechanism (including automatic sanctions) at the EU and national levels.
Authored by: Malgorzata Antczak, Marek Dabrowski, Michal Gorzelak
Published in 2005
This paper confronts the traditional balance-of-payments (BoP) analytical framework (with its dominant focus on the size of a given country’s current account imbalance and its external liabilities) with the contemporary realities of highly integrated international capital markets and cross-country capital mobility. Some key implicit assumptions of the traditional framework like those of a fixed residence of capital owners and home country bias are challenged and an alternative set of assumptions is offered. These reflect the unrestricted character of private capital flows (with no “home country bias” and fixed domicile) determined mostly by the expected rate of return. As a result, the importance of BoP constraints (in their “orthodox” interpretation) diminishes and they disappear completely with respect to individual member states within a highly integrated monetary union. This does not mean, however, immunization from other kinds of macroeconomic risks.
Authored by: Marek Dąbrowski
Published in 2006
This paper evaluates achievements and shortcomings of the Lisbon Strategy launched by the European Union in the spring of 2000 aiming to increase the competitiveness of the European economy within ten years. A careful examination of the Strategy’s pros and cons shows that its general rationale was sound and helpful despite an incorrect and naive political call to economically outperform the rest of the world in such period. The main priorities of the Strategy: promoting growth through creating more and better jobs and developing the knowledge base of the economy, remain valid for today and for the future. However, it has to be underlined that implementing desired changes requires time. At the moment, it is crucial to accomplish structural reforms, which have significant impact on job creation, business performance and growth. Among them, it is essential to complete the Single Market, still limited by many administrative barriers.
The paper shows main areas of necessary improvements to be undertaken by the Community and the member states. To strengthen real ownership of the Lisbon process, politicians must change their thinking from short-term and national to long-term and beneficial for the entire Community. Only such committed leadership can persuade the citizens to support the reforms, aiming to build a common European public good. Exploring these ideas would be a desirable return to the basic concept of the European Community, shaped by its founding fathers short after the World War II.
Authored by: Barbara Blaszczyk
Published in 2005
This study seeks to determine the extent to which countries of the former Soviet Union are "infected" by the Dutch Disease. We take a detailed look at the functioning of the transmission mechanism of the Dutch Disease, i.e. the chains that run from commodity prices to real output in manufacturing. We complement this with two econometric exercises. First, we estimate nominal and real exchange rate models to see whether commodity prices are correlated with the exchange rate. Second, we run growth equations to analyse the possible effects of commodity prices and the dependency of economic growth on natural resources.
Authored by: Balazs Egert
Published in 2009
This report is concerned with the analysis of privatization and private sector development for the eastern and southern Mediterranean countries partnered with the European Union and collectively known as MED-11. Noting that the analysis applies to the situation prior to the dislocations of the Arab Spring, we review the shift in the relative shares of the public and private sectors in these countries, as well as the business climate affecting the development of the private sector, examine a number of cultural factors that may influence the development of the private sector, and discuss some alternative scenarios for future developments. In the last 20 years, efforts have been made in all countries of the MED-11 to encourage private sector development and, to a greater or lesser extent, privatization of stateowned assets. However, there is a great deal of differentiation among the countries in the group. In the MED-11, Israel has not only the most business-friendly policy environment but also the most developed private sector, accounting for almost 80% of employment. The other countries of the region can be divided into two groups: one, including Algeria, Libya, and Syria, where reforms promoting privatization and private sector development have been very limited, and the rest, in which they have been much more extensive (the Palestine Authority is, for obvious reasons, a rather special case). A generally poor business environment makes for a large informal sector in almost every country in the region; however, generally speaking, we do not find the cultural factors we examine to be hostile to private sector development. Optimistic, reference and pessimistic scenarios are discussed; which of these is realized in any particular MED-11 country will depend greatly on the direction of change following the events of 2011’s Arab Spring.
Written by Mehdi Safavi and Richard Woodward. Published in October 2012.
PDF available on our website at: http://www.case-research.eu/en/node/57858
Financial market integration and growth 2011sirio788
This document provides an introduction to a volume on financial market integration and growth in the European Union. It discusses how policy events over the last two decades have influenced the structure of financial markets among original EU members and incentives to invest in new member economies. The volume aims to study relevant European and global dynamics through chapters focusing on topics like the transatlantic banking crisis, financial market integration in the EU15, and the impact of financial development and foreign direct investment in countries like Portugal, Ireland, Greece and Spain as well as new member states. The introduction argues that new member countries represent both a geographical enlargement of the EU and a natural experiment in institutional changes and economic internationalization, providing analytical challenges to understand developments across the EU.
The paper first considers why central European countries wish to join EMU soon. The main reasons are the risk of macroeconomic instability they face outside the euro zone if they wish to grow quickly. At the same time, Central Europe is highly integrated as regards trade with EMU, so it is little exposed to asymmetric shocks that would require a realignment of exchange rates. Finally, it is argued that there is no cost in terms of slower growth from EMU accession, so that there is no trade-off, as has been claimed, between nominal convergence to EMU and real convergence to EU average GDP levels. Second, the paper assesses whether Central European accession to EMU would be disadvantageous to current members. It concludes that accession cannot increase inflationary pressure on existing EMU members, as has been claimed, but that slow growing members of EMU might suffer increased unemployment, unless they increase the flexibility of their labour markets. Incumbent members may also be unwilling to share power with Central Europeans in EMU institutions.
Authored by: Jacek Rostowski
Published in 2003
Press release for the St. Petersburg International Economic Forum (SPIEF), which will be held on 18-20th of June 2015, with support and participation of the President of the Russian Federation Vladimir Putin.
The aim of this study is to undertake an up-to-date assessment of market power in Central and Eastern European banking markets and explore how the global financial crisis has affected market power and what has been the impact of foreign ownership. Three main results emerge. First, while there is some convergence in country-level market power during the pre-crisis period, the onset of the global crisis has put an end to this process. Second, bank-level market power appears to vary significantly with respect to ownership characteristics. Third, asset quality and capitalization affect differently the margins in the pre-crisis and crisis periods. While in the pre-crisis period the impacts are similar for all banks regardless of ownership status, in the crisis period non-performing loans have a negative effect and capitalization a positive effect only for domestically-owned banks.
Authored by: Georgios Efthyvoulou, Canan Yildirim
Published in 2013
This document analyzes the effects of the 2004 EU enlargement, Russia's entry into the WTO, and a potential free trade agreement between Russia and the enlarged EU using a computable general equilibrium model. It finds small positive effects on GDP and trade from EU enlargement. Russia's WTO accession on top of an enlarged EU is estimated to further increase trade somewhat. A free trade agreement between Russia and the EU could significantly boost bilateral trade flows, with overall moderate economic impacts.
This document is a paper analyzing inflation and monetary policy in Russia between 1992-2001. It seeks to identify the main factors driving inflation in Russia during this period through empirical testing and econometric analysis. The paper finds that money expansion and exchange rate depreciation fueled inflation, though the underlying trends changed over time. Until 1999, fiscal policy posed the biggest obstacle to disinflation, while later, attempts to target both money supply and exchange rate simultaneously through monetary policy caused inflationary pressures.
This paper analyses the public finance performance and the dynamics of government expenditures on education and health in the Kyrgyz Republic in 2007-2010, when the country was hit by the global economic crisis and then by an internal political crisis in 2010. Despite these crisis conditions, public health expenditures have increased substantially. In education, recurrent expenditures have been protected, while capital investments have been cut dramatically. Both sectors suffer from chronic under-financing, which results in an insufficient quality of services. The country's fiscal situation in the medium-term is going to be difficult, so efficiency-oriented reforms need to be implemented in health care and especially in education in order to sustain the development of these critical services in Kyrgyzstan.
Authored by: Roman Mogilevsky
Published in 2011
In this paper the authors undertake an ex-post evaluation of whether the special economic zones (SEZs) introduced in Poland in 1994 have been successful in meeting regional development objectives. They evaluate the policy of as many of its objectives as possible: employment creation, business creation (which includes attracting foreign direct investment), income or wage effects, and environmental sustainability. They use different panel data methods to investigate this question at the powiat and gmina levels in Poland during the 1995-2011 period. It is also possible to include numerous controls to reduce the problem of the omitted variables bias such as education level, dependency rates, state ownership, general subsidies and whether the area is urban or rural. The results indicate that SEZs in Poland have been successful in a number of their objectives such as private business creation. The positive effect of the policy however mainly comes through foreign direct investment (FDI), whereas the effects on e.g. investment and employment are small or insignificant. In other areas, such as securing higher income levels and locking firms into the sustainability agenda through the adoption of green technologies and reduced air pollution, the authors find only a small positively moderating effect of the policy on what are traditionally economically disadvantaged areas in Poland that used to be dependent on the socialist production model. Hence, despite high levels of FDI, the zones policy has not managed to overcome the legacy of backwardness or lagging regions. The main policy implication of the paper is that SEZs may be successful in stimulating activity in the short run but the policy must be seen as one of necessary temporality and can therefore not stand alone. Before launching SEZs, policymakers must have plans in place for follow up measures to ensure the longer term competitiveness and sustainability implications of such an initiative. There is a need to understand the connection between the specific incentive schemes used (in this particular case tax incentives were used) and the kinds of firms and activities they attract, including the behavioral models that those incentives promote.
Authored by: Camilla Jensen
Published in 2014
Christine teaching in socially networked classroomScholars Burton
Teachers can harness students' drive to reconnect through social media to expand learning opportunities. When using tools like wikis and blogs, teachers can monitor student work, provide feedback, and better understand individual contributions to group projects. Social networking allows teachers to track student progress and engagement, while helping students learn collaboration skills in a way that is familiar and motivating to today's plugged-in students.
La Fundación ReECO promueve el reciclaje y reutilización de materiales electrónicos a través de campañas de donación y proporcionando información sobre su sitio web y correo electrónico de contacto.
Open access for researchers, policy makers and research managers, librariesIryna Kuchma
Open access advocates for making research output widely available through open access repositories and policies. It highlights evidence that open access accelerates the research cycle by allowing more rapid discovery and uptake of findings. Open access repositories provide access to peer-reviewed articles, theses, reports and other materials. They help increase the visibility, usage and impact of research.
The email is from Renny and provides an update on a project. It states that the client has approved the design proposal and requested a few minor changes. Renny asks if production can begin next week after incorporating the changes to the design.
A presentation for ph.d´s and employees at DTU Library (Technical Information Center of Denmark, DTU) with hints, inspiration and information about what they can do them selves, and what their local library helps them with in relation to making their research visible by use of social media, open access knowledge and sharing
Unlike the crisis years of 2007-2009 (when the insolvency of large banks was a major problem), the current round of the global financial crisis has fiscal origins. Almost all developed countries suffer from an excessive public debt burden that has been built up over the last two decades or more. The financial crisis caused a further deterioration of government accounts as a result of ill-tailored countercyclical fiscal response and, in some cases, a costly financial sector rescue. All excessively indebted countries must conduct fiscal adjustment, even if this involves economic and political costs in terms of lower output and higher unemployment. Central banks can reduce these costs through accommodative monetary policies but without compromising their anti-inflationary missions and institutional independence. The ECB is additionally constrained by its institutional status which is based on a delicate cross-country political consensus. Excessive ECB involvement in quasi-fiscal rescue operations can undermine this consensus and lead to a disintegration of the Eurozone. There are also strong arguments in favor of strengthening fiscal and banking integration within the EU, especially the fiscal discipline mechanism at national levels, and building the EU rescue capacity in respect to sovereigns and banks based on strong policy conditionality.
Authored by: Marek Dabrowski
Published in 2012
The financial crisis of 2007-2009 led to a renewed increase in government deficits and debts in many EU countries, causing a full-fledged fiscal crisis in Greece and severe fiscal pressures in other euro-area countries. This has prompted a series of proposals for improving the fiscal framework of the European Monetary Union, the Excessive Deficit Procedure and the Stability and Growth Pact. The first part of this paper reviews the main properties and developments of that framework until 2007. On that basis, it discusses the recent proposals for reform, which range from marginal improvements of the existing framework to the introduction of an explicit framework for managing fiscal crises in the member states, and the expansion of the scope of policy coordination to address macro economic imbalances and the competitiveness of the member states. We find the proposal of a mechanism for dealing with government default most useful. Attempts to suppress current account imbalances and to target national competitiveness positions would most likely result in serious economic losses and do damage to the internal market of the EU. This would increase the wedge between members and non-members of the euro area.
Authored by: Jurgen von Hagen
Published in 2010
The document discusses Europe's fragmented bond markets, which have become more divided during the euro crisis. Government bond yields have varied widely between member states, making fiscal adjustment difficult for countries with high borrowing costs and slowing economic growth. While market differentiation pressures fiscal discipline, the current level of variance is unsustainable. Integrating Europe's bond markets into a large, unified market could help overcome difficulties by creating more liquidity and lowering interest rates, but this cannot undermine budget constraints for highly indebted countries.
This paper uses a multi region DSGE model with collateral constrained households and residential investment to examine the effectiveness of fiscal policy stimulus measures in a credit crisis. The paper explores alternative scenarios which differ by the type of budgetary measure, its length, the degree of monetary accommodation and the level of international coordination. In particular we provide estimates for New EU Member States where we take into account two aspects. First, debt denomination in foreign currency and second, higher nominal interest rates, which makes it less likely that the Central Bank is restricted by the zero bound and will consequently not accommodate a fiscal stimulus. We also compare our results to other recent results obtained in the literature on fiscal policy which generally do not consider credit constrained households.
Authored by: Jan in't Veld, Werner Roeger, István P. Székely
Published in 2011
This paper reports the progress of nominal and real convergence of Spain, Portugal and Greece during their accession to the Economic and Monetary Union (EMU). When the EMU was designed, it was hoped that it would induce nominal convergence (convergence of interest rates and inflation rates) and stimulate investments and economic growth through its positive microeconomic effects. As had been expected, nominal interest rates have converged quite early during the accession, output has been growing fast, and the countries experienced an inflow of foreign direct investments (FDI) and an increase of domestic investment rates. However, once within the EMU, all three countries experienced persistently higher inflation rates, which may be consistent with the convergence of price levels, instead of inflation. While all the above phenomena can be related to the EMU accession, in an econometric estimation for Spain in which we control for macroeconomic policies, we are unable to detect significant microeconomic effects of the EMU. Therefore, we conclude that it is the policies induced by the necessity to satisfy the Maastricht criteria that matter primarily for the macroeconomic performance soon after accession. In any case, the experience of the SPG is encouraging for the new member states facing accession to the EMU in the future.
Authored by: Marek Jarocinski
Published in 2003
1) If the EU did not exist, European countries would face greater economic instability without the euro as a common currency. There would be more volatility in exchange rates and prices, exacerbating the crisis in weaker economies.
2) Without EU coordination of responses, countries would be less willing to help troubled banks and firms for fear of revealing weaknesses. This could prolong and deepen the crisis.
3) A lack of cooperation could also increase protectionism as countries act solely in their own interests rather than working together.
Breaking the common fate of banks and governments by Daniel Gros and Cinzia A...Círculo de Empresarios
The document discusses the eurozone debt crisis and proposals for addressing it. It argues that while policymakers have focused on fiscal discipline, the crisis has deeper roots in inconsistencies in the eurozone's financial market regulation. The fiscal compact will not solve the crisis on its own because it fails to address the tight linkage between governments and banks, which is at the core of their common fate. Breaking this linkage is key to overcoming the crisis.
POSITION PAPER: Euro Zone Crisis. Diagnosis and Likely Solutions (ESADEgeo)ESADE
Author: Fernando Ballabriga
ESADEgeo - February 2014
Southern euro countries are in a situation of vulnerability due to three factors: their high debt levels, their eroded competitiveness and their difficulties to restart growth. Together, these factors generate a vicious circle which is difficult to exit and which can even degenerate into a self-fulfilling economic downward spiral. This policy brief provides a short guiding tour to the euro zone crisis. It looks at the current situation, the full context conditioning the solutions to the situation, how we got here, and the possible way out. The latter section outlines a set of minimum steps required to make the euro sustainable.
Harvard Kennedy School: Eurozone Study Jan. 2017 chaganomics
This document summarizes a paper that examines the resilience of the Eurozone in the face of crises. Deep financial integration created interdependence among Eurozone members, providing mechanisms to reallocate resources and absorb economic shocks. Global market pressures forced political leaders to reinforce the monetary union through fiscal and monetary backstops. Ongoing progress on banking supervision and regulation has further strengthened the currency union. While the Eurozone still falls short as an optimal currency area, financial integration may drive further integration through banking reforms, even amid populist opposition to other reforms.
The arguments for fiscal as well as monetary rules in a monetary union aiming at low inflation, the main weaknesses in the Stability and Growth Pact, and proposals for its reform are reviewed. Our own proposal for reforming the SGP is put forward: a requirement for eurozone Member States to enact entrenched legislation which would forbid budgets that led to public debt exceeding a certain proportion of GDP. Countries which failed to enact such provisions or which rescinded them could not remain in the eurozone. This would solve the key “enforcibility problem” that the SGP faces, without centralizing fiscal power in the European Commission. However, effective reform proposals are unlikely to be politically acceptable, and the SGP is likely to continue to be a dead letter. This suggests that the EMU was implemented prematurely.
Authored by: Jacek Rostowski
Published in 2004
1) Prior to the crisis, EU financial integration increased, especially in interbank markets. However, retail banking remains fragmented along national lines. The crisis reversed integration in interbank markets, increasing financial fragmentation.
2) The document proposes three reforms: 1) thorough bank asset reviews and recapitalization from private sources, 2) restructuring non-viable banks through cross-border mergers, 3) developing corporate bond and equity markets to absorb shocks and reduce reliance on banks.
3) Timing is key - banking sector problems must be addressed first to support the economy, but decisions could shape future stability if not accompanied by cross-border integration and capital market reforms.
A minimal moral hazard central stabilization capacity for the EMU based on wo...ADEMU_Project
This document proposes an "export-based stabilisation capacity" (ESC) for the Eurozone that allows for cross-border transfers in response to changes in world trade across different sectors. The ESC would provide transfers from countries less affected by a decline in world trade in a given sector to countries more dependent on that sector. This is intended to cushion economic shocks while avoiding moral hazard concerns since the transfers are based on exogenous world trade factors. A simulation using historical export data finds the transfers would be countercyclical and stabilize over time, suggesting the risk of permanent transfers is low. However, timely availability of sectoral trade data could pose practical challenges to implementation.
The document discusses the EU crisis, which goes beyond just being a Euro crisis. It summarizes that the intergovernmental constitution established to deal with financial issues has faced limitations. Measures taken to manage the crisis have exacerbated relations between peripheral and central EU members and lacked legitimacy. The crisis also highlights broader issues of political stagnation in the EU since rejection of the proposed constitution. It aims to analyze the EU response to the crisis and structural causes of EU problems beyond just the global financial crisis influences.
The new European Union (EU) economic governance package released by the European Commission on September 29, 2010 includes two major components, i.e., changes and amendments to the Stability and Growth Pact (SGP) and new regulation on the prevention and correction of macroeconomic imbalances within the EU and European Monetary Union (EMU). While the first piece offers a certain improvement in the EU fiscal surveillance rules the second one looks deeply flawed and operationally unenforceable
Authored by: Marek Dąbrowski
Published in 2010
This document discusses the need for greater economic integration and coordination within the European Union to address issues revealed by the sovereign debt crisis. It argues that the EU needs more powers to enforce economic policy coordination and promote convergence between member states. It proposes giving the EU more authority to overrule national economic decisions that violate agreed targets. It also advocates developing an orderly default mechanism for member states and introducing European Debt Certificates. However, it acknowledges that increasing EU powers could exacerbate the democratic deficit, so it is important to also increase the legitimacy and accountability of EU decision-making.
This paper describes the general framework of the EU’s emerging relationship with its new neighbours and investigates the potential economic impact of the European Neighbourhood Policy (ENP), both for the EU itself and for its neighbours. In particular, it seeks to develop an answer to the question of whether the ENP is sufficiently attractive so as to induce the governments in neighbourhood countries to adopt (or accelerate the adoption of) the types of economic and governance reforms that were implemented in the new member states during their accession processes. Although the specifics of the ENP are still being developed, the lack of incentives as regards to unclear accession to the EU is identified as the main weakness of the ENP.
Economically, the ENP seeks to ease trade restrictions through the implementation of legislative approximation and convergence with EU standards, before accessing the EU’s single market can become a reality. Positively though, is that the access to the single market could improve significantly under the ENP. As experienced by the Central European states, FDI is instrumental to transform the economies of the Western CIS and the Caucasus. The ENP can be a supportive framework for improving investor confidence. Likewise, the new European Neighbourhood Instrument can add more coherence in technical assistance, and provide more financial support for creating capacities for trade infrastructures and institutional and private sector development. Finally, measures to promote increased labour migration between the new neighbours and the enlarged EU may be worth to put on the agenda for the future development and impact of the ENP.
Authored by: Susanne Milcher, Ben Slay
Published in 2005
This document provides a roadmap towards establishing a genuine Economic and Monetary Union (EMU) in the euro area. It proposes a three stage process:
1) Ensuring fiscal sustainability and breaking the bank-sovereign link by 2013.
2) Completing an integrated financial framework and promoting structural reforms by 2014 through a common resolution authority and contractual reform agreements.
3) Improving EMU resilience after 2014 by establishing a fiscal capacity to absorb economic shocks, coupled with incentives for sound fiscal policies and deeper integration of budgets and policies.
The document argues this process is urgently needed to strengthen EMU mechanisms and ensure stability in response to challenges from within and outside the euro area.
Twenty years of euro history confirms the euro’s stability and position as the second global currency. It also enjoys the support of majority of the euro area population and is seen as a good thing for the European Union. The European Central Bank has been successful in keeping inflation at a low level. However, the European debt and financial crisis in the 2010s created a need for deep institutional reform and this task remains unfinished.
This document summarizes and analyzes a policy paper that proposes a two-step market-based approach to debt reduction in the eurozone without default.
Step 1 involves the EFSF exchanging existing Greek, Irish, and Portuguese government debt for EFSF bonds at market prices over 90 days. Step 2 assesses debt sustainability and either writes down debt to market levels if sufficient, or agrees to lower interest rates with GDP warrants. The goal is to restore private market access without seniority over remaining private claims. The ECB would stop bond market interventions, and the IMF could provide bridge financing until fiscal adjustments are complete.
The public debt crisis is not limited to Greece or to the Euro area. In fact, several developed economies face rapidly growing debt-to-GDP ratios, which raise doubts about their long-term solvency. Thus, suggesting that the Eurozone is undergoing a currency crisis or is in danger of disintegration is not the right diagnosis (or at least premature). However, if prudent fiscal policies, fiscal discipline and far-reaching structural reforms are not undertaken soon, both the EU and EMU may face serious internal tensions and obstacles to future economic growth.
Authored by: Marek Dąbrowski
Published in 2010
Similar to CASE Network Studies and Analyses 433 - Euro Zone Crisis and EU Governance: Tackling a Flawed Design and Inadequate Policy Arrangements (20)
The report examines the social and economic drivers and impact of circular migration between Belarus and Poland, Slovakia, and the Czech Republic. The core question the authors sought to address was how managing circular migration could, in the long term, help to optimise labour resources in both the country of origin and the destination countries. In the pages that follow, the authors of the report present the current and forecasted labour market and demographic situation in their respective countries as well as the dynamics and characteristics of short-term labour migration flows between Belarus and Poland, Slovakia, and the Czech Republic, concentrating on the period since 2010. They also outline and discuss related policy responses and evaluate prospects for cooperation on circular migration.
Podręcznik został opracowany w celu przekazania trenerom i nauczycielom podstawowej wiedzy, która może być przydatna w prowadzeniu szkoleń promujących pracę rejestrowaną. Prezentuje on z jednej strony korzyści z pracy rejestrowanej, z drugiej – potencjalne koszty związane z pracą nierejestrowaną. W pierwszej kolejności informacje te przedstawiono w odniesieniu do pracowników najemnych (rozdział 2), podkreślając w sposób szczególny to, że negatywne konsekwencje pracy nierejestrowanej są ponoszone przez całe życie. Ze względu na specyficzną sytuację cudzoziemców pracujących w Polsce konsekwencje ponoszone przez tę grupę opisano oddzielnie (rozdział 3). Ponadto zaprezentowano skutki dotyczące pracodawców z szarej strefy z wyodrębnieniem tych, którzy zatrudniają cudzoziemców (rozdział 4). Uzupełnieniem przedstawionych informacji jest opis działań podejmowanych przez państwo w celu ograniczenia zjawiska pracy nierejestrowanej w Polsce (rozdział 5) oraz prowadzonych w Wielkiej Brytanii, czyli w kraju będącym liderem w walce z szarą strefą (rozdział 6).
European countries face a challenge related to the economic and social consequences of their societies’ aging. Specifically, pension systems must adjust to the coming changes, maintaining both financial stability, connected with equalizing inflows from premiums and spending on pensions, and simultaneously the sufficiency of benefits, protecting retirees against poverty and smoothing consumption over their lives, i.e. ensuring the ability to pay for consumption needs at each stage of life, regardless of income from labor.
One of the key instruments applied toward these goals is the retirement age. Formally it is a legally established boundary: once people have crossed it – on average – they significantly lose their ability to perform work (the so-called old-age risk). But since the 1970s, in many developed countries the retirement age has become an instrument of social and labor-market policy. Specifically, in the 1970s and ‘80s, an early retirement age was perceived as a solution allowing a reduction in the supply of labor, particularly among people with relatively low competencies who were approaching retirement age, which is called the lump of labor fallacy. It was often believed that people taking early retirement freed up jobs for the young. But a range of economic evidence shows that the number of jobs is not fixed, and those who retire don’t in fact free up jobs. On the contrary, because of higher spending by pension systems, labor costs rise, which limits the supply of jobs. In general, a good situation on the labor market supports employment of both the youngest and the oldest labor force participants. Additionally, a lower retirement age for women was maintained, which resulted to a high degree from cultural conditions and norms that are typical for traditional societies.
Until now, the banking sector has been one of the strong points of Poland’s economy. In contrast to banks in the U.S. and leading Western European economies, lenders in Poland came through the 2008 global financial crisis without a scratch, without needing state financial support. But in recent years the industry’s problems have been growing, creating a threat to economic growth and gains in living standards.
For an economy’s productivity to increase, funds can’t go to all companies evenly, and definitely shouldn’t go to those that are most lacking in funds, but to those that will use them most efficiently. This is true of total external financing, and thus funding both from the banking sector and from parabanks, the capital market and funds from public institutions. In Poland, in light of the relatively modest scale of the capital market, banks play a clearly dominant role in external financing of companies. This is why the author of this text focuses on the bank credit allocation efficiency.
The author points out that in the very near future, conditions will emerge in Poland which – as the experience of other countries shows – create a risk of reduced efficiency of credit allocation to business. Additionally, in Poland today, bank lending to companies is to a high degree being replaced by funds from state aid, which reduces the efficiency of allocation of external funds to companies (both loans and subsidies), as allocation of government subsidies is not usually based on efficiency. This decline in external financing allocation efficiency may slow, halt or even reverse the process, that has been uninterrupted for 28 years, of Poland’s convergence, i.e. the narrowing of the gap in living standards between Poland and the West.
The economic characteristics of the COVID-19 crisis differ from those of previous crises. It is a combination of demand- and supply-side constraints which led to the formation of a monetary overhang that will be unfrozen once the pandemic ends. Monetary policy must take this effect into consideration, along with other pro-inflationary factors, in the post-pandemic era. It must also think in advance about how to avoid a policy trap coming from fiscal dominance.
This paper is organized as follows: Chapter 2 deals with the economic characteristics of the COVID-19 pandemic and its impact on the effectiveness of the monetary policy response measures undertaken. In Chapter 3, we analyse the monetary policy decisions of the ECB (and other major CBs for comparison) and their effectiveness in achieving the declared policy goals in the short term. Chapter 4 is devoted to an analysis of the policy challenges which may be faced by the ECB and other major CBs once the pandemic emergency comes to its end. Chapter 5 contains a summary and the conclusions of our analysis.
Purpose: This paper tries to identify the wage gap between informal and formal workers and tests for the two-tier structure of the informal labour market in Poland.
Design/methodology/approach: I employ the propensity score matching (PSM) technique and use data from the Polish Labour Force Survey (LFS) for the period 2009–2017 to estimate the wage gap between informal and formal workers, both at the means and along the wage distribution. I use two definitions of informal employment: a) employment without a written agreement and b) employment while officially registered as unemployed at a labour office. In order to reduce the bias resulting from the non-random selection of
individuals into informal employment, I use a rich set of control variables representing several individual characteristics.
Findings: After controlling for observed heterogeneity, I find that on average informal workers earn less than formal workers, both in terms of monthly earnings and hourly wage. This result is not sensitive to the definition of informal employment used and is
stable over the analysed time period (2009–2017). However, the wage penalty to informal employment is substantially higher for individuals at the bottom of the wage distribution, which supports the hypothesis of the two-tier structure of the informal labour market in Poland.
Originality/value: The main contribution of this study is that it identifies the two-tier structure of the informal labour market in Poland: informal workers in the first quartile of the wage distribution and those above the first quartile appear to be in two partially different segments of the labour market.
This document provides a comparative analysis of the rule of law and its impact on economic development in Poland and Germany. It finds that while both countries have strong rule of law frameworks de jure, there are significant differences de facto, with Polish firms showing less trust in the state and courts compared to German firms. Empirical analysis suggests higher levels of investment and economic development in Germany can be partially attributed to firms' greater recognition of the rule of law's ability to reduce transaction costs. Erosion of the rule of law in Poland since 2015 has likely negatively impacted investment and capital accumulation compared to Germany.
The report analyzes the VAT gap in the EU-28 member states in 2018. It finds that the total VAT gap in the EU was an estimated €137 billion, representing 12.2% of the total VAT liability. This is an increase compared to 2017, when the gap was €117 billion or 11.2% of the total liability. The report examines VAT revenue, total VAT liability, and VAT gap estimates for each member state from 2014 to 2018. It also conducts econometric analysis to identify factors influencing VAT gap levels across countries.
The euro is the second most important global currency after the US dollar. However, its international role has not increased since its inception in 1999. The private sector prefers using the US dollar rather than the euro because the financial market for US dollar-denominated assets is larger and deeper; network externalities and inertia also play a role. Increasing the attractiveness of the euro outside the euro area requires, among others, a proactive role for the European Central Bank and completing the Banking Union and Capital Market Union.
Forecasting during a strong shock is burdened with exceptionally high uncertainty. This gives rise to the temptation to formulate alarmist forecasts. Experiences from earlier pandemics, particularly those from the 20th century, for which we have the most data, don’t provide a basis for this. The mildest of them weakened growth by less than 1 percentage point, and the worst, the Spanish Flu, by 6 percentage points. Still, even the Spanish Flu never caused losses on the order of 20% of GDP – not even where it turned out to be a humanitarian disaster, costing the lives of 3-5% of the population. History suggests that if pandemics lead to such deep losses at all, it’s only in particular quarters and not over a whole year, as economic activity rebounds. The strength of that rebound is largely determined by economic policy. The purpose of this work is to describe possible scenarios for a rebound in Polish economic growth after the epidemic.
A separate issue, no less important, is what world will emerge from the current crisis. In the face of the 2008 financial crisis, White House Chief of Staff Rahm Emanuel said: “You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things that you think you could not do before.” Such changes can make the economy and society function better than before the crisis. Unfortunately, the opportunities created by the global financial crisis were squandered. Today’s task is more difficult; the scale of various problems has expanded even more. Without deep structural and institutional changes, the world will be facing enduring social and economic problems, accompanied by long-term stagnation.
"Many brilliant prophecies have appeared for the future of the EU and our entire planet. I believe that Europe, in its own style, will draw pragmatic conclusions from the crisis, not revolutionary ones; conclusions that will allow us to continue enjoying a Europe without borders. Brussels will demonstrate its usefulness; it will react ably and flexibly. First of all, contrary to the deceitful statements of members of the Polish government, the EU warned of the threats already in 2021. Secondly, already in mid-March EU assistance programs were ready, i.e. earlier than the PiS government’s “shield” program. The conclusion from the crisis will be a strengthening of all the preventive mechanisms that allow us to recognize threats and react in time of need. Research programs will be more strongly directed toward diagnosing and treating infectious diseases. Europe will gain greater self-sufficiency in the area of medical equipment and drugs, and the EU – greater competencies in the area of the health service, thus far entrusted to the member states. The 2021-27 budget must be reconstructed, to supplement the priority of the Green Deal with economic stimulus programs. In this way structural funds, which have the greatest multiplier effect for investment and the labor market, may return to favor. So once again: an addition, as a conclusion from the crisis, and not a reinvention of the EU," writes Dr. Janusz Lewandowski the author of the 162nd mBank-CASE seminar Proceeding.
Dla wielu rodaków europejskość Polski jest oczywista, trudno jest im nawet wyobrazić sobie, jak kształtowałyby się losy naszego kraju bez uczestnictwa w integracji europejskiej. Szczególnie młode pokolenie traktuje osiągnięty przez nas dzięki uczestnictwie w Unii ogromny postęp cywilizacyjny jako coś danego i naturalnego. Jednak świadomość tego, jaki był nasz punkt wyjścia, jaką przeszliśmy drogę i jak przyczyniły się do tego unijne działania oraz jakie wynikały z tego korzyści powinna nam stale towarzyszyć. Bez tej świadomości, starannego weryfikowania faktów i docenienia naszych osiągnięć grozi nam uleganie niesprawdzonym argumentom przeciwników integracji europejskiej i popełnienie nieodwracalnych błędów. Dla tych, którzy chcą poznać te fakty, przygotowany został raport "Nasza Europa. 15 lat Polski w Unii Europejskiej". Podjęto w nim ocenę 15 lat członkostwa Polski z perspektywy doświadczeń procesu integracji, z jego barierami i sukcesami, a także wyzwaniami przyszłości.
Raport jest wynikiem pracy zbiorowej licznych ekspertów z różnych dziedzin, od wielu lat analizujących wielowymiarowe efekty działania instytucji UE oraz współpracy z krajami członkowskimi na podstawie europejskich wartości i mechanizmów. Autorzy podsumowują korzyści członkostwa Polski w Unii Europejskiej na podstawie faktów, nie stroniąc jednakże od własnych ocen i refleksji.
This report is the result of the joint work of a number of experts from various fields who have been - for many years – analysing the multidimensional effects of EU institutions and cooperation with Member States pursuant to European values and mechanisms. The authors summarise the benefits of Poland’s membership in the EU based on facts; however, they do not hide their own views and reflections. They also demonstrate the barriers and challenges to further European integration.
This report was prepared by CASE, one of the oldest independent think tanks in Central and Eastern Europe, utilising its nearly 30 years of experience in providing objective analyses and recommendations with respect to socioeconomic topics. It is both an expression of concern about Poland’s future in the EU, as well as the authors’ contribution to the debate on further European integration.
Poland’s new Employee Capital Plans (PPK) scheme, which is mandatory for employers, started to be implemented in July 2019. The article looks at the systemic solutions applied in the programme from the perspective of the concept of the simultaneous reconstruction of the retirement pension system. The aim is to present arguments for and against the project from the point of view of various actors, and to assess the chances of success for the new system. The article offers a detailed study of legal solutions, an analysis of the literature on the subject, and reports of institutions that supervise pension funds. The results of this analysis point to the lack of cohesion between certain solutions of the 1999 pension reform and expose a lack of consistency in how the reform was carried out, which led to the eventual removal of the capital part of the pension system. The study shows that additional saving for old age is advisable in the country’s current demographic situation and necessary for both economic and social reasons. However, the systemic solutions offered by the government appear to be chiefly designated to serve short-term state interests and do not create sufficient incentives for pension plan participants to join the programme.
The document summarizes the evolution of the Belarusian public sector from a command economy to state capitalism. It discusses how the Belarusian economic model has changed over time, moving from a quasi-Soviet system based on state property and central planning, to a more flexible hybrid model where the public sector still dominates the economy. The paper analyzes the role and characteristics of the state sector in Belarus and how it has developed since independence. It considers various theoretical perspectives for understanding statist economies like Belarus, but concludes that a new multidisciplinary approach is needed to fully capture the dual nature of the Belarusian economic system.
Belarusian economy has been stagnating in 2011-2015 after 15 years of a high annual average growth rate. In 2015, after four years of stagnation, the Belarusian economy slid into a recession, its first since 1996, and experienced both cyclical and structural recessions. Since 2015, the Belarusian government and the National Bank of Belarus have been giving economic reforms a good chance thanks to gradual but consistent actions aimed at maintaining macroeconomic stability and economic liberalization. It seems that the economic authorities have sustained more transformation efforts during 2015-2018 than in the previous 24 years since 1991.
As the relative welfare level in Belarus is currently 64% compared to the Central and Eastern Europe (CEE) countries average, Belarus needs to build stronger fundaments of sustainable growth by continuing and accelerating the implementation of institutional transformation, primarily by fostering elimination of existing administrative mechanisms of inefficient resource allocation. Based on the experience of the CEE countries’ economic transformation, we highlight five lessons for the purpose of the economic reforms that Belarus still faces today: keeping macroeconomic stability, restructuring and improving the governance of state-owned enterprises, developing the financial market, increasing taxation efficiency, and deepening fiscal decentralization.
Inflation in advanced economies is low by historical standards but there is no threat of deflation. Slower economic growth is caused by supply-side constraints rather than low inflation. Below-the-target inflation does not damage the reputation of central banks. Thus, central banks should not try to bring inflation back to the targeted level of 2%. Rather, they should revise the inflation target downwards and publicly explain the rationale for such a move. Risks to the independence of central banks come from their additional mandates (beyond price stability) and populist politics.
Estonia has Europe’s most transparent tax system (while Poland is second-to-last, in 35th place), and is also known for its pioneering approach to taxation of legal persons’ income. Since 2000, payers of Estonian corporate tax don’t pay tax on their profits as long as they don’t realize them. In principle, this approach should make access to capital easier, spark investment by companies and contribute to faster economic growth. Are these and other positive effects really noticeable in Estonia? Have other countries followed in this country’s footsteps? Would deferment of income tax be possible and beneficial for Poland? How would this affect revenue from tax on corporate profits? Would investors come to see Poland as a tax haven? Does the Estonian system limit tax avoidance and evasion, or actually the opposite? Is such a system fair? Are intermediate solutions possible, which would combine the strengths or limit the weaknesses of the classical and Estonian models of profit tax? These questions are discussed in the mBank-CASE seminar Proceeding no. 163, written by Dmitri Jegorov, deputy general secretary of the Estonian Finance Ministry, who directs the country’s tax and customs policy, Dr. Anna Leszczyłowska of the Poznań University of Economics and Business and Aleksander Łożykowski of the Warsaw School of Economics.
The trade war between the U.S. and China began in March 2018. The American side raised import duties on aluminum and steel from China, which were later extended to other countries, including Canada, Mexico and the EU member states. This drew a negative reaction from those countries and bilateral negotiations with the U.S. In June 2018 America, referring to Section 301 of its 1974 Trade Act, raised tariffs to 25% on 818 groups of products imported from China, arguing that the tariff increase was a response to years of theft of American intellectual property and dishonest trade practices, which has caused the U.S. trade deficit.
Will this trade war mean the collapse of the multilateral trading system and a transition to bilateral relationships? What are the possibilities for increasing tariffs in light of World Trade Organization rules? Can the conflict be resolved using the WTO dispute-resolution mechanism? What are the consequences of the trade war for American consumers and producers, and for suppliers from other countries? How high will tariffs climb as a result of a global trade war? How far can trade volumes and GDP fall if the worst-case scenario comes to pass? Professor Jan J. Michałek and Dr. Przemysław Woźniak give answers to these questions in the mBank-CASE Seminar Proceeding No. 161.
This Report has been prepared for the European Commission, DG TAXUD under contract TAXUD/2017/DE/329, “Study and Reports on the VAT Gap in the EU-28 Member States” and serves as a follow-up to the six reports published between 2013 and 2018.
This Study contains new estimates of the Value Added Tax (VAT) Gap for 2017, as well as updated estimates for 2013-2016. As a novelty in this series of reports, so called “fast VAT Gap estimates” are also presented the year immediately preceding the analysis, namely for 2018. In addition, the study reports the results of the econometric analysis of VAT Gap determinants initiated and initially reported in the 2018 Report (Poniatowski et al., 2018). It also scrutinises the Policy Gap in 2017 as well as the contribution that reduced rates and exemptions made to the theoretical VAT revenue losses.
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3. CASE Network Studies & Analyses No.433 – Euro zone crisis and EU governance: …
2
Contents
Abstract...................................................................................................................................4
Introduction ............................................................................................................................5
1. Roots of strain in the EU ...................................................................................................5
1.1 A Financial System Gone Astray ................................................................................5
1.2 The EMU: sub-optimality and institutional and policy weaknesses........................7
1.3 EU Failures in Policy Action......................................................................................10
1.4 Redistribution of power in the world economy and global imbalances................10
1.5 Policy lessons ............................................................................................................11
2. The EU Policy Response: crisis management and reforming the EU (EMU)
governance ...........................................................................................................................12
2.1The EMU design needs fundamental repair (deceptive euro zone aggregate
deficits)..............................................................................................................................13
2.2 Fiscal Consolidation ..................................................................................................16
2.3 Implement growth-enhancing structural reforms ...................................................18
2.3.1 Increasing Competitiveness...............................................................................18
2.3.2 Fostering Employment........................................................................................19
2.4 Financial Sector’s Regulation and Supervision Reform.........................................20
2.5 Dealing with global imbalances ................................................................................22
3. Issues Pertaining to NMSs ..............................................................................................22
3.1 Financial stability in NMS ..........................................................................................22
3.2 Euro Adoption ............................................................................................................23
3.3 Tax Harmonization Across the EU............................................................................24
3.4 The Threat of Low Equilibria and Pitfalls of a One Size Fits All Economic Policy
...........................................................................................................................................24
4. Other Issues to Ponder On..............................................................................................25
Final Remarks.......................................................................................................................27
References............................................................................................................................29
4. CASE Network Studies & Analyses No.433 – Euro zone crisis and EU governance: …
Daniel Daianu is Professor of economics, The National School of Political and
Administrative Studies in Bucharest; member of the European Parliament, 2007-2009;
Finance Minister of Romania, 1997-1998; Chief Economist of the National Bank of Romania,
1992-1997; Deputy Minister of Finance, 1992; Chairman of The Romanian Economic
Society; member of the Romanian Academy; member of the European Council on Foreign
Relations; visiting professorships at Berkeley, UCLA, Bologna University, etc. President of
Junior Achievement, Romania; Honorary President of the Romanian Association of
European Studies; member of the Black Sea Region Commission. Selected writings: “Which
Way Goes Capitalism?”, CEU Press, 2009;with Radu Vranceanu (ed.), Ethical Boundaries of
Capitalism”, Ashgate (UK), 2005; “Transformation As A Real Process”, Aldershot (UK),
Ashgate, 1998; “Economic Vitality and Viability. A Dual Challenge for European Security”
Frankfurt, Peter Lang, 1996. ddaianu@hotmail.com
3
5. CASE Network Studies & Analyses No.433 – Euro zone crisis and EU governance: …
4
Abstract
This paper focuses on roots of strain in the European Monetary Union (EMU). It argues that
there is need for a thorough reform of the governance structure of the Union in conjunction
with radical changes in the regulation and supervision of financial markets. Financial
intermediation has gone astray in recent decades and entailed a big bubble in the
industrialized world. Waves of financial deregulation have enhanced systemic risks, via
speculative behavior and growing inter-connectedness. Moreover, the EMU was sub-optimal
from its debut and competitiveness gaps did not diminish against the backdrop of its
inadequate policy and institutional design. The euro zone crisis is not related to fiscal
negligence only; over-borrowing by the private sector and poor lending by banks, as well as
a one-sided monetary policy, also explain this debacle. The EMU needs to complement its
common monetary policy with solid fiscal/budget underpinnings. Fiscal rules and sanctions
are necessary, but not sufficient. A common treasury (a federal budget) is needed in order to
help the EMU absorb shocks and forestall confidence crises. A joint system of regulation and
supervision of financial markets should operate. Emergency measures have to be
comprehensive and acknowledge the necessity of a lender of last resort; they have to
combat vicious circles. Structural reforms and EMU level policies are needed to enhance
competitiveness in various countries and foster convergence. The EU has to work closely
with the US and other G20 members in order to achieve a less unstable global financial
system.
6. CASE Network Studies & Analyses No.433 – Euro zone crisis and EU governance: …
5
Introduction1
The sovereign debt crisis has created enormous anguish in the European Monetary Union
(EMU) and emergency measures are used in order to prevent its breakdown. The European
Council summit of October 2010 considered a Task Force report with a telling name:
“Strengthening economic governance in the EU”. This document is to be examined in
conjunction with the governance reform proposals issued by the European Commission and
related documents. In March 2011,the Council adopted the Euro Pact and the European
Parliament approved the 6 pack reform in the second half of 2011. But this demarche is not
an attempt to explore a terra incognita. From the very beginning of the EMU there was some
discomfort with its institutional underpinnings and there were misgivings regarding its
optimality as a currency area. This explains why a train of thought underlines a political
rationale, too, for its creation. Likewise, criticism over the way regulation and supervision
were established in the Union is not of recent vintage. And insufficiencies of the Stability and
Growth Pact (SGP), with almost all member states flouting its rules at various points in time,
were repeatedly pointed out. This said, however, the flaws of financial intermediation have
been less considered by policy-makers and central bankers for reasons which, partially, are
to be found in a paradigm which has dominated economic thinking in recent decades. This
paper focuses on roots of the huge strain in the Union and policy issues ensuing from the
current crisis. Nota Bene: there is a “political reality” which constrains decisions in the EMU;
the latter is not a federal structure and what appears to be rational when defined strictly
economically may clash with implications of the political configuration of the Union.
1. Roots of strain in the EU
1.1 A Financial System Gone Astray
Financial stability has staged a formidable comeback on the policy-making agenda in
advanced economies. The current crisis has exposed flaws in the working of financial
markets; this crisis cannot be explained only by years of cheap money and growing
1 The paper prepared for the CASE conference ‘The Future of European Integration”, Warsaw 18-19 November,
2011; it relies on Daianu (2010) and Daianu&Lungu (2011)
7. CASE Network Studies & Analyses No.433 – Euro zone crisis and EU governance: …
imbalances in the world economy. Mistakes in macro-economic policy were accompanied by
gross abuses of securitization, excessive leverage, abnormally skewed incentives and a loss
of moral compass, inadequate risk-assessment models and failures to check for systemic
risks, a breakdown of due diligence and an almost blind belief in the self-regulating virtues of
markets.
Structure is key in understanding the current crisis. On the one hand, it can derail even
brilliantly conceived policies; on the other hand, it can shape policies wrongly. For instance,
complacency vis-à-vis the expansion of financial entities overexposes economy to major
risks (like it happened with Iceland,Ireland, UK, etc). Or take a premature opening of the
capital account, as it occurred in numerous emerging economies, and the paradigm and
policy approach which propounded total deregulation of financial markets as a means to
foster economic growth.
Financial intermediation, as it has evolved during the past decades proves that not all
financial innovations are good, that inadequate risk and business models have been used by
banks and other financial institutions. Quite a while ago warnings were sent regarding the
growing opaqueness of markets due to securitization and off balance sheet activity.
Lamfalussy (2000, p.73) noted that financial integration made “crisis prevention and handling
it more difficult”; unregulated financial markets have turned into an in-built destabilizer..
Moreover, the financial industry has become oversized in not a few economies.
The paradigm shift which is, currently, underway is rediscovering systemic risks: the
complexity and inter-connectedness of financial markets, contagion effects, “Minsky
moments”2. But there is need to make here a distinction between two opposed cognitive
approaches: one that believes that nothing can be done about the evolution of markets,
whatever the way financial innovation goes; and another approach, which does not take the
complexion of markets as God given and has misgivings about a range of financial
innovations. Networks do not mushroom accidentally only; they are also shaped by policies.
As Haldane, the director of research at the Bank of England remarked: “Deregulation swept
aside banking segregation and, with it, decomposability of the financial network. The upshot
was a predictable lack of network robustness…”(2009, p.31).
2These are moments when, according to Minsky, financiers lay waste to the economy. A Minsky moment comes
after a long period of boom, after much speculation via borrowed money; it happens when over-indebted
investors are desperate to sell good assets to pay back their loans, causing huge drops in financial markets and
big surges in demand for cash. Paul McCulley of PIMCO concocted it to describe the Russian financial debacle of
1998 (Lahart).
6
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Prior to the financial crisis the European leaders failed to recognize the extent to which
European banks were involved in the origination and distribution of toxic financial products.
Financial sector practices have also obscured the size and dangers of the shadow-banking
sector in Europe.
This crisis is also one of deep financial integration, which the intensity of the sovereign debt
crisis mirrors glaringly3. In Europe, integration, with its financial component, was seen as a
principal way to achieve catching up. And this approach entailed benefits, but it has also
caused vulnerabilities, which are not to be linked with weak policies exclusively. For even
countries which were quite prudent policy-wise and limited their external disequilibria were
caught into the crisis maelstrom. Big bubbles and much investment in non-tradeable goods
sectors occurred in several NMSs4 following the opening of the capital account. Inadequate
regulatory and supervisory arrangements operate in their case, too, against the backdrop of
massive cross-border financial flows and the domination of local markets by foreign banks.
Outside Europe and learning from previous crises, emerging economies tried to forestall
shocks by the accumulation of foreign exchange reserves as a buffer (a high premium was
attached to them); uphill financial flows were seen as a purposeful cost for the build up of a
wherewithal capacity in the advent of unanticipated shocks5. Industrial policy aims, too,
played a role in this respect.
1.2 The EMU: sub-optimality and institutional and policy
7
weaknesses
Nowhere is the impact of structure more obvious than in the European Union, in the EMU in
particular. For, in this area substantial cross border operations take place while national
prerogatives in regulation and supervision, in tax and budget policies stay, basically, in
national hands. In addition, the EMU is far away from an optimal currency area, as it was
from its debut.
Challenges for the functioning of the EMU are rooted in the economics of currency areas.
The optimum currency area (OCA) theory6 says that the adoption of a single currency pays
off when the monetary area is highly integrated economically and has the capacity to adjust
quickly to asymmetrical shocks. Traditionally there are five core OCA properties namely:
3 Reinhart and Rogoff’s observation that deep financial crises are followed by sovereign debt crises is quite
meaningful in the case of a highly integrated monetary union (2009)
4 A Bruegel publication highlights this type of capital flow into the Baltic economies, Romania, Bulgaria (Becker et
al., 2010, especially chapter 2).
5 There is, arguably, an optimal degree of financial integration in the global economy in view of destabilizing
capital flows (see also Stiglitz, 2010). A legitimate question is what should be done in the EU about it, since
unhindered capital flows are a rule of the game in the Union.
6 Mundell (1961)
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wage and price flexibility, trade integration, cyclical convergence, factor mobility, and fiscal
federalism, which are used to assess a success of an OCA area. In the EU wage setting
continues to be done, predominantly, at the national level, and quite often at the sectorial
level. This mechanism reinforces the relative inflexibility of the individual countries’ labour
markets. Within the euro-area real wages have tended to be downwardly rigid with a
relatively high level of indexation. Moreover, although nominal interest rates had largely
converged, there was a wide discrepancy among real interest rates of the euro zone
members. Although business cycles synchronization has increased within the euro zone
countries, much of it had to do with the fall in the amplitude of global business fluctuations,
which benefited from low interest rates and low inflation during the past decade. But
considerable structural differences remain at the euro-zone country member level. European
labour mobility remains fairly limited, despite persistent differences in regional
unemployment.
The current crisis has highlighted the inadequacy of existing institutional and policy
arrangements and a stark fact: that not all problems have a fiscal origin (though they may
end up, ultimately, as public debt). These arrangements have favored the accumulation of
internal imbalances against the background of one-sided, inadequate policy tools. The “one
size fits all” monetary policy of the European Central Bank (ECB) could not prevent
excessive capital, frequently of a speculative nature, flowing into less developed areas of the
EMU, in the EU as a whole. Resource misallocation and bubbles were stimulated in this way.
Likewise, an increasing entanglement of mutual exposure among financial entities7 has taken
place while burden-sharing arrangements in case of a failed entity were missing. After the
crisis erupted the ECB has turned into a de facto unwilling lender of last resort to various
governments, which have tried to prop up financial institutions, be it indirectly (by accepting a
wide range of bank collaterals). Contagion effects have reinforced the sentiment that
institutional and policy arrangements are more than precarious. Systemic risks, which have
been engendered by “too big to fail” cases, have been compounded by effects of a “too big to
be saved”8 syndrome.
The EMU is the only integrated area in the world which has a centralised monetary policy but
favours a rather local (state) based approach to fiscal policy. The foundation for the latter
was laid out in the Stability and Growth Pact (SGP), which acts as a coordinating instrument.
However, all EMU member states breached its rules. Because the financial crisis has had a
7 Banks outside of Greece, Ireland, Portugal and Spain hold 2 trillion euro in debt instruments from these
countries, which underscores the systemic risk to the financial system if one or more borrower countries fails
(data compiled by Jacques Cailloux, cited by Kanter, 2010)
8 The overexpansion of some financial entities has dwarfed the capacity of home states to intervene in order to
deal with systemic risks (Gros and Micossi, 2008).
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very severe impact on national public budgets the very SGP rules have been put on the
shelf. The cost of bank bailouts is quite staggering and the rise in public debts is pretty
worrying9. There are several issues for debate in this regard. One relates to what could
evolve as an unsustainable indebtedness of the EMU area. If the cumulated budget deficits
(in the EMU), together with private sector indebtedness, turn into a substantial external
current account deficit for the euro area as a whole, while its flaws persist, this situation
would damage the status of the euro over the longer term10. Although, one could doubt the
viability of the euro zone, in its current configuration, unless its flaws are addressed in a
timely manner. Another aspect of the debt problem regards the relationship between those
economies, in the EMU, which are running surpluses on their current account (primarily
Germany) and those which are running persistent large deficits (such as Portugal, Italy,
Greece). This financial crisis has shown the internal tension which such an uneven
distribution of competitiveness (as a lack of sufficient convergence) in the EMU creates11.
This inner major weakness has to be dealt with if the euro area is to avert highly damaging
cracks. Given the existence of a common monetary authority, the ECB, and insufficient
convergence in the euro zone, the argument for an EMU fiscal authority is compelling. This
would create more room for manoeuvre for the mechanisms of fiscal transfers in the face of
idiosyncratic shocks. It would also place less pressure on the ECB when dealing with
regional divergences.
The regulation and supervision of financial markets is a huge policy issue in the EMU, in the
EU in general. The distribution of responsibilities between home and host country and the
inexistence of detailed burden-sharing arrangements in the event of a crisis has been a
major handicap for the single market under conditions of deep financial integration12.Under
current arrangements, responsibility for the stability of financial institutions belongs to the
supervisor of the country where they are headquartered whereas responsibility for the
stability of financial systems belongs to the supervisor of the host country. This crisis
reinforces the idea that a common rulebook, more integrated supervision, and a common
framework for crisis resolution are all needed to match the degree of financial integration. On
the other hand, the burden-sharing issue prompts national governments and supervisors to
9 Apart from the effects of the current financial crisis (the cost of bail outs and big rises in government borrowing),
another threat to sound public finances is the ageing of population. Reforms of the welfare systems are a must
under the circumstances. Multi-annual budgetary frameworks are useful because they limit the scope for
opportunistic government interventions in fiscal policy but adopting a longer-term vision for the EU public finances
would require changes in the way fiscal policy is conducted.
10 One would have to factor in the crowding out effect large public debts would exert on domestic business, which
would damage private investment and, consequently, economic growth in the EU.
11 For diverging competitiveness in the euro area see also “EMU at 10” (2008)
12As the de Larosiere et al. (2009) report notes, ‘The absence of a sound framework for crisis management and
resolution (with sufficiently clear principles on burden sharing, customers’ protection, assets transferability and
winding up) complicates the introduction of an effective and efficient supervisory system to avoid financial crises
in the first place’ (p. 76).
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think more along national lines, in view of their accountability toward national taxpayers.
The bottom line is that, in order to function properly, be viable, the EMU should have solid
fiscal/budget underpinnings; the latter would imply a common budget (common treasury)
and the issuance of joint bonds –like in federal states (US, Canada, Germany, etc) when
seen as monetary unions. Likewise, a common regulation and supervision of financial
markets does make sense in the EMU. In practice however, this is very difficult to achieve
because of political reasons.
1.3 EU Failures in Policy Action
In the face of crises the European institutions have almost always had a reactive approach,
doing just enough to fix the problem in the short term. But, most of the time, decision-making
has been too little and too late. At the root of this cause are conflicting national interests and
inadequate institutional and policy arrangements. The two previous notable European
initiatives, the Lisbon Strategy and the SGP have both failed because rules enforcement was
weak, not to say largely inadequate. With domestic interests at stake, peer governments
loathed penalizing each other. Proposals of automatic sanctions, triggered in the event of
breaching the rules, have been consistently ignored. Another reason why those initiatives
failed is because they minimized the role of major discrepancies among member countries at
various levels: structural, economic and political and the cost incurred to fulfill the stated
objectives.
The Europe 2020 Agenda aims at making up for past policy mistakes. In a global space
where competition takes place, frequently, via zero-sum games, the EU economy has been
consistently losing ground over the last decade. Although national policies do make a
difference, the issue goes deeper than economics and concerns the whole range of values
and norms embraced by a particular society.
1.4 Redistribution of power in the world economy and global
10
imbalances
The Lisbon Agenda was enacted in 2000, as a EU response to Asia’s growing assertiveness
in the world economy. This is a resuscitation of the Lisbon Agenda, which was hardly a
success. But one of the lessons of the past decade is that national policies make a
difference. The results of Scandinavian countries, of Germany in undertaking reforms with a
view of improving competitiveness are a proof in this regard.
Global imbalances enhance crises, which produce contagion effects. Can the EU push for a
reform of the IFIs and of global arrangements which should limit dangerous global
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imbalances? The EU would gain in persuasion and bargaining power in the G20 to the
extent it can deal with its own problems effectively. Yet, conflicting views and interests
among EU member states reduce its internal cohesion and harm its power projection
externally.
1.5 Policy lessons
There are lessons which policy-makers need to learn from this crisis:
11
- price stability is not sufficient for securing financial stability
- fiscal prudency is not sufficient for securing economic stability;
- unless financial markets are properly regulated and supervised they pose
enormous systemic risks; this is particularly valid in a deeply integrated area
such as the EU;
- private sector over-indebtedness creates systemic risks when it involves “too
big to fail” financial entities;
- ways have to be found so that private investors bear the risks they assume (for
the rescue programs have increased moral hazard); banks (their share-holders,
bond-holders) should not take for granted that whatever they do tax-payers’
money stays behind them;
- deep financial integration demands stronger regulation and supervision at the
EU level;
- because of deep integration contagion effects hardly leave one immune to the
effects of a crisis;
- the incompleteness of the policy regime in the EU and the EMU’s flawed design;
- deep financial integration collides with the reality of national tax prerogatives;
- policy coordination needs to take into account EU-wide interests;
- trustworthiness among member states is essential for the sale of preserving the
common public goods;
- national policies do matter for improving competitiveness, even when the room
of manoeuvre is quite limited;
- we live in an increasing uncertain world, which diminishes policy effectiveness
and asks for “policy space” (which includes fiscal space) in order to cope with
“tail events” and non-liniarities13).
13 For the importance of random events in our life see, among others, Mandelbrot (2004) and Taleb (2008).
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2. The EU Policy Response: crisis management and reforming
the EU (EMU) governance
The EU policy response to the financial and economic crisis has two components:
I. A crisis management undertaking, which has tried to mitigate the economic downturn and
avert a financial meltdown. The ECB has been compelled to take an active role in this, which
has gone much beyond its usual mandate. This exercise is impaired, however, by conflicting
views regarding the root causes of the euro zone crisis. And the inexistence of an effective
lender of last resort (since the ECB is constrained in its operations and the EFSF is quite
weak) has magnified a confidence crisis which has engulfed the euro zone.
II. Measures aimed at reforming the EU’s economic governance. This component is multi-faced
12
and has several aims, namely:
• Fiscal consolidation by addressing the sustainability of pensions, health
care and social benefits together with the adoption of national fiscal rules.
• Growth-enhancing structural reforms through higher employment and
competitiveness
• The reform of the regulation and supervision of financial markets and
restore the health to the financial sector.
• The set up of a permanent lending facility in the euro area-the European
Stability Mechanism (ESM)
The reform proposals package was adopted by the European Parliament in late 2011. The
first three directions mentioned above form the object of the Euro Pact Plus(EPP)14, which
has already been agreed by the euro area heads of state jointly with several non-member
states15. Under the EPP proposals, each individual country would be responsible for the
specific action it would choose to implement in achieving the commonly agreed objectives,
monitored through a set of economic indicators. From a normative point of view the proposed
measures could be seen as a step forward in improving the functioning of the euro currency
area. But, big challenges remain. These relate to the implementation, coordination and
enforcement of these measures as well as to filling in the gaps of the existing agreement.
The basic flaws of the EMU are not yet tackled resolutely. The EMU needs proper fiscal
14The EPP is viewed by many as reflecting, basically, a Berlin view, but it also relies on proposals made by the
European Commission and the task force headed by the president of the European Council, Herman van
Rompuy.
15These are Bulgaria, Denmark, Latvia, Lithuania, Poland and Romania. Hungary, the Czech Republic, Sweden
and the United Kingdom decided to opt out from the EPP.
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underpinnings and adequate regulatory and supervision arrangements of financial markets.
The agreement to create the EFSF and the European Stability Mechanism (ESM) answer a
necessity but is insufficient. And the EFSF has proved to be quite ineffective as a crisis
management tool, as a means to prevent contagion. There are several issues to be noted
about the ESM.
First, there is the issue of the individual member contribution to the ESM capital structure.
Countries with lower credit ratings will end up paying up more to the ESM capital. Second,
questions are raised over the perceived limited lending capacity of both EFSF and ESM.
With Portugal being the third country, which asked for financial assistance in April 2011, the
pressure has been moving to Spain and Italy. Under this scenario the existing EFSF lending
capacity is strained much beyond the current limit. And its leveraging raises, itself, a host of
technical problems. Third, the mechanism by which a loan guarantee is triggered in ESM
places sudden pressures on domestic budgets in member countries, potentially worsening
their budgetary positions.
The view that the proposed sovereign debt default mechanism will make the EMU, as it is
now, more prone to crises has been validated by events16. A related problem is that the ESM
could bring about another inconsistency, namely: the possibility of default, persistent
imbalances and lack of proper fiscal arrangements (Munchau, 2010). This brings us back to
square one, namely, the possibility of having a monetary union without solid fiscal (budget)
underpinnings. Added to this is how to foster real economic convergence in the EMU.
2.1The EMU design needs fundamental repair (deceptive euro zone
aggregate deficits)
European Central Bank (ECB) and Commission top officials note recurrently that the
aggregate deficits of the euro zone (EMU) are inferior to those of the US and of other big
countries (Japan is probably meant here since it has a public debt above 200% of its GDP).
By this assertion they want to underline that the overall state of the euro zone is not worse
than that of the US, or of other major economies; and that, consequently, it should not cause
bigger worry. It is true that the US’ public debt, which has gone over 95% lately, is above the
aggregate level of the EMU; and the latter’s budget deficit was ca. 6% of GDP in 2010,
whereas the figure for the US exceeded 9% of GDP. However, these numbers need to be
judged in conjunction with the roots of the euro zone crisis, of the sovereign debt crisis in the
EMU. For, although the level of aggregate public debt does matter, the main cause of the
euro zone crisis lies elsewhere, in its poor design. Until the eruption of the current financial
16Since it will introduce speculative dynamics into it, and an analogy is made with the Exchange Rate Mechanism
(ERM) that preceded the start of the Eurozone (de Grauwe, 2010b)
13
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and economic crisis, this flawed construction was obscured by cheap credit and cheap
imports, by markets’ myopia.
Economic history, of longer and recent vintage, teach us in this respect. Let us think of what
differentiates the US and Canada, as federal structures, from the euro zone. A US sovereign
debt crisis cannot be ruled out, in the long run, were its public debt continue to grow and
markets lose confidence in the US dollar as a reserve currency. But an “American crisis”
would rather occur as a massive depreciation of the USD, which would entail high domestic
inflation. For the foreseeable future, US T-bills and bonds are among the safest investments
in the world. Nobody assumes a disappearance of the US dollar, whereas not a few people
are worried about the fate of the euro zone (and implicitly, of the euro), and various scenario
are imagined in this regard. Moreover, markets have already priced in, more or less, tail
events (default), contagion, linkages between sovereign debt and bank balance-sheets in the
euro zone. Were an American state threatened by bankruptcy hardly anyone would doubt the
existence of the US as a monetary union. Bank recapitalization in the US has proceeded
better and more transparently than in Europe, and there are federal institutions for the
regulation and supervision of financial markets across the Ocean. That their functioning has
been inadequate, not least because of waves of deregulation (including the rescinding of the
Glass Steagall Act of 1999 and the Commodity Futures Modernization Act of 2001), is a
different matter for discussion. The US “single market” functions better then in the EMU.
Such examples can continue.
A telling argument that markets do not pay much attention to EMU’s “aggregate” numbers is
that, since the start of the current crisis, they have increasingly discriminated among the
sovereign debt of euro zone member countries. The interest rate convergence of the past
decade was, arguably, a market myopia, a market failure, which brought about over-borrowing
by state and private sectors and massive resource misallocation. This crisis has
forced a wake up call, though this is happening with damaging overshooting, panics and
vicious circles. Another question can be illuminating on aggregate numbers: how much fear-mitigating
would be a diminishing external deficit of the euro zone were it accompanied by a
growing cleavage, competitiveness-wise, between Germany, the Netherlands and the
periphery (Greece, Portugal, Spain, Italy)in the euro zone? As this crisis shows external
imbalances do matter in the EMU too.
The very setting up of the European Financial Stability Facility(EFSF) proves the weakness
of aggregate numbers as an argument. An analogy could be made between TARP(Toxic
Assets Recovery Program) in the US and EFSF. But TARP aimed at propping up financial
entities; it was not set up because of the threat to the US as a monetary union. Instead, there
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are undisguised worries regarding the future of the EMU. Further, the very operations of
ECB, of buying sovereign debt of member states, firm up the thesis that the EMU is lacking
common fiscal (budget) underpinnings. The EFSF tries, inter alia, to relieve the ECB of an
immense burden that has been bestowed on it as it operates as a “fireman”, much beyond its
traditional mandate of preserving price stability. It appears, however, that the EFSF, be it with
substantially bolstered resources and a broader range of operations (including bank
recapitalization and sovereign debt purchases in secondary markets) would be an imperfect
substitute to a solid budget arrangement. Anyhow, EFSF needs to beef up its firepower in
order to deal with a crisis that is infecting Italy and Spain.
Unfortunately, there is a major cognitive dissonance on fiscal (budget) integration among
euro zone leaders. One approach, which is embraced by Germany, the Netherlands, Finland,
etc sees euro-bonds as a culmination of a gradual process of integration, apart from political
and legal impediments; the other approach sees euro bonds as an effective method to
combat speculative attacks, and as a major step toward creating a solid fiscal complement to
the common monetary policy17. The fact that there are such conflicting views on this subject,
the lack of capacity to make decisions in due time (as it happened constantly since the euro
zone crisis has started), the precarious intervention tools the EMU has at its disposals, make
the aggregate deficits-based observation unconvincing. It may be that the deepening crisis
would force a radical change of outlook and action, and trigger a speedy pace of fiscal
integration in the euro zone. If not, it is pretty hard to see how the euro zone will survive in
the current configuration. Asking governments to deflate once and again, for the sake of
closing down productivity gaps and reduce overall indebtedness, is arguably not sustainable.
Structural reforms may look nice on paper, but actual results may be too time consuming and
uncertain and, thereby, further damage the cohesiveness of the EMU. The attempts of
various governments to reinstate the gold standard during the inter-war period, in the past
century, gives plenty of food for thought on this matter. And, by the way, at that time
governments could still use their own national monetary policy instruments.
This crisis shows that incrementalism does not work. Fiscal rules are needed, as sanctions
are. But fiscal rules are far from being sufficient; they cannot be a substitute for a solid fiscal
arrangement, that must, arguably, include a common treasury. Appointing a finance czar for
the euro zone, who should make judgments and recommend penalties, is not enough either.
There are EMU countries (Ireland, Spain) that had pretty cautious budget policies and,
relatively, low public debts before this crisis. And everything was blown out because of
excessive borrowing on the part of the private sector, which invited a boom and bust cycle.
17A proposal made by the German Council of Economic Advisors indicates a shift in this direction (see Bofinger et
al, 2011). This proposal is in the vein of the ides suggested by Depla and Weiszacker (2010)
15
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The euro zone needs a rounded up common policy in order to survive. This policy would
have to respond to asymmetric shocks, as it is done in the US and Canada via the federal
budget, where unemployment insurance is provided; it would also have to deal with deep
financial integration via a common regulation and supervision of financial entities as well as
joint resolution mechanisms. For all this to operate there is need for fiscal integration, a
common treasury. Even if Greece were to exit the euro zone in an orderly fashion and
without entailing major contagion (is it possible?), the EMU would still need fiscal integration.
2.2 Fiscal Consolidation
The EU’s sovereign debt crises, which ensued from the financial and economic crisis, have
heightened concerns for fiscal sustainability. Governments’ responses during this crisis and
in other crises episodes show that, avoiding a systemic collapse necessarily entails
burdening public debt. Thus, the policy of strengthened fiscal discipline should be seen in
conjunction with policies addressing macroeconomic imbalances in the EU. A stronger SGP
will be strengthened by improved surveillance and better data quality gathered from EU
member states. The new system would rely on a much stronger compliance regime via
“financial and reputational sanctions”. The introduction of fiscal rules, as set out in the SGP,
in national legislation is expected to enforce compliance with the SGP rules – which have
been so often broken in the past.
The preventive arm of the SGP considers the sustainability of overall public debt, while the
corrective arm targets a budget deficit path, which should bring down the debt to GDP ratio
over time, in a consistent manner. The preventive component of SGP will limit public
spending growth below the medium-term GDP growth until the target is met. It will also
require that ’’best practice’’ budgetary procedures are implemented i.e. the adoption of multi-year
budget planning, overview of fiscal targets by independent fiscal councils, the
implementation of fiscal rules and increased transparency in statistics. These are useful
innovations, which are likely to strengthen the preventive arm of the SGP.
However, there are changes to the corrective arm of the SGP, which would prove to be more
challenging to implement in practice. The modification of the corrective component of SGP
envisages the introduction of a 60% of GDP target for public debt, in addition to the 3% of
GDP deficit limit. And, if public debt exceeded 60% of GDP, the country would be forced to
bring it down at a pace of one twentieth of the excess over the previous three years18. These
changes could raise several problems in practice:
18A breach of either the deficit or debt limits would trigger an infringement procedure and a fine of 0.2% of GDP if
the country fails to comply. Rejecting a penalty proposed by the Commission would need a qualified majority in
the Council of Ministers, i.e. by ’’reversal voting’’. ’’Excessive imbalances’’ of other economic indicators trigger a
0.1% of GDP penalty.
16
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¾ Requiring a country to bring down its public debt during recession may be self-defeating,
17
owing to the pro-cyclical nature of debt to GDP ratios.
¾ Since debt ratios are above 60% of GDP in most EU countries, collective action
in reducing public debt could have a negative impact on the whole EU
economic growth.
¾ Meeting the objectives of the revised SGP in the absence of a workable
framework for bank debt resolution and recapitalization could be challenging for
all EU members. Both targets could be easily overshot in circumstances when
some private institutions,deemed too big to fail, would need to be bailed out by
national governments.
¾ Countries with high debt/GDP ratio could face credibility problems in meeting
the targets at the required speed, as their policies would face serious economic
and social constraints. This could impact their borrowing costs for a long time,
hampering their fiscal adjustment program.
¾ The EC’s penalty system might not be credible as some of the indicators
monitoredare not policy variables and thus cannot be controlled by government
policy (Manasse, 2010).
The EPP places a disproportionate weight on fiscal adjustment issues. But, fiscal indiscipline
was not a cause of the crises in Ireland or Spain, for instance. Moreover, the risk of almost all
EU countries behaving the same, i.e. enforcing the Maastricht criteria on public debt and
deficit, could have a powerful recessionary bias in Europe.
Except Hungary, NMSs do not have large public debts. But budget deficits have gone up
dramatically in the wake of this crisis. Moreover, not a few NMSs were running meaningful
structural deficits prior to the crisis, based on their existing economic growth model at the
time. Consequently, the Baltic countries, Bulgaria and Romania have had to implement their
fiscal consolidation programs because of the permanent loss of output and impairment of
economic growth --against the backdrop of a highly unfriendly external environment that has
been entailed by the turmoil in financial markets. But, as Becker et all (2010) note, fiscal
consolidation has to take into account the risk of adding public deleveraging to the ongoing
private deleveraging, a factor which could harm economic recovery.
NMSs would benefit hugely from a high degree of absorption of EU structural and cohesion
funds. These resources would offset the influence of expenditure reduction on aggregate
economic activity while giving a boost to public investment in a period of economic distress.
The availability of these resources would help prevent fiscal consolidation becoming pro-cyclical
during a recession. The IFIs and EU supported adjustment programs in NMSs have,
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arguably, not paid sufficient attention to the strategic role of EU structural and cohesion funds
in this new context.
For NMSs the introduction of fiscal rules is desirable, as it would discipline fiscal policy and
remove, to a great extent, the influences of political business cycle on the economy. But, the
limitation of budget deficit at 3% of GDP could be a serious constraint at times, given the
nature of mandatory expenditure. For instance, it matters a great deal how contributions
made to private pensions schemes, which are part of the pension system reform, are
accounted for in the measurement of the structural budget deficit. The risk is that such
legislative changes could be reversed in extreme circumstances if the degree of public
endurance with fiscal reforms wears thin.
2.3 Implement growth-enhancing structural reforms
The EPP proposes two main areas where improvements could be made: labor market and
competitiveness. It has to be noted that the same areas were singled out in need of
enhancement in the Lisbon 2010 Treaty. However, progress in achieving those objectives
was only marginal at best, in most of the EU economies. The new proposals aim at
remedying this. But, in practice they could raise more problems and lead to growing
discrepancies among EU economies.
18
2.3.1 Increasing Competitiveness
The EPP suggests assessing wage and productivity developments by looking at relative unit
labor costs (ULC) in euro area countries and their trading partners. Imbalances between
costs and productivity are supposed to be resolved through wage control growth, product
market liberalization, improvement in R&D, infrastructure and innovation as well as the
business environment.
There are problems with the way in which proposals have been made. First, the one-size-fit-all
logic applied across EU countries could have unintended consequences. Witness the
effects that a single monetary policy had on EU peripheral economies during the boom
years. Then, economies such as Spain or Ireland would have needed higher interest rates in
order to prevent domestic macroeconomic imbalances building up. The same reasoning
applies to the stated objectives of EPP on competitiveness. Initial conditions do matter and,
an attempt to somehow correlate unit labor costs19across EU member states using current
19 There are various measures of competitiveness indicators, which often yield different results. Although
proposals by the EPP suggest a range of ULC indicators to be used for various sectors of the economy, these still
remain just one measure of competitiveness – most likely chosen because they facilitate comparisons across EU
countries on a similar basis.
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indicators as benchmarks, have the potential to lead to more destabilizing conditions in the
future. Besides, economic growth is likely to slow further following the introduction of these
measures, at a time when growth pick up is paramount for the success of country
stabilization programs.
Second, competitiveness is not a policy instrument, and it cannot be influenced
unambiguously and directly by governments’ economic policy. The authorities could strive to
create premises for an economy to develop but the ultimate outcome is a complex result of a
market given context. NMSs, for instance, have traditionally benefited from lower labor costs
but other factors such as inappropriate physical and skilled human capital in various sectors,
or a low level of R&D impact adversely on their long-term competitiveness. Moreover,
building up higher stocks of capital takes time and implies fast economic growth rates. For
most NMSs a major policy issue is how to enhance resource allocation toward tradable
sectors. For this crisis has revealed flaws of the precrisis growth model.
Not least, the focus on ULC as a measure of a country’s competitiveness might be seriously
misleading. Felipe and Kumar (2011) suggest that there are conceptual problems with it. If
ULC are considered, then unit capital cost (UCC), that is the ratio of profits to capital
productivity, would also have to be looked at. The authors show that capital productivity has
been displaying a declining trend in the EU. Moreover, a ULC for tradable goods comparison
across EU countries could be misleading because of the complexities of export products,
which vary across the EU economies. NMSs tend to export lower value added and lower
technology products while Germany, for example, exports over 12% of the world’s top 10
most complex products. Thus, if Germany were supposed to provide a benchmark for
competitive policies in the EU, based on ULC, it would in fact distort the whole picture and
impose unfounded constraints on NMS’ policies.
There would also be major implications for national policies, which are asked to undertake
corrective measures. Governments could become more involved in the management of the
economy, in mediating between social partners for the sake of achieving competitiveness
targets. And as competitive devaluation can be damaging overall the same could happen
with “competitive” wage controls throughout the EU.
19
2.3.2 Fostering Employment
The EPP suggests each national state would have to implement policies aimed at increasing
participation rate, lowering labor tax rates or increase lifelong learning. While from a
normative point of view such policies are desirable, their pursuance might yield the expected
21. CASE Network Studies & Analyses No.433 – Euro zone crisis and EU governance: …
outcome in the long term only. The labor market is far from being flexible across EU
countries. Apart from labor market restrictions – which still apply to some NMSs such as
Romania or Bulgaria, five years after they joined the EU – labor mobility within the EU
remains low compared to the US for instance. Citizens of NMSs face relatively high migration
costs, given their earning power. A uniform labor market reform across EU economies could
have asymmetric effects as labor, being mobile, could shift towards most developed
economies where wages are much higher. The richer EU countries are also devising means
to attract highly skilled labor from poorer countries.
2.4 Financial Sector’s Regulation and Supervision Reform
European policy-makers are advancing with an overhaul of the regulatory and supervisory
structures of financial systems, including the parallel (shadow) banking sector and rating
agencies. Harmonization of rules is not a sufficient response to the crisis, since the very
content of regulations and supervision needs radical change20. A reformed regulatory and
supervisory framework would observe basic principles such as regulation of all financial
entities (including the shadow banking sector, hedge funds and private equity funds), higher
capital and liquidity adequacy ratios, capping leverage, bringing derivatives into the open and
having their trading regulated, preventing regulatory arbitrage, transparent accounting rules,
and addressing systemic risk.
In the EU there is need to strengthen the regulation and supervision of major financial
groups, which operate cross-border. The European Systemic Risk Board (ESRB) together
with the new supervisory authorities should bring a decisive plus in this regard.
In September 2011 Britain’s Independent Banking Commission released its report, which
suggested that the financial system would be more resilient to future crises if banks’ retail
were ring-fenced as against investment units. But this proposal comes short of the proposal
put forward by Paul Volker, the former Federal Reserve Chairman, which suggested a
complete separation between the two bank activities, as they were prior to the abrogation of
the Glass-Steagall Act of 1933. As a matter of fact, the “too big to fail” issue is still
unaddressed by policy-makers and, ironically, the unfolding of the financial crisis has
resulted in bank consolidation, which entails a heightened moral hazard problem (Johnson
and Kwak, 2010) 21 . Global competition and the fear of regulatory arbitrage are not
peremptory arguments in this respect. The persistence of this problem rather reflects the
20This is what comes out prominently from the de Larosiere et al. (2009) report and the Turner (2009) report (in
the UK), from documents of the European Parliament and directives of the European Commission, the Monti
(2010) Report, etc.
21As put by Goldstein and Veron (2011) this issue is more challenging in Europe owing to a higher concentration
of banking markets than in the US, general reluctance to let banks fail, the interdependence between banking and
political systems and, not least, nationalism.
20
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power of vested interests.
One large component of the policy response namely consistent public sector bailouts of the
private sector, notably of the banking sector, continues to pose more questions than it
solves. The cross border structure of European bank operations and the years of resource
misallocation have left many banks in Germany, France or Austria with a heavy exposure to
peripheral EU countries and NMSs, i.e. those countries which now undergo painful
adjustment programs. There is now a vicious circle emerging in which the refinancing of debt
from countries with lower credit ratings is being done indirectly by those euroarea member
countries which have a solid interest in protecting the health of their national commercial
banks’ balance sheets. But the onus of adjustment is almost entirely put on the taxpayers of
the countries in distress, which raises a host of practical and moral issues. A legitimate
question therefore arises: is such an arrangement appropriate and sustainable (does it take
into account the need for burden-sharing22?).
The EU can acknowledge an insolvency problem and come up with some form of debt
restructuring for distressed sovereigns whose public debt is on an unsustainable path23; it
would imply a restructuring or even closing down insolvent European banks24 (until recently
stress tests performed across European banks have failed to incorporate extreme scenarios,
such as default by a member state, simply because such a default is perceived to be
politically inconceivable and would trigger powerful contagion effects). This option would also
go some way in addressing the so-called ‘burden sharing’ issue among EU countries, since it
was the banks from creditor EU members which provided loans that subsequently turned
bad, in the first place25. Clearly, such an action asks for a political decision in the EU donor
countries, in Germany in particular26.
The 50% haircut applied to Greek sovereign debt is a breakthrough in this regard and forces
banks to build up their capital, but it also creates a precedent in terms of capacity to contain
22Burden sharing can be seen through two pair of lenses. One regards whether private investors (bond-holders)
share into the costs of debt restructuring. The other one refers to the distribution of costs among EU member
countries. Hence arises the political sensitivity of this issue. Both perspectives imply the impact of an eventual
sovereign debt restructuring on banks’ balance sheets.
23The prevailing common view at various EU institutions, including the ECB, is that a country, which commits itself
to a credible adjustment program, cannot be considered insolvent and thus should not be placed in a position to
restructure its debt. What the ECB has seemed to fear mostly is contagion brought about by a sovereign debt
restructuring, be it done in an orderly manner.
24 See also Darvas, Pisani Ferry and Sapir (2011)
25The possibility of adoption of collective action clauses (implying haircuts) by euro-area members, involving
agreements between debtors and creditors over debt restructuring, has been explored at the European level (see
BiniSmaghi, 2010)
26For the political and social climate, which goes against such a solution, see also Guerot and Leonard(2011).
The spectacular political advance of the “True Finns Party” in Finland speaks volumes about the contradiction
between economic logic and political reality.
21
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contagion. For sovereign debt restructuring27, however orderly it can be, may not prevent
contagion, which would have its cost open-ended. This is, arguably, what the ECB fears
mostly in a rushing of things. But putting off the day of reckoning may not be less costly.
The crux of the matter seems to be how to make private investors accept haircuts while
reopening financial markets to the countries in financial distress by making their adjustment
programs as credible as possible. This is a catch-22 dilemma. Coping with this dilemma
brings the issue of fundamental repair of the EMU design to the fore (see 2.1).
2.5 Dealing with global imbalances
The current crisis has reinforced one of Keynes' intellectual legacies, which was enshrined in
the Bretton Woods arrangements —namely, that highly volatile capital flows are inimical to
trade and growth and that financial markets are inherently unstable. As a matter of fact
restraining financial flows is a way to solve the impossible trinity, which says that an
autonomous monetary policy, stable exchange rate and free capital flows cannot be
achieved concomitantly28. The increasing number of emerging economies which resort to
capital controls (in order to stem speculative flows) is quite telling about actual dynamics in
the world economy. The IMF’s policy turnaround in this respect is also noteworthy.
22
3. Issues Pertaining to NMSs
3.1 Financial stability in NMS29
Financial stability in NMSs relates to, on one hand, crisis management in the euroarea and,
on the other hand, to specific concerns. Crisis management in the euroarea gives a very high
profile to contagion. Let us keep in mind that financial markets in NMSs are heavily
dominated by foreign groups and their economies are significantly ‘euro’-ised.
There are several means to enhance access to liquidity and mitigate solvency threats at a
supra-national level; many of remedies have been implemented during the crisis: rules on
convergence of deposit guarantees, which should prevent beggar-thy-neighbor policies;
medium-term financial facilities; IFIs credit lines and investments. Two avenues to improve
the EU’s support to NMSs deserve discussion: swap lines between the ECB and central
27 Debt restructuring distinguishes between reprofiling of bonds, with their maturity extended, and write-downs
(haircuts) on the value of the debt. The latter would impact significantly on not a few banks’ balance sheets, which
would need recapitalization.
28 This is shown, analytically, by the Mundell-Fleming model.
29This section draws on Becker at al (2011).
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banks of non-euro area countries; a broadening of ECB range of accepted collaterals to
national currency denominated bonds issues by non-euro NMS countries. These two
measures, which would have helped to ward off euro liquidity shortages, were considered but
not implemented at the height of the crisis.
Preventing credit booms will be an issue again in NMSs, sooner or later. Instruments that
can be used are: counter-cyclical capital and reserve requirements; dynamic provisioning
against expected losses; limits on leverage and maturity mismatches; discretionary macro-prudential
measures under the guidance of newly created macro-prudential supervision
bodies such as the European ESRB. The difficulty for the NMSs is that this toolbox mostly
applies to countries where credit is in the hands of national banks or autonomous local
subsidiaries of foreign banks. It is not likely to be effective in countries where credit is mostly
in the hands of foreign bank branches or lending can be outsourced to foreign entities of the
banking group (i.e. the parent bank or a subsidiary in another country). Coordination among
supervisors can be a response and should continue being developed but calling for
coordination is no solution when institutions participating in it have different, possibly
conflicting mandates and incentives. This is where the role of the ESRB comes prominently
into the picture.
NMSs cannot rely on capital controls as the single market prohibits such measures 30.
Therefore, the risk of destabilizing capital inflows leading to credit bubbles has to be
addressed through other means, which may include action on the demand for credit.
Regulatory and tax instruments can, for example, be used to tame mortgage credit when
deemed excessive from a macro- prudential point of view. All such measures, in order to be
effective, would need to be adopted on a supra-national level.
3.2 Euro Adoption
The crisis in the euro area shows that removing the option of adjusting a nominal exchange
rate may be very costly in terms of fiscal adjustment if it is not accompanied by efforts to limit
excessive demand in the private sector, even if fiscal policy is broadly in order. However,
limiting excess demand in the private sector is not easy to achieve for national governments
that have surrendered their power over monetary policy in an environment with free capital
mobility. It is noteworthy that housing and credit booms in Ireland and Spain, and in several
NMS have been quite similar, suggesting that the fall in real interest rates as the result of
financial integration and economic catching-up matters both inside and outside the euro
30As some countries use waivers to restrict what they consider to be destabilizing labor inflows a similar logic
could apply when EU countries are faced with destabilizing capital inflows. Tax tools could be used in order to
diminish such inflows. Obviously, this would require a flexible interpretation of EU rules.
23
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area. Euro outsiders should therefore be careful before fixing the exchange rate and should
allow as much flexibility as possible on the way to euro adoption; they, in any case, should
introduce measures preventing the emergence of unsustainable credit booms. But host
country authorities may not be effective in this effort because of deep financial integration.
However, they are not completely impotent: measures such as dynamic provisioning, using
loan-to-value ratios, increasing minimum reserve requirements can provide buffers against
excesses.
The crisis in the euro zone, in particular, the competitiveness problems of Spain, Portugal
and Italy and the inability of these countries to adjust their competitiveness inside the euro
area highlights a big policy issue: Should the criteria for the optimal currency area (OCA) be
fulfilled ex ante, i.e. before a country enters the euro area, or is it sufficient to expect that
they will be fulfilled ex post, i.e. euro admission will create structural changes in the economy
that will make the country suitable to the monetary union, even if it had not been before? The
inability of southern EMU countries to adjust to competitiveness pressures inside the Euro
zone indicates that it is wise for euro aspirants if OCA criteria are satisfied ex ante and there
are policy instruments to guide the eventual need to adjust real exchange rate divergences
ex post.
The NMSs form a multi-colored cluster; some of them are better integrated in EU industrial
networks and show balanced trade accounts, while others (including Romania) have skewed
trade imbalances and much of capital inflows went into non-tradable sectors. Therefore, their
chances of joining EMU are not similar.
3.3 Tax Harmonization Across the EU
One proposal of the EPP is for the EU members to explore the opportunity for tax
harmonization. Agreeing to corporate tax harmonization across EPP countries, for instance,
would go against the competitiveness concept. Removing incentives based on different
taxation systems would be a major setback for less developed EU countries, such as NMS,
in their efforts to attract investment. Tax competition policies are an important instrument in
countries, which are involved in the catching-up process and thus need to build up capital
because it is a useful tool in luring foreign investment.
3.4 The Threat of Low Equilibria and Pitfalls of a One Size Fits All
Economic Policy
The current financial and economic crisis has revealed flaws of the growth model that
24
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depends on massive external borrowing and inattention paid to resource allocation. In some
NMSs much of investment went into non-tradable sectors, which created the framework for
unsustainable growth and hid structural budget deficits. Very painful corrections of
imbalances are underway in several NMSs. These adjustments need to consider a changing
international (European) context regarding credit terms, capital flows, trade competition,
investing in education and, not least, the challenge of enhancing the growth of tradable
sectors when national policy is constrained by EU rules.
The euro pact brings novelties regarding fiscal discipline and policy coordination. But unless
it pays thorough attention to the needs of emerging (low income) EU economies the latter
may get stuck in low equilibria situations (Portugal’s experience is quite relevant in this
regard). EU funds absorption has to increase manifold in order to help develop their
infrastructure, raise fixed capital investment in tradable sectors. Would foreign banks that
operate in these countries change their lending proclivity and be more forward oriented as
stakeholders? It is true that there is a sort of economic recovery in NMSs and some of them
are bouncing back impressively by relying on exports. But sustainable high economic growth
rates, liable to achieve convergence, ask for much more as a recipe for economic catching
up. One should also bear in mind significant differences among NMSs; some of them (the
Czech Republic, Hungary, Slovakia, Poland) are better integrated in European industrial
networks and perform better trade-wise.
The threat of being caught in a region of low equilibria has to be judged in conjunction with
pitfalls of a one size fits all economic policy. For example, very low inflation (as Maastricht
criteria demand) is pretty hard to obtain in an emerging economy31; it could even constrain
growth. Or take the policy guideline of imposing limits to current account deficits (in the
vicinity of 5% of GDP) in the countries that signed up to the EPP. If FDI is substantial and
goes prevailingly into tradable sectors there should not cause much worry; in such a case a
current account deficit which may go beyond 10% of GDP is not an unwelcome imbalance.
25
4. Other Issues to Ponder On
Disentangling private from public debt has become an overwhelming issue in the EU in view
of its deep financial integration. Private sector (bank) debts are making up enormous
contingent liabilities on public debts when bankruptcies are not tolerated (not to mention the
31Not least because of the Balassa-Samuelson effect and the prospects of further rises in the relative price of
basic commodities (assuming that their consumption does no go down drastically)
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moral hazard problem). This is one of the revelations entailed by the current crisis. And the
inability to disentangle the myriad of intertwined debts will impact, negatively, on fiscal
policies for years to come. Even now this feature of deep financial integration seems to be
under-estimated by some. What is worrisome is that bank consolidation would preserve the
hostage relationship governmental budgets are held into. Ways must be found to make sure
that a golden rule of market economy operates, namely, that investors bear the risks they
assume and losses are not socialized32.
Fiscal rules, surveillance and peer pressure are not enough for strengthening the cohesion of
the EMU, of the EU in general. A handicap in the EU is linked with the political reality that
taxpayers are, ultimately, national citizens. Can “common goods” (including the euro) be
protected unless “common resources” (the EU budget?) are more substantial? Can
resolution schemes and orderly restructuring schemes of sovereign debts be devised so that
they compensate the smallness of the EU budget and complexity of the EU decision making
process? Can the EU policy-makers use additional instruments in order to foster more real
convergence in the EMU, in the EU as a whole? Is there room for strengthening policies at
EU level?
Were this crisis come to an end, would a deflationary bias in the conduct of monetary policy
appear in view of the willingness to prick bubbles in their infancy? On the other hand, would
not it, by fostering less instability, support long-term growth? In a way, answering this
question is analogous to deciding on a proper speed of implementing Basel III: for a too fast
implementation could stifle recovery; on the other hand, a too slow implementation would
create prerequisites for a new crisis.
Does size matter for judging fiscal risk? It appears it does. Large economies are, seemingly,
considered to have a bigger capacity to resists shocks; they are, potentially, more resilient.
Resilience (ability to withstand external and internal shocks) will increasingly be a principal
policy aim in the years to come.
What would be the impact of new technology for circumventing rules (ex: high-frequency
trading)? Regulators and supervisors need to take it into account as well, when thinking
about financial stability. The latter can be linked also with the capacity of economy to
withstand effects of natural disasters, with social strain. Demographics, too, play in a role
when it perturbs inter-generational balance and, consequently, fiscal equilibria.
The years to come will quite likely be accompanied by an increasingly uncertain
environment; complexity will also be on the rise. These circumstances advocate a more
simple, resilient financial intermediation system, for the sake of its own stability. If this does
32“…the current imperfect world where bondholders of banks and nations are shielded from suffering any pain
cannot last. Something has to give”(Milne, 2011)
26
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not happen and global imbalances persist, more fragmentation is to be expected, with
societies turning, probably, more inward looking. This will have profound implications for the
global system. It may be that, in view of the lessons of financial crises and of the need to
lend to economies more resilience, there is an optimal size of openness (trade and finance-wise).
This implies that firms need to think globally and operate selectively as a means for
mitigating risks33. It may also be the case that we will end up with a three blocs-based
financial system as a means to maintain a relatively open global system.
“Japanization” of EU economies is a distinct possibility in view of the legacy of this terrible
crisis and power redistribution in the global economy. One should also bear in mind the
erosion of the middle class that has been taking place during the last couple of decades in
the US and in numerous European countries; this process complicates adjustment and
reforms, in general.
27
Final Remarks
Structure and networks are key in understanding the roots of the current crisis and the
tension in the EU (EMU). Such a perspective reinforces the rationale for a reform of the EU
economic governance and a radical overhaul of the EMU institutional and policy
arrangements. As this crisis indicates it is not only fiscal rules and their compliance with that
a proper functioning of the EMU hinges on. Flaws of financial intermediation, growing
imbalances stemming from the dynamics of private sector saving and investment flows,
inadequate regulation and supervision of financial markets, and, not least, inadequate budget
arrangements (the lack of a common treasury and missing instruments in combating
asymmetric shocks) have played a major role in triggering the sovereign debt crisis in the
EMU. The overexpansion of financial institutions and their investment behavior are to be
highlighted as well. Consequently, a reform of the EU economic governance has to deal with
fiscal rules and compliance, macroeconomic disequilibria and competitiveness gaps, the
regulation and supervision of financial markets; the design of the EMU needs to be
thoroughly remade. In the meantime, firm crisis management has to be used in order to
prevent a break down of the euro zone. The need to tackle global imbalances and overhaul
international arrangements is to be mentioned in this context.
33Other catastrophic events (like the Fukushima disaster) highlight the risks of over-dependency on various
sources of supply.
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Fostering real economic convergence remains a huge challenge in the EMU, in the EU as a
whole. A threat for the EMU is a growing cleavage between its northern tier and its southern
tier, with the latter becoming, possibly, mired into vicious circles, incapable of overcoming the
impact of fiscal consolidation in a hostile external environment34. Another chasm could
deepen between older EU member states and some NMSs. Can Europe 2020 provide a light
in this regard? NMSs have a deep stake in EU governance reform since they cannot escape
the impact of EU wide externalities and the functioning of their economies depends on the
rules of the Union.
34 A sort of “Mezzogiornification” of the South of the EMU, but with more tensions than those envisaged by
Krugman (1993, p.80) and more threatening for the viability of the Union. See also Amato et.al (2010)
28
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29
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