<![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Sat, 20 Sep 2014 12:32:51 +0100 http://www.bruegel.org/fileadmin/images/bruegel-logo.png <![CDATA[Bruegel - Latest Updates]]> http://www.bruegel.org Zend_Feed http://blogs.law.harvard.edu/tech/rss <![CDATA[Fact: T.L.T.R.O. is Too Low To Resuscitate Optimism]]> http://www.bruegel.org/nc/blog/detail/article/1436-fact-tltro-is-too-low-to-resuscitate-optimism/ blog1436

Yesterday the ECB held the first auction of liquidity under its new TLTRO programme. The take up was well below expectations, raising questions about the actual ability of the ECB to regain control of its balance sheet.

It’s the third week of September and the sky is already getting quite grey, over Frankfurt. The ECB held yesterday the first allotment of liquidity under its new TLTRO programme. It was introduced in June and it foresees two initial auctions (September and December 2014) in which banks will be able to borrow up to an initial allowance of roughly 400bn plus a number of additional leveraging operations.

Expectations on the take up in the first operation were high. A Bloomberg poll this week showed that analysts, on average, expected banks to bid for €174bn of loans in September and €167bn in a second auction in December. The actual amount allotted, however, was only 82.6 billion, i.e. less than half the average expectation for this first operation.

Actual amount allotted was only 82.6 billion, less than half of the expected for this first TLTRO operation

Results at the country level are not known in full yet, but sparse news suggest that around 46% of the total went to Spanish and Italian banks (Figure 1) . Reuters reports that ten Italian banks, including Italy's top three lenders Intesa Sanpaolo, UniCredit and Monte dei Paschi di Siena, took a combined 23 billion euros. This represents 28 percent of the total 82.6 billion allotted, and about 30% of Italian banks’ potential allotment (of 75 billion). El Mundo reports that Banco Santander, BBVA, Caixabank, Banco Popular and Bankia took in total 15 billion, whereas Banco Sabadell and Bankinter did not participate. This represents 18 percent of the total and about 28% of Spanish banks’ initial allowance. Bloomberg reports that Amsterdam-based ING Groep NV and ABN Amro Bank NV said they subscribed for funds (but did not disclose the amount), whereas Austria’s three largest banks, Erste Group Bank AG, UniCredit Bank Austria AG and Raiffeisen Bank International AG, didn’t take part.

In light of this outcome, a number of questions forcefully ask to be answered.

First, why was the take up so low compared to expectations? Quite obviously, it is not a matter of price. The interest rate has never been so low. Actually, Mario Draghi himself stressed during the last press conference that the cut in the interest rate was also meant to signal “ to the banks that are going to participate in the TLTRO that they should not expect any further lowering in interest rate, so they should not hesitate to participate in the TLTRO because of this reason, because they could wait for a lower interest rate in the future.”

Rather than using very cheap liquidity, euro area banks are actually reimbursing it

It may be, as many suggest, that banks may just prefer to wait for the end of the ECB’s comprehensive assessment of bank balance sheets, before taking up more ECB liquidity. If this were a correct interpretation, take up in the December TLTRO should be significantly higher. The “stigma” argument was a powerful one at the height of the crisis, when there existed a liquidity emergency in some part of the euro area banking system and therefore borrowing at the ECB facility could have a bad signalling effect. But the current situation is very different and the “liquidity emergency” (with its implications) is an old memory. Not to mention that the ECB assessment is almost complete (and run on balance sheet data of end-2013), so it’s not obvious how borrowing now could affect the results.

The real reason may actually be more of a thorn in the side for the ECB. While it is true that interest rates are at record low, banks in the euro area have had the possibility to borrow very cheap liquidity for years, by now. But rather than using it, they are actually reimbursing it. Figure 2 below shows the evolution of excess liquidity outstanding in the euro area together with what appears to be the main factor behind its shrinkage: anticipated repayments by banks of the funds they borrowed at the ECB under the previous LTRO. Banks have been repaying ECB liquidity since february 2013. Interestingly enough, between June (when Draghi announced the TLTRO) and now, repayments have accelerated, probably with the objective to “swap” the repaid LTRO funds for TLTRO ones.

There is not an exogenous shortage of cheap liquidity in the euro area right now. But in the South of the euro area - where non-performing loans are high - banks would need to discount high expected default rates (and relative provisions). Moreover, lending to SMEs implies high risk weights and, consequently, capital charge. The profitability of borrowing very cheaply at the ECB to lend to the private sector (especially SMEs) is therefore not guaranteed, and the incentive of banks to take part in the TLTRO is not guaranteed either.

This however raises important and uncomfortable questions for Frankfurt, about the actual ability to deliver on the commitments recently taken in the fight against low inflation. During the last press conference, Mario Draghi in fact said that the aim of the ECB’s measures is to bring the size of the balance sheet back to the level it had in mid-2012.

From that peak (3 trillion) the ECB’s balance sheet has shrunk by about 35%, mostly due to the aforementioned reimbursement of LTRO funds. Bringing it back would require a boost of about 1 trillion.

Bringing the ECB balance sheet back to peak would require a boost of about 1 trillion

Speaking with Bloomberg, vice-president Constancio said that “within the whole package of measures that we have taken, in terms of the effect they can have on our monetary base, the bulk will come from the targeted longer-term refinancing operations”, which isn’t surprising in light of both the reduced size of the ABS market in Europe and the difficulties that the ECB is facing in its attempts to broaden the range of instruments it could buy.

But is it realistic? Figure 2 shows that the 400 billion available for the first two TLTRO operations are barely enough to cover the reimbursement of the outstanding 372 billion of old LTROs. This means that the net effect of these two initial operations on the ECB balance sheet will be a small additional 28 billion. Therefore, even assuming full take up in the December operation, the participation to the second phase of the TLTRO - which is based on banks meeting certain net lending benchmarks - looks crucial for the scheme to be sizable. And as far as this is concerned, we already pointed out that one important issue is still pending, i.e how banks will be prevented from using the funds borrowed now and in December for purposes different from lending.

There are a number of factors possibly playing a role in the low take up of this TLTRO operation. In addition to those already mentioned, the ECB itself might have modified the reaction function of banks, with its announcement of an ABS programme. Knowing that the ECB is going to buy ABS starting soon, and knowing that  - at least for the moment - the ECB is unlikely to buy ABS that it would not accept as collateral, banks might prefer to wait and sell those ABS to the ECB rather than just pledge them now.

T.L.T.R.O. may soon become famous as an acronym for “Too Low To Resuscitate Optimism”

Certainly, we need to wait until December to have a clearer view on the matter. But there is something that can and should be pointed out already. These results show yet one more time the risk of doing a “(not so) unconventional” monetary policy à la ECB: it is ultimately outside the central bank’s control, because it is driven by banks’ demand. Regaining control of the balance sheet with measures that are less demand-driven is a prerequisite to make an impact, but if the ECB’s great expectations are predominantly put on the refinancing operations, this might not happen. And the T.L.T.R.O. may soon become famous as an acronym for “Too Low To Resuscitate Optimism”.

Fri, 19 Sep 2014 08:07:28 +0100
<![CDATA[Blogs review: The economics of sanctions between Russia and the West]]> http://www.bruegel.org/nc/blog/detail/article/1435-blogs-review-the-economics-of-sanctions-between-russia-and-the-west/ blog1435

What’s at stake: In the context of Russian involvement in Ukraine and the annexation of the Crimea, the EU, US and other countries have announced sanctions against Russia. These include restrictions of access for Russian banks to EU and US financial markets, bans on military and “dual use” goods as well as travel restrictions for individuals close to the Russian government. Russia has retaliated by imposing bans on the import of food from Western countries.

Long-term financial prospects of the Russian oil sector depend on its ability to continue pressing into new sources of oil

Matthew Yglesias writes that the last package of EU sanctions agreed on July 29 deals Russia three big blows: Firstly, cutting a large share of the Russian banking sector from EU-based sources of financing forces the Russian government to either spend money on the banking system that then cannot be used for creating mischief in Ukraine or watch the economy collapse as bank finance dries up. Secondly, the ban on arms trade is more effective by stopping imports of Russian-made equipment to the EU (EUR 3.2 bn p.a.) than by restricting EU arms exports to Russia (EUR 300 m p.a.). Thirdly, the ban on EU exports of equipment used in deep-sea drilling, arctic exploration, and shale oil extraction won’t put much pressure on the Russian economy in the short run, but will divide the Russian elite: The long-term financial prospects of the Russian oil sector depend on its ability to continue pressing into new sources of oil.

Fig. 1 Russia gross export sales, 2013, USD bn

Francesco Pappadia looks at the impact of the events around the Ukrainian crisis (including sanctions announcements but also the Crimean “referendum” or the shooting down of flight MH17) on stock markets in Russia, the USA and EU. While the impact was generally negative in all markets concerned, the Russian economy suffered more than twice as much as the American one. EU markets took a middle position with no significant intra-EU differences. In order to predict the impact on political reactions, the ability to bear economic pain is however just as crucial as the damage sustained. Russia with its little democratic vigour may have an advantage in the short run and in the long run one should expect democracies to prevail – but the short to medium run may be rough.

If a Russian bank that is more than 50 percent owned by the government issues stock or bonds, no European can participate

Peter Spiegel  summarizes the EU’s financial markets sanctions: if a Russian bank that is more than 50 percent owned by the government issues stock or bonds, no European can participate. According to the European Commission’s estimate, between 2004 and 2012, $16.4bn was raised by Russian state-owned financial institutions through IPOs in EU markets. And in 2013 alone, about 47 per cent of all bonds issued by those banks — €7.5bn out of €15.8bn – were issued in the EU. However, no restrictions are Russian sovereign bonds will be implemented at this time, as a retaliation in kind by Russia could put EU sovereign bonds that currently enjoy low borrowing costs under pressure.

Robert Kahn writes that although the markets may underprice the escalation risks, Russia had (in April) already suffered a 9% stock market decline and capital flight of USD 60-70 bn in the first quarter of 2014 alone. Further sanctions (which have since been implemented) could meaningfully reduce Russian wealth through bans on trade and investment, but the most powerful effect on Russia comes from financial sanctions. The complexity of Russian entities' financial dealings with the West creates the potential for forced, rapid deleveraging—an intense "Lehman moment" of the sort witnessed in global markets after the failure of Lehman Brothers in September 2008. Risks of Russian retaliation exist particularly in the domain of energy exports, but the longer-term effects of a reorientation of European energy imports elsewhere would be far more damaging to the Russian economy than to the West.

The Economist writes that, as of September 2014, the sanctions have so far been in vain. Sanctions have hurt the Russian economy, but they have had no discernible effect on Mr Putin’s military strategy. Further measures could include blocking the property and accounts of entire sectors of the Russian economy, stretching asset freezes and financing restrictions across the entire banking industry or blocking Russia access to the SWIFT network, which is the arterial system for international bank-to-bank payments (and would make life very difficult for all Russia’s internationally active companies). Although historic precedents give rise to some scepticism over the effect of sanctions, which often do not achieve their immediate goals, there are two good reasons to impose them: First, they force aggressors to factor the growing costs of escalation into their decision-making. Second, they can be used as a bargaining chip to be conceded later, when the other side is coaxed into talks.

Contagious effects of sanctions?

It seems improbable that no contagion should exist, as financial streams between East and West will be affected

Wolfgang Münchau  wonders at adjustments of the IMF’s economic forecasts after the announcement of sanctions. The 2014 growth forecast for Russia has been reduced by 1.1 percentage points to 0.2%, the forecast for Germany has been raised from 1.7% to 1.9%, but it seems improbable that no contagion should exist, as financial streams between East and West will be affected.

Robert Kahn writes that due to the view that Russia is of little systemic importance to the global economy (e.g. due to limited integration in global supply chains), the view of most investors is that sanctions against Russia would have limited regional contagion effects. In reality, contagion through trade channels is indeed likely to be limited. However, the financial market sanctions could cause strong effects on other markets: Particularly given the high external debt of Russia (equity exposure is limited), a rapid deleveraging of Russian financial institutions could cause sizeable losses for Russian and external investors. It is too sanguine to assume in a global market that the effects of sanctions will be limited to a region.

Retaliatory sanctions by Russia

Open Europe analyses the exposure of European countries to Russia in agricultural trade. In aggregate terms, agricultural exports are about 7% of total EU exports. Of this, 10% goes to Russia and not all goods are affected by the sanctions. In terms of specific countries, the Baltic countries (Latvia, Lithuania and Estonia) will be hardest hit in terms of the trade as a share of GDP. In absolute terms, Poland, the Netherlands, Germany and Denmark will also face losses. On the Russian side, agricultural imports are 13.3% of total imports, equivalent to 1.2% of annual GDP.

Fig. 2 Shares of agricultural trade with Russia as percent of annual GDP, 2013

Food price rises will have a significant impact on the average Russian household, affecting the poor the most

Sarah Boumphrey writes that although the Russian ban on imports may strongly affect some EU countries, Russia may score an own goal here. Russia is a food importer with a trade deficit in food, live animals and beverages of US$23,878 million in 2013; and the ban on EU products could push up inflation, already high at 6.8% in 2013. Also, food and non-alcoholic beverages accounted for 30.5% of all consumer spending in the country in 2013. Food price rises will therefore have a significant impact on the average Russian household, affecting the poor the most.

Gabi Thesing and Whitney McFerron write that lower food prices, not restrictions in the gas supply, may give rise to the biggest negative fallout of the Ukraine crisis on the EU’s economy. Exports of EU food products now banned by Russia were worth €5.1 billion ($6.5 billion) last year, or 4.2 percent of the bloc’s agricultural shipments, according to the European Commission. Food prices now are falling: According to Copa-Cogeca, one of Europe’s largest farmers’ unions, prices for Dutch cucumbers and tomatoes dropped 80 percent and the price of apples in the Czech Republic dropped by 70 percent after the ban went into effect. Falling food prices seem now to be the biggest downward influence on already critically low Euro area inflation.

The Economist’s Buttonwood is surprised by Russia’s retaliatory ban on food imports from Western countries. As Russia will presumably still have to buy these goods on the world market, world market demand will remain unchanged, with just some pairings of producers and consumers changed. The problem is that food is a fungible good and one demand market can simply be substituted by another as long as aggregate demand remains the same. The same holds for export embargoes to selected countries: Sanctions may just create intermediary traders (also see this older piece by Johny Tamny on trade embargoes and fungible goods). Only if a good is not fungible – like gas, which could not easily be replaced – do trade sanctions seem potentially more effective. But Russia’s dependency on gas revenues makes this another possible own goal.

Coordination issues and smart sanctions

Daniel Drezner (HT Tyler Cowen) empirically investigates whether cooperation between multiple sanctioning states improves the success of sanctions – and finds that it does not. His evidence suggests that the lack of success of cooperation in sanctioning is due to enforcement problems, not bargaining difficulties between would-be sanctioning countries. After an agreement between cooperating sanctioners is reached, these equilibria seem not to be robust as incentives of cooperating parties may change, destabilising equilibria dependent on cooperation. If sanctions are supported by an international organisation, however, the success probability of cooperative sanctions is higher.

Erik Voeten advances the argument that “smart sanctions”, targeting the elites of the target country instead of its broad population, may fail because restricting access to finance and financial services in other countries, including blocking access to assets, could tie elites even more strongly to their regimes.  This argument is similar to one often voiced against the International Criminal Court, namely that it restricts exit options for elites. Of course, the normative appeal of smart sanctions as well as their possible deterrence effect should also be weighed in the argument, but when ways to undermine regimes are sought (the author wrote on the issue of Syria), positive incentives such as rewards for defectors should also be considered as another option.

Wed, 17 Sep 2014 09:07:32 +0100
<![CDATA[Do it yourself European Unemployment Insurance]]> http://www.bruegel.org/nc/blog/detail/article/1434-do-it-yourself-european-unemployment-insurance/ blog1434

In their Policy Brief prepared for the September 13 informal meeting of EU finance ministers (ECOFIN), Claeys, Darvas and Wolff (2014) discuss the benefits, drawbacks and possible designs for a potential European Unemployment Insurance (EUI) scheme. They end their discussion by formulating 10 key decisions that policy makers would have to take before implementing such a scheme.

To illustrate this Policy Brief, this blog post proposes to give the reader the opportunity to make the main decisions on the design of an EUI scheme. Given that one of the main purposes of an EUI scheme would be to act as a stabilization mechanism by providing resources to the countries with increasing unemployment rates, these simulations allow you to see what would have been the potential outcomes of such a scheme if it had existed since 2000 depending on the various design parameters.

The decisions to take concerning the parameters are the following:

  1. At what level should the scheme be implemented: at the European Union (EU) or at Euro Area (EA) level?
  2. Should it be an ‘all-time” basic unemployment insurance (that would replace partly or fully national schemes) or a ‘catastrophic’ one (which would only be activated when there is a significant increase in the unemployment rate in a country)? In the case of a catastrophic insurance, what should be the trigger to activate it?
  3. Should the scheme try to be neutral over the cycle for each country (thanks to differentiated contribution rates across countries) or should it allow potential persistent transfers (with a single rate across the EU/EA)?
  4. What should be the replacement rate (i.e the share of the previous wage received as unemployment benefit)?

In order to simplify the choices for the non-expert reader, another possibility offered by our simulation tool is to run simulations by choosing directly the objectives you want the scheme to achieve rather than the exact parameters:

  1. Again, you will have to choose at what level the scheme should be implemented:  European Union or Euro Area?
  2. What should be the degree of stabilization achieved by the scheme? Do you want it to deal with all shocks, just large shocks, or only very large shocks?
  3. What should be the degree of solidarity achieved by the scheme?  Do you want a scheme that minimizes lasting transfers across countries or not?

The table resulting from your design choices displays net payments as a percentage of GDP that would have been received by the countries from an EUI scheme since 2000. Positive numbers, in green, represent net payments to the countries, whereas negative numbers, in red, represent net contributions to the EUI scheme. The last 4 rows of the table indicate annual and cumulative cash positions of the scheme for each year (in % of GDP and in € billions).  Positive numbers, in green, represent positive cash positions of the scheme that could be saved for the future, whereas negative numbers, in red, represent negative cash positions that would have to be financed by borrowing in the capital markets.

Sat, 13 Sep 2014 13:32:49 +0100
<![CDATA[Benefits and drawbacks of European Unemployment Insurance]]> http://www.bruegel.org/publications/publication-detail/publication/847-benefits-and-drawbacks-of-european-unemployment-insurance/ publ847

Prepared for the ECOFIN in Milan on 13 September 2014.

See also interactive simulation to design your own EUI scheme.

The issue: Unemployment in Europe has increased to high levels and economic growth has remained subdued. A debate on additional policy instruments to address the situation is therefore warranted. Fiscal stabilisation mechanisms have not provided adequate fiscal stabilisation during the crisis in some countries nor in the euro area as a whole. Different preferences and historical developments mean that national labour markets are differently organised, which sometimes hinders the efficient working of the monetary union. European Unemployment Insurance (EUI) has been proposed as a measure to contribute to fiscal policy management and improve labour markets.

Policy challenge: European Unemployment Insurance is one option for stabilising country specific economic cycles thanks to risk sharing, but it would not substantively influence the area-wide fiscal stance. Moral hazard problems are significant but can be reduced by a less generous design and more harmonisation of labour markets. The former would, however, reducethe scheme’s stabilisation effect. Reform and harmonisation of labour markets would improve the functioning of monetary union, but would undermine long-standing preferences and ideals which the subsidiarity principle guarantees. The complexity of the design and implementation of EUI and the question of the rightlegal base suggests that it would be a long-term project and not a measure to help quickly the millions currently unemployed.

Benefits and drawback of European Unemployment Insurance (English)
Sat, 13 Sep 2014 12:03:23 +0100
<![CDATA[The comprehensive assessment, the ECBs´ new role and limits of a common supervision in the EU]]> http://www.bruegel.org/nc/events/event-detail/event/461-the-comprehensive-assessment-the-ecbs-new-role-and-limits-of-a-common-supervision-in-the-eu/ even461

We are happy to announce the conference “The Comprehensive Assessement, the New Supervisory Role of the European Central Bank and Limits of a Common Supervision in the EU”, to be held on Thursday, October 30, 2014 at Auditorium Friedrichstrasse in Berlin.

The conference topic relates to the new supervisory architecture in the Euro area. The European Central Bank will take over the direct supervision of big European banks beginning November and has been conducting an asset quality review in combination with stresstests. The outcome of the Comprehensive Assessment will have far reaching implications, as regards financial stability, credibility of the ECB, economic recovery in EU member states as well as on burden sharing. We will also shed ligth on limits of a common supervision in the EU, tackling political issues and constraints in shaping a workable Banking Union. We will end with a panel on the future of the financial system and unfinished reforms debating also constituents of a fair financial order in the EU.

We will discuss these topics intensely, with a public interest and scientific stance. In the discussions we will bring together regulators, politicians, academics and industry experts. We think that having a public debate on these issues is very reasonable and also necessary.

Note that the programme of this event is under construction and more information will be available shortly


Confirmed keynote speakers:

Keynote I Thomas Hoenig, Vice Chairman, FDIC

Keynote II Erkki Liikanen, Governor, Bank of Finland

Confirmed panel participants:

Prof. Arnoud Boot (University of Amsterdam and ESRB Scientific Advisory Committee), Constanza Bufalini (Head of Europ and Regulatory Affairs, Unicredit), Matthias Dewatripont (National Bank of Belgium) Andrea Enria (Chairperson, European Banking Authority), Sven Giegold (MEP/The Greens), Andrew Gracie (Executive Director Resolution, Bank of England), Dr. Dierk Hirschel (Head of the Economic Policy Division, Verdi Trade Union), Dr. Levin Holle (Federal Ministry of Finance), Aerdt Houben (Director Financial Stability, Dutch National Bank), Dr. Elke König (President, Federal Financial Supervisory Authority), Sylvie Matherat (Global Head of Gov and Regulatory Affairs, Deutsche Bank), Paulina Przewoska (Senior Policy Analyst, Finance Watch), Prof. Lucrezia Reichlin (London Business School), Dr. Natacha Valla (Deputy Director, CEPII), Nicolas Veron (Senior Fellow, Bruegel and Peterson Institute for International Economics), Prof. Jose Vinals (Director Monetary and Capital Markets Dep, International Monetary Fund), Jeromin Zettelmeyer (Director General for Economic Policy, Federal Ministry for Economic Affairs) as well as the heads of the scientific co-organizers Prof. Henrik Enderlein (Jacques Delors Institut Berlin), Prof. Marcel Fratzscher (DIW Berlin), Prof. Jörg Rocholl (ESMT) and Dr. Guntram Wolff (Bruegel).

Practical details

  • Time: 30 October 2014, 8.00-18.00.
  • Contact: conference(at)frsn.de

Conference partners are the Financial Risk and Stability Network (organizer), the Brussels Think Tank Bruegel, the German Institute for Economic Research DIW Berlin, the ESMT European School of Management and Technology and the Jacques Delors Institut Berlin (scientific co-organizers).

Fri, 12 Sep 2014 10:29:16 +0100
<![CDATA[11th Asia Europe Economic Forum]]> http://www.bruegel.org/nc/events/event-detail/event/460-11th-asia-europe-economic-forum/ even460

We are pleased to announce that the 11th AEEF conferencewill take place on 5-6 December 2014 in Tokyo, Japan. The event is jointly organised by this year’s host Asian Development Bank Institute (ADBI), Chinese Academy of Social Sciences (CASS), and Korea University (CEAS) on the Asian side and Bertelsmann Stiftung, Bruegel and Centre d'Etudes Prospectives et d'Informations Internationales (CEPII) on the European side. The event will bring together a range of high-ranking participants, including active and former senior policymakers, recognized academic experts and private sector specialists.

The programme of this evet is still under construction. More information will be available on this page shortly.

About AEEF

With a growing recognition for the need to diversify and consolidate the linkage between economists and practitioners from Asia and Europe, five institutions from Asia and Europe agreed in 2006 to establish an Asia Europe Economic Forum (AEEF) to serve as a high level forum, giving Asian and European policy experts an occasion for in-depth research-based exchanges on global issues of mutual interest.

Thu, 11 Sep 2014 15:37:32 +0100
<![CDATA[Mobility of students in European higher education]]> http://www.bruegel.org/nc/events/event-detail/event/459-mobility-of-students-in-european-higher-education/ even459

Education is central to the growth agenda in Europe. Knowledge and skills are key drivers of productivity growth in advanced economies. Enrolment in tertiary education has increased in recent years, especially in newer EU member countries. The earning premiums for people with higher education are significant.

However, education is not just about the level of attainment, but also about the skills acquired and whether those capabilities are adequate for the job market. Increasing youth unemployment and the growing skill and job gaps in Europe unfortunately suggests that it is not the case. In that regard, mobility can play an important role, as one of a set of measures, by expanding the experiences and perspectives of young people and broadening their mindset about future opportunities.

The importance of both higher education and mobility are reflected in EU policy. Currently, only 10% of students in higher education are mobile. Under the Bologna Process agreement, the mobility of at least 20% of higher-education students should complete some of their studies in another country by 2020.

In this session, we will discuss the opportunities and challenges of mobility for students in higher education as part of the broader issue of addressing the skills and employment gaps in Europe. A recent EIF working paper, “Financing the Mobility of Students in European Higher Education” will be shared which provides an overview of the importance and tendencies of financing higher education and students’ mobility. The analysis investigates problems stemming from unequal access to financing of education and associated costs of mobility and the necessity of policies to correct existing market failures. These and other EU-level policies will be discussed.

The discussion will be moderated by Karen Wilson, Senior Fellow at Bruegel. The meeting will start promptly at 12:00 and run until 13:30. A light lunch will be served until 14:00 to provide time for further discussion and networking.


  • Michael Gaebel, Head of Higher Education Policy Unit, European University Association (EUA)
  • Marjut Santoni, Deputy Chief Executive, European Investment Fund
  • Chair: Karen Wilson, Senior Fellow, Bruegel

About the speakers

Michael Gaebel is the head of the Higher Education Policy Unit, at the European University Association (EUA). The Unit focuses on issues related to higher education learning and teaching, including the Bologna Process, lifelong learning, e-learning and MOOCs, internationalisation and global dialogue. When he first joined the organisation in 2006, he was in charge of developing EUA’s international strategy and global exchange and cooperation. Before joining EUA, Michael worked for more than a decade in higher education cooperation and development in the Middle East, the former Soviet Union and Asia. From 2002 to 2006, he was the European Co-Director of the ASEAN-EU University Network Programme (AUNP) in Bangkok. Michael graduated with a Masters in Middle Eastern Studies and German Literature and Linguistics from the Freie University Berlin, Germany.

Marjut Santoni has been the Deputy Chief Executive of the EIF since 1 August 2013. Previously, she was in the European Commission, Directorate General Economic and Financial Affairs (1996 - July 2013) holding various roles in the field of SME and infrastructure financing as well as sovereign lending. Prior to joining EIF, Marjut Santoni dealt with the strategic design and implementation of financial instruments for infrastructure and climate change policies, which also included the management of the Euratom loan facility in the nuclear sector. From 2008 until 2010 the balance of payments lending to non-euro countries or macro financial assistance lending to third countries also fell under her responsibilities. From 2001 until June 2007, she was advisor to Commission’s members on the EIF Board of Directors. Earlier, she was in the Internal audit department of Dresdner Bank in Frankfurt am Main (1992-1995) and before that Loan officer in the credit department of Dresdner Bank, Cologne and Leipzig (1991-1992).

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Tuesday, 14 October 2014, 12.00-14.00. Lunch will be served at 13.30.
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Thu, 11 Sep 2014 11:24:00 +0100
<![CDATA[To restructure or not? Managing the euro area debt crisis]]> http://www.bruegel.org/nc/events/event-detail/event/458-to-restructure-or-not-managing-the-euro-area-debt-crisis/ even458

Will debt restructuring save Europe from economic stagnation?

William R. Cline’s new book, Managing the euro area debt crisis, addresses this question. The author – a Senior Fellow at the Peterson Institute of International Economics - traces the history of the recession and makes projections of future debt sustainability. The book offers a detailed analysis of the mistakes, successes and options for Europe as it struggles to overcome its worst economic disaster since World War II.

At Bruegel’s Talk Cline will present his findings and engage in a discussion with the audience. To attend, please register through the online form below. We look forward to welcoming you on the 24th September at 12:45pm. Lunch will be provided.


  • William R. Cline, Senior Fellow at the Peterson Institute for International Economics
  • Discussant: Zsolt Darvas, Senior Fellow at Bruegel
  • Chair: Guntram Wolff, Director of Bruegel

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Wednesday, 24 September 2014, 12:45-14.30. A light lunch will be served from 12:45 to 13:00.
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Thu, 11 Sep 2014 09:56:52 +0100
<![CDATA[Chart: Alibaba IPO underlines rise of Chinese private sector]]> http://www.bruegel.org/nc/blog/detail/article/1432-chart-alibaba-ipo-underlines-rise-of-chinese-private-sector/ blog1432

On Friday, September 5, Alibaba Group filed details about its forthcoming Initial Public Offering, suggesting a mid-range valuation of 155 billion US dollars. This would make the Hangzhou-based web retailer the most valuable listed private-sector company headquartered on the Chinese mainland, ahead of its Shenzhen-based online rival Tencent Holdings.

For all the fashionable talk of China’s dominant state capitalism and “Guo Jin Min Tui”, the numbers tell a slightly different story

Alibaba’s coming of age underlines a continuous trend of the last half-decade. For all the fashionable talk of China’s dominant state capitalism and “Guo Jin Min Tui” (“the state advances, the private sector retreats”), the numbers tell a slightly different story, as illustrated by the following chart:

This chart shows the shares of four categories of companies in the aggregate market value of the largest listed Chinese firms, namely those that feature in the FT Global 500 list of the world’s 500 largest listed companies by market capitalization which is regularly compiled by the Financial Times. Companies are included irrespective of the location of their main stock market listing, whether Hong Kong, Shenzhen, Shanghai or, in Alibaba’s case, New York. The three main groups are state-owned enterprises (SOEs) of the People’s Republic of China (PRC), such as Petrochina, Industrial & Commercial Bank of China, or China Mobile; companies from Hong Kong and Macao (mostly private-sector but also including municipal companies such as MTR, which operates the profitable Hong Kong metro system), such as Hutchison Whampoa, AIA Insurance, or Sands China; and private-sector companies from the mainland, such as Tencent or Ping An. A smaller fourth group includes banks with hybrid ownership of state and private-sector shareholders (with a public-sector majority), such as China Merchants, Industrial Bank, or Shanghai Pudong Development Bank.

The numbers are as of December 31 of each year except in 2014, where the ranking as of June 30 is used. In the right-hand bar, Alibaba is added to the list on June 30 with the notional market value of USD155bn. This inclusion results in a corresponding expansion of the relative share of the mainland private sector. (The other companies’ market values were not adjusted from their June 30 amount, but this would not materially change the overall picture.)

Alibaba’s IPO is likely to be remembered as the symbolic moment of a momentous transformation of the Chinese corporate landscape

The chart suggests three observations. First, with about two-thirds of the total, the PRC’s government retains a firm control of the “commanding heights” of Chinese business, as has been plain since the massive IPOs of state-owned enterprises in the mid-2000s. Second, however, this measure suggests a continuous erosion of state control for the past half-decade, as new entrants such as Tencent and Alibaba gain ground – and as private firms in Hong Kong and Macao have also comparatively recovered somewhat from their low point of the late 2000s. Third, and for the first time with Alibaba’s addition to the mix, large private-sector companies from the mainland collectively weigh as much as their peers from Hong Kong and Macao when measured by aggregate value.

As always in China, one must keep in mind that the distinction between public and private sector remains somewhat fuzzy. Ultimate ownership of private-sector firms is often unclear, and the Communist Party of China retains ways to influence the strategy and behaviour of many nominally private-sector companies. Nevertheless, the gradual rise of private-sector companies as compared with the state-owned giants is too continuous to be ignored. Alibaba’s IPO is likely to be remembered as the symbolic moment of this momentous transformation of the Chinese corporate landscape.

Thu, 11 Sep 2014 07:00:56 +0100
<![CDATA[Elements of Europe's energy union]]> http://www.bruegel.org/publications/publication-detail/publication/846-elements-of-europes-energy-union/ publ846

Read Georg Zachmann's Memos to the new Commissioner for Energy and the new Commissioner for Climate Action

The issue: European Union energy policy is guided by three objectives: sustainability, security of supply and competitiveness. To meet its goals in these areas, the EU is updating its energy strategy with new targets for 2030. The starting point for this is the assessment of the previous EU climate and energy package, at the centre of which were the 20-20-20 targets for 2020. Although the EU is largely on track to meet these targets, EU energy policy is generally not perceived as a success. Recent events have undermined some of the assumptions on which the 2020 package was built, and the policies for achieving the 2020 targets – although at first sight effective – are far from efficient.

Policy challenge: ;To meet the EU's objectives for emissions, electricity supply and gas security of supply, well-designed European markets could provide better results at lower cost than uncoordinated national approaches. In other areas – such as energy efficiency and supporting innovation – markets alone might not be enough. Europe should thus rethink its quantitative headline targets for 2030.The proposed 40 percent decarbonisationtarget is in line with a stronger emission allowance market, but the target for renewables should be defined in terms of innovation rather than deployment, and the energy-efficiency target should be defined in terms of encouraged energy and cost savings, not the amount of energy consumed in a certain period.


The European Union is largely on track to meet the so-called 20-20-20 climate and energy targets1, which were seen as quite ambitious when they were adopted in 2009. EU final energy consumption fell by 7 percent from 2005-11 (Figure 1), energy production from renewable sources increased by 4.2 percentage points from 2005-12 (Figure 1) and greenhouse gas emissions dropped by 13 percent in the same period (Figure 2). By 2012, emissions were already 19.2 percent below the 1990 level, leaving just a small gap before the EU meets the 20 percent reduction target for 20202.

However, EU energy policy is generally not perceived as a success. Recent events have undermined some of the assumptions on which the 2020 package was built, and the policies for achieving the 2020 targets – although at first sight effective – are far from efficient.

In terms of supply security, the Ukraine crisis has shown that energy efficiency and increased deployment of renewables have been so far insufficient to eliminate Europe’s reliance on Russian gas.

In terms of sustainability, other major emitters have not wholeheartedly followed the EU lead to cut emissions. New fossil energy resources make it more difficult to believe that such a global agreement is feasible because it would imply not using most of the fossil-fuel bounty. So the global impact of Europe's emission reductions will be close to insignificant, while Europe’s decarbonisation strategy turned out less ambitious than originally claimed, because the recession (and some other factors) supplied much of the promised emissions reduction.

In terms of competitiveness, various developments have made the energy mix envisaged in 2008 relatively more expensive. The Fukushima accident resulted in the closure of cheap nuclear plants while increasing the already high cost of new nuclear. It also became clear that carbon capture and storage technology3 is unlikely to become competitive any time soon relative to other low-carbon electricity generation technologies. Consequently, decarbonisation in Europe might have to rely even more on variable renewables, which is likely to drive up the cost of the transition. Meanwhile, the US shale gas boom caused a widening transatlantic energy price gap. All this happened during the EU’s most severe economic crisis, and shifted the focus of policymakers from long-term industrial policy projects such as developing renewables, to defending the competitiveness of sectors such as energy-intensive steel plants.

In addition, the 2020 climate and energy policies have inherent problems. Decarbonisation has been mainly delivered by a combination of economic downturn and renewables policy (CDC, 2014). Consequently, the EU emissions trading system (ETS) – which would have been able to identify much cheaper abatement options – was barely used. Furthermore, most investments in power plants, networks and consumption have been based on national remuneration schemes, undermining the internal energy market and failing to deliver a well-balanced European energy system that could support the climate and energy policy objectives.

Nevertheless, the EU package for 2020 was a valid hedging strategy in a world of scarce and expensive energy. It addressed the questions of its time, and could have been quite effective in a scenario that saw renewable energy quickly become indispensable in all parts of the world.

Now, European Commission proposals for 2030 foresee an emissions reduction of 40 percent and a 27 percent share of renewables (European Commission, 2014). There is also some momentum for a binding energy efficiency target that could be set at 30 percent. The differentiated increase in the three targets indicates a change in priorities:

  • The 40 percent emissions reduction relative to 1990 is a compromise. It is an ambitious unilateral target as long as there is no global agreement. It provides a signal for low-carbon investment and allows the political decarbonisation instruments – such as emission trading – to be boosted without excessive cost. It therefore keeps the door to a more aggressive decarbonisation policy open, should other major economies join the battle. But the target is less than optimal to deliver Europe's share of the global 2050 objective4.
  • The 27 percent renewables target is essentially insignificant5. Its main justification is to form the legal basis for national renewable support schemes that might otherwise be challenged for undermining the internal energy market.
  • A 30 percent energy efficiency target would be an acknowledgement of the importance of efficiency to achieve the energy policy objectives. But the case for the chosen metric and the corresponding number is weaker than that for the other two targets.

The proposed quantitative targets testify to the prioritisation within EU energy policy – 40-30-27 instead of 20-20-20 – but are not a consistent strategy to respond to the changing energy policy challenges6. The strategic task is to translate the prioritisation of objectives and the interaction between instruments into a consistent policy framework.

From a strategic perspective, it is important to note that it is impossible to determine which menu of investments is most conducive to achieve security of supply, sustainability and competitiveness of energy supply. So the main role of policy is to develop reliable frameworks that will encourage the investment that will enable stable energy services at the lowest direct and external cost.

A well-functioning internal energy market is the core of such a framework, complemented by an equally well-functioning European market for emission allowances and a market for supply security. Europe also needs an ambitious framework to speed up low-carbon innovation. The final element is a system to make energy efficiency policies at different levels of government comparable in order to come up with the best mix.

Revamping the market

A functioning internal energy market in which companies and technologies freely compete to provide the best services at the lowest price, while respecting societal and environmental constraints, could be hugely welfare enhancing. Despite three EU legal packages, neither the provisioning of gas nor of electricity is organised in such markets. In electricity, the attempt to create a European market by coupling national day-ahead markets proved only partially successful. While national prices have somewhat converged, no internal electricity market has developed because important parts of the electricity sector are still subject to widely differing national rules and arrangements7. Investment decisions in the electricity sector are thus based on national policies, not European markets. This non-cooperation is costly, and the corresponding welfare loss is set to increase with the rising shares of renewables in the power system8.

A European electricity market will not spontaneously evolve based on the enforcement of some first principles. Functioning electricity markets need to be designed: products need to be defined and schemes for their remuneration need to be engineered. An efficient market design needs to include all parts of the relevant system. It must ensure efficient incentives for trade-offs such as demand response versus storage, transmission lines versus decentralised generation or solar versus lignite. And to be efficient, this design needs to be European.

The first step is to ensure that national energy regulations are not used for domestic industrial or social policy. Regulated final consumer tariffs in France below what the market would offer, the same electricity price in south and north Germany despite a lack of interconnection, or paying premiums to domestic plants – which is essentially what capacity mechanisms and renewables support schemes do – are all inconsistent with a functioning internal market.

This implies that the fuel mix prerogative of the member states should be restricted to preferences against certain technologies, such as ‘no nuclear in Germany’ or ‘no shale gas in France’. While restricting certain technologies, if done transparently and predictably, would be consistent with a functioning European market, there can be no European market if member states prescribe certain fuel mixes, such as ‘more than 40 percent of electricity from German renewables in Germany’ or ‘more than 80 percent of Polish electricity from Polish coal’.

Given the substantial distributive effects9, a European energy market requires accountable governance. Market designs need to be regularly adapted to changing circumstances, so the governance structure needs to be institutionalised. But, the European Commission has neither been given the authority to strike a deal between vested interests, nor does it possess the manpower for such a complex task10. Consequently, the Commission relies on selected stakeholders to negotiate compromises over individual issues11.

To develop a truly functioning internal market, the Commission needs to prepare a fourth legal package outlining the European energy market framework. This should not shy away from curtailing the role of national energy policymaking. It should propose one or several generic market designs. The European Parliament and Council should then decide which of those generic designs should be developed further. Because of the complexity, the substantial information asymmetries between stakeholders and the significant redistributive effects, this task of developing a market model should be entrusted to a well-staffed and accountable institution that will also be responsible for the ongoing implementation of the design12 – for example, the Agency for the Cooperation of European Regulators (ACER). This would, however, require resources matching its responsibility13 and an overhaul of the decision-making process. The final design would then be ratified by the European Parliament and Council.

Creating a functioning internal energy market would be a major shift that will not be achieved through smooth convergence of national markets. The alternative would be to return to a system of more-or-less managed national electricity systems – with some unreliable cross-border exchanges of energy. This would not only make the systems less efficient. It will also make national security of supply more costly, and deployment of renewables beyond a certain level prohibitively expensive.

Re-establishing the ETS

The ETS covers most carbon-emitting industries and will run indefinitely, with a shrinking annual supply of allowances. It is an effective and efficient tool to mitigate emissions14.

But, the price of ETS allowances has collapsed because of an oversupply15 and the undermining of the system’s credibility. The risk in these developments is that the ETS gets replaced by less-efficient national, sectoral and time-inconsistent measures. A revamp is therefore important to incentivise the use of current low-carbon alternatives (for example burning gas instead of coal) and to ensure low-carbon investment.

The European Commission proposal to revamp the ETS is (1) to increase the speed by which the annual allocation of allowances are curtailed from 1.74 percent to 2.2 percent every year after 202017 and (2) to introduce a ‘market stability reserve’ through which any surplus of allowances above a certain level will be removed from the market, and reintroduced when the surplus falls below a certain level.

Steeper reduction of annual allowance allocations after 2020 is a sensible step to ensure that Europe plays its part in the containment of global warming. There is however a risk that the sectors covered by the ETS could fall out of step with the emission reductions in sectors that do not fall under the ETS, such as transport and heating. For example, electricity for electric vehicles and heat pumps falls under the ETS, while combustion-engine cars and oil heating do not. The most elegant solution to avoid different carbon prices for different technologies would be to extend the scope of the ETS to all relevant sectors18.

The Commission's proposed ‘market stability reserve’ is intended to avoid politically motivated intervention in the market. But the use and workability of such a mechanism are highly disputed19.

A more promising way to effectively shield the ETS from political interference would be to ensure that future policymakers that decide to undermine the ETS have to compensate companies that invested based on the claims made by policymakers today that the ETS is stable.

This could be organised through private contracts between low-carbon investors and the public sector. A public bank could offer contracts that will pay in the future any positive difference between the actual carbon price and a target level20. Low-carbon investors would bid to acquire such contracts to hedge their investments. This would produce three benefits. First, the public bank would be able to collect money upfront (a sort of insurance premium) and make a profit if a sufficiently tight climate policy is maintained. Second, the private investor significantly reduces its exposure to the – political – carbon market and hence accepts longer pay-back times for its investments. This would unlock long-term investment that is currently too risky. Third and most importantly, public budgets would be significantly exposed to the functioning of the ETS. If future policymakers take decisions that increase the number of available allowances, they might be called back by their treasuries because this would activate the guarantees pledged to investors. This would serve as a much more credible commitment to preserve the integrity of the ETS.

Supply security

The EU's perceived vulnerability to a reduction in gas (and oil) supplies from Russia in the context of the Ukrainian crisis has put supply security back on the agenda21.

Security of gas supply is not primarily about reducing import dependency or increasing Europe’s negotiating power with foreign suppliers. Rather, it is about maintaining unused alternatives that could be tapped into for an indefinite period in case the most important supplier fails for technical or political reasons.

There is a long-standing debate about whether completing the internal market will deliver supply security. A functioning internal market offers the most efficient rationing mechanism during crises and market-based long-term prices in Europe ensure that suppliers have the right incentives to develop new sources. On the other hand, the market – which typically goes for the cheapest available source – might fail to sufficiently diversify. For example, the current market design will not provide infrastructure to connect sources that are in normal circumstances uncompetitive, but which serve as insurance in case the cheapest supplies become unavailable.

But managed approaches, such as providing security via public investment in certain infrastructure, could crowd out private investment if not properly shielded from the market. If, for example, Europe financially supports a pipeline from Turkmenistan, the business case for the corresponding volume from the Levant region might disappear. Furthermore, national managed approaches regularly fail to select the most efficient options (eg demand curtailment, storage, LNG plants, pipelines, domestic production, domestic fuels).

So neither the current market design nor ad-hoc managed approaches appear well suited to efficiently ensure gas supply security. We therefore propose a market for ‘reserve supplies’. Each domestic gas supplier would be legally required to maintain a certain amount of alternative supply, such as 20 percent of the contracted energy demand for three years. Suppliers can meet their obligation through different options such as (i) interruptible contracts with their consumers, (ii) volumes in storage, or (iii) option contracts with other domestic and foreign suppliers. Europe's suppliers would need to make sure that the transport capacities – pipelines and terminals – needed to deliver the corresponding volumes to customers are available. Furthermore, ‘reserve supplies’ could not be met by options involving pivotal suppliers/infrastructure. That is, holding an option for additional supplies from Russia would not qualify as ‘reserve supplies’. To ensure this, pivotal suppliers/infrastructure will have to be identified. In case a supplier finds itself in a situation in which all existing infrastructure is either already used or pivotal, it will have to invest in new infrastructure. Suppliers would only be able to draw on these ‘reserve supplies’ in security crises following an official declaration. This system, the cost of which the domestic suppliers will largely pass through to their customers, should ensure security of supply for all at lowest cost and without undermining the internal market.

Such an approach would obviously have distributive effects. Consumers in well-connected regions that face a very limited risk of supply disruptions will have to pay for ‘their’ share of reserves, which most likely only their less well-connected neighbours might need. But this solidarity will not wash away regional differences arising from different infrastructure endowments because suppliers in areas with less-developed infrastructure will find it more costly to ensure the level of supply security. This is efficient because it provides an incentive against locating the most vulnerable sectors in vulnerable markets. For example, a chemical plant in Cyprus will only get an interruptible contract because no supplier could affordably secure the required reserve capacities.

RES-innovation target

Since the EU 20 percent target for renewables was decided, some of the reasons for investing in renewables have become less urgent. There is less risk that fossil fuels will run out quickly, more reliable suppliers are entering the global energy market22 and a global agreement to mitigate greenhouse gases seems distant. Nevertheless, in the longer-term, issues such as dependence on imports from uncertain sources and rising hydrocarbon costs will return. Most importantly, affordable decarbonisation of the energy sector will require competitive renewable energy sources (RES).

Consequently, the focus of renewables support should shift from a deployment target that encourages the quick roll-out of the cheapest currently renewable technology, to an ambitious innovation target that encourages investment to cut the cost of RES. If successful, an innovation target will be the largest possible contribution of Europe (and its partners) to saving the global climate, and might be instrumental in developing a competitive edge in what will become a major global market23.

It is difficult to establish the optimal size, selection, balance and timing of 'push' and 'pull' measures – for example, public R&D support, or feed-in tariffs to create demand for a new technology. Zachmann et al (2014) indicate that both public support to boost innovation and the timing of instruments matters. It is not massive actual deployment24, but the prospect of deployment that is the carrot for industry to commercialise the technologies developed through publicly-supported R&D. A long-term deployment target – such as the 20 percent for 2020 – is helpful, not least because it incentivises innovation and investment in complementary technologies such as storage or networks. However, the deployment target should be broken down to technology-specific targets and developed as part of an innovation policy that optimally supports a broad portfolio of technologies at different stages of maturity. A revised Strategic Energy Technology Plan25 could form the basis for defining measures and allocating support to technologies.

The current and envisaged renewables policies are not focused on innovation. Europe currently spends on relevant R&D about a hundredth of what it spends on renewables deployment (Figure 3)26. It does not integrate its deployment and R&D policies into a strategic innovation policy and does not coordinate its deployment policies across borders.

Energy efficiency

The key tool to ensure efficient energy usage is confronting all users with market-based price signals. Wasteful usage does not only refer to using more energy to produce a certain good, but also artificially maintaining a specialisation in energy-intensive goods. As Europe should not strive to subsidise labour costs to make the European textile industry competitive with Asia, Europe should not subsidise energy costs to make European aluminium production competitive with the US, especially as defending energy-intensive sectors at all cost locks in high energy consumption and implies that Europe needs to draw on more expensive supplies for all other sectors.

Beyond the issue of prices, the question is if energy efficiency needs to be regulated and if this should be done at European level. The need for regulation is often deduced from the finding that even efficiency measures with positive net present values are not delivered by the market27. As energy efficiency is an issue in virtually all sectors, there is a myriad of existing and proposed measures. So, energy efficiency policies can be welfare enhancing, but their efficiency depends on their design.

The same holds for the question of subsidiarity. The obvious argument for a European energy efficiency policy is its interdependence with the single market. National product energy-efficiency standards, national energy-efficiency schemes for energy companies or even distorting energy taxes could weigh on the single market’s integrity. On the other hand, national regulatory environments and structures for important energy consuming sectors (eg buildings) differ markedly. This might make a one-size-fits-all European energy efficiency policy very inefficient in these fields.

So the somewhat generic conclusion on energy efficiency is that individual market failures should be addressed by the most efficient measures at the right level of government. For the broad portfolio of regional, national and European policies that is necessary, a binding EU 2030 energy consumption target is not well suited. It neither addresses who has to deliver nor does it properly take economic developments into account. To benchmark energy-efficiency policies we would suggest a bottom-up approach. Based on the ex-post evaluation of each individual energy efficiency policy, the incentivised demand reduction and the corresponding policy cost should be reported. For example, the energy-efficiency loans in Germany in 2011 had an estimated cost of about €1 billion and encouraged annual savings of 0.1 million tonnes of oil equivalent (Mtoe).

Two targets would then serve to benchmark the success of the overall policy framework up to 2030: one for total incentivised energy savings (eg more than 400 Mtoe of induced energy savings between 2020 and 2030) and one for total energy efficiency policy cost (eg less than €100 billion). This target might be broken down by member state (or even to sub-national level) and even made binding.


Policy and market failures in the energy sector are common. There is too little energy saving, too little investment in security and innovation and emissions are too high. Governments tend to over-invest in big supply projects and use energy-sector regulation for other national policy purposes, preferring to solve the issues of the day instead of addressing the structural problems.

The European 2030 framework should strive to address the market failures without falling for the government failures. Essential elements will be well-designed European markets for emissions, electricity supply and gas security of supply. Better policy frameworks are also needed to encourage energy efficiency and innovation in low-carbon energy technologies.

This would be a radical step-change in European energy and climate policy, but so were the 2020 targets. But in planning for 2030, Europe cannot avoid substantially revising the governance of its energy sector, without compromising on security of supply, sustainability and competitiveness.

Research assistance from Marco Testoni is gratefully acknowledged. The author would also like to thank those who provided valuable comments on an earlier draft. The research underpinning this paper benefited from support from the Simpatic project (EU Seventh Framework Programme, grant agreement 290597, www.simpatic.eu). All notes and full references are available in the .pdf.

Elements of Europe's energy union (English)
Wed, 10 Sep 2014 13:53:20 +0100
<![CDATA[Fact: The World still fears fiscal crises (and much else)]]> http://www.bruegel.org/nc/blog/detail/article/1431-fact-the-world-still-fears-fiscal-crises-and-much-else/ blog1431

Last week, the World Economic Forum (WEF) published its Global Risk Report for 2014/15. The report is an exercise conducted by the WEF since 2006, but this year’s issue is particularly interesting because it adopts an historical perspective, offering very interesting insights on how the world has changed in respondents’ eyes and concerns.

The Global Competitiveness Report (GRR) assesses risks that are global in nature and have the potential to cause significant negative impact across entire countries and industries if they take place. A “global risk” is defined - for the purpose of the GRR’s exercise) - as “an occurrence that causes significant negative impact for several countries and industries over a time frame of up to 10 years”. 31 such risks are identified in the report and grouped under five categories – economic, environmental, geopolitical, societal and technological.

  • Economic Risks include fiscal and liquidity crises, failure of a major financial mechanism or institution, oil-price shocks, chronic unemployment and failure of physical infrastructure on which economic activity depends.
  • Environmental Risks encompass both natural disasters and man-made risks such as collapsing ecosystems, freshwater shortages, nuclear accidents and failure to mitigate or adapt to climate change.
  • Geopolitical Risks cover politics, diplomacy, conflict, crime and global governance. These risks range from terrorism, disputes over resources and war to governance being undermined by corruption, organized crime and illicit trade.
  • Societal Risks are intended to capture risks related to social stability – such as severe income disparities, food crises and dysfunctional cities – and public health, such as pandemics, antibiotic-resistant bacteria and the rising burden of chronic disease.
  • Technological Risks covers major risks related to the centrality of information and communication technologies to individuals, businesses and governments (such as cyber attacks, infrastructure disruptions and data loss).

The objective of the report is to map the risks - by means of a survey - according to the level of concern they arouse, their likelihood and their potential impact. Additionally, the GRR also looks at the perception of interconnections between risks and the strength of their potential systematicity. The survey for this edition was conducted between October and November 2013 among respondents from business, government, academia and non-governmental and international organizations.

Note: From a list of 31 risks, survey respondents were asked to identify the five they are most concerned about.

Table 1 show the top-10 of risks for respondents in the GCR 204/15. Economic issues dominate the lists. The possibility of fiscal crises in key countries appears to be the concern that kept everybody awake at night, followed by post-recession structurally high unemployment or underemployment and concerns of severe income disparity. These concerns appear to be well-substantiated if one looks at the current situation in the euro area (even though the GCR unfortunately does not give a country or region breakdown of the responses).  

Environmental concerns are also high-ranked, with failure to mitigate/adapt to climate change rank in the top-5 as well as water crises, whereas geopolitical risks are low in the ranking. This is most likely due to the timing of the survey (October-November 2013), which was conducted before the escalation in the Ukrainian crisis and the conflicts in the Middle East (which were in the top-5 back in 2008). Health issues - which disappeared from the list in 2011 - are also likely to come back next year, as the world struggles to manage the Ebola outbreak in Africa.

Figures below show the ranking of risks in terms of both likelihood and impact separately, for 2014 as well as for the previous 7 years. It has to be stressed that the exact definition of these risks has been changed by the WEF over the years, but the insights are many and interesting.

Economic risks are recurrently perceived as highly likely risks and as those having the strongest impact

Economic risks are recurrently perceived as highly likely risks and as those having the strongest impact. But it is very interesting to see how the economic concerns have changed over the years, following the developments in the global financial crisis first and of the euro sovereign crisis later. In 2008-10, the most dangerous economic risk in the perception of respondents was most naturally asset price collapse. In 2011, following the emergence of a sovereign crisis in Europe, fiscal crises climbed on top of the list. As the sovereign-banking troubles intensified during 2011/12, the risk of major systemic financial failures gained relevance. Now, as the emergency phase of the crisis is over but we are left to face its legacy of high debt burdens and economic slack, the focus has shifted to fiscal crises and structurally high unemployment as the high impact economic risks.

It is also interesting to see that the risk of growing income disparity has been ranking first in terms of likelihood since 2012 (well before the whole Piketty’s debate started) but does not seem to be considered a high-impact risk (even though the question asked explicitly clarifies that “impact” is “to be interpreted in a broad sense beyond just economic consequences”).

The risk of a major systemic financial failure appears less pressing than it was two years ago, but it still remains in the top-10, perhaps signalling that at the time the survey was conducted there was still significant uncertainty about the ongoing process of financial sector assessments in Europe and about banks’ possible capital needs in the near future (as we mentioned here).

Note: Global risks may not be strictly comparable across years, as definitions and the set of global risks have been revised with new issues having emerged in the 10-years horizon. For example, cyber attacks, income disparity and unemployment entered the set of global risks in 2012. Some global risks were reclassified: water supply crisis and income disparity were reclassified as environmental and societal risks, respectively, in 2014.

Another interesting part of the GCR exercise concerns the mapping of perceived interconnectedness across risks. Fiscal crises are perceived to be strongly connected with structural unemployment and underemployment, which in turn feed back social risks e.g. rising income inequality and political and social instability. The central node to the map of risk interconnectedness is represented by the risk of failure in global governance, from which a cascade of economic and socio-political risks would spill over.

The recent history of the Euro area proves perhaps better than any other case studies the existence of risk interconnectedness

The recent history of the Euro area proves perhaps better than any other case studies the existence of such interconnectedness. The financial turmoil of 2008-09 evolved into a sovereign-banking crisis with fiscal consequence, which in turn left behind a legacy of high unemployment and dissatisfaction vis à vis Europe, with the risk of increased social malaise and political instability. Governance played a great role in shaping the developments over the last five years and it will have to play a (perhaps even bigger) role in dealing with what will hopefully be a normalisation, over the next five years. In our recently published EU2DO list of memos for the new EU leadership, we try to offer some advice in view of this enormous challenge.

Wed, 10 Sep 2014 08:32:05 +0100
<![CDATA[EU to DO 2015-2019: Memos to the new EU leadership]]> http://www.bruegel.org/publications/publication-detail/publication/845-eu-to-do-2015-2019-memos-to-the-new-eu-leadership/ publ845

The new EU leadership – the president of the European Commission and his team of commissioners, and the presidents of the European Council and of the European Parliament – will have to address pressing challenges.

Go to eu2do.bruegel.org to read all the Memos, download the individual Memos and send the Memos to your Kindle.

‘THERE IS NOW A DISTINCT POSSIBILITY that this crisis will be remembered as the occasion when Europe irretrievably lost ground, both economically and politically’. This was the starting sentence of our memos to the new EU leadership five years ago. Five years later, it is fair to say that this possibility has become a reality. Unemployment has reached record levels and growth has disappointed. Meanwhile, the world outside the EU has continued to change rapidly. Emerging markets in particular have increased their weight in the global economy and in decision making.

The new EU leadership – the president of the European Commission and his team of commissioners, and the presidents of the European Council and of the European Parliament – will have to address pressing challenges. Despite the significant steps taken by Europe – among them the creation of a European Stability Mechanism, the start of a banking union, the strengthening of fiscal rules and substantial structural reforms in crisis countries – results for citizens are still unsatisfactory. It is impossible to summarise all the memos in this volume but a common theme is the need to focus on pro-growth policies, on a deepening of the single market, on better and more global trade integration. Reverting to national protectionism, more state aid for national or European champions – as frequently argued for by national politicians – will not be the right way out of the crisis. On the contrary, more Europe and deeper economic integration in some crucial areas, such as energy, capital markets and the digital economy, would greatly support the feeble recovery. But in other areas, less Europe would also be a highly welcome signal that the new European leadership is serious about subsidiarity. Internal re-organisation of the European Commission to ensure that it better delivers would also be welcome.

Beyond the pressing challenges – above all crisis resolution, jobs and growth – the memo to the presidents recommends that the new EU leadership should make sure that Europe makes the necessary treaty changes to strengthen Economic and Monetary Union and to permit the coexistence within the EU of countries belonging to the euro area and those that have no intention to join it. Working towards a consensus on this within the European Council and with European citizens is crucial for Europe’s future and to enable bold decisions on pressing issues.

Our focus in these memos is on economics. But clearly, political and other challenges have multiplied in the last five years. We therefore offer strategic policy advice that we deem both sensible given the problem at hand and politically achievable.

Regrettably, we have unexpectedly not been able to include in this volume a memo to the new Commissioner for Employment and Social Affairs. Yet, we believe that this Commissioner will have the major task of setting out how to improve Europe’s employment and social performance. In many countries, labour market institutions need to be modernised, for instance by making unemployment insurance systems more efficient. Benchmarking could be a way of converging on more sustainable and equitable social models. But reducing unemployment rates will also require better macroeconomic policies, on which the new Commissioner for Economic and Financial Affairs will have an important role to play.

The memos have all been written by Bruegel scholars and their preparation has been coordinated by Senior Fellow André Sapir. Like all Bruegel publications, the content reflects the views of the author(s), and there has been no intention to write a ‘Bruegel programme’. But the memos have been discussed extensively within the team to improve quality and ensure coherence.

Throughout the preparation of this volume, Bruegel’s editor Stephen Gardner has contributed considerably to improving the formal and substantive quality of the individual memos. Our gratitude goes to him as well as to all of those who have given feedback on drafts of specific memos.

André Sapir and Guntram Wolff

September 2014

Memos to the new EU leadership (English)
Wed, 10 Sep 2014 06:55:09 +0100
<![CDATA[Why does Italy not grow?]]> http://www.bruegel.org/nc/blog/detail/article/1430-why-does-italy-not-grow/ blog1430

In April this year, the Italian debt-to-GDP ratio was expected to peak by year-end at 135 percent of GDP. That projection assumed a real GDP growth rate of 0.6 percent and inflation of about 0.7 percent. The projected decline in the debt ratio starting 2015 required a step up in growth and inflation along with historically large primary budget surpluses.

Italy is now in a six-year-long recession and has barely grown since joining the euro in 1999

However, at this point in 2014 (in September), the prospects for Italian growth and inflation have weakened considerably—they may well be close to zero for the year. By U.S. criteria, as Frankel (2014) points out, Italy is now in a six-year-long recession. Indeed, the Italian economy has barely grown since it joined the euro area in 1999.

The stakes are high. With the government committed to an austerity mode for several years, growth and inflation are likely to be held back. And households facing tougher times are unlikely to open their pockets and start spending. The public debt ratio could rise relentlessly. An urgent search is on for a restart to Italian growth.

Much hope has been pinned on “structural” reforms to jump start growth. Germany’s Hartz reforms are often invoked as the example to emulate. But as the recent research reaffirms (Dustmann et al., 2014), German growth after the Hartz reforms was due primarily to a prior, nearly decade-long, restructuring of German businesses in concert with labor and new outsourcing networks in Eastern Europe. These investments allowed the leverage of deep German expertise in manufacturing in an unusually buoyant period of world trade between 2003 and 2007. 

Italy has been technologically and physically aging for some decades. It has been unable to keep pace with the technological demands of a competitive global economy. The Italian technological lag reflects a falling behind in educational standards: low growth and weak investment in technology and human capital have reinforced each other. The aging population has made reversing these trends a formidable task.

The Miracle Fades

The Italian economic “miracle” after the Second World War was the economy bouncing back from devastation. Barry Eichengreen has described the bounce back as extensive growth—economic reconstruction based on widely-available techniques, requiring limited domestic technological effort to enhance and differentiate. Much of the early growth came in the agricultural sector, where this characterization was especially appropriate. However, that early dividend was self-limiting and growth gradually slowed down (Figure 1a). However, growth slowed everywhere in Europe—and, starting as a “poorer” country, Italy’s faster growth allowed it to catch up by the 1990s (Figure 1b).

Italy’s virtual economic stagnation after 1999 reflects, above all, a dismal productivity performance.

Italy, however, had not prepared to replace the fading momentum of the post-war bounce with a new source of growth. After the oil-price-induced turmoil in the second half of the 1970s, growth required more intensive domestic technological effort. But Italy was unable to rise to that challenge. Hassan and Ottaviano (2013) report that Italian total factor productivity began a steady decline from its 1970s pace, turning negative in the years after Italy joined the euro area. Italy’s virtual economic stagnation after 1999 reflects, above all, a dismal productivity performance.

In the rest of this article, we compare Italy’s economic performance with that of Sweden, which again raced ahead while Italy struggled to grow. France, which falls in between the two, helps emphasize the forces we focus on.

The Innovation Gap

We use the number of patents registered by the residents of each country in the United States patent office. By focusing on the United States, we apply the high standards of the world’s most competitive technological environment. As figure 2 shows, despite swings over time, Sweden has continuously had a sizeable lead over Italy (and France) in terms of patenting propensity.

In turn, the Swedish patenting advantage derives from its lead in research and development (R&D).  While Swedish R&D ratios have been in the range of 3.5 to 3.8 percent of GDP, the Italian ratios have been between 1 and 1.3 percent of GDP. France has fallen in between at about 2¼ of GDP. The differences in R&D propensities across these countries represent two sources. Sweden moved to a “high-technology” based production economy in the 1990s after a period of eroding international competitiveness in the 1980s. The higher Swedish R&D ratio reflects, in part, the fact that high-tech production sectors are, by definition, more R&D intensive. But, in addition, a sectoral analysis shows that Italian R&D ratios are lower even when compared sector-by-sector. In other words, not just the composition of production, but an overall lag explains the lower Italian R&D ratio.

Compromises between egalitarianism and efficiency have largely resulted in achieving neither, as Italy has fallen behind its peers

The Swedish innovation lead is attributed to many factors—more public support of entrepreneurship, university-business links, availability of venture capital. However, at its core, Swedish innovation capacity and growth derive from the country’s long-standing commitment to education.  This proposition mirrors the diagnosis by Alesina and Giavazzi (2006) and Bertola and Sestito (2011) that at the root of Italian economic ills is an education gap. Bertola and Sestito conclude that a set of compromises between egalitarianism and efficiency have largely resulted in achieving neither, as Italy has fallen behind its peers.

The Education Gap

Figure 3a—an index of human capital per person—shows that Italy’s human capital is of lower quality than Sweden’s (and France’s) human capital. The index reflects a combined measure of years of education and returns to education in the domestic economy, providing a general measure of how much education contributes to a person’s economic life in each country.  

In 2012, only 18% of the Italian labor force had some tertiary education, compared to Sweden’s 34%

Italy measures even more poorly against Sweden when rates of tertiary education are isolated (Figure 3b). Ang, Madsen, and Islam (2011) find that tertiary education is more appropriate to innovation, whereas primary and secondary education are more useful for adopting foreign methods and technologies. In 2012, only 18 percent of the Italian labor force had some tertiary education, compared to Sweden’s 34 percent.  Bertola and Sestito (2011) emphasize that not only in terms of quantity, but the Italian quality gap relative to peers has also increased over time.

Piero Cipollone (2010) suggests that Italian educations levels are low because returns to education are relatively low in Italy. This tends to be self-perpetuating. The OECD (2012) reports that children of poorly-educated parents are often caught in a low-education trap. Additionally, Figure 4 shows that government spending on education in Italy is also relatively low when compared to Sweden and France. Indeed, in 2011, Sweden invested 6.82 percent of its GDP on education, France 5.68 percent, and Italy only 4.29 percent of its GDP.  Not only do Italians invest less in their education because of lower returns to their efforts; the Italian government also sees it as less worth its while to spend money on education.

As the Italian growth crisis digs in, the returns to education continue weaken, compromising future growth. With high unemployment, Italian children are at elevated risk for underperforming in school or even dropping out of school (OECD, 2012).

The Demographics

With an ever declining share of young citizens, who are likely to be most technologically dynamic, the demographic trend is aggravated by extremely high youth unemployment (unemployment among those between the ages of 15 and 25 years, which reached as high as 33 percent in 1999 and in January 2014 topped 42 percent).  Moreover, in 2013, among unemployed Italians under the age of 25, the share of long-term unemployment was possibly as high as 46.8 percent, according to Eurostat. These young long-term unemployed tend to have limited education and reside largely in the Italian South.

The more highly-skilled Italians leave, the worse the domestic economic performance

Finally, traditionally, Italians with tertiary education have been more likely to emigrate than their counterparts in Sweden and France. 1990, 4.5 percent of Swedes with tertiary education migrated abroad whereas 10.28 percent of Italians did. Although the gap between Sweden and Italy appears to be slowly closing, Italians with tertiary education continue to migrate in large numbers: In 2010, 6.55 percent of tertiary-educated Swedes migrated abroad, while 9.14 percent of Italians did so. France consistently fell in between. Presumably, many of the most educated Italians have left because of the poor future prospects for the Italian economy. But the more highly-skilled Italians leave, the worse the domestic economic performance, which perpetuates the tendency for future generations to also leave.


A consistent pattern emerges. Italy has failed to reshape its comparative advantage. Low GDP growth and virtually non-existent productivity growth reflect lagging innovation and educational attainments. In turn, the incentives to invest in education and innovation are weak since economic prospects are bleak. In an aging population, this trap has become self-reinforcing. Breaking the trap is the policy challenge. Ultimately, such particularities of Italy as the North-South differentials in economic dynamism will guide specific policy measures. Some have proposed more competition for Italian producers (Forni et al., 2012); Manasse and Manfredi (2014) propose that wage bargains should be decentralized to the firm-level. But, as Gros (2011) points out, both product and labor market competition in Italy are no lower than in Germany. A longer list of reform no doubt exits. But for Italy to grow again, it needs an audacious investment in a new generation of education and infrastructure.  

We are very grateful to Giuseppe Bertola and Ugo Panizza for their help.


Ang, James, Jakob Madsen, and M. Rabiul Islam. 2006. “The Effects of Human Capital Composition on Technological Convergence.” Journal of Macroeconomics 33: 465-476

Alesina, Alberto, and Federico Giavazzi. 2006. The Future of Europe: Reform or Decline. Cambridge, MA: MIT Press.

Bertola, Giuseppe, and Paolo Sestito. 2011.  "A Comparative Perspective on Italy's Human Capital Accumulation", Banca d'Italia Quaderni di Storia Economica n.6, 2011. An abridged version is published as “Human Capital” (with Paolo Sestito), Chapter 9, 249-270 in G.Toniolo (ed.) The Oxford Handbook of the Italian Economy Since Unification, New York: Oxford University Press, 2013.

Brücker H., Capuano, S. and Marfouk, A. (2013). Education, gender and international migration: insights from a panel-dataset 1980-2010.

Cipollone, Peiro. 2010. “Spending on Research and the Returns to Education in

Italy.” Review of Economics Conditions in Italy 3: 323-343, 345-349.

Dustmann, Christian, et. al. 2014. “From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy.” Journal of Economic Perspectives 28(1): 167-188.

Eichengreen, Barry. 2007. The European Economic Since 1945: Coordinated Capitalism and Beyond. Princeton: Princeton University Press.

Eurostat Euroindicators. 2014. Accessed August 24, 2014 from epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/3-28022014-AP/EN/3-28022014-AP-EN.PDF. 28 February

Eurostat education and training indicators. 2014. Accessed August 26, 2014 fromhttp://epp.eurostat.ec.europa.eu/portal/page/portal/education/data/ main_tables

Forni, Lorenzo, Andrea Gerali, and Massimiliano Pisani. 2012. “Competition in the Services Sector and Macroeconomic Performance in the European Countries: The Case of Italy.” Vox EU. April 3, accessed August 26, 2014 from www.voxeu.org/article/raising-competition-case-italy

Frankel, Jeffrey. 2014. “Italian growth: New recession or six-year decline? Vox EU. August 11, accessed August 25, 2014 from www.voxeu.org/article/italian-growth-new-recession-or-six-year-decline.

Gros, Daniel. 2011. “What is Holding Italy Back?” Vox EU. November 9, accessed August 26, 2014 from www.voxeu.org/article/what-holding-italy-back

Hassan, Fadi, and Gianmarco Ottaviano. 2013. “Productivity in Italy: The Great Unlearning.” Vox EU. November 30, accessed August 24, 2014 from www.voxeu.org/article/productivity-italy-great-unlearning.

Manasse, Paolo, and Thomas Manfredi. 2014. “Wages, Productivity, and Employment in Italy: Tales from a Distorted Labour Market.” Vox EU. April 19, accessed August 26, 2014 from www.voxeu.org/article/wages-productivity-and-employment-italy

OECD. 2012. Education at a Glance 2012: Italy. Accessed May 29, 2014 from www.oecd.org/italy/EAG2012%20-%20Country%20note%20-%20Italy.pdf.

Tue, 09 Sep 2014 06:42:47 +0100
<![CDATA[Blogs review: The shift in the Beveridge curve]]> http://www.bruegel.org/nc/blog/detail/article/1429-blogs-review-the-shift-in-the-beveridge-curve/ blog1429

What’s at stake: The traditional interpretation of shifts in the Beveridge curve – the relationship between the vacancy rate (jobs openings/labor force) and the unemployment rate – as increases in the structural level of unemployment has been challenged over the past few weeks as the shift identified in 2009 for the US economy appears to vanish. Recent research also points that outward shifts in the Beveridge curve have been common occurrences during previous recoveries and that, by itself, an outward shift does not say much about future levels of structural unemployment.

The traditional interpretation of a shift in the Beveridge curve

The euro area Beveridge curve suggests the emergence of a structural mismatch across euro area labor markets

In his Jackson Hole speech on euro area unemployment, Mario Draghi writes that the euro area Beveridge curve suggests the emergence of a structural mismatch across euro area labor markets. In the first phase of the crisis strong declines in labor demand resulted in a steep rise in euro area unemployment, with a movement down along the Beveridge curve. The second recessionary episode, however, led to a further strong increase in the unemployment rate even though aggregate vacancy rates showed marked signs of improvement. This may imply a more permanent outward shift. […] All in all, estimates provided by international organizations – in particular, the European Commission, the OECD and the IMF – suggest that the crisis has resulted in an increase in structural unemployment across the euro area, rising from an average (across the three institutions) of 8.8% in 2008 to 10.3% by 2013.

Peter A. Diamond and Ayşegül Şahin write it is tempting to interpret a deterioration in the matching/hiring process in the economy as a structural change in the way that the labor market works and thus to assume that it is orthogonal to changes in aggregate demand. Indeed, that approach to interpreting a shift in the Beveridge curve has been standard in the academic literature, going back to Dow and Dicks-Mireaux (1958). If valid, this interpretation would support an obvious policy implication: however useful aggregate stabilization policies while unemployment is very high, they are likely to fail in lowering the unemployment rate all the way to the levels that prevailed before the recession, since the labor market is presumed to be structurally less efficient than before in creating successful matches.

In their lecture on hysteresis for an advanced undergraduate class, Christina Romer and David Romer write that a shift in the Beveridge curve may also show that the normal vacancy rate has risen or that both the normal vacancy rate and normal unemployment rate has risen. Since between the 1960s and 1980s, the unemployment rate associated with a given level of vacancies rose about 4 percentage points and that most experts think that the natural rate of unemployment rose about 2 percentage points over the same period, a rule of thumb might be that the raise in the natural rate is ½ the shift out in the Beveridge curve.

Historic shifts and unemployment recoveries

Peter A. Diamond and Ayşegül Şahin write that looking at 60 years of data, instead of just the last 14 years, reveals that outward shifts in the Beveridge curve after the point of maximum unemployment rate are common occurrences in the U.S. labor market. Interestingly, the only business cycle during which the unemployment-vacancy pairs did not shift, but stayed on the same downward sloping Beveridge curve, is the 2000-2006 cycle. In all the others there is a notable outward shift in the curve after the maximum unemployment rate is reached.

The Beveridge Curve has moved outward seven times before. Four times the unemployment rate didn’t make it back to its previous lows

Real Time Economics writes that Beveridge Curve has moved outward seven times before. Four times the unemployment rate didn’t make it back to its previous lows. But three times, it did. The Beveridge Curve shifted out but then the unemployment rate still made a complete recovery. Peter A. Diamond and Ayşegül Şahin write that if, by itself, the outward shift were a good predictor of a sustained rise in structural unemployment, it should be the case that, after a shift in the curve, the unemployment rate does not reach its pre-recession minimum during the recovery period.

Christina Romer and David Romer write that this typical pattern early in recoveries may reflect the changing composition of firms toward those that tend to post more vacancies (bigger firms, non-construction firms).

Was there a shift to begin with?

Murat Tasci and Jessica Ice write that whether or not a shift implies an actual structural change – specifically, a decline in the matching efficiency of the labor market – is still debatable. However, one thing is clear: there is no shift to begin with. 

Murat Tasci and Jessica Ice write that early on in the current recovery, economists and policymakers were worried about a potential shift in the Beveridge curve. The data at the time suggested to some that a shift was occurring that would indicate that efficiency was falling: Job vacancies were rising, but the unemployment rate was not declining, fueling a debate about a structural problem in the labor markets. Exactly four years ago, we touched upon this issue here, and argued that it was too early to call what had happened a shift. Most of the arguments for a shift were based on data from the Job Openings and Labor Turnover Survey (JOLTS), which had only started measuring economy-wide job openings in December 2000. It is safe to say that what seemed like a shift in the Beveridge curve ended up being another manifestation of the “normal” dynamics of unemployment and vacancies in the United States. 

Mon, 08 Sep 2014 07:32:37 +0100
<![CDATA[Quantifying the macroeconomic impact of the European fund for investments]]> http://www.bruegel.org/nc/blog/detail/article/1428-quantifying-the-macroeconomic-impact-of-the-european-fund-for-investments/ blog1428

Introduction: The European Fund for Investments

In his keynote address at the 2014 Bruegel Institute annual dinner Poland’s Minister of Finance Mr. Mateusz Szczurek laid out a proposal for jumpstarting the EU economy, avoiding a prolonged stagnation and building solid foundations for long run growth. This proposal is based on European-level program of scaling up public investment by around 5.5% of European Union GDP or 700 billion euros within the next 5 years. The capital spending would start at 0.5% of European GDP in 2015, peak at 2% in 2017, and be gradually phased out afterwards (Figure 1). The gradual path reflects the nature of large scale public investment projects and gives policymakers time to react and adjust the size of the program to changing economic conditions. In order to mobilize such considerable investments, European Fund for Investments (EFI) would be established. A gradual injection of paid-in capital and guarantees by all EU Member States would be leveraged by borrowing in the financial market. The Fund capital would be directly invested in the selected infrastructure projects, with particular focus on energy, transportation and ICT.

This note presents the background calculations of the program’s potential effects on the EU GDP and justifies its proposed size of 5,5% of EU-28 GDP.

Figure 1. Proposed path of EU-28 public investment under the EFI

Uncertainty about the sources of low growth and the size of output gap

The weak economic recovery across Europe and the risk of the so-called secular stagnation are the key motivations behind the proposal. Nearly six years since the beginning of the financial crisis the European GDP is still well below its pre-crisis level and around 10% below the level consistent with trend growth prior to the crisis. Figure 2 summarizes this situation. It shows three curves. The solid line is the evolution of actual real GDP of the 28 EU economies since 2002. The dashed line is an extrapolation of the average 2% trend-growth prior to the financial crisis; this is the EU’s potential output if no permanent underlying stagnation occurred. The dotted segment on the other hand is an extrapolation based on the meager average growth of 0.8% since the trough in 2009. The EU economy is now about 10% below where it could be if the pre-crisis trends were maintained. If the current slow growth continues, it will be 16% below in 2019.

Figure 2. Losing ground after the crisis

There are two polar ways to interpret the current (and projected) economic weakness.


  • EU economy is only suffering from depressed demand in the aftermath of the global financial crisis and sovereign debt troubles in Europe. In this scenario, EU could and should return to the pre-crisis potential growth path (dashed line). Expansionary macroeconomic policies are needed in order to achieve this goal.
  • EU has entered a prolonged period of slow or non-existent growth which fully explain current output size. In this scenario, EU’s potential growth is permanently lowered due to productivity slowdown, regulatory burden and demographic changes, and deep structural reforms are needed to boost long run growth.

The truth lies somewhere in between and uncertainty over the nature of the current economic weakness complicates the proper policy response to the current situation. If deficient demand is to blame, relying exclusively on structural reforms is likely to be insufficient. Such reforms take a long time to affect growth and in the meantime a prolonged recession (due to deficit of demand) may turn into structural problems (stagnation of potential GDP) through the so-called hysteresis effects, e.g. because of the loss of skills and labor-force attachment of long term unemployed, forgone investment in physical and human capital and innovation (DeLong and Summers, 2012). If underlying problems are of structural nature, stimulating macro policies will be ineffective and risk overheating the economy, but this risk can be easily managed as discussed below.

Europe needs investment stimulus

While the output gap persists, conventional policy choices for the EU are severely restricted at the moment. Expansionary monetary policy is limited by the zero lower bound while expansionary fiscal policies are constrained by fiscal discipline induced by the SGP.

The situation calls for a new policy approach. The fact that the economic crisis caused a historically unprecedented collapse in capital investment in the EU (Figure 3) and current historically low level of long term interest rates suggest that cheap and plentiful savings are not being transformed into much-needed productive capital by the private sector. Boosting public investment, which is the goal of EFI, seems to offer an attractive and viable option for such a new policy approach. It would address both the lack of demand and the slowdown of potential growth in an environment where the risk of crowding out of private investment is extremely low.

Figure 3. The collapse of EU investment rate

Quantifying the impact and sizing the EFI

The impact of the investment boost on economy, and its optimal size depend on two considerations:  

First, as discussed above it depends on the economy’s current output gap. Given the uncertainty over this variable discussed earlier, the “naïve” but reasonable approach is to target closing about half of the 16% gap between the low-growth projection and the pre-crisis trend that is expected to occur in 2019 in the absence of the EFI.

Second, the effect of the additional public spending of EU-28 GDP depends on the size of the multiplier, so quantifying the effects of EFI program and deriving its size are based on latest research on the size of output multipliers associated with government expenditure.  Namely we adopt a multiplier of 1.5, which is consistent with recent estimates from the IMF (Blanchard and Leigh, 2013) and somewhat conservative, taking into account depressed state of economy, which tends to increase multipliers (Auerbach and Gorodnichenko, 2013).

Figure 4 illustrates the impact of the EFI public investment of 5.5% of GDP on the EU-28 economy under these assumptions. The extra investment boosts average growth over 2015-19 from 0.8% to 2.3%, reducing the gap in 2019 between current output and the path of uninterrupted 2% growth from almost 16% to 8.9%.

Figure 4. Effects of EFI Program on EU-28 GDP


The objective illustrated in Figure 4 seems to be prudent given the uncertainty about the size of the output gap. It is also quite robust.

In the case that true potential is indeed represented by the pre-crisis trend (and thus the output gap is very large) the multipliers will likely prove to be larger than the ones used here. It is now commonly accepted that the magnitude of the effect is likely much greater in a depressed economy where interest rates are close to the zero lower bound and when spending is directed towards productive public capital.  Specifically, in an important recent contribution Auerbach and Gorodnichenko (2013) point to large and persistent effects of government investment in a depressed economy. The impact of the EFI would then probably be higher, if output gap was bigger than assumed here.

The policy itself also offers some important flexibility. If the EU economy continues to experience low inflation and stagnant labor markets as growth rates of GDP pick up, indicating that output gap remains substantial,  the scale of the EFI project should be increased and its duration extended.

In the case that the true potential is much below the pre-crisis growth path (dashed line), there is a concern that a stimulus like the EFI could lead to overheating of the economy and a surge of inflation. This is unlikely to be a serious issue for the EFI for several reasons. First, the latest research demonstrates that the effects of the fiscal expansion in an economy that is not in a recession are much more modest. Thus if the output gap isn’t very large to start with, the policy will have much less potential to overheat the economy (Auerbach and Gorodnichenko, 2013).  Second, the inherent asymmetry of the zero lower bound helps to contain any downside risk to inflation. While it is hard for the ECB to stimulate the economy further with interest rates already at or close to their minimum, it would find no difficulty cooling the economy by raising them, should that be required. Additionally, given the gradual scaling up of investment over the five years, policymakers would have ample time for course-correction should the stimulus prove excessive.

Long Run Benefits of the EFI

One of the crucial aspects of our proposal is that the investment boost is directed at large scale infrastructure projects in energy, transportation and ICT. Such projects will not only add to the economy’s capital stock and mobilize idle saving. They will also increase the economy’s long term potential growth rate. Thus, if we are seriously concerned about the slowdown in potential growth of the EU economy, we should embrace this idea even more wholeheartedly. Given the current economic weakness and dire forecast, doing too little seems like a greater danger than doing too much.


Auerbach, Alan J., and Yuriy Gorodnichenko. 2012. "Measuring the Output Responses to Fiscal Policy." American Economic Journal: Economic Policy, 4(2): 1-27.

Olivier Blanchard, O.  and Daniel Leigh, “Growth Forecast Errors and

Fiscal Multipliers”, IMF Working Paper, January 2013.

DeLong, B. and L. Summers, “Fiscal Policy in a Depressed Economy”, Brookings Papers on Economic Activity,  Spring 2012

Woodford, Michael. 2011. “Simple Analytics of the Government Expenditure Multiplier.” American, Economic Journal: Macroeconomics 3 (1): 1–35.

Fri, 05 Sep 2014 13:46:47 +0100
<![CDATA[Super Mario: 1up?]]> http://www.bruegel.org/nc/blog/detail/article/1427-super-mario-1up/ blog1427

The stake at this month’s meeting of the ECB’s Governing Council was exceptionally high. Mario Draghi himself raised the bar of expectations, with his intervention at Jackson Hole. That speech marked a significant change in his language, on a number of important dimensions. The risk that the Governing Council would not endorse this shift was not to be underestimated ex ante, with all the implications of betraying expectations at their height. Eventually, Super-Mario delivered.

Language and assessment

A first important point in Draghi’s press conference is the confirmation of a major change in the ECB’s language over both inflation and the economic outlook.

Concerning inflation, at the press conference in August the official line was still that “inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%.” At Jackson Hole, Draghi’s language was markedly different. He explicitly acknowledged the growing risks that inflation expectations could dis-anchor: “financial markets have indicated that inflation expectations exhibited significant declines at all horizons. (…) if we go to shorter and medium-term horizons the revisions have been even more significant.”

At yesterday’s press conference, the shift in confidence became part of the official  language. The ECB president said that the inflation outlook worsened in August and that during the month the ECB had seen “downward movement in all indicators of inflation expectations, across all maturities”. The 5y/5y swap rate – ECB’s preferred measure for inflation expectations - backed up after the Jackson Hole speech but other measures did not, scaring the Governing Council.

Importantly, the usual reference to “firmly anchored inflation expectations” completely disappeared from the introductory remarks. Draghi only touched upon the issue when explicitly asked, in a question, whether inflation expectations can still be defined as well anchored. He said they still are, but that the downward risk is increasing (to a point that obviously calls for ECB action).  

Another interesting point Draghi made – again in the Q&A – was about the drivers of (dis)-inflation surprises. He said that while in the past forecast errors on inflation could largely be explained by errors in forecasting the food/energy components, recently the link with factors that are “not exogenous to the Eurozone economy”, such as the degree of slack, has been growing.

And the language was also markedly different in the qualification of the economic outlook. The previous Governing Council meeting referred to a “continued moderate and uneven recovery of the euro area economy, with low rates of inflation and subdued monetary and credit dynamics.” In Jackson Hole, Draghi went further, saying “the recovery in the euro area remains uniformly weak, with subdued wage growth even in non-stressed countries suggesting lackluster demand.” Yesterday, any optimism about the economic cycle seemed to be gone, as the ECB president said that “the recovery is likely to continue to be dampened by high unemployment, sizeable unutilised capacity, continued negative MFI loan growth to the private sector, and the necessary balance sheet adjustments in the public and private sectors”. The ECB staff’s macroeconomic projections for economic activity do indeed depict a bleaker outlook, with annual real GDP expected to increase by only 0.9% in 2014, 1.6% in 2015 and 1.9% in 2016, implying a downward revision of projections both 2014 and 2015.

Rate cut

At yesterday’s meeting, the Governing Council lowered all the rates in the corridor. The rate on main refinancing operations was lowered by 10 basis points to 0.05%, starting from the operation to be settled next week. The interest rate on the marginal lending facility will be decreased by 10 basis points to 0.30% whereas the interest rate on the deposit facility will be decreased by 10 basis points to -0.20%, again with effect from 10 September 2014.

Only 4 out of 47 economists polled by the Wall Street Journal were expecting the ECB to move on rates. Part of the reason why the rate cut was largely unanticipated is related to a previous statement at theJune monthly press conference – when the MRO rate was cut to 0.15% - Draghi has said in fact that “for all practical purposes” the ECB had “reached the lower bound”. However, he had also added that this did not “exclude some little technical adjustment” which could “lead to some lower interest rates in one or the other or both parts of the corridor”. The ambiguity was enough for the cut to be unanticipated and have a strong impact, with the euro/dollar reaching the lowest since July 2013 on announcement.

In the Q&A Draghi clarified that the rate cut is intended to make sure that no doubt remains about the fact that the ECB has now reached the lower bound, where these “technical adjustments” are no longer possible. Importantly, this decision also serves as a signal to the banks, in view of the approaching TLTRO operations. With the MRO at 0.05%, the terms of the TLTRO imply that the operation will be conducted at a rate of 0.15% (MO rate + 10 bp). Draghi explicitly said in the Q&A that the rate cut removes any incentive that banks participating in the TLTRO could possibly still have to hesitate in expectation of lower rates, because the rates will not be lower than this. Although several issues remain about the effectiveness of the TLTRO (see here and here, for previous discussions) this measure is a message to banks that the ECB expects them not to be shy in the take up.

Asset purchases

In addition, the Governing Council decided to start purchasing non-financial private sector assets, as recommended in our paper on the ECB's shopping list to fight weak inflation. The Eurosystem will purchase a “broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP)”. In parallel, the Eurosystem will also run a third wave of purchases of covered bonds issued by MFIs domiciled in the euro area (CBPP3).

Interventions under these programmes will start in October 2014 and the detailed modalities of these programmes will be announced after the Governing Council meeting of 2 October 2014. The announcement and the discussion in Q&A raise further important points.

  • Size: perhaps the most awaited piece of information – the size of the programme – is still missing. Draghi said that the complexity of the operation does not allow the ECB to name a figure at the moment (although it could be argued that the ECB did name a figure on announcements of previous covered bonds purchase programmes). It is not clear whether size will be part of the announcement due on the 2nd of October, but it should be, as ambiguity and opacity could reduce the effect on expectation.

    Draghi indirectly dropped a possible hint, however. He said that the aim of the package adopted is twofold: on one hand, broaden the measures that go in the direction of easing credit; on the other hand, significantly stir the size of the ECB’s balance sheet towards the size it had in 2012. As I highlighted in a previous analysis, a “special” feature in the development of the ECB’s balance sheet over the last year is that fact that the shrinkage is outside the control of the ECB, as the main driver is precisely banks’ decision to reimburse funds they borrowed from the ECB itself.

  • Composition: Draghi reiterated that the target will be “simple and transparent” product and stressed that the ECB wants to make sure “these ABS are used to extend credit to real economy“. ABS are the key to unlocking Europe’s credit market. Obviously one key missing point is the exact definition of “simple” and “transparent”, but the Draghi said that the ECB has experience in valuation and pricing of ABS due to the inclusion of these securities in the collateral framework, so this might suggest the target pool be limited to what is already eligible as collateral for the lending operations. Importantly, Draghi clarified that ABS purchase will include RMBS – which could be indeed necessary to achieve a meaningful firepower. This was not obvious in June, and it may seem contradictory with the fact that the TLTRO instead does not include mortgages.

    Concerning covered bonds programme - the only previous examples of ECB unsterilised asset purchases – the assessment of the two previous programmes by the ECB was positive. Bank bonds are indeed the second largest asset class of assets that the ECB could purchase (after government bonds, which seem to be ruled out of the picture). However, as previously noted here, buying bank bonds before the completion of the Comprehensive Assessment (and its follow up) could put the ECB in an uncomfortable position and raise issue of conflicts of interest.

  • Unanimity: Mario Draghi said that the decision was not unanimous, although based on what he defined as a “comfortable majority”. He explicitly said that some Governors wanted to do more and some less. This raise again the important issue of transparency on the ECB’s. The issue of publishing the minutes of the ECB’s meeting – as done by FED and BoE – was raised in a recent past but it is unclear when this will happen. This Governing Council meeting shows probably better than anything else why this would be needed and helpful.

The Structural reform compact

The central bank can ease credit a lot, but if those who ask for credit then have to wait months or years before they can open their business, easy credit does not help. This is perhaps the clearest example that Draghi could have chosen to explain his view on structural reforms, which have been increasingly featured in his public speeches.

Yesterday, he repeated his stance of Jackson Hole. The basic idea in that speech was that three instruments can be helpful in revamping growth: fiscal policy, monetary policy and structural reforms. But Draghi is more and more explicit about the fact that no fiscal or monetary stimulus can do the job without “ambitious, important and string structural reforms”. This is why the ECB president said structural reform effort needs to gain momentum, and while these reforms can be costly, low growth is also a major cost.

Importantly, he re-stated his call for a discussion about the aggregate Eurozone fiscal stance, a major change of mind from the institution that was on the forefront for advocating the fiscal compact in 2011. But the language about the “flexibility discussion” surrounding the application of fiscal rules was equally crystal clear. “The SGP is our anchor of confidence” – he said, and confidence is highly needed because in the Eurozone there are different reasons why growth not coming back, but one of these is lack of confidence. Then, “from a confidence strengthening viewpoint it would be much better if we were to have first a very serious discussion on structural reforms and then a discussion of flexibility”. Draghi’s preferred sequencing is therefore clearly stated, as his the fact that the ECB does not intend and cannot do national governments’ job.

Concerning the structural reforms, it’s also clear that the preferred solution of the ECB would be one at the European level, underpinned by a rigorous application of the macroeconomic imbalance procedure. Draghi’s language was remarkably sharp on this point: country should not consider this a loss of sovereignty, but a sharing of it, as for monetary policy. Draghi said that previously to euro, all central banks (perhaps with the exception of one) had actually lost sovereignty. “The Euro created the possibility to share it.” Implicitly, the message seems to be that sharing sovereignty on structural reforms would not be very different.

This was probably the most important move of the ECB since the announcement of the OMT, in September 2012. At stake was the credibility of Mario Draghi and the ability to push his Jackson Hole position through the Governing Council. The risk of betraying the exceptionally high expectations that he had created was not to be underestimated, but Mario Draghi eventually delivered, even though the actual size of the programme needs to be clarified. In poker-like twist, he also made clear that it’s now the turn of European policymakers to meet his expectations.

Fri, 05 Sep 2014 08:04:54 +0100
<![CDATA[Keynote address from Mateusz Szczurek, Minister of Finance of Poland]]> http://www.bruegel.org/nc/blog/detail/article/1426-keynote-address-from-mateusz-szczurek-minister-of-finance-of-poland/ blog1426

Europe, the way ahead will be on the focus of this year’s Bruegel annual meeting. In the fall and after the European election, a new leadership will come into office. It will be time to reflect on the next steps Europe should take to overcome its weak growth performance; to re-invent its institutions and the collaboration process among them; to address the remaining banking problems; and also to revive the debate on the constitution and legitimacy of Europe.

At the annual meeting, we would like to have an open and frank debate. High-level representatives of Bruegel's state corporate and institutional members will gather on 4-5 September in Brussels to discuss the economic issues that will shape Europe under the new leadership and in the context of new global challenges.

September 4 (on the record)

  • 19:30 - Bruegel annual dinner
    • Chair: Jean-Claude Trichet, Bruegel chairman
    • Dinner keynote: Finance Minister Mateusz Szczurek, Poland

The Dinner keynote is available as a recording above. The full text is published below or as pdf download.

Investing for Europe’s Future

Dear President, Jean Claude Trichet,

Dear Director, Guntram Wolff,

Dear Members of the European Parliament,

Ladies and Gentlemen, good evening,

Dear Jean Claude, dear Guntram, thank you very much for your kind invitation.

The Bruegel Institute is one of the most influential European think-tanks and the quality of its research is continuously increasing its impact on policy-making. It is therefore my honour and great privilege to be here and to address this exceptional audience.

Europe is at risk

We are meeting here at the time when Europe is facing a great threat. It is not the danger of sovereign debt crisis or of the collapse of the euro area. We have managed to decisively avert those risks through a coordinated effort at the European level. Unfortunately, neither is it the threat of the so-called “lost decade” because the “lost decade” is already Europe’s baseline scenario. Remember, six years have already passed since the start of the financial crisis and European GDP is still well below its pre-crisis level and around 10% below the level consistent with trend growth prior to the crisis. As a continent we are doing worse than Japan in the aftermath of the financial meltdown of the 80s and worse than during Great Depression in the 30s. The timid recovery, which gave us so much hope, has recently stalled. Unemployment and the negative output gap are at record-highs and we are on the verge of deflation. Even Poland, with its continuing economic expansion, still faces elevated unemployment and below-potential growth.

You may ask: what risk could be added to such a gloomy baseline? It is the threat of secular stagnation, the trap of permanently depressed demand and meagre long term growth rates. It is also the threat of a lost generation: a generation of young people who will never find their way into quality employment and will never reach their full human and economic potential. To realize that such a gloomy scenario may already be unfolding, look no further than our labour market. Almost a quarter of all young people in Europe are without work. Persistent unemployment, inequality, and a debt burden increasing with each month of stagnant income and near-deflation threaten not only Europe’s economic development, but risks unravelling the entire social structure of the European Union. The radical parties are gaining strength, and as Europeans we should never forget that it was depression and deflation, and not hyperinflation, that brought to power the totalitarian regime that devastated our continent through the world war and unspeakable atrocities 75 years ago.

Europe needs concerted and decisive action

Europe is not doomed, but we do need concerted and decisive actions at both national and European levels to close the output gap, create jobs and strengthen the long term growth potential, all the while ensuring the sustainability of public finance and the stability of financial sector. 

Such actions, many of which we have already undertaken, span a wide spectrum of policies, reforms and regulatory changes. Much attention has already been devoted to three broad areas: structural reform, European monetary policy and national fiscal policies.

Structural reforms are essential to promote flexibility and increase long-term growth. We need labour market reforms, we have to cut red-tape and we must reduce the regulatory burden. Completing the Single Market is key to ensuring efficient allocation of resources; meanwhile, the European Banking Union should complement other reforms to promote financial stability. The crisis – despite its obvious costs– offers a tremendous opportunity to overhaul the ailing aspects of the European economy and to boost its potential.

The challenge looming on the horizon is deflation. This threat makes traditional monetary policy instruments inadequate or irrelevant. Reviving recovery and reaching inflation target therefore requires continued monetary expansion through unconventional measures. The recent announcement of President Draghi about possible QE operations in the near future is a source of optimism. However, this optimism should be qualified by the relative impotence of monetary policy at the zero bound: the situation when interest rates are already zero or very close to zero and cannot be reduced further.

The new European fiscal framework will be the foundation of public finance sustainability. Together with ECB’s resolve, it has already restored confidence and averted a debt crisis. This is a great achievement. But to provide more growth momentum, we need smarter national fiscal consolidation strategies within the constraints of the Stability and Growth Pact (SGP). And I underline here the importance of the SGP rules as they represent necessary restraint and provide trust in our economic policy in Europe.

Europe needs investment

Ladies and gentlemen, while progress on each of these three fronts: structural reforms, monetary policy and public finance stability is necessary, it is time to face the fact that it will not be sufficient. It will not be sufficient to overcome the fundamental problem holding back the European economy: depressed investment demand.

The economic crisis caused a historically unprecedented collapse in capital investment in the European Union. Six years after the beginning of the financial crisis, private investments are still almost one fifth below pre-crisis levels. Public investment also fell significantly.  This has become the main target for fiscal consolidation in most of Europe, with cuts reaching 60% in some countries.

Investment is very low when it is needed more than ever. Higher capital expenditures could be a powerful way to boost economic recovery and close the output gap in the short-term, as investment multipliers are particularly high in deep recessions. This is especially true during the balance sheet recessions when private sector is in the process of deleveraging,  while interest rates are constrained by the zero lower bound, unable to balance saving and investment. Greater investment would also increase long-term productivity growth rates in Europe, further stimulating private capital expenditure. What is more, scaling-up of investments is also critical for achieving the vision of Europe 2020, the vision on which all Member States agreed and which we all share.

Those who fear that secular stagnation is already our reality point to a particularly worrying combination: an investment shortfall coincides with historically low interest rates. Cheap and plentiful savings are not being transformed into productive capital for three reasons.  First, the private sector lacks confidence in future demand for its products; second, real interest rate cannot turn negative due to deflationary environment; and third, in most EU member states the public sector lacks fiscal space   to scale up investment operations. Meanwhile, necessary structural reforms will take time to bear fruit, and often have only an indirect influence over the crucial saving-investment balance.

Time for action at the European level

I believe that to overcome these constraints, we need a decisive public investment initiative at the European level. I propose that we take advantage of the favourable financial market conditions right now in order to undertake strategic public investment projects across Europe and in line with the rules underpinning the Stability and Growth Pact. It will aid our growth in the long term, while at the same time helping us escape the current economic weakness and avert the danger of a generation-long stagnation.

We estimate, based on conservative assumptions about the size of the current output gap and fiscal multipliers, that closing the output gap in the medium term requires phased-in European public investment spending of around 5.5% of European Union GDP or 700 billion euros[1].

The capital spending would start at 0.5% of European GDP in 2015, peak at 2% in 2017, and be gradually phased out afterwards. This path is proposed as large scale public investment projects are likely to take time to get started. It also gives policymakers time to react and adjust the size of the initiative if economic conditions change in the coming years.

The proposed initiative should ensure that infrastructure critical to the long-term growth of Europe is put in place, in line with estimates given by the European Commission. The additional resources should supplement - not replace - European Investment Bank financing and the multiple functions of the EU budget.

How to mobilize such considerable investments? We propose to establish the European Fund for Investments, preferably operating as a special purpose vehicle under the umbrella of the European Investment Bank Group. The capital of the Fund would be leveraged by borrowing in the financial market and directly invested in the selected infrastructure projects because Europe needs actual capital expenditures, not merely extra funding. Even in Poland and Germany investment credit demand remains subdued.

Direct public sector participation would bring in private investors, who are currently chasing a relatively small number of potentially “bankable” projects, because they tend to consider large-scale infrastructure projects too risky in terms of future demand, regulatory environment and profitability. The assets created through these investments would eventually be privatised, generating revenues for the Fund. However, the logic of the excess savings at the zero lower bound, as well as the experience of other balance sheet recessions should make us prepared for prolonged ownership of newly created assets.

The Fund’s size, its direct investment in infrastructure and long-term investing horizon would be the key differences with the existing European Investment Fund, which has only 4,5 billion EUR capital and facilitates SME’s access to finance through intermediary institutions with shorter investment horizon.

To start operating, the new vehicle would require a gradual injection of paid-in capital and guarantees by all EU Member States in a similar way and on the similar scale as was done for the European Stability Mechanism. This would be necessary to ensure its triple-A rating. The contributions of Member States to the capitalization of the Fund would be excluded from the calculation of the budget deficit and its borrowing on financial markets would be recorded as EFI debt, and not re-routed to the Member States. This treatment would be exactly the same, as it is the case under the ESM, and in line with the rules underpinning the Stability and Growth Pact. It is important that all EU Member States take part in the initiative to prevent free-riding.

The Fund would facilitate directing currently idle private savings towards large-scale, pan-European infrastructure projects, with particular focus on energy, transportation and ICT. These sectors have long been defined as priority areas for long-term sustainable growth in Europe, and the principle of subsidiarity justifies taking the action at the European level. These investment projects would contribute to energy interconnectedness, independence and security, also known as energy union, reduction of carbon emissions, promotion of trade, investment and mobility among Member States, and shifting Europe towards digital union and knowledge-based model of growth.

At the same time, investment projects in the most depressed economies, as measured by output gaps, should be prioritised through front-loading. The Fund must not become another income redistribution tool. It should not promote economic laggards whose inadequate growth is simply a result of their structural weakness. But it will be a mechanism for synchronizing the business cycle, it will combat intra-European imbalances and reduce the pressure on labour migrations and on macro-prudential regulation. Moreover, it will result in Member States competing in reforms to increase potential output.

Many of you will be asking yourselves if Europe can afford to take on such an additional financial burden at the current juncture.  The question is whether we can afford not to take it on.  Before you answer that question, consider the present market conditions.  Consider the historically low interest rates. Consider the potentially large multipliers generated  by investment spending in a depressed economy.  Consider the stimulus to demand and the uptick in long-term growth rates.  Consider the additional publicly owned capital stock. Consider the evidence that public investment may actually reduce debt in medium term and strengthen long-term sustainability. And consider the alternative: the risk of secular stagnation, which may already be with us.  Do we really have a choice?

Ladies and Gentlemen, Europe’s road to recovery requires us to show determination in reaching our goals and courage in taking difficult decisions. Steps undertaken to counteract the recent crisis prove that, despite our sometimes divergent views, Member States can find mutually beneficial solutions to our shared problems. The future of the European Union depends on our determination to implement an ambitious agenda of reforms and on our capacity to adjust to new challenges.

At this juncture, boosting European investments is, in my view, the most important, but perfectly achievable economic policy challenge. This evening I have outlined an effective and fiscally responsible economic and institutional answer to this challenge. I am looking forward to working with all our European friends to develop it in full detail, and to implement it as promptly as possible.

In conclusion, let me make one thing absolutely clear. I am happy and proud that Poland was the only country in Europe that never stopped growing throughout the crisis. However, we cannot afford to be complacent. As Europeans, we can sustainably meet our growth aspirations only within strong and growing Europe. The responsibility for ending the lost decade and avoiding the lost generation is on all the EU Member States, and the European Fund for Investments is the way to achieve this goal. This is why, I can confirm without any hesitation that I would like to see Poland as its founding member.

I am counting on your support and cooperation.

Thank you very much

[1] See the analytical note.

Thu, 04 Sep 2014 16:37:35 +0100
<![CDATA[Tweaking China’s loan-deposit ratio rule]]> http://www.bruegel.org/nc/blog/detail/article/1425-tweaking-chinas-loan-deposit-ratio-rule/ blog1425

In the wake of the latest easing of Chinese monetary policy, the CBRC, China’s banking regulator, has recently modified a few details of how it calculates the bank loan/deposit ratio, which is currently capped at 75 percent by the country’s banking law. This move, in combination with an easier monetary policy stance, aims to ease the tight Chinese financial conditions, allocate more credit to Chinese agriculture and SMEs, and adapt China to its rapidly changing financial landscape.

The newly announced changes to the computation formula of the loan/deposit ratio fall into three categories, all in an apparent attempt to make the 75% cap less of a constraint on bank lending.

First, the numerator of the ratio (‘loan’) is shrunk by excluding certain categories of bank loans extended to agriculture and SMEs or funded by non-puttable term debt securities.

Second, the denominator (‘deposit’) is widened to include new financing instruments such as certificates of deposits (CDs) issued to firms and households and net term deposits from foreign parent banks.

Third, the currency relevant for calculating the ratio is now restricted to local currency only (involving both ‘loan’ and ‘deposit’). Since the foreign-currency loan/deposit ratio is over 100 percent for China’s banking sector, the change helps ease the constraint system-wide.

Together, this CBRC move might manage to expand the aggregate lending capacity of Chinese banks by some 1 percent, easing the tight financial conditions while in theory favouring lending to agriculture and SME borrowers and bank loans funded by new instruments such as CDs, which are supposedly priced by market demand and supply.

This is no doubt a positive policy move that may mitigate the prevailing tightness in Chinese financial conditions, as the overall banking sector has approached the 75 percent regulatory ceiling (Graph 1). The measure also may facilitate further interest rate liberalisation.

Graph 1: Loan-to-deposit ratios of Chinese banks listed in Hong Kong (In Percent, June 2014)

Note: CMB=China Merchant Bank; BOCOM=Bank of Communication; BOC=Bank of China; Minsheng= Minsheng Bank; CITIC=CITIC Bank; CCB=China Construction Bank; ICBC=Industrial and Commercial Bank of China; ABC=Agricultural Bank of China; CRCB= Chongqing Rural Commercial Bank.

Source: Barclay Capital.

So far, so good. But then why all the fuss for the CBRC to painstakingly refine technical calculation details of this loan/deposit ratio? Why not simply to raise the official 75 percent cap outright to say 90 percent or 100 percent?

That is because that the 75 percent cap on the loan/deposit ratio is precisely set in stone by the 1995 Chinese Banking Law that can only be changed by the Chinese national legislature. Indeed, the CBRC was not even born yet when this banking law first came into effect.

So there is nothing the CBRC can do but to enforce, tweak or wait at least until the Chinese national legislature convenes in the first quarter next year. In hindsight, it would be better if the Chinese banking law had simply stated that the bank regulator can impose and adjust some loan/deposit ratio as it sees fit.

The 75 percent cap on the loan/deposit ratio was introduced two decades ago, with good reasons. First, inflation was running at double-digit in 1994. Second, China did not yet embrace the Basel capital requirement then. Third, there was a forthcoming policy of abolishing official bank loan quotas at the time. Therefore, the Chinese government hastily formulated this blunt rule into a national banking law in early 1995, as a major policy tool to manage the banking sector.

But by now, this 20-year old regulatory rule has become essentially outdated, also for good reasons.

First, it favours big state-controlled banks which have vast retail and corporate deposit bases and disadvantages the smaller banks that tend to lend more to SMEs, thereby adding to the financial tightness in the broader economy. Structurally, the ratio may also inhibit the growth of the more productive sectors.

Second, banks attempt to circumvent the rule by shifting some lending off balance sheet, thus fuelling excessive shadow banking in China, which is in part the product of regulatory arbitrage in response to a more binding loan/deposit ratio, high reserve requirements and partially regulated interest rates.

Third, the funding sources of Chinese banks have become more diversified over time, with more debt securities including CDs and the declining importance of deposits in the recent years.

Fourth, China’s banking regulatory regime has now supposedly more embraced the new Basel Accord III that features enhanced capital and liquidity requirements, thus possibly rendering the 75 percent cap on the loan/deposit ratio redundant.

While helpful both cyclically and structurally, the latest CBRC tweaking to the loan/deposit ratio is no more than a stopgap measure. Those who fancy that this tweaking can meaningfully boost SME financing would be very disappointed, if experience in other economies without such a regulatory cap is any guide.

In my view, the most underappreciated benefit of the latest tweak is to remind us the risk that greater competition for deposits among smaller banks facing this old cap may mix with the new interest rate liberalisation to produce the chemicals that could poison China’s financial system. Indeed, such a dated, rigid regulatory rule itself could become a potential source of financial instability in a more liberalised environment.

This also highlights the need for complementary institutional changes in order to enhance the potential benefits and mitigate the potential risks associated with rate deregulation. This strengthens the case for a financial liberalisation strategy of faster exchange rate liberalisation ahead of full interest rate deregulation in China.

While time is ripe for a removal of any specific numerical cap on the loan/deposit ratio from the Chinese banking law, a smart way going forward would be to keep the loan/deposit ratio as a supplementary policy instrument but grant the CBRC the full discretion to adjust its ceiling. A heavy, broken umbrella could turn out to be handy on a day of pouring rain.

Wed, 03 Sep 2014 07:31:00 +0100
<![CDATA[Blogs review: The bond market conundrum redux]]> http://www.bruegel.org/nc/blog/detail/article/1424-blogs-review-the-bond-market-conundrum-redux/ blog1424

What’s at stake: Fed tapering was widely expected to push up US yields. Instead, US yields have fallen since the beginning of the year, raising the question of whether we’re seeing a new version of the Greenspan 2005 conundrum. Interestingly, a successful explanation of this new conundrum cannot just rely on a flight to safety explanation as it also needs to rationalize why 5-year yield and 10-year yield have diverged over the same period.

Tapering and interest rates

Jeff Sommer writes that yields have been falling with embarrassing consistency in 2014 despite forecasts to the contrary from most Wall Street analysts at the beginning of the year. David Beckworth writes that the Fed has been tightening monetary policy with its tapering of QE3 and yet the benchmark 10-year treasury interest rate has been falling since the beginning of 2014. Marc to Market writes that moreover, the US market rally has taken place amid a tick up in both core and headline measure of consumer prices.

Source: Dealbook

James Hamilton writes that as the U.S. economy returns to healthier growth, many of us expected long-term interest rates to return to more normal historical levels. But the general trend has been down since the end of the Great Recession. The 10-year rate did jump back up in the spring of 2013. But during most of this year it has been falling again.

In his famous 2005 testimony before Congress, Alan Greenspan noted that long-term interest rates [had] trended lower in recent months even as the Federal Reserve [had] raised the level of the target federal funds rate by 150 basis points. This development contrasts with most experience, which suggests that, other things being equal, increasing short-term interest rates are normally accompanied by a rise in longer-term yields. Calculated Risk writes that Mr. Greenspan is referring to the expectations theory of interest rates were long rates are the geometric average of expected future short rates plus a risk premium that would usually increase with duration of the instrument. This theory assumes that arbitrage between instruments of different durations will set the price. 

David Beckworth uses a decomposition of the long term interest rate into an average expected real short-term interest rate, average expected inflation and a term premium to argue that it’s the term premium has been steadily falling.

The divergence of 5-year and 10-year yields

James Hamilton writes that interestingly while the return on a 10-year Treasury has been falling for most of this year, the 5-year yield has held fairly steady. If investors are risk neutral, the drop in the forward rate during 2014 indicates that something happened this year to persuade people that rates in the future (for 5 to 10 years from now) were going to be lower than they had been expecting.

Robin Harding and Michael Mackenzie write that this is unprecedented: no other global shock going back to the 1960s has ever caused US 5 and 10-year yields to diverge like this.

Note: US 5y10y yield correlation; Source: @RobinBHarding

James Hamilton writes that it’s hard to attribute it to changing perceptions about the Fed, which should surely matter more for the next 5 years than they would for 5 to 10 years from now. More confidence that the U.S. government will be able to keep debt from growing relative to GDP over the next decade may have played a role. Another possibility is that more people are starting to take seriously the suggestion that we’re on a path now of secular stagnation with weak economic growth and poor investment opportunities over the next decade. But that’s hard to reconcile with the stock market, which climbed impressively this year.

Tue, 02 Sep 2014 06:52:56 +0100
<![CDATA[Is Europe saving away its future?]]> http://www.bruegel.org/nc/blog/detail/article/1423-is-europe-saving-away-its-future/ blog1423

The Crisis affected public spending. Research and innovation is one area often highlighted as needing protection. This column does not find strong evidence that European countries sacrificed research and innovation more than other government expenditure. However, there is strong heterogeneity across countries. Innovation lagging and fiscally weak countries cut R&I spending while innovation-leading forged it ahead. Research of this divide and long-term growth is still limited.

Trends in public R&I budgets in EU countries during the crisis

The dangerous cocktail in many European countries of high debt and subdued growth calls for smart fiscal consolidation. Cost-cutting programmes should minimise the potentially negative short-term effect on economic activity, while establishing a foundation for long-term growth, with growth-enhancing public expenditure safeguarded from cuts, or even increased (Teulings 2012).

1 Source: Eurostat. An alternative source to look at is the government financed part of GERD (Gross Expenditures of R&D) (Source: OECD). Both series have their strengths and weaknesses. GBAORD covers budgeted items, while GERD covers actual expenditures. GBAORD allows direct comparison with the other budgeted items. GBAORD data is more recently available compared to GERD. Trend results are similar when using GERD rather than GBAORD (see Veugelers 2014).

An area often highlighted as needing protection in the context of shrinking overall public budgets is Research and Innovation. To examine how public expenditure on R&I fared in Europe during the crisis (i.e. since 2007), in Veugelers (2014) we look at the GBAORD (government budget appropriations or outlays for research and development) data.1

On average, there is no strong evidence that EU countries sacrificed their R&I budgets more than other government expenditure during the crisis. However, while R&I investments were part of the stimulus packages at the onset of the crisis, more recently, R&I spending has started to trend downwards.

Figure 1. Trend in government expenditures on R&D in the EU 2007-2012 (GBOARD)

2 This classification is based on their budgetary consolidation position: countries with an above-median cumulative change in their structural primary balance since the year in which consolidation started (the year with the lowest negative structural primary balance in the period 2008-10). Source: EUROSTAT and AMECO. Also included in the high fiscal consolidation group are the Economic Adjustment Programme countries.

4 Among the leading innovators, Sweden, Germany and Denmark increased their public R&I budgets even more than other government spending. In Finland, the increase has remained flat since 2011. The UK began to cut its public R&I budgets already in the early years of the crisis, and more deeply than its overall public expenditure.

5 Among the innovation followers, Austria has increased its public R&I budget substantially, by more than its overall public budget. France has increased its public R&I budget on average, but not consistently. In the Netherlands, there was a decline in the R&I share of the public budget.

6 Among the innovation laggards, Estonia was under high financial consolidation pressure but has nevertheless continued to expand its R&I budget so substantially that it now the EU's highest public R&I spender, in relative terms.

7 Spain cut its public R&I budget substantially, by even more than its overall public budget, driving the R&I share of its overall budget down to 1.25% in 2012 from 1.95% in 2007. Italy has seen similar substantial cuts in public R&I spending, reducing the share of R&I in its public budget to an historic low (1.1% in 2012). Greece also had to cut its R&I budgets mostly in line with its overall budgetary cuts, but these cuts have deepened, reducing the share of R&I in Greece's overall budget from an already-low share (0.7% in 2012). By contrast, Portugal has expanded its public R&I budget and has only made cuts in recent years.

8 Other countries, including Estonia, Finland, Germany, and Italy, have no substantial R&I tax incentives. The use of tax credits, therefore, seems to mark another divide in Europe – some countries are heavy and increasing users, while others continue to refrain from using the instrument.

9 This is the case for Estonia, Hungary, Lithuania, Poland, and Slovakia. In Latvia, structural fund allocations even triple the public R&I budget. But also in Portugal, structural funds represent 31% of total public R&I. In Greece, structural funds support for public R&I represents 40%. A low implementation rate brings the actual share in Greece down to 21%. Lacking resources for co-funding may imply that not all of the allocated budget can be implemented.

10 The share of R&I in the total EU budget is now about 8% much higher than the share of R&I spend in member state budgets (1.4% in 2012).

Note to Figure 2EU funds are both the structural RTDI funds (left panel) as well as the FP7 funds (right panel). Latvia is excluded as an extreme outlier in the left panel
Source: Bruegel calculations on the basis of IUC 2007, Eurostat and AMECO.

The average EU trend masks, however, an increasing divide among EU countries.   To further explore this country heterogeneity, we distinguish innovation leaders (Denmark, Finland, Germany, Sweden, and the UK), innovation followers (Austria, France, Ireland, Luxembourg, and the Netherlands) versus the rest (innovation laggards).2 We also distinguish high fiscal consolidationcountries (Bulgaria, Cyprus, the Czech Republic, Estonia, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Poland, Portugal, Romania, Slovakia, and Spain) versus the rest (low fiscal consolidation).3

Figure 1 shows that innovation leaders increased public expenditure on R&I during the crisis by more than their increase in other public expenditure.4 Innovation followers reduced their public R&I expenditure more than other categories of public expenditure.5 Innovation laggards – including Italy and Spain – substantially cut public R&I expenditure, even more so than other parts of their budgets, resulting in a considerable drop in the share of R&I in public expenditure, which was already below the EU average. Most innovation laggards, perhaps not by coincidence, are also under greater fiscal consolidation pressure. Countries under high fiscal consolidation pressure have significantly cut their public R&I expenditure.6,7  

  • The crisis seems therefore to have widened the gap in public R&I expenditure between EU countries.

Public budgetary support for business R&I includes direct support through grants but also indirect support – predominantly through tax incentives. This indirect support is not visible in the GBAORD data. Tax incentives have become the main channel of government support for business R&I in countries such as Belgium, France, Ireland, and the Netherlands. In all of these countries, use of tax credits increased much faster than grants during the crisis.8

The increasing shift towards tax credits during the crisis is unsurprising given that tax credits for R&I are an easier-to-use instrument in times of fiscal consolidation. However, there is no strong evidence that tax credits are a more effective instrument for boosting private R&I compared to grants (see Veugelers 2014 for more on this).

European Commission policy on public R&I in a time of fiscal consolidation

How has the EU treated public R&I during the crisis, both through its own EU budget (structural funds and research funds), and its monitoring of member state R&I budgets and policies through the European Semester?

EU own R&I budget spending

The major sources of EU R&I funding are the structural funds (from 2007-13, about a quarter of structural funds went to R&I) and the Framework Programme research funding/Horizon 2020. This funding complements member states’ own public investment in R&I. In some countries, structural funds for research and innovation are of the same magnitude as national R&I budgets.9

Figure 2. EU research and innovation funds and Innovation Union scoring

The EU budget serves as mechanism to somewhat ease the growing public R&I divide in Europe. EU funds are relatively more significant for innovation-lagging countries with low national R&I budgets. Figure 2 illustrates clearly the negative relationship between EU funds as a share of national R&I spending and countries’ innovation scores. This is particularly evident for the structural funds. But it also holds, albeit to a lesser degree, for research funds allocated through FP7 excellence-based competitions.

EU funding in countries with declining R&I spends is likely to become even more important in future. With Horizon 2020, EU funding for R&I will amount to €80 billion, an increase of 30% compared to its predecessor (2007-13).10 In addition, a greater share of the structural funds is earmarked to be spent on Europe 2020 challenges during 2014-20 – from 50 to 80%.

Country-specific recommendations for R&I in the European Semester

The European Commission monitors the progress of member states towards their own R&I targets in pursuit of the Europe 2020 goals through the European Semester. An analysis of the Commission's latest country-specific recommendations (Veugelers 2014) shows that recommendations related to R&I are patchy. The recommendations are not supported by the systematic use of evaluation tools to assess the impact on long-term growth.

The ‘investment clause’ use for public R&I budgets

A further means by which the Commission could promote R&I investment during crisis as part of smart fiscal consolidation is through the so-called ‘investment clause’. This allows member states that are in deep recession but that have budget deficits below the 3% of GDP threshold and that respect the public debt reduction rule, to temporarily deviate from the fiscal targets of the Stability and Growth Pact (SGP), to the extent of their national co-funding of EU-funded investments. The Commission proposed this in summer 2013 in response to the request of the European Council (2013). The investment clause, which extends beyond R&I, has however so far not been activated (Barbiero and Darvas 2014).

Are EU public R&I budgets being consolidated smartly?

The critical question that still needs to be addressed is whether the diverging trends on public R&I are good or bad news. Are the cuts in the weaker countries evidence of smart use of public R&I investment, i.e. were they effective in supporting recovery and growth and in eliminating inefficiently spent public resources? Or have the public R&I cuts been too aggressive, jeopardising long-term growth? Is the Commission right to not allow members states in weak fiscal positions, which also happen to be weak innovators, to shelter their public R&D budgets from fiscal exigencies? Or should the Commission be more lenient and exercise the investment clause option?

11 The impact and hence justification for public funding of science and innovation goes beyond its economic effects on GDP growth; it also encompasses societal challenges, such as health and a clean environment. Here we look at a more narrow question, namely the justification for public R&I budgets as areas of smart fiscal consolidation, which is why the discussion concentrates on the growth-enhancing impact of public R&I.

12 The EU-FP7 funded SIMPATIC project aims to contribute to micro- assessment of the causal impact of R&D grants and tax credits, by assessing the net private and social rates of return using structural modelling and integrating this micro-assessment into an endogeneous R&D macro model to assess the long-term impact on growth and jobs. For more on SIMPATIC, see www.SIMPATIC.eu

13 If Italy spends less public money on R&I, does this increase the supply of R&I employees in the UK? If the UK introduces a patent box scheme, should France follow? How much could be gained from coordinating member states R&I tax credits, in order to avoid the negative effects of R&I tax competition? How much does Greece benefit from increased German R&I spent?

Answering these questions requires an assessment of the long-term impact of public R&D on growth with the appropriate methodologies to evaluate causal effects.11  Although the number of studies evaluating public R&I programmes have grown substantially, they are still grappling with the causal link between public intervention and its impact on growth, and establishing proper counterfactuals to assess what the outcome would have been for the beneficiaries had they not received the support. In addition, most evaluation studies only look at the immediate impact of public support on private research and development and innovation, checking whether it crowds out or generates additional private investment (the so- called ‘additionality’). There are few assessment exercises that pin down the longer-term social returns and growth impact of R&I, which is the impact that matters for smart fiscal consolidation. Assessing social returns and the growth impact is a much more complex exercise requiring an integration of micro-additionality exercises into macro-growth-models.12 Such an integrated approach will allow an assessment of the complementary framework conditions needed to realise the growth dividend from public R&I and when needed, to identify which structural reforms (in product markets, labour markets, financial markets) are needed to generate innovation-based endogenous growth. An advantage of deploying integrated macro-models at the EU level compared to a country-by-country approach is that the EU scale allows assessment of the cross-country spillovers from national R&I policies.13

Only when member states’ public R&I plans are properly assessed for their growth impact in an integrated framework, will we be able to conclude if the growing EU public R&I divide is a good or a bad trend.

LEGAL NOTICE: The research leading to these results has received funding from the Socio-economic Sciences and Humanities Programme of the European Union's Seventh Framework Programme (FP7/2007-2013) under grant agreement no. 290597. The views expressed in this publication are the sole responsibility of the authors and do not necessarily reflect the views of the European Commission.


Barbiero, F and Dalvas, Z (2014) “In sickness and in health: protecting and supporting public investment in Europe”, Bruegel Policy Contribution, Brussels.

Teulings C (2012), “Fiscal consolidation and reforms: Substitutes, not complements”, VoxEU.org, 13 September

Veugelers, R (2014), “Undercutting the future? European research spending in times of fiscal consolidation”, Bruegel Policy Contribution 2014/06, Bruegel, Brussels.   

Veugelers R (2014), “Public R&I budgets for smart fiscal consolidation”, SIMPATIC working paper, presented at the second annual SIMPATIC conference, The Hague, April 2-4, 2014, available at http://www.simpatic.eu

Mon, 01 Sep 2014 08:46:03 +0100
<![CDATA[EU at a Crossroads]]> http://www.bruegel.org/nc/events/event-detail/event/457-eu-at-a-crossroads/ even457

We are pleased to announce that Italian Finance Minister Pier Carlo Padoan is coming to Bruegel to talk about the economic choices ahead for Europe.

High unemployment, low private and public investment and rising social inequalities mark the current stagnation of European economy. Despite the joint effort of Member States, the recovery is still fragile and it calls for strong action to foster growth and jobs. The EU is therefore at a crossroads, where it has to review its policy mix both at EU and country level.


  • Introduction by Guntram Wolff, Director of Bruegel
  • Keynote by Pier Carlo Padoan, Italian Minister of Finance
  • Moderated by Tom Nuttall, The Economist

The keynote will be followed by a commentary by the moderator and a lively discussion with the audience.

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Monday 13 October, 12.45-14:30. Lunch will be served at 12.45 after which the event begins at 13.00
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Fri, 29 Aug 2014 15:45:00 +0100
<![CDATA[Improving the role of equity crowdfunding in Europe's capital markets]]> http://www.bruegel.org/publications/publication-detail/publication/844-improving-the-role-of-equity-crowdfunding-in-europes-capital-markets/ publ844


Crowdfunding is a growing phenomenon that encompasses several different models of financing for business or other ventures. Despite the hype, equity crowdfunding is still the smallest part of the crowdfunding market. Because of its legal framework, Europe has been at the forefront of equity crowdfunding market development.

Equity crowdfunding is more complex than other forms of crowdfunding and requires proper checks and balances if it is to provide a viable channel for financial intermediation in the seed and early-stage market in Europe. It is important to explore this new channel of funding for young and innovative firms given the critical role these start-ups can play job creation and economic growth in Europe.

We assess the potential role of equity crowdfunding in the overall seed and early-stage financing market and highlight the potential risks of equity crowdfunding. We describe the current state of play in this nascent industry, considering both the innovations introduced by market operators and existing regulation. Currently in Europe there is a patchwork of national legal frameworks related to equity crowdfunding and this should be addressed in a harmonised way.


Crowdfunding is increasingly attracting attention, most recently for its potential to provide equity funding to start-ups. Providing funding to young and innovative firms is particularly relevant given their importance for job creation and economic growth (OECD, 2013; Haltiwangner et al, 2011; Stangler and Litan, 2009). In addition, at a time when banking intermediation is under pressure (Sapir and Wolff, 2013), it is important for European Union policymakers to further explore alternative forms of financial intermediation. But questions remain about the appropriateness of crowdfunding for providing seed and early stage equity finance to new ventures and how this market could be developed and regulated.

While there is growing hype around crowdfunding, there are also many wrong perceptions. The bulk of crowdfunding is for philanthropic projects (in the form of donations), consumer products often for creative ventures such as music and film (in the form of pre-funding orders) and lending. Equity crowdfunding, sometimes called crowdinvesting is relatively new and currently comprises the smallest part of the crowdfunding market. However, it is currently more active in Europe than in other regions.

Growth of crowdfunding

Crowdfunding can be defined as the collection of funds, usually through a web platform, from a large pool of backers to fund an initiative. Two fundamental elements underpin this model and both have been enabled by the development of the internet. First, by substantially reducing transaction costs, the internet makes it possible to collect small sums from a large pool of funders: the crowd. The aggregation of many small contributions can result in considerable amounts of capital. Second, the internet makes it possible to directly connect funders with those seeking funding, without an active intermediary. Crowdfunding platforms assume the role of facilitators of the match.

While people tend to talk about crowdfunding in general, the crowdfunding phenomenon encompasses quite heterogeneous financing models. There are four main types:

  • Donation-based, in which funders donate to causes that they want to support with no expected compensation (ie philanthropic or sponsorship-based incentive).
  • Reward-based, in which funders’ objective for funding is to gain a non-financial reward such as a token gift or a product, such as a first edition release.
  • Lending-based (crowd lending), in which funders receive fixed periodic income and expect repayment of the original principal investment.
  • Equity-based (usually defined as crowdinvesting), in which funders receive compensation in the form of fundraiser’s equity-based revenue or profit-share arrangements. In other words, the entrepreneur decides how much money he or she would like to raise in exchange for a percentage of equity and each crowdfunder receives a pro-rata share (usually ordinary shares) of the company depending on the fraction of the target amount they decide to commit. For example, if a start-up is trying to raise €50,000 in exchange for 20 percent of its equity and each crowdfunder provides €500 (1 percent of €50,000), the crowdfunder will receive 0.20 percent (1 percent of 20 percent) of the company’s equity.

The four models vary in terms of complexity and level of uncertainty. The donation-based model is the simplest. Legally the transaction takes the form of a donation. The risk is that the project does not achieve its declared goals, but the backer does not expect any material or financial return from the transaction. Equity crowdfunding is the most complex. From a legal standpoint, the funder buys a stake in the company, the value of which must be estimated. Moreover, the level of uncertainty in equity crowdfunding is much greater compared to the other models because it concerns the entrepreneur’s ability to generate equity value in the company, which is extremely difficult to assess. Overall, these complexities pose problems that are distinct and more fundamental than those of the other crowdfunding models. These complexities require special attention from policymakers, as this Policy Contribution will discuss.

In general, crowdfunding is experiencing exponential growth globally. In the period 2009-13, the compound annual growth rate (CAGR) of the funding volumes was about 76 percent with an estimated total funding volume of $5.1bn in 2013. In terms of geography, the biggest market has been North America (and mostly the US where the concept of crowdfunding started) with 60 percent of the market volume, followed by Europe, which has 36 percent.

Equity crowdfunding is the smallest category of the overall industry and had a CAGR of about 50 percent from 2010 to 2012. Most of that growth was through European crowdfunding platforms because legal barriers currently prevent the development of equity crowdfunding in the US (see Box 2). As a result, Europe is currently the leading market for this financing model (see further discussion in section 4).

While in Europe equity crowdfunding is growing, the understanding of its risks and opportunities is still limited. We first assess the potential role of equity crowdfunding in the overall seed and early-stage financing market. Second, we point out the potential risks of equity crowdfunding. Third, we describe the state of this nascent industry considering both the innovations introduced by market players and existing regulation. Finally, we discuss the implications of our analysis for policy.

The seed and early-stage financing market

Equity crowdfunding is receiving attention from policymakers as a potential source of funds for start-ups, a segment of the economy that has limited access to finance. Young firms have no track record and often lack assets to be used as guarantees for bank loans. In addition, information asymmetries make it difficult for investors to identify and evaluate the potential of these firms.

Traditionally there have been three sources of equity funding for young innovative firms: founders, family and friends; angel investors; and venture capitalists.

  • The most common source of funding for new ventures is the founders’ own capital, even if that is funded through credit cards. Family and friends sometimes also provide finance to the entrepreneur in the first phases of development of the start-up (seed stage).
  • Angel investors are experienced entrepreneurs or business people that choose to invest their own funds into a new venture. They typically invest in seed and early stage ventures with amounts ranging from $25,000 to $500,000. Angels invest not only for the potential financial return, but in many cases to give back by helping other entrepreneurs.
  • Venture capital is considered ‘professional’ equity, in the form of a fund run by general partners, and aims at investments in firms in early to expansion stages. The source of capital pooled into venture capital funds is predominately institutional investors. Venture capital firms typically invest around $3m and $5m per round in a company.

The contributions of angel investors and venture capital firms are not limited to the provision of finance. They are actively involved in monitoring the companies in which they invest and often provide critical resources such as industry expertise and a valuable network of contacts (Gorman and Sahlman, 1989; Baum and Silverman, 2004; Hsu, 2004).

The importance of angel investors has increased in recent years given the difficulties young innovative firms face in securing finance from other channels (Wilson, 2011). As a result of the financial crisis, banks are even more reluctant to fund young firms because of their perceived riskiness and lack of collateral (Wilson and Silva, 2013). Meanwhile, venture capital firms are focusing more on later-stage investments and have left a significant funding gap at the seed and early stage. Angel investors, particularly those investing through groups or syndicates, are active in this investment segment and thus help to fill this increasing financing gap.

Equity crowdfunding departs from the models of traditional angel investors and venture capital firms because transactions are intermediated by an online platform. Some platforms play a more active role in screening and evaluating companies than others (see section 4). Also, their role during the investment and post-investment stages can vary dramatically. While there is a great deal of variation among the approaches adopted by the different platforms (Collins and Pierrakis, 2012), equity crowdfunding platforms generally follow the phases described in Figure 3.

Platforms usually charge companies a fee, typically 5-10 percent of the amount raised, plus sometimes a fixed up-front fee. Some platforms also charge fees to investors that are either fixed or a percentage of the amount invested or a percentage of the profit for investment. For example, Crowdcube charges entrepreneurs 5 percent plus a £1,750 fee for successful fund raising. Symbid charges entrepreneurs a €250 registration fee plus 5 percent of the amount raised and charges investors 2.5 percent of the amount invested. Seedrs charges entrepreneurs 7.5 percent of the amounts raised and charges investors 7.5 percent of the profits from the investment.

To understand how equity crowdfunding can complement the market incumbents in seed and early-stage finance, we have to consider characteristics such as investment size, investment motives, the risk/return profile, the investment model and investor characteristics.

Figure 4 shows the funding per project in equity-based crowdfunding. Compared to the other sources of finance described above, we can see that equity crowdfunding mostly operates in the financing segment covered by angel investors1.

Another characteristic that equity crowdfunding has in common with angel investors is that financial return is not the sole motive for an investment. Crowdfunders might also derive social and emotional benefits from financing a company. In other words, they are likely to be motivated to provide funding to a company to be connected with an entrepreneurial venture that shares their own values, vision or interests. A survey of Seedrs2 users revealed that the three top motivations for investors to fund start-ups are the desire to help new businesses get off the ground, the ability to exploit tax reliefs3, and the hope of achieving meaningful financial returns (Seedrs, 2013).

In terms of investment preferences, venture capitals tend to concentrate on technology-based companies, which typically are high-risk/high-return investments. Angel investors tend to invest in a wider range of sectors and geographies, covering some investment segments in which venture capital typically would not invest (Wilson, 2011). Because the crowd might encompass quite heterogeneous investment motives, the investment spectrum of equity crowdfunding can be even broader. For example, Seedrs users have invested in sectors as diverse as food and drink, high-tech, art and music, fashion and apparel, real estate and many others (Seedrs, 2014). The fact that crowdinvestors derive also non-financial benefits from the investment implies that they might also be willing to accept higher risks or lower returns than an investor seeking to maximise financial returns (Collins and Pierrakis, 2012).

Unlike venture capital and angel investment, equity crowdfunding requires entrepreneurs to publicly disclose their business idea and strategy. This early information disclosure might be harmful for firms with an innovative business model that can be easily imitated (Hemer, 2011; Agrawal et al, 2013; Hornuf and Schwienbacher, 2014a). Therefore, crowdfunding might be most beneficial for start-ups that can protect their intellectual capital through means other than secrecy, or for start-ups whose business is not particularly innovative.

Another common element shared by business angels and crowdinvestors is that neither type of financing model necessarily involves an active financial intermediary that makes the investment decisions. Venture capital firms pool financial commitments from institutional investors into funds and then select a portfolio of companies over time in which they invest. For angel investors and crowdinvestors, the decision to finance a company is ultimately made by the individual investor. Some equity crowdfunding platforms pool the funds of the crowd into an investment vehicle and act towards the company as the representative of the interests of the crowd. However, even in this case the platform does not act as a financial intermediary in portfolio management for the crowd, and the decision to invest in a specific company is taken by the individual investor.

While angel investors are typically high net worth individuals who are sophisticated investors, crowdinvestors are individuals that might or might not have experience and knowledge of financial markets and early-stage financing. Moreover, while angel investors tend to invest locally, crowdinvestors might invest in start-ups that are quite distant from them. Agrawal et al (2011) show that the average distance between a revenue-sharing crowdfunding platform's entrepreneurs and investors was approximately 3,000 miles (4,828 km). According to their study, only 13.5 percent of the investors provided funds to entrepreneurs within 50 km.

Table 1 summarises the key characteristics of equity crowdfunders, angel investors and venture capitalists, highlighting their similarities and differences.

Overall, equity crowdfunding can provide a complementary channel through which start-ups can obtain finance. In addition, equity crowdfunding can provide some advantages by fully exploiting the potential of the internet.

For example, crowdfunding allows a start-up to gain online visibility in the first phases of its development. As crowdinvestors are also potential consumers, an entrepreneur can benefit from crowdfunding through early advertisement of its products and by obtaining information on potential market demand and product preferences (Agrawal et al, 2013; Hornuf and Schwienbacher, 2014a). This early assessment of demand could help to reduce inefficient investments in start-ups with weak business potential.

Compared with traditional angel investing transactions that rely mostly on word-of-mouth, crowdfunding can improve the efficiency of the market by enabling faster and better investor-company matches. Moreover, geographical factors that might affect traditional forms of seed and early-stage financing might be less important in crowdfunding (Mollick, 2013a; Agrawal et al, 2011 and 2013).

Finally, the crowdfunding industry is well-positioned to benefit from the so-called 'big data' paradigm (Agrawal et al, 2013). Being online-based, crowdfunding deals leave data trails on investors, entrepreneurs, companies and deals, unlike angel investment and even most venture capital transactions. Through time, the analysis of this data could enable crowdfunding platforms to provide better matches between investors and companies and maximise the correlation between the crowd and product demand.

Risks in equity crowdfunding

Seed and early-stage financing can be high risk but with the hope of a high return. Eurostat data4 show that in EU the one-year survival rate for all enterprises created in 2009 was 81 percent, while the five-year survival rate of all enterprises started in 2005 was only 46 percent. Despite the expertise of professional investors, the risk of investing in start-ups remains high. Shikhar Ghosh, senior lecturer at Harvard Business School, analysed data from more than 2,000 US companies that received venture financing and found that about 30-40 percent of them fail, while more than 95 percent fail to generate the expected return on investment (WSJ, 2012). There is a misconception about success rates and returns on investment in start-ups (Shane, 2008) and the average individual is not aware of the risks.

The characteristics of crowdfunding can make investments in seed and early-stage companies even riskier. Information asymmetry problems common to seed and early-stage financing are exacerbated in equity crowdfunding. Below we describe some of the issues that might arise in each phase of the investment.

Selection and valuation

Before investing in a company, business angels and venture capitalists routinely perform due diligence to assess the potential value of the firm. This can be costly in terms of time and resources. However, evidence shows that due diligence is a major determinant in achieving returns on the investment (Wiltbanks and Boeker, 2007). This expense is often justified in light of the considerable size of such investments. Because their investments are relatively small, crowdinvestors have less incentive to perform due diligence. Moreover, individual investors have the possibility of free-riding on the investment decisions of others. This implies that the crowdfunding community may systematically underinvest in due diligence (Agrawal et al, 2013).

Crowdfunders also likely lack the expertise and skills to perform adequate due diligence. Since everyone is able to join, the crowd often includes non-professional investors, who do not have the knowledge or capabilities to properly estimate the value of a company.

Finally, company valuation performed by a crowd might be affected by social biases and herding behaviour5. Evidence suggests that a crowdfunder’s investment decision might be affected by those of the other investors (Agrawal et al, 2011; Kuppuswamy and Bayus, 2013). Moreover, different studies have found that both the crowd and entrepreneurs are typically initially overoptimistic about potential outcomes (Mollick, 2013b; Agrawal et al, 2013).


Equity crowdfunding often relies on standardised contracts that are provided by the portal. However, equity investment into seed and early-stage firms often requires tailored contracts to align the interests of the entrepreneur to those of the investor. For example, venture capital and business angels use various covenants in their contracts, such as anti-dilution provisions that protect against down-rounds6, tag-along rights7 that facilitate exit opportunities, and liquidation preferences that secure higher priority in the distribution of value (Hornuf and Schwienbacher, 2014a). Moreover, in order to reduce risk exposure and increase control over the entrepreneur’s behaviour, seed and early-stage investors often split their investments into tranches that are conditional on the attainment of defined milestones. All of these mechanisms are difficult to replicate in the crowdfunding setting.

Another strategy applied by venture capitalists and business angels is to invest in a portfolio of companies in order to diversify their risk. Equity crowdfunders might be able to replicate this strategy given that crowdfunding platforms expose them to a variety of projects. However, non-professional investors might not be aware of the importance of this strategy and could potentially concentrate all their investments in a single venture. For example, Seedrs statistics show that 41 percent of investors hold only one company in their portfolio (Seedrs, 2014).

Moreover, crowdfunders might not be able to participate in follow-on investment rounds. The failure to do so might mean that the investor’s shares get diluted, thus reducing their chances to attain a positive return from the investment.

Post-investment support and monitoring

As we have described, business angels and venture capitalists not only provide finance to start-ups, but are also actively involved in increasing the value of the company. While the crowd could potentially provide active support to the venture, there are reasons to believe that this support can be less valuable than that provided by traditional seed and early-stage financiers. Given their typical small level of investment, crowdfunders have less incentive to provide active support to the company because the return for their action is lower (Agrawal et al, 2013). However, if too many investors choose to become active, it could be excessively costly for a small firm to manage a crowd of investors that want to participate. This is particularly relevant considering that the venture has limited ability to select its crowdinvestors.

Moreover, high information asymmetry also characterises the post-investment phase, thus limiting the monitoring potential of the crowd. One of the elements contributing to the increase in information asymmetry is geographical distance between funders and the entrepreneur. While this characteristic enables backers to attain access to a wider pool of entrepreneurs (and visa-versa), it also entails higher monitoring costs. Literature suggests that distance increases the costs that an investor must bear in order to monitor the venture (Grote and Umber, 2007). This is in line with the observation that venture capital funds invest predominantly in firms close to them (Lerner, 1995).

Finally, the lack of repeated interactions reduces the potential of reputation as a mechanism to incentivise the entrepreneur to behave in line with the interests of the investor (Agrawal et al, 2013). In other online marketplaces, such as eBay, participants have a low incentive to misbehave because, if they do, they might, in effect, be prevented from participating in the market in the future because of the feedback and ratings mechanisms. Since sourcing equity finance through the internet is often a one-time event for an entrepreneur, the incentives for behaving correctly are lower, which can lead to potential fraud. More active crowdfunding platforms screen companies. However, not all platforms have the same standards.


The lack of adequate monitoring is particularly worrisome in a setting in which investments often take 5-10 years or more to produce a return, if any. Crowd investors might not appreciate that long periods are necessary for these investments to either succeed or fail, or that most of these investments are unlikely to yield any return. Moreover, equity investments are mostly long-term illiquid assets. Therefore, it is important that non-professional investors are adequately informed about the illiquid characteristics of this asset class.

For equity investments to provide a return to investors, a positive 'exit' must take place at some point. This can be through an initial public offering (IPO) or, as more often the case, through a merger or acquisition (M&A). Unfortunately, these positive exits became increasingly rare during the financial crisis. In Europe, EVCA data (2013) shows that only 15 percent of venture capital exits in 2012 (in terms of number of companies) were through trade sales, and even fewer, 5 percent, were IPOs. These numbers are clearly lower than pre-crisis (2007) figures that pointed to 22 percent of exits through trade sales and 8 percent through IPOs.

For angel investments and equity crowdfunding investments, the path to a positive exit can be longer and even less likely. IPOs and M&As do not happen by chance. Venture capitalists and the firms themselves often have an exit strategy in mind from the beginning and proactively work towards making it a reality over a long period (Wilson and Silva, 2013).

In conclusion, the lack of adequate pre-investment screening and due diligence, weaker investment contracts and poorer post-investment support and monitoring can make the risk associated with equity crowdfunding significantly higher than the risk usually borne by business angels and venture capitals. Moreover, while the potential for fraud is exacerbated in the equity crowdfunding setting, information asymmetry makes investments in the start-ups of even well-intentioned entrepreneurs riskier, since the competence of the entrepreneur and the quality of the business plan cannot be properly assessed.

While there are some successful equity crowdfunding cases (such as the biotech start-up Antabio8 in France, which succeeded in producing a positive return for its investors) and failure cases (such as the liquidation of betandsleep9 or sporTrade10 in Germany), the industry still lacks a sufficient track record to assess its ability to create value for both investors and entrepreneurs.

Crowdfunding platforms and the regulatory environment

The issues we have raised demonstrate the greater exposure that equity crowdfunding market has compared to other forms of seed and early-stage investment. In particular, adverse selection problems could increase the cost of capital up to the point at which only low-quality ventures will eventually choose to seek financing through crowdfunding, while high-quality ventures will continue to secure venture capital or angel investor financing (Agrawal et al, 2013). Competition between platforms and between the crowdfunding industry and traditional financing is pushing platforms to design innovative solutions to avoid the unintended consequence of creating a ‘market for lemons’.

Overall, the main limitation of equity crowdfunding is that it allows a non-professional investor, who might lack the incentive and/or capabilities to adequately assess and monitor a start-up, to make an investment. Efforts to address this limitation to date have included the introduction of an intermediary between the crowd and the company that is able to perform these tasks, or the reduction of the crowd to only qualified investors.

The first approach involves the provision of an active intermediary that could act as a representative of the interests of the crowd in performing due diligence and monitoring start-ups. Following this trend, many platforms are active in performing due diligence, while others operate a nominee and management system in which they represent the interests of investors with the crowdfunded business (eg Seedrs). Another example is provided by platforms such as MyMicroInvest in Belgium, which allows investors to co-invest with an experienced business angel. In this case, the crowd benefits from the financial contracting skills and from the post-investment monitoring of an experienced active investor. While this approach provides some benefits, it also entails some risks: by leveraging the investment decisions of a business angel, this mechanism may increase the risk propensity of the angel, thus biasing his or her investment decisions.

A second approach is to reduce the crowd, by limiting the investment to a restricted group of people, possibly accredited investors, each contributing more capital than the average crowd investor. In this case, crowdinvesting would more closely resemble angel investor groups than the typical crowdfunding model. Examples of this model are CircleUp and FundersClub in the US or Seedups based in Ireland, whose offers are restricted to accredited investors. Other examples are platforms that impose high investment minimums, thus reducing the crowd to a few investors. Finally, some platforms (such as Seedrs and Crowdcube in the UK) require crowdinvestors to pass a test before investing in a company, to certify that they are sufficiently aware of the investment risk.

The efficacy of these measures needs to be evaluated and appropriate policies should take into account these assessments. Moreover, while the market gives incentives to platforms to adopt the best practice, some platforms could deviate from the best practices because of lack of long-term vision, incompetence or other hidden interests (Griffin, 2012). The financial crisis showed that leaving the financial market to self-regulate can be costly. Many of these crowdinvestors could lose their money before the market has time to self-correct and force out inadequate platform models.

Crowdfunding platforms have an incentive to build a good reputation by securing attractive deals for their crowds, since in the long run reputation results in market-share gains. Apart from this reputational incentive, platforms differ in the structure of fees they derive from the deals. As described in section 2, most of the platforms derive revenues as a percentage of the amount raised, while only a few (eg Seedrs) derive monetary benefit from a successful exit by imposing a fee as a percentage of investor’s profits. This typical fee structure implies that platforms derive monetary incentive to close deals while there are only reputational incentives to provide successful deals in the long run. If long-run reputational incentives are lower than short-term monetary incentives, conflicts of interest could arise and platforms might downplay investment risk to the crowd in order to secure deals. In light of this potential conflict of interest, a supervisory body for crowdfunding platforms is probably desirable.

From a legal standpoint, equity crowdfunding is currently possible in some jurisdictions by exploiting exemptions to existing securities regulations (Hornuf and Schwienbacher, 2014b). Securities laws generally require an issuer to register with the national securities authority and to comply with strict reporting standards in order to gain access to the general public. These requirements are prohibitively expensive for small firms, which are the typical beneficiaries of crowdfunding.

In the EU, exemptions as defined in national regulations pertaining to prospectus and registration requirements, allow start-ups to gain access to the general public through equity crowdfunding (Hornuf and Schwienbacher, 2014b). Exemptions include the maximum amount that can be offered to the public, the maximum number of investors to whom the offer is made, the minimum contribution imposed on investors and whether the offer is made to ‘qualified’ or ‘accredited’ investors. While these exemptions to existing securities legislation allow small firms access to the general public for financing, they also imply weaker protections for investors.

EU member states have adopted different practices on whether the equity crowdfunding platform must register as an investment intermediary or obtain a bank license. For example, in Germany, crowdinvesting platforms explicitly stating that they do not provide any investment advice or brokerage service have no obligation to provide any documentation in terms of advisory records or to act in the interest of the investor (Dapp and Laskawi, 2014). As a result, most German platforms are not registered as investment intermediaries (ECN, 2013). In the UK, platforms are regulated by the Financial Conduct Authority (FCA) (ECN, 2013; Hornuf and Schwienbacher, 2014b). In France, equity crowdfunding platforms such as Wiseed, Anaxago, Finance Utile and SmartAngels are registered as financial investment advisers, since their activities consist of advice in providing financing (ECN, 2013; Hornuf and Schwienbacher, 2014b).

Finally, national corporate laws can also have an effect on equity crowdfunding (De Buysere et al, 2012; Hornuf and Schwienbacher, 2014b). For example, because they are relatively inexpensive in most countries, closely held company types (eg private limited liabilities companies) are the typical entity type chosen by start-ups. However, in many countries these company types have limitations or might be prohibited from offering equity to new investors. Even when allowed, equity transactions for these kinds of companies often require formalities, such as notarial intervention, which increases the costs for start-ups.

Despite the harmonising role played by Directive 2010/73/EU (Box 1), the EU remains a patchwork of different regulations. This lack of uniformity inhibits the development of a pan-European industry by making cross-border deals more difficult, and highlights the lack of consensus on whether equity crowdfunding could be welfare-enhancing or not.

Considerations for policymakers

Crowdfunding can be an additional tool for providing seed and early-stage equity finance to new ventures. However, policymakers should proceed with caution by carefully assessing the risks of this new financial intermediation tool. We argue that the challenges that equity crowdfunding poses are distinct and more complex than those posed by other forms of crowdfunding. As we have outlined, the risks also differ from other forms of seed and early-stage equity finance, such as angel investing and venture capital. Equity crowdfunding can open up additional channels for new ventures to access finance at a time when securing funding is difficult, but the risks, including those related to investor protection, need to be addressed.

These risks could result from potential fraudulent activities of start-ups or platforms or, more likely, poor investment decisions made by unsophisticated investors. The current legal framework mainly addresses this issue by reducing the exposure that individual investors can have to riskier assets. The goal is to make sure that the investor is able to bear a potential loss. However, as the equity crowdfunding volumes continue to grow, this solution does not prevent the potential loss of significant amounts of capital.

Overall, the legal framework should not allow a crowd of investors, who might lack the incentive and/or the expertise to invest in a start-up, to do so without adequate intermediation and protection. If the crowd is made up of non-qualified investors, we argue that there should be at least one participant that legally represents the interest of the crowd in the investment in a business. This participant could be the crowdfunding platform. The crowd could also be allowed to co-invest alongside professional investors. However, also in this case, the platform should take significant steps to protect the interests of the crowd from the misbehaviour of other investors. Finally, in order to monitor potential conflicts of interest of platforms, supervision by national security authorities is important.

Crowdfunding currently is a highly deregulated market with little legal protection provided to funders. In the EU, some member states have introduced ad-hoc legislation for crowdfunding, while some others will introduce new laws soon. The European Commission is currently studying equity crowdfunding, along with the other forms of crowdfunding, to assess its risks and opportunities. In this regard, the Commission started a public consultation late in 2013 and published a Communication in March 2014 (EC, 2014). At this stage, the Commission’s efforts are focused on increasing awareness of the opportunities and risks of crowdfunding, spreading best practice and improving the general understanding of this growing phenomenon. The Commission is also exploring the potential of a ‘quality label’ to spread good practice and build user confidence.

Being based online, equity crowdfunding has the potential to contribute to a pan-European seed and early-stage financial market to support European start-ups. However, in order to maximise this benefit, harmonised policies to address equity crowdfunding models should be adopted in common by all member states. This approach would maximise the benefits of equity crowdfunding and help to reduce the risks. We urge the Commission to work with member states to address the current patchwork of national legal frameworks, which constitute an obstacle to the development of this nascent model of funding across Europe.

Finally, legislators should take a holistic approach in assessing the regulatory burden on the industry. Corporate law in many countries imposes limitations or prohibits closely held company types – the typical legal form chosen by start-ups – from selling equity to new investors. These provisions are another significant obstacle to the development of equity crowdfunding. Corporate laws should be harmonised and should take into account this new financing channel for start-ups. In addition, other financial regulations which might interact with and have an impact on the market should be assessed.

In conclusion, all types of crowdfunding can provide significant and new sources of funding for many types of organisations, ranging from charities to companies. Equity crowdfunding, however, is more complex and requires the proper checks and balances if it is to provide a viable channel for financial intermediation in the seed and early-stage market in Europe.


1. Nevertheless, this distribution might not reflect simply the investment preferences of the crowd. Legal constraints currently provide upper limits to the capital that can be raised from nonqualified investors. See section 4.

2. Seedrs is an equity crowdfunding platform based in the United Kingdom. It allows users to invest as little as £10 into the start-ups. In the first 18 months since its launch in July 2012, Seedrs collected more than €6.8 million through 56 funded campaigns and counted more than 29,000 users.

3. In particular, the Seed Enterprise Investment Scheme (SEIS) launched by the UK government in April 2012.


Improving the role of equity crowdfunding in Europe's capital markets (English)
Fri, 29 Aug 2014 07:44:28 +0100
<![CDATA[Healthcare Systems and Ageing Populations]]> http://www.bruegel.org/nc/events/event-detail/event/456-healthcare-systems-and-ageing-populations/ even456

The ageing of populations is the most influential factor of healthcare system design. In Japan, 25% of the total population in 2013 was aged 65 years or older and the government population agency predicts that the proportion of this age cohort will rise to 30% and 39% in 2025 and 2050, respectively. A key concept of healthcare reform in Japan is “integration” in terms of both healthcare delivery system and healthcare finance system. There are, however, high political barriers.

Europe is facing similar issues in terms of an ageing population and the implications for healthcare systems. Europe has the added challenge of balancing EU and Member State responsibilities in terms of the economic and social imperatives in healthcare.

This event aims to shed light on the nexus of aging population and the sustainability and efficacy of healthcare systems. It will explore the funding and healthcare delivery systems in Japan and Europe, highlighting some of the lessons learned from Japan and their possible implications for Europe.


  • Yukihiro Matsuyama, Research Director, The Canon Institute for Global Studies, Japan
  • Richard Torbett, Chief Economist at EFPIA, Brussels
  • Andrzej Rys, Director of Health Systems and Products, DG SANCO, European Commission, Brussels
  • Sang Woo (SW) Kim, President, Corporate Affairs Europe, Samsung
  • Petra Keil, Head of Global Public Policy, Novartis
  • Chair: Karen Wilson, Senior Fellow at Bruegel

About the speakers

Yukihiro Matsuyama, PhD, is Research Director, the Canon Institute for Global Studies, Appointed Professor, International University of Health and Welfare, Visiting Professor, the Center for Clinical Governance Research, Faculty of Medicines, University of New South Wales, Australia. His research examines the sustainability of safety-net systems in Japan including healthcare, pension, pandemic crisis and employment through international comparison analysis.

Richard Torbett is Chief Economist at EFPIA. He is responsible for strategy as well as economic analysis and EFPIA’s relations with international economic institutions, including the Troika and the OECD. Richard’s current work focuses on the relationship between Health and Economic Growth. Richard joined EFPIA in August 2012 having spent the previous six years at Pfizer Inc., most recently as Senior Director and Head of International Affairs. During his time at Pfizer Richard led the policy development work in developed countries outside the US. He also represented the company and wider pharmaceutical industry with a range of governments and international institutions. Prior to joining the pharmaceutical industry, Richard worked as a government economist. He was a Senior Economist at the Department of Trade and Industry (DTI) in the UK. As a Government official, he held a number of posts at DTI, Cabinet Office and the European Commission. Richard has degrees in economics from the University of Sussex and the University of Grenoble. He completed his PhD at the Science Policy Research Unit (SPRU), University of Sussex in 2001. He is Visiting Professor at the IMT Institute for Advanced Studies, Lucca.

Andrzej Ryś, Health Systems and Products Director, Health and Consumers DG, European Commission.

Medical doctor specialized in radiology and public health and graduated from Jagiellonian University, Krakow (PL). 1991: established School of Public Health at the Jagiellonian University. SPH's director till 1997. 1997-1999: director of Krakow’s city health department. 1999-2002: deputy Minister of Health in Poland. Member of the Polish accession negotiators team. 2003: established and ran as a director, the Center for Innovation and Technology Transfer at Jagiellonian University. 2006: joined the European Commission as the Director for Public Health and Risk Assessment in the Directorate-General for Health and Consumers in Luxembourg. 2011: appointed Director for Health Systems and Products in the Directorate-General for Health and Consumers in Brussels.

SW Kim is President Europe, Corporate Affairs, of Samsung Electronics Europe. He was formally head of global compliance at Samsung Electronics headquarters in Seoul. He trained as a lawyer and was between 1992-2005 Public Prosecutor in the Korean Ministry of Justice. SW Kim graduated in Law from Seoul National University before taking Visiting Scholarships at Stanford and Duke Law Schools and attending Columbia Law School.

Petra Keil is the Head of Global Public Policy for Novartis. She started her career as a scientist in basic medical research at the Universities of Munich and Freiburg, Germany. From 1995-1998 she worked for The Boston Consulting Company in Zurich, Switzerland focusing on Health Care. In 1999 she joined Pfizer in Groton, Connecticut first in a strategic role in the R&D division and later moved on to become the Global Head of Strategic Planning for Pfizer Pharmaceutical, located at the Pfizer HQ in Manhattan. Since 2006 she is working for Novartis in Basel. First as the Head of Central Development Operation and starting in 2007 as the Head of Global Public Policy for Novartis, touching on all relevant issues of the Pharma industry across all Novartis divisions. Topics range from R&D policy over Payment policy to Corporate Social Responsibility.

She holds a masters in Theoretical Medicine, a PhD in Cell Biology and an MBA from INSEAD

Practical details

  • Venue: Bruegel, Rue de la Charité 33, 1210 Brussels
  • Time: Tuesday, 23 September 2014, 12.00-13.30. A light lunch will be served until 14:00 to provide time for further discussion and networking.
  • Contact: Matilda Sevón, Events Manager - registrations@bruegel.org

Thu, 28 Aug 2014 14:47:54 +0100
<![CDATA[Fact: Dim Sum bonds are not coming to rescue Russia's banks]]> http://www.bruegel.org/nc/blog/detail/article/1421-fact-dim-sum-bonds-are-not-coming-to-rescue-russias-banks/ blog1421

The imposition of joint US-EU sanctions meant a significant number of investment opportunities for both Russian companies and banks disappeared. Despite Russian efforts, it seems Asian markets will not provide a quick fix, as yields on yuan-denominated bonds issued by Russian entities have been increasing after the sanctions.

China and Russia are getting increasingly closer economically and financially. China matters more and more in Russia’s export and Russia reached a $400 billion agreement in May 2014 to supply natural gas to China through a new pipeline over 30 years. Bloomberg reports the ruble-yuan currency pair reached a record 3.8 billion rubles in trading volume ($105 million) on July 31st 2014.

As the US and the EU imposed new sanctions this summer, Russian companies and banks were therefore prompted - being traditionally reliant on dollar-denominated syndicated loans - to look to China for a financial escape route.

Dim sum is the name used to indicate bonds denominated in Chinese yuan and issued in Hong Kong, attractive to foreign investors who wish to get into yuan-denominated assets, but are restricted by China's capital controls from investing in domestic Chinese debt. The issuers of dim sum bonds are largely entities based in China or Hong Kong, and occasionally foreign companies. Dim sum bonds issuance has been going a bit up and down during 2012 and 2013, probably due in part to concerns about the Chinese economy (Figure 1 from WSJ).

Russian companies are not new to the renminbi market and Dim Sum bonds issuance. In early 2013, Russian banks – including JSC VTB Bank, Russian Agricultural Bank OAO and Russian Standard Bank ZA– had already raised $482m, compared to $477m by Chinese companies and compared to the just $309 million issued over the previous three years (Figure 2 from FT).

These developments seem to have been mostly demand driven. Comments reported in the FT and the WSJ suggest that investors are keen to buy these bonds because being issued by state-backed Russian banks they offer an attractive yield and exposure to the Chinese currency while having a lower risk profile than many of the local issuers. For Russian banks themselves, dim sum bonds represented a significantly cheaper source of funding. Russian Agricultural Bank for example issued in 2013 a three-year dim sum bond with a yield of 3.6 per cent, compared to a comparable (slightly longer maturity) dollar bond, that paid a  coupon of 5.3 per cent.

In the immediate aftermath of sanctions, therefore, a question was whether Asia’s capital markets could serve as an easy funding alternative for Russian companies frozen out of the US and Europe.

It looks like this is not going to be so easy. Yields on Russian corporate bonds denominated in yuan have been rising after the sanctions (IFR Asia). The yield on VTB’s 4.5% October 2015 offshore renminbi bonds rose to around 6% in end of July from less than 4% on July 24, while Russian Agricultural Bank’s 3.6% February 2016s were quoted at between 5% and 6.6%, up from 4.67% on July 16. Both banks were added to the list of those subject to US sanctions last week. The yield on Gazprombank’s 4.25% January 2017 Dim Sum bonds rose to 6.5%  from 5.01% on July 16, the day Gazprombank was hit with US sanctions.

These data suggest that Asian investors may be  becoming increasingly wary of credits from Russia and worried of the impact of sanctions, even if they are not directly involved. And the dim sum way around western sanctions may prove harder than expected.

Thu, 28 Aug 2014 08:12:39 +0100
<![CDATA[Chart: Sharp decline in intra-EU trade over the past 4 years]]> http://www.bruegel.org/nc/blog/detail/article/1420-chart-sharp-decline-in-intra-eu-trade-over-the-past-4-years/ blog1420


Source: Bruegel based on IMF data (Direction of Trade Statistics database).

Note: The above figure shows intra-EU and intra-Eurozone shares of export on total export of the two groups respectively. Each of the two lines were constructed taking into account the changing composition of the European Union and the Euro Area over time, meaning that a given country is included in the series only by the time it joined the EU or the Euro. However, further calculations shows results do not change dramatically if considering a fixed group of countries in either series.

The share of the intra-EU export of the EU total export experienced a steady rise since the early 80’. In fact, the rise was up to 8 percentage points in that period. However, after stagnating from the mid-90’s until the end of the 2000’s, intra-EU saw a sharp downward trajectory in the last four years, implying global trading partners have become and are becoming more important. Interestingly, the data also show that the Euro Area has been following nearly the exact same pattern as the European Union as a whole, suggesting the common currency might not have had the expected effect on trade between Euro Area members.

Wed, 27 Aug 2014 13:18:25 +0100
<![CDATA[Modi has promises to keep]]> http://www.bruegel.org/nc/blog/detail/article/1419-modi-has-promises-to-keep/ blog1419

This opinion was published by the Business Standard.

The roar of Narendra Modi's sweeping election victory and its narrative of radical change set up high expectations. Soon, however, came the whimper. The proposal of a modest rise in rail fares was quickly pulled back. And the appeasement of the Maharashtra sugar lobby deepened long-standing inefficiencies and inequities. At first, the mood was to dismiss these in the hope of a radical Budget. But the straws in the wind proved reliable guides: Finance Minister Arun Jaitley lost his nerve.

Is radical change really underway but perhaps artfully hidden from the public? Is the government biding its time, first wooing voters with goodies in the coming state elections and then launching into a new era of transformative governance?
Modi offered a focal point for the collective disgust and increasingly frustrated public aspirations. He had an apparently credible storyline around the Gujarat experience and the image of a tough leader. And he fed the fantasy of a saviour. He will, most likely, undo the most egregious failings of the United Progressive Alliance administration, and the stalled economy should show some life.

But transformative change will remain elusive. The business-as-usual economic policy, with which this government has begun, should have been expected. For about a century, a motley group of lower middle class voters has steered Indian politics. Since independence, meeting their insistent livelihood demands has been the prime objective of every political party and government. The Bharatiya Janata Party (BJP) attentively wooed this coalition with finely-tailored promises and remains anxious to hold on to this constituency in the forthcoming state elections. India's central political dynamic remains intact.

In his autobiography, Jawaharlal Nehru reflected that the political base of the Indian National Congress - and, hence, of the freedom movement - was the petite bourgeoisie, the lower middle classes. Picking up on Nehru's theme after independence, K N Raj, the diminutive but intellectually-towering economist and political thinker, argued that the lower middle classes had remained India's central political constituency. They defined, he said, the country's governing coalition, an "intermediate regime."

The "intermediate regime" is a heterogeneous patchwork of claimants, including salaried workers, farmers and small entrepreneurs. They earn enough to get by and because they have established property rights - and enjoy government largesse - they have a stake in the system. But they live under a basic insecurity that their livelihoods may be easily compromised and eroded.

Raj's claim was that political success in India required harnessing this "intermediate" coalition of interests. The formal coalition may require multiple parties or be absorbed in single party (as in the Congress in its dominant years and the BJP in its latest election). But although the characters in Delhi inevitably change, all governments must cater to the demands of the "intermediate" regime - not least because members of every party are drawn from the same milieu. Hence, indispensable policy continuity is built into the political process.

While the poor are important to the rhetoric and receive some sops, their aspirational benchmarks remain those of the lower middle classes, who, therefore, remain salient in framing the policy dialogue. The political equilibrium is reached by granting generous rents to the rich.

Today, the heterogeneous "intermediate" group is more extensive, better off, more educated and more politically active. Indeed, with progress in reducing the number below the poverty line, the ranks of the "intermediate" class have swelled.

Between 2009 and 2014, the BJP and Congress essentially swapped vote shares: the BJP's share rose from 19 to 31 per cent between 2009 and 2014, while Congress' share fell from 29 to 19 per cent. Roughly 50 per cent voted for regional parties in both elections. The electorate may well have sought major changes in how the government functions, but it is not yet ready to give up on the blend of consumer subsidies, income-support programmes and the coddling of agricultural interests.

For any political party, the political calculation is simple. Is it possible to inflict short-term pain on the "intermediate" groups with the promise of acchey din, better days? The narrow electoral arithmetic dictates the answer. Because acchey din are uncertain and, in the meantime, no lobby can be left behind, the goodies cannot be taken away.

Technocratic cheerleaders of the new government are dismayed. India's threat to disrupt the World Trade Organisation (WTO) unless subsidies to farmers are allowed, leads the distinguished economist Surjit Bhalla to lament, "Why, in the name of god and India, is Modi-BJP pursuing an illogical and regressive stance at the WTO?" The government's WTO position should not be any more surprising than its pandering to Mumbai's urban commuters, Maharashtra's sugar lobby or kerosene consumers.

The accommodation with Indian business interests has been achieved through the entrenchment of a rentier class. Then, it was industrial licences and protection through high import tariffs. Now, it is the award of rights to land, natural resources and government contracts. The new rent-seeking is more distasteful and corrosive. With inherited wealth increasingly concentrated in a few families, the new maharajas - and their acolytes - show contempt for public norms and distaste for productive enterprise.

The Jaitley Budget had three telltale signs of political continuity. First, the government plans to hold on to the nationalised banks. Put simply, there is no economic reason for them today - if ever there was one. All social objectives can be met through more efficient and equitable means. Nationalised banks persist because they are a source of fiscal largesse to political constituents. The banks are especially desirable because the financial favours can be doled out without public scrutiny. Eventually, the unaccounted losses on account of waivers and non-performing loans appear as claims on the central government's Budget for bank recapitalisation.

Second, all are agreed that the public-private partnership (PPP) model of infrastructure construction has failed to deliver, even as it has spawned wanton corruption. But PPPs are another avenue to feed the rentier class, while claiming that other financing options are largely closed. Third, the BJP, which voted for MGNREGA, cannot now dismantle it. Perhaps, the programme's productivity can be improved, but the political "leakages" will remain endemic.

The nod to aspirational India comes in the promise of "smart" cities, high-speed trains and linking of India's river systems. This over-the-top promise is either a cynical ploy or a serious disconnect with reality. While China remains the elusive model for such grand ventures, its example of low-cost housing for hundreds of millions and clean toilets does not have a political constituency.

What is missing is a coherent programme for growth. Today, more so than ever, the one variable that will determine long-term growth prospects is the quality of education. The achievements remain dismal. In a fiercely competitive global system, as the Red Queen may have said to Alice, we must run faster to stay in the same place. But are we willing to learn from China's example in the provision of world-class primary and secondary education?

The absence of a transformative agenda is a calculated accommodation to India's political economy. Modi brilliantly channelled the cry for change into an electoral platform. But the government has neither the mental model nor the political courage to effect real change. As so often, political and bureaucratic elites have made promises to the Indian electorate that they cannot keep. Acchey din may be a long way off.

Wed, 27 Aug 2014 07:15:57 +0100
<![CDATA[Asia and Europe’s challenges for the autumn: A macroeconomic and financial perspective]]> http://www.bruegel.org/nc/events/event-detail/event/455-asia-and-europes-challenges-for-the-autumn-a-macroeconomic-and-financial-perspective/ even455

Side-event to the 11th ASEM Finance Ministers Meeting, Milan, Italy

Growth remains sluggish in Europe and increasingly is beginning to slow down cross emerging markets in Asia. This roundtable of leading economists will examine this issue by looking at the key factors that are likely to shape the evolution of Asian and European economies in the forthcoming months. Key issues that will be addressed include the effectiveness of monetary expansion in Asia and Europe as well as possible spillover effects of the US Federal Reserve’s tapering; the importance of the macro-financial links and the role of fiscal policy in European and Asian perspectives; the effectiveness of the new institutional framework developed in the context of the European Banking Union as well as the impact of the ECB’s comprehensive assessment; and the role of global demand factors and of investment in fostering sustainable growth.

Programme download

10:00: Introductory remarks by Ambassador ZHANG Yan, Executive Director, Asia-Europe Foundation

10:15: Presentation of the panel by Moderator Mr. Guntram WOLFF, Director, Bruegel

Discussion with

Dr. Alan AHEARNE – Head of Economics at the National University of Ireland, Galway and External Advisor to the Strategy, Practice and Review Department of the International Monetary Fund

Dr. FAN Gang – Director, National Economic Research Institute and Secretary-General of China Reform Foundation

Mr. Carlo MONTICELLI – Director General for International and Financial Relations, Treasury Department, Ministry of Economy and Finance Italy

Dr. André SAPIR – Professor of Economics at Université Libre de Bruxelles and former Economic advisor to the president of the European Commission

12:00: Buffet lunch offered by the Asia-Europe Foundation (ASEF) to all attendees


by email at registrations@bruegel.org


Alan Ahearne is Professor and Head of Economics at the National University of Ireland, Galway. He is currently Adviser to the Strategy, Practice and Review Department of the IMF, and a Member of the Commission (Board of Directors) of the Central Bank of Ireland. He has been a research fellow at Bruegel since 2005. He served as Special Adviser to Ireland’s former Minister for Finance Brian Lenihan from 2009 to 2011. In this role, he advised the Minister on economic, budgetary and financial policy in responding to the economic and financial crisis. Alan obtained his PhD from Carnegie Mellon University (in Pittsburgh) in 1998 and subsequently joined the Federal Reserve Board in Washington DC, where he worked for seven years as a Senior Economist. At the Fed, he advised Alan Greenspan, Ben Bernanke and other Fed Governors on developments in the global economy. He was the principal economist at the Fed covering the Japanese and Chinese economies.

Fan Gang is chairman of China Reform Foundation and Director of the National Economic Research Institute. He is also Professor of Economics at Peking University and the Graduate School of Chinese Academy of Social Sciences. He is also an advisor to various departments of Chinese Central government and provincial governments; was independent member of China Monetary Policy Committee during 2006-2010; guest professor of number of universities and graduate schools; and served as economic consultant to various international organizations and played leading roles in research projects commissioned by The World Bank, ADB, UNDP, OECD, etc. PhD in economics, he received Docteur Honoris Causa (Honorary Doctor) from University of Auvergne, France, and Royal Road University of Canada, in 2004 and 2011 respectively, and was listed as one of “World’s Top 100 Public Intellectuals” jointly by Foreign Policy and Prospect, in 2005 and 2008 consecutively and listed as one of “100 Global Thinkers” by Foreign Policy in 2010.

Carlo Monticelli is Head of International Financial Relations in the Italian Ministry of the Economy and Finance.
His responsibilities include analysis of economic, financial and institutional matters, the preparation of Ministerial international meetings like Eurogroup-Ecofin, G7, GB, G20 as well as the participation to formal and informal groups and committees. He is Alternate Governor for Italy in the World Bank, in the Asian Development Bank and in the African Development Bank. He is also Member of the Board of Directors in the EIB.
He has contributed to develop the Advance Market Commitment for Vaccines pilot project on pneumococcal disease, successfully completed with joining and support of international donors and partners. Until 2002, he was for long attending to economic research and policy analysis, particularly in Monetary and in International Financial sectors, as Deputy Director in the Research Departments of Bank of Italy and, successively, as Head of European Economy - Global Markets Research of the Deutsche Bank in London.
His activities still include presentations at many conferences and workshops of international relevance, as well as teaching in post-graduate courses. He has contributed several articles to academic journals.

André Sapir is Senior Fellow of Bruegel and Professor at the Solvay Brussels School of Economics and Management, Université Libre de Bruxelles. He is Vice-Chair of the Advisory Scientific Committee and voting member of the General Board of the European Systemic Risk Board (ESRB). From 2005 to 2009 he was member of the Economic Advisory Group to European Commission President José Manuel Barroso. Previously, he worked 12 years for the European Commission, first serving as Economic Advisor to the Director-General for Economic and Financial Affairs, then as Economic Advisor to President Romano Prodi. André Sapir has written extensively on various aspects of Europe’s Economic and Monetary Union, including banking, as well as on international policy coordination, international trade and globalisation. He received a PhD in Economics from The Johns Hopkins University in Baltimore, USA. He was elected Member of the Academia Europaea in 2010 and of the Royal Academy of Belgium for Science and the Arts in 2012.

Guntram Wolff is the Director of Bruegel since June 2013. His research focuses on the European economy and governance, on fiscal and monetary policy and global finance. He regularily testifies to the European Finance Ministers' ECOFIN meeting, the European Parliament, the German Parliament and the French Parliament and is a member of the French prime minister's Conseil d'Analyse Economique. He joined Bruegel from the European Commission, where he worked on the macroeconomics of the euro area and the reform of euro area governance. Prior to joining the Commission, he was coordinating the research team on fiscal policy at Deutsche Bundesbank. He also worked as an adviser to the International Monetary Fund. He holds a PhD from the University of Bonn, studied economics in Bonn, Toulouse, Pittsburgh and Passau and previously taught economics at the University of Pittsburgh and at Université libre de Bruxelles.

Practical details

  • Venue: Meliá Milano Hotel, Via Masaccio, 19, 20149 Milan
  • Time: 10.00-12.00, 12 September 2014
  • Contact: Matilda Sevón Events Manager at Bruegel - registrations@bruegel.org

Organised jointly with Asia-Europe Foundation and the Italian Presidency of the EU Council

Mon, 25 Aug 2014 15:06:33 +0100
<![CDATA[Blogs review: Is this a European U-turn?]]> http://www.bruegel.org/nc/blog/detail/article/1418-blogs-review-is-this-a-european-u-turn/ blog1418

What’s at stake: Speaking at the Federal Reserve Bank of Kansas City's annual conference Jackson Hole, Wyo., ECB President Mario Draghi made an important speech recognizing that the recovery in the euro area remains uniformly weak and that the euro area fiscal stance was not helping the ECB do its job. Interestingly, French leaders also reintroduced over the weekend the notion of aggregate demand, a concept they had noticeably moved away from with the “Pacte de responsabilite”.

The qualification of the European economic outlook

Joe Weisenthal writes that Draghi’s speech is significant because it acknowledges that the eurozone is in a massive ongoing crisis. Only two weeks ago, ECB President Draghi still considered that “the available information remain[ed] consistent with our assessment of a continued moderate and uneven recovery of the euro area economy”. This time, Draghi described that the “the most recent GDP data confirm[ed] that the recovery in the euro area remains uniformly weak, with subdued wage growth even in non-stressed countries suggesting lackluster demand.”

Greg Ip writes that Mario Draghi sounded strangely dismissive of price development concerns after his last press conference. He noted that excluding food and energy inflation was 0.8%, and argued that the decline in inflation expectations was all in the short term, whereas “long-term expectations remain anchored at 2%.” At his speech on Friday in Jackson Hole, his tone was much less sanguine. Inflation, he noted, has been on a downward path from around 2.5% in the summer of 2012 to 0.4% most recently. Departing from his prepared text, he said, if “low inflation were to last a long period of time, risks to price stability would increase.” He said inflation expectations had experienced a “significant decline at the long horizon,” by 15 basis points (five-year inflation starting in five years’ time). “If we go to shorter and medium term horizons,” the declines “are even more significant.

Joe Weisenthal reports that Citi's top economist, Willem Buiter, expects monetary policies to widely diverge as both the Bank of Japan and the European Central Bank would engage in "major" quantitative easing programs later this year or early next year. This is because their economies are flagging, particularly in Europe, where inflation expectations are collapsing. On the flipside, the Fed and the Bank of England are both expected to begin the normalization process (rate hikes) fairly soon (sometime next year). In its daily email, Sober Look writes that the euro’s decline accelerated on Sunday evening, as Jackson Hole discussions solidified the expectations of diverging monetary policies between the US and the Eurozone.

The departure from previous fiscal policies

Brian Blackstone writes that ECB President Mario Draghi on Friday signaled a departure from the austerity-focused mind-set that has dominated economic policy-making in the euro zone since the onset of the region's debt crisis nearly five years ago. Mario Draghi writes that “since 2010 the euro area has suffered from fiscal policy being less available and effective, especially compared with other large advanced economies […] it would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this, while taking into account our specific initial conditions and legal constraints.“

Simon Wren-Lewis writes that to understand the significance of Draghi’s speech, it is crucial to know the background. The ECB has appeared to be in the past a center of what Paul De Grauwe calls balanced-budget fundamentalism. Traditionally ECB briefings would not be complete without a ritual call for governments to undertake structural reforms and to continue with fiscal consolidation. The big news is that Draghi does not (at least now) believe in balanced-budget fundamentalism. Instead this speech follows the line taken by Ben Bernanke, who made public his view that fiscal consolidation in the US was not helping the Fed do its job.

Simon Wren-Lewis writes that we should celebrate the fact that Draghi is now changing the ECB’s tune, and calling for fiscal expansion because it may begin to break the hold of balanced-budget fundamentalism on the rest of the policy making elite in the Eurozone. But Draghi is only talking about flexibility within the Stability and Growth Pact rules, and these rules are the big problem. Paul Krugman writes that even if Draghi gets the situation, the combination of the euro’s structure and the intransigence of the austerians means that the situation remains very grim.

Richard Portes and Philippe Weil write European citizens must hope that their policy makers will recognize that the acute, pressing problem is aggregate demand. Repairing the credit system, implementing serious reforms of state expenditure and taxation, creating more flexible labor markets, finally opening the services market to cross-border competition – all are indeed very important. But they will not liberate the eurozone from stagnation.

France and Jean-Baptiste Say

There has also been a striking change in the language used by French President Francois Hollande over the weekend. A few months ago, Francois was re-named Jean-Baptiste Hollande in the blogosphere for reviving the “supply creates demand” fairy as he embraced the view of his compatriot Jean-Baptiste Say that to boost growth one needs only to care about creating optimal condition for production and supply, and that demand will follow.

In his recent interview with Le Monde, Francois Hollande appeared to rebalance his approach saying that Europe faced a clear lack of demand (“le diagnostic est implacable: il y a un problème de demande dans toute l'Europe”). He suggested that Europe should support overall demand while national policy should mostly remained focus on supply side policies. Meanwhile, Arnaud Montebourg, the economy minister, shortly joined by Benoit Hamon, the Education minister went further and called for a new policy direction, also at the national level, arguing that the fiscal consolidation path needed to be adjusted substantially and that France shouldn’t accept the economic choices and ideological preferences of the German CDU. 

Mon, 25 Aug 2014 07:35:08 +0100
<![CDATA[Economic curriculum reform: why do we need it?]]> http://www.bruegel.org/nc/blog/detail/article/1417-economic-curriculum-reform-why-do-we-need-it/ blog1417


A student learns a paradigm to become a member of a particular scientific community. As he graduates, he “joins men who learned the bases of their field from the same concrete models, his subsequent practice will seldom evoke overt disagreement over fundamentals.

- Thomas Kuhn, The Structure of Scientific Revolutions

The economic curriculum reform has been a burgeoning topic of debate in academic and policy circles 2008

The economic curriculum reform has been a burgeoning topic of debate in academic and policy circles since the global financial crisis erupted in 2008. High-level policymakers and student groups from numerous universities around the world are pushing for a curriculum reform to bring the so called “dismal science” closer to the real world and introduce pluralism into its educational system.

A single dominating paradigm in economics

One of the most controversial aspects of the current economics curriculum is that it focuses almost exclusively on mainstream economics - both Neoclassical and New Keynesian. The International Student Initiative for Pluralism in Economics’ (ISIPE) state that:

Such uniformity is unheard of in other fields; nobody would take seriously a degree program in psychology that focuses only on Freudianism, or a politics program that focuses only on state socialism. An inclusive and comprehensive economics education should promote balanced exposure to a variety of theoretical perspectives...

The report Economics, Education and Unlearning by the Post-Crash Economic Society heavily criticises what they call the “monoculture” of mainstream or orthodox economics at the University of Manchester, which they claim is a generalised problem in UK universities:

Monoculture makes it easier for professors to believe that their way is the only way to do economics

This monoculture also makes it easier for professors to believe that their way is the only way to do economics or at least that it is the only valid way which in turn justifies its status as the only kind of economics taught at our university. Many of our lecturers sincerely believe that the economic paradigm their methods represent is the only legitimate way of doing economics…

It is no accident that economics is dominated by a single paradigm: applying Kuhn’s theory

Economics is a monoculture discipline because it is an established normal science, while other social sciences are still pre-paradigmatic.

Following the historic evolution of natural sciences, Thomas Kuhn describes in his Structure of Scientific Revolutions how science evolves from a ‘pre-paradigm period’ to a ‘normal science’. Once it has become a normal science, it progresses through consecutive cycles involving crises that may lead to a scientific revolution and its subsequent paradigm shift, returning to normal science.

The pre-paradigm period “is regularly marked by frequent and deep debates over legitimate methods, problems, and standards of solution, though these serve rather to define schools than to produce agreement.” Instead of having a consensus over a single paradigm that defines how the science should progress, there is “competition between a number of distinct views of nature, each partially derived from, and all roughly compatible with, the dictates of scientific observation and method.”

A paradigm arises when a scientific community universally recognises a set of scientific achievements “that for a time provide model problems and solutions to a community of practitioners”. A paradigm’s achievements have to be “sufficiently unprecedented to attract an enduring group of adherents away from competing modes of scientific activity.” It also needs to be “sufficiently open-ended to leave all sorts of problems for the redefined group of practitioners to resolve […] Men whose research is based on shared paradigms are committed to the same rules and standards for scientific practice. That commitment and the apparent consensus it produces are prerequisites for normal science, i.e., for the genesis and continuation of a particular research tradition.”

When a paradigm (as defined above) exists, we can speak of a normal science. Kuhn describes the kind of research performed by a normal science “as a strenuous and devoted attempt to force nature into the conceptual boxes supplied by professional education.”

Normal science, the activity in which most scientists inevitably spend almost all their time, is predicated on the assumption that the scientific community knows what the world is like […] Normal science, for example, often suppresses fundamental novelties because they are necessarily subversive of its basic commitments.

Kuhn only mentions economics once in his essay, when he briefly discusses the state of social sciences back in 1962:

It may, for example, be significant that economists argue less about whether their field is a science than do practitioners of some other fields of social science. Is that because economists know what science is? Or is it rather economics about which they agree?

Funnily enough, when Kuhn wrote his essay, macroeconomics had not yet reached the consensus of being dynamic, quantitative and micro-founded. This would not happen until the beginning of the 70s when the freshwater vs saltwater schools had a pre-paradigmatic battle of sorts - a crisis - that did not lead to a scientific revolution. Neoclassical economics arose as a definitive victor when Keynesian economists decided to use the methods of the dominating paradigm (i.e. to micro-found their theories) to create what became New Keynesian economics.

If all normal sciences are dominated by a single paradigm, why should we worry about the lack of pluralism in economics?

In short, the world has become too aware of the anomalies (those phenomena that cannot be explained by the paradigm) of economics to keep ignoring them or explaining them in an ad hoc manner within the paradigm. Thus, economics is facing a crisis that may lead to a scientific revolution and introducing pluralism to its educational system could increase its likelihood.

No paradigm can explain all the phenomena of a science. Behavioural and experimental economics have been highlighting the anomalies that cannot be explained under the assumption of rational expectations since the publication of Prospect Theory in 1979. Contrary to what Popper’s falsificationism would suggest, falsifying a paradigm is not enough to reject it. And going back to Kuhn:

The decision to reject one paradigm is always simultaneously the decision to accept another, and the judgment leading to that decision involves the comparison of both paradigms with nature and with each other […] To reject one paradigm without simultaneously substituting another is to reject science itself.

The current economic paradigm has not been replaced and will not be replaced until a better substitute arises; there is also no way back to the pre-paradigm period, although “research during the crisis very much resembles research during the pre-paradigm period…”

All crises begin with the blurring of a paradigm and the consequent loosening of the rules for normal research. As this process develops, the anomaly comes to be more generally recognised as such, more attention is devoted to it by more of the field's eminent authorities.

Using Kuhn’s terminology and definition, economics is in a crisis period as the world has become too aware of its anomalies. And as noted by Benoît Cœuré, “the Nobel prize co-awarded to Robert Shiller last year will certainly encourage more research in [an alternative] direction”.

The teaching of economics is “both rigorous and rigid”. An economics student learns the paradigm (mainstream economics) to become a member of the economic community. As he graduates, he joins economists “who learned the bases of [the] field from the same concrete models, his subsequent practice will seldom evoke overt disagreement over fundamentals.”

This is exactly how Kuhn described the educational system of any mature science. But in the case of a science that is facing a crisis, changing this rigid educational system to a more pluralistic one, might help to increase the likelihood of a scientific revolution, i.e. the transition to a new paradigm.

For Kuhn, science progresses in two levels: in a cumulative manner through puzzle solving or efforts to fit nature into conceptual boxes of normal scientific research and in leaps through scientific revolutions. Without the latter, i.e. if the scientific community was not aware of anomalies, and crises and paradigm shifts did not occur, science would degenerate.

Student networks around the world call for a curriculum reform

What most of the leading student organisations and other global institutions are jointly pushing for is an economic curriculum with increased pluralism and greater relevance to real-world policy issues.

By pluralism these institutions mean, as ISIPE’s open letter puts it:

Theoretical pluralism: covering a wider range of schools of thought

Methodological pluralism: including qualitative methods

Interdisciplinary pluralism: the interaction between economics and other social sciences, for instance, philosophy of economics, history and history of economic thought, psychology, political science, etc.

“Bringing the discipline closer to the real world” could be interpreted in at least two different ways. For some, it is a call for less abstraction (less model-based) and more empiricism in economics and public policy analysis. For others like Benoît Cœuré, it is about introducing more real-world complexities, instead of stopping short at the models’ often oversimplified representations of reality.

The former interpretation might not be a problem for all economics undergraduate programmes, as some departments do emphasise applied over theoretical economics. But in many cases, the analysis of real-world events with theoretical tools is relegated to Q&A sessions or to the final class of each course, which is often not even graded. Regardless of the way we interpret it, bringing economics closer to the real world would allow students to apply the theoretical tools they learn to analyse contemporary challenges.

Breeding better economists for better policies

Today’s undergraduates are tomorrow’s policymakers”. Improving the economics curriculum is essential to produce better equipped professionals and deliver better economic policies in the future.

For a central banker, the problem with the economics curriculum is a different one. In his speech, Rethinking economics after the crisis, Benoît Cœuré emphasises the temporality problem between academia and policy making: academia pursues a long-run objective of searching for the truth, while policymakers “do not have the luxury of a long time horizon”.

Unfortunately, these different temporalities have an impact on economic thinking. The typical methodology of economic theory is first to consider a frictionless benchmark, corresponding for instance to a long-run steady state equilibrium, and then enrich it with frictions. While this is understandable from a methodological point of view, this approach can easily imply a neglect of the short and medium-term dynamics, drastic adjustments and complexities that are important for central banks.

Benoît Cœuré’s perspective is somewhat different from that of student groups: although he also mentions the need for a more pluralistic approach and making economics more relevant for policy, he focuses on the importance of teaching of frictions and complexities of the real world within the mainstream approach, something that is usually only covered at the PhD level.

Another unfortunate outcome is that the typical economics curriculum tends to emphasise the frictionless benchmark more than the realistic variants. Shifting the academic focus to a world with frictions would have a welcome impact on teaching, allowing central banks to hire from a pool of young economists better equipped with methods and tools to address policy challenges...

The most common justification for using oversimplified models at the undergraduate level is that they involve a degree of mathematical complexity that goes beyond what an average student can be expected to understand. Nevertheless, the implications of micro-founded models with frictions, market failures, sticky prices and other real world complexities, like bounded rationality, can be taught effectively without the mathematical rigor of a doctoral programme.

Students’ understanding of economics could be greatly enhanced by teaching them economic intuition and conclusions of complex models that they would otherwise only learn if they undertook a PhD in economics.

Concluding remarks

To recapitulate, economic schools should improve their economics curriculum by:

Schools should bring economics closer to the real world

Bringing economics closer to the real world though the introduction of complexities into undergraduate level education: this would allow public institutions, as well as private firms, to hire from a pool of better equipped young economists with tools to address policy challenges and understand our current unconventional economic environment.

Increasing theoretical, methodological and interdisciplinary pluralism without giving up the necessary rigor - which prepares students to solve the puzzles of normal science - in the teaching of mainstream economics. This would result in a new generation of more critical economists that are more likely to question the foundations of economics and will ultimately lead scientific progress.

I gratefully acknowledge Esther Bañales and Noah García for their editing and suggestions and professor Luís Marciales for his comments.

All quotations from Kuhn (including both, those in quotation marks and paragraphs in italics are taken from: Kuhn, Thomas S. (2012-04-18). The Structure of Scientific Revolutions: 50th Anniversary Edition . University of Chicago Press. Kindle Edition.

Thu, 21 Aug 2014 15:11:35 +0100
<![CDATA[Monetary policy cannot solve secular stagnation alone]]> http://www.bruegel.org/nc/blog/detail/article/1415-monetary-policy-cannot-solve-secular-stagnation-alone/ blog1415

This article is an extract from the vox.eu eBook Secular Stagnation: Facts, Causes and CuresEdited by Coen Teulings, Richard Baldwin

Larry Summers crystallized an important development and question in a recent speech given at the IMF research conference: has the world economy entered a period of “secular stagnation”? The slow recovery in the US since the financial crisis is his starting point and he argues that secular stagnation could retrospectively also explain features of previous decades such as low inflation. Professor Summers thereby picked up an old term by Alvin Hanson (1939), who made it in the Presidential Address of the American Economic Association in 1938. Back in 1938, Hanson focussed on the importance of (public) investment expenditure to achieve full employment. His argument was that for such investment to happen, the economy needs new inventions, the discovery of new territory and new resources and finally population growth.

Summers argument is centred on the fact that inflation rates have been falling in the past two decades and have been mostly lower than expected. Is there a permanent fall of the equilibrium real interest rates? Do our economies need real interest rates of -2 or -3 % to generate enough demand to achieve full employment? Is the fact that inflation rates were so low and even falling over the last decades really a sign that the global economy suffered from a permanent demand weakness? Was there really no demand excess?

Olivier Blanchard (2013) has published a blog post summarizing the recent IMF conference at which Larry Summers spoke and drawing lessons. One lesson is that it paid off if one had kept one’s fiscal house in order prior to the crisis. He then focuses on how to macro-manage a liquidity trap. In fact, if one agrees with his assessment that the effects of unconventional monetary policy are “very limited and uncertain”, then one can come rapidly to his conclusion that it would be advisable to have higher inflation rates in normal times, which makes it possible that in a crisis to drive down nominal interest rates more so that real interest rates fall even further. Krugman (2013)) goes one step further and even argues that the new normal may be a permanent liquidity trap, it would therefore not be advisable to have low inflation rates in the euro area (Krugman 2013b)

Three central policy measures to deal with secular stagnation

While I see the merit of the arguments by Krugman, Blanchard and Summers, I am worried that too little thinking is being put into the actual real economic drivers of secular stagnation and what could be done about them. Let me organize my thinking around three central points.

First of all, prior to the crisis, the global economy generated just enough demand to achieve reasonable employment rates thanks to significant bubbles in a number of major economies, excess borrowing by low-income households, high corporate borrowing, and/or unsustainable fiscal policies to balance the large amount of global savings. With the erupting crisis, high household, corporate and government borrowing and the house-price bubbles became visible as unsustainable sources of global demand. So would the answer to secular stagnation really have been more demand? Or put differently, how could one have achieved higher inflation rates prior to the crisis as Blanchard suggested without creating even more bubble-like phenomena? Isn’t the suggestion to solve the liquidity trap problem by running higher inflation rates prior to the crisis an attempt to cure the problem with the problem itself? If there is an insufficiency of demand even in normal times, this problem would need to be addressed with structural policies. The answer can hardly be more bubbles so that inflation rates go up. Using monetary policy to drive the real interest rate permanently to low, or perhaps, even negative rates is difficult and can create significant distortions in the economy.

This point can be illustrated by the US example: while monetary policy has been very supportive and has helped avoid a slide into deflation during the crisis, arguably before the crisis it contributed to the build-up to many of the problems in the US economy. The massive bubbles that resulted from the combination of lax monetary policy and an inadequate financial regulatory system should certainly be considered a problem, not a solution. A perhaps more important part of the solution to the current problem has been the acceptance of structural policies that are more conducive to a recovery: the US recovery has been helped by very significant debt reductions in the household sector thanks to non-recourse mortgages and similar things. More importantly, the banking system has been relatively quickly cleaned up, which also helped the recovery.

Turning to the euro area, I would advise against changing the ECB’s inflation target of close to but below two percent for two reasons. For once, such a step would severely undermine trust in a young institution, whose actions are still criticized in some countries of the EU’s young monetary union. It would constitute a break in the contract under which Germany subscribed to the monetary union. Second, changing the target in current circumstances would be largely ineffective: already the current target will not be achieved in the relevant time horizon and a higher target would only increase this gap.


Second, like Hansen, I believe in the importance of the structural factors that actually provide investment opportunities. The overall lesson of secular stagnation, as outlined by Larry Summers, seems to go in a different direction than monetary policy that in normal times can hardly help address an equilibrium negative real interest rate without risking major bubbles and unsustainable borrowing as the European and US experiences suggest. The fundamental question is why globally the equilibrium interest rate has been falling and the global economy has entered “secular stagnation”. Is it global demographics? Is it the lack of good investment opportunities? Is it the fact that we miss new places that can be “conquered”?

Certainly, population growth is starting to fall in many countries, especially in the more advanced economies. Yet, global population is still increasing. This would suggest that globally there should still be ample investment opportunities if framework conditions are put right. This is where the role of the integration of Asian and African economies into the global economy becomes central. More than half of the world population is concentrated in a small circle in Asia, including China and India. The more they are integrated into the global economy, the more they should increase global demand. The more opportunities for profitable investment should exist. To achieve this, a well-working financial system is critical. It would need to prevent excessive risk taking while channelling savings to the right countries and deployments. Clearly, a critical question is if and how saving and investment patterns will change in Asia. It will also be critical how sustainably capital accounts are opened up.

The euro area also provides important evidence that structural policies that allow for capital to be channelled into productive uses, that allow new innovations to emerge and that allow for new inventions are critical. Prior to the crisis, many thought that the euro area had solved the secular stagnation problem and actually provided the right framework conditions for more investment. The capital flows in the European periphery were praised for proving that capital would flow “downhill”, where its marginal productivity is still highest. Unfortunately, the reality turned out to be much less rosy. Instead of being used productively, much of the capital flows went into consumption spending, including on housing. Like in the US and UK, the increasing house prices initiated a financial accelerator model, in which more and more borrowing followed thereby driving a consumption boom.

The European experience underlines the importance of structural reforms that allow for proper business opportunities and innovation. The downhill capital flows are in principle welcome, but they only contribute to sustainable growth if they flow into an environment, in which they can drive investment as Hansen had outlined. In the European case, part of the problem was that the financial system did not properly steer capital flows into those productive uses. The regulatory and supervisory system of Europe’s monetary union was not properly developed, risk became too concentrated and moral hazard was prevalent. The creation of Europe’s banking union, while incomplete, is certainly a step in the right direction to solve this problem. But I am also convinced that Europe should be able to create much better investment opportunities to solve its stagnation. For this, reforms that reduce administrative burdens, improve education systems and better conditions for R&D are central.

Turning to Japan, the importance of structural reforms also becomes apparent. Since the election of Shinzo Abe as prime minister, Japan has embarked on a QE program of unprecedented scale. The effect has been a much weaker yen together with an increase in inflation. This was a welcome policy development. Yet, one year later, it also becomes clear that a strategy based on a weaker yen to increase export as the only anti-deflation strategy cannot work forever. To return to growth and inflation, the third arrow of Abenomics equally matters: improving investment conditions, creating new business opportunities, increasing competition in the economy and deepening trade integration.


Third, how shall macroeconomic policies deal with the liquidity trap, low inflation and insufficient demand problem in the euro area of today? Six years after the beginning of the crisis, growth remains sluggish and inflation rates are low or falling. The euro area is still at risk of falling into deflation. Euro area core inflation rates, i.e. inflation rates excluding volatile energy and food prices, have been falling since late 2011. Inflation expectations two years ahead are hardly above one percent and even at the five-year horizon, the market-determined inflation forecast is 1.19 percent. This has consequences. Lower-than-expected inflation redistributes wealth from debtors to creditors and increases the burden of the debtors. Thus, disinflation in the euro area undermines private and public debt sustainability, in particular in the periphery where the debt overhang is greatest. It is therefore a real risk for the euro area as a whole and should be addressed.

I see a role for both, monetary and fiscal policy, in helping overcome this low growth-low inflation environment. Turning first to monetary policy, it has to deal with two central problems in the euro area. The first is that monetary policy should not undermine the ongoing relative price adjustment process between the euro area periphery and the euro area core (see Figure). A monetary policy measure that would increase inflation in the periphery only would undermine the restoration to health of the Eurozone economy. Instead, the policy measure should ensure to increase inflation rates in Germany as well as in the periphery. Ideally, German inflation rate should move well above the two percent target that the ECB has set for the euro area as a whole. The second concern in the euro area right now is that the process of banking sector clean-up is unfinished. The ECB certainly would like to avoid preventing a bank restructuring with monetary policy measures that would overly distort prices.




Source: DG ECFIN – E4. Note: the real effective exchange rate vs EA 18 aims to assess a country’s price or cost competitiveness relative to the currency area as a whole. It corresponds to the nominal effective exchange rate deflated by the GDP deflator.



In Claeys et al (2014), we have argued that a quantitative easing programme focussed on the purchase of ESM/EFSF/EIB/EC bonds, corporate bonds and ABS would overcome those constraints and help to increase inflation via a portfolio rebalancing effect and a weaker exchange rate. The recent decision by the ECB (2014) – while a welcome form of monetary and credit easing – is unlikely to be enough to push demand and inflation upwards. I am thus not quite as negative on QE as Olivier Blanchard and also the Japanese experience shows that a large monetary policy measure can be part of the solution even if the nominal interest rate is already at the zero lower bound.

But fiscal policy will also have to play a larger role. One of the big problems in the euro area has been the weakness in public investment in the last years in contrast to the US, where public investment actually increased. A lot of the weakness in public investment needs to be solved by more public investment in Germany. More European level investment in European public goods such as new and better energy and digital networks should also be undertaken. This brings us back to the work by Hansen: public investment and new investment opportunities are needed to address secular stagnation.



Blanchard, Olivier (2013), Monetary policy will never be the same, Voxeu Blog, 27 November 2013 

Claeys, Darvas, Merler, Wolff (2014), Addressing low inflation: the ECB’s shopping list, Bruegel policy contribution.

ECB (2014), ECB press conference 

Hansen, (1939), Economic progress and declining population growth, American Economic Review, March

King, Stephen (2013), There is no easy escape from secular stagnation, FT blog 25 Nov 2013 

Krugman, Paul (2013), Three charts on secular stagnation 

Krugman, Paul (2013b), Secular stagnation in the euro area

 Summers, Lawrence H (2013), "Crises Yesterday and Today", speech at the 14th Jacques Polak Annual Research Conference, November

Tue, 19 Aug 2014 09:53:44 +0100