Brussels Economic Forum
Remarks by Angel Gurría, OECD Secretary-General
18/05/2011 - Thank you, ladies and gentlemen, for giving me the opportunity to speak to you today.
The global recovery is becoming self sustained and more broad based. The OECD projects global output to grow by around 4¼ per cent in 2011 and 4½ per cent in 2012. For the euro area we project about 2% in both 2011 and 2012.
The recovery is taking place at different speeds, between advanced and emerging economies, and also within the EU. But unemployment remains elevated across most of the EU countries. There are almost 50 million people unemployed today in OECD countries, more than one-third of them in the EU.
Vibrant domestic demand growth, negative supply shocks and strong capital inflows in non OECD economies are generating inflationary pressures prompting policy restraint that could slow the recovery. In most OECD economies, headline inflation is rising, and expectations are also drifting up; however, underlying inflation seems likely to edge up only slowly.
Such a scenario calls for differentiated policy responses in advanced and emerging economies. In both groups of countries structural reforms should play a key role while taking into account country-specific needs and institutional features. In advanced economies structural reforms have to play an increasing role in boosting growth as fiscal policy is forced to pursue consolidation and monetary policy is gradually returning to a more normal configuration.
In emerging economies, monetary policy should tighten more to curb inflation, but this option risks being constrained by inducing stronger capital inflows. In emerging economies structural reforms could make growth more sustainable and inclusive, while contributing to global rebalancing and enhancing long-term capital flows.
The outlook is surrounded by risks. Upside risks include unexpected short-term stimulus from additional structural measures and more buoyant private-sector activity as confidence increases. Most risks are on the downside, however, including: further increases in oil and other commodity prices which could feed into core inflation, a delayed recovery in Japan following the earthquake and tsunami, which could have unforeseen consequences on global supply chains, a deeper slowdown in China, an unsettled fiscal situation in the United States and Japan and renewed weakness in housing markets.
Financial and debt vulnerabilities are increasing in the euro area in spite of strong adjustment efforts in peripheral countries.
A concern is that, if downside risks interact, their cumulative impact could weaken the recovery significantly, possibly triggering stagflationary developments in some advanced economies.
All this suggests that the global crisis may not be over yet. It is a delicate moment for the global and the EU economies. But also this is the time for Europe to seize the opportunity to push forward with structural policies and fiscal adjustment so as to put growth on a strong and sustainable path. This, in turn, requires a medium term strategy addressing the following challenges: dealing with high unemployment and preventing it from becoming entrenched, sustaining growth and avoiding stagnation while making it greener and more inclusive, making progress in fiscal consolidation, managing payment imbalances, and last but not least dealing with the crisis in the periphery of the euro area.
Dealing with unemployment
The first challenge must be that of dealing with widespread unemployment, the most pressing legacy of the recession. While the recovery is bringing some improvements in labour market conditions, unemployment remains high in many countries.
At the OECD, we are drawing lessons from the crisis on how to redesign and improve labour market policies, which have a key role to play in preventing cyclical unemployment from turning structural. Such policies could include more effective services and training to match workers and jobs, rebalancing employment protection towards temporary workers, temporary reduction in labour taxation through well targeted marginal job subsidies in countries where labour demand is weak, and well designed work-sharing agreements that can minimize employment loss in downturns. The employment impact of such measures would be boosted by stronger competition in sectors such as retail trade and professional services.
Return to work and competition-enhancing measures would also contribute to stronger potential growth, which could, otherwise, remain weak. Indeed, as experience shows, following financial crises there are risks of stagnation as structural adjustment and financial repair are delayed. Stagnation could possibly also emerge from persistent deterioration of the structural and business environment. Such risks are present in the euro area where some economies have experienced stagnation-like growth over the recent past.
OECD projections suggest that, if nothing is done, the pace of growth in the euro area over the next fifteen years will be around half what it has been since 1995. The potential for growth-enhancing structural reforms and policies to unleash new sources of growth is therefore substantial. And Europe 2020 provides a concrete strategy to meet such challenges. Structural and innovation friendly policies should contribute to making the economy greener, as discussed in the OECD Green Growth Strategy, which will be released next week at our annual Ministerial Council Meeting.
Making progress in fiscal consolidation
Lower growth would feed back negatively on fiscal consolidation. And evidence shows that, beyond some threshold, public debt levels have a negative impact on growth. In spite of some improvement in fiscal positions, consolidation requirements to merely stabilise debt are substantial for many countries. Government debt is set to rise to close to 96% of GDP on average in the euro area this year and to just above 100% of GDP in the OECD area as a whole. This is about 30 percentage points above the pre-crisis level and continues a trend since the early 1970s.
There is massive potential to increase the efficiency of public services through fiscal consolidation programmes. This would allow frontline services to be maintained at a lower cost. There could also be greater recourse to green revenue in fiscal consolidation programmes, including receipts from green taxes and carbon trading.
Structural reforms, while boosting growth, can also help fiscal consolidation. To illustrate, OECD analysis shows that a durable increase in employment rates by one percentage point through structural reforms could improve government budget balances by 0.3 to 0.8 percentage points of GDP in the OECD area. National fiscal institutions could reinforce discipline provided by the Stability and Growth Pact.
Finally, on this point, let me remind you that it would be dangerous to believe that higher inflation could address debt sustainability. Higher and persistent inflation could damp real growth by raising price and exchange-rate volatility. It could also risk unhinging inflation expectations, and as a result interest rates would soon increase more than inflation.
Dealing with imbalances
One lesson we have learned from the crisis is that payment imbalances matter also in monetary unions. More than this, the introduction of the euro has increased the size and persistence of imbalances, reflecting greater financial integration. The crisis in some euro area countries is also the consequence of a build-up of imbalances that have proved to be unsustainable (so called “bad”) imbalances, which, in turn, reflect misallocation of resources amplified by the global credit cycle.
The challenge for Europe and the global economy, of course, is not to eliminate imbalances but to keep them sustainable, so as to facilitate international reallocation of savings in ways that are supportive of growth. Indeed this is one of the channels through which monetary union, through its impact on financial integration, can boost overall growth.
This, however, requires stronger adjustment and competitiveness enhancing mechanisms in euro area countries at large. In deficit countries, competitiveness should be improved though product and labour market policies. In surplus countries, investment opportunities can be enhanced by more competition in product markets. In both structural reforms can correct misallocation in key markets (products, housing), while macroprudential policies should be used to control credit booms.
Prospects for the euro area periphery
The challenges of high unemployment, excessive debt and weak growth are particularly difficult for some countries of the euro area. Today’s problems have their origins in underlying economic, financial and fiscal imbalances that built up during the past economic upswing. Low real interest rates in some countries sparked credit and housing booms, leading to weakening competitiveness.
The banking system channelled funds on a massive scale from countries with high savings to deficit economies. Market discipline, together with insufficiently robust fiscal and financial policies, failed to prevent the build up of excessive deficits and surpluses. The monetary union as a whole has been an anchor of stability during the financial crisis, but a renewed wave of instability has touched some members.
Moving forward, there is an urgent need to restore competitiveness to offset the weakness of domestic demand in Greece, Ireland and Portugal. Wages and prices need to adjust to shift resources from domestic sectors that grew too big during the boom years. Support from the EU, EFSF and the IMF creates some space to address fundamental problems, but market finance is unlikely to return until there is confidence that debt dynamics are sustainable.
The shift from market to official financing over the coming years will increase the sensitivity of investors to these risks. A clear assessment needs to be made now, ahead of the introduction of the ESM in 2013, of what actions will be taken to put debt in these economies back onto a sustainable path. It is essential that banking systems are restored to good health, including by reducing vulnerability to sovereign debt risk.
An impressive effort has been put in place by the euro area authorities to transform and strengthen common institutions to deal with financial instability. This confirms that Europe can learn from its difficulties and transform a crisis into an opportunity to move forward.
The progress to overhaul the architecture of the euro area is welcome. The creation of the European Stability Mechanism (ESM), by acknowledging the possibility of insolvency, puts clear responsibility on national governments to manage their public finances prudently.
The reform of the Stability and Growth Pact contains important measures, including a system of ex ante fines and a quantitative standard for debt reduction. However, the objectives risk being undermined by the element of subjective judgment that has been included in the formulation of debt reduction standard. Reversing the voting majority on Council decisions under the SGP, quasi-automatic voting, would be an important signal that European governments are no longer willing to accept risks from bad policies in other countries.
A change in mindset is required in many countries to put fiscal policy on the right track. But it would be a mistake to focus only on fiscal issues and neglect private sector imbalances. Effective macro-prudential instruments at European and national level are needed. A single EU supervisor for large cross-border banks should be considered.
To conclude, ladies and gentlemen,
The global economy is exiting the recession, but is not returning to business as usual. The post-crisis economy will have to deal with old and new challenges, while pursuing new, green, and inclusive sources of growth. This requires rethinking policy frameworks as we draw lessons from the crisis.
In framing a new, post-crisis policy paradigm some of the existing principles underlying policy should be maintained. This includes those related to supply-side responses to boost growth, while recognizing that such policies have additional positive effects on fiscal consolidation and rebalancing. But additional lessons should be drawn.
In particular, the endogenous generation of instability and imbalances out of (apparent) tranquillity, a phenomenon common to several -- if not all -- crisis episodes, has been dangerously overlooked. This calls for financial-sector reform and tighter prudential policies both at the micro and macro levels.
Another lesson from the crisis is that international cooperation is important both in dealing with the emergency and in shaping the way forward, agreeing on common principles, and, if necessary, setting common rules, while allowing for country-specific needs.
As we slowly leave the crisis behind us we should be wary of the risk of losing impetus in the search for better global economic governance.
Thank you for your attention.
See also: www.oecd.org/oecdEconomicOutlook