Can Europe recover without credit? Bruegel Policy Contribution 2013/03, 15 February 2013

• Data from 135 countries covering five decades suggests that creditless recoveries, in which the stock of real credit does not return to the pre-crisis level for three years after the GDP trough, are not rare and are characterised by remarkable real GDP growth rates: 4.7 percent per year in middle-income countries and 3.2 percent per year in high-income countries. • However, the implications of these historical episodes for the current European situation are limited, for two main reasons: • First, creditless recoveries are much less common in high-income countries, than in low-income countries which are financially undeveloped. European economies heavily depend on bank loans and research suggests that loan supply played a major role in the recent weak credit performance of Europe. There are reasons to believe that, despite various efforts, normal lending has not yet been restored.Limited loan supply could be disruptive for the European economic recovery andthere has been only a minor substitution of bank loans with debt securities. • Second, creditless recoveries were associated with significant real exchange rate depreciation, which has hardly occurred so far in most of Europe. This stylised fact suggests that it might be difficult to re-establish economic growth in the absence of sizeable real exchange rate depreciation, if credit growth does not return.

The euro area's tightrope walk: debt and competitiveness in Italy and Spain. Bruegel Policy Contribution 2013/11, September 2013

Competitiveness adjustment in struggling southern euro-area members requires persistently lower inflation than in major trading partners, but low inflation worsens public debt sustainability. When average euro-area inflation undershoots the two percent target, the conflict between intra-euro relative price adjustment and debt sustainability is more severe. In our baseline scenario, the projected public debt ratio reduction in Italy and Spain is too slow and does not meet the European fiscal rule. Debt projections are very sensitive to underlying assumptions and even small negative deviations from GDP growth, inflation and budget surplus assumptions can easily result in a runaway debt trajectory. The case for a greater than five percent of GDP primary budget surplus is very weak. Beyond vitally important structural reforms, the top priority is to ensure that euro area inflation does not undershoot the two percent target, which requires national policy actions and more accommodative monetary policy. The latter would weaken the euro exchange rate, thereby facilitating further intra-euro adjustment. More effective policies are needed to foster growth. But if all else fails, the European Central Bank’s Outright Monetary Transactions could reduce borrowing costs.

Electricity without borders: a plan to make the internal market work. Bruegel Blueprint Series 20, 5 September 2013

The most straightforward European single energy market design would entail a European system operator regulated by a single European regulator. This would ensure the predictable development of rules for the entire EU, significantly reducing regulatory uncertainty for electricity sector investments. But such a first-best market design is unlikely to be politically realistic in the European context for three reasons. First, the necessary changes compared to the current situation are substantial and would produce significant redistributive effects. Second, a European solution would deprive member states of the ability to manage their energy systems nationally. And third, a single European solution might fall short of being well-tailored to consumers’ preferences, which differ substantially across the EU. To nevertheless reap significant benefits from an integrated European electricity market, we propose the following blueprint: First, we suggest adding a European system-management layer to complement national operation centres and help them to better exchange information about the status of the system, expected changes and planned modifications. The ultimate aim should be to transfer the day-to-day responsibility for the safe and economic operation of the system to the European control centre. To further increase efficiency, electricity prices should be allowed to differ between all network points between and within countries. This would enable throughput of electricity through national and international lines to be safely increased without any major investments in infrastructure. Second, to ensure the consistency of national network plans and to ensure that they contribute to providing the infrastructure for a functioning single market, the role of the European ten year network development plan (TYNDP) needs to be upgraded by obliging national regulators to only approve projects planned at European level unless they can prove that deviations are beneficial. This boosted role of the TYNDP would need to be underpinned by resolving the issues of conflicting interests and information asymmetry. Therefore, the network planning process should be opened to all affected stakeholders (generators, network owners and operators, consumers, residents and others) and enable the European Agency for the Cooperation of Energy Regulators (ACER) to act as a welfare-maximising referee. An ultimate political decision by the European Parliament on the entire plan will open a negotiation process around selecting alternatives and agreeing compensation. This ensures that all stakeholders have an interest in guaranteeing a certain degree of balance of interest in the earlier stages. In fact, transparent planning, early stakeholder involvement and democratic legitimisation are well suited for minimising as much as possible local opposition to new lines. Third, sharing the cost of network investments in Europe is a critical issue. One reason is that so far even the most sophisticated models have been unable to identify the individual long-term net benefit in an uncertain environment. A workable compromise to finance new network investments would consist of three components: (i) all easily attributable cost should be levied on the responsible party; (ii) all network users that sit at nodes that are expected to receive more imports through a line extension should be obliged to pay a share of the line extension cost through their network charges; (iii) the rest of the cost is socialised to all consumers. Such a cost-distribution scheme will involve some intra-European redistribution from the well-developed countries (infrastructure-wise) to those that are catching up. However, such a scheme would perform this redistribution in a much more efficient way than the Connecting Europe Facility’s ad-hoc disbursements to politically chosen projects, because it would provide the infrastructure that is really needed.

The European Central Bank in the age of banking union. Bruegel Policy Contribution 2013/13, 1 October 2013

During the crisis the European Central Bank’s roles have been greatly extended beyond its price stability mandate. In addition to the primary objective of price stability and the secondary objective of supporting EU economic policies, we identify ten new tasks related to monetary policy and financial stability. We argue that there are three main constraints on monetary policy: fiscal dominance, financial repercussions and regional divergences. By assessing the ECB’s tasks in light of these constraints, we highlight a number of synergies between these tasks and the ECB’s primary mandate of price stability. But we highlight major conflicts of interest related to the ECB’s participation in financial assistance programmes. We also underline that the ECB’s government bond purchasing programmes have introduced the concept of ‘monetary policy under conditionality’, which involves major dilemmas. A solution would be a major change towards a US-style system, in which state public debts are small, there are no federal bail-outs for states, the central bank does not purchase state debt and banks do not hold state debt. Such a change is unrealistic in the foreseeable future.

Will income inequality cause a middle-income trap in Asia? Bruegel Working Paper 2013/06, 10 October 2013

The Asian economy is expected to realise favourable growth during the first half of this century, but there is no guarantee. There is a discussion about a ‘middle-income trap’, which refers to a country that has realised rapid growth to become a middle-income country but is unable to grow further. A middle-income trap could occur not only if there is a delay in shifting the economy toward a productivity-driven structure, but also if there is a worsening of income distribution.We consider this in line with the theories of development economics and through a quantitative analysis. The relationship between income inequality and the trap can be explained by the Kuznets hypothesis and the basic-needs approach. Our quantitative analysis supports the Kuznets hypothesis, and indicates that,although a low-income country can accelerate its economic growth with the worsening of income distribution as an engine, a middle income country would experience a decreasing growth rate if it fails to narrow the income gap between the top and bottom income groups. The results also show that the basic-needs approach is also applicable in practice, and imply that the improvement of access to secondary education is important. A sensitivity analysis for three Asian upper-middle-income countries(China, Malaysia and Thailand) also shows that the situation related to a middle-income trap is worse than average in China and Malaysia. These two countries, according to the result of the sensitivity analysis, should urgently improve access to secondary education and should implement income redistribution measures to develop high-tech industries, before their demographic dividends expire. Income redistribution includes the narrowing of rural urban income disparities, benefits to low-income individuals, direct income transfers, vouchers or free provision of education and health-care, and so on, but none of these are simple to implement.

The Dragon awakes: Is Chinese competition policy a cause for concern? Bruegel Policy Contribution 2013/14, 22 October 2013

China’s Anti-Monopoly Law, adopted in 2007, is largely compatible with antitrust law in the European Union, the United States and other jurisdictions. Enforcement activity by the Chinese authorities is also approaching the level seen in the EU. The Chinese law, however, leaves significant room for the use of competition policy to further industrial policy objectives. The data presented in this Policy Contribution indicates that Chinese merger control might have asymmetrically targeted foreign companies, while favouring domestic companies. However, there are no indications that antitrust control has been used to favour domestic players. A strategy to achieve convergence in global antitrust enforcement should include support for Chinese competition authorities to develop the institutional tools they already have, and to improve merger control by promoting the adoption of a consumer-oriented test and enforcing M&A notification rules.

Life after Bali: renewing the world trade negotiating agenda. Bruegel Policy Contribution 2013/17, December 2013

The crisis has contributed to a slowdown in global trade volumes, with trade virtually stagnant in the twelve months to July 2013. In this context, fruitful negotiations in the World Trade Organisation’s 9th Ministerial Conference in Bali are crucial to sustain the institution’s credibility and prove that multilateral negotiations can still deliver success. WTO trade talks are the only ongoing trade liberalisation process that has development at its core. The Doha mini-package under consideration at Bali is a collection of watered-down but deliverable elements of a deal comprising agriculture, trade facilitation and special and differential treatment/less developed country concessions. Post-Bali, the WTO should aim to reverse the current disenchantment with multilateral trade negotiations. This means formulating a relevant trade negotiating agenda with an understanding of global value chains at its core. However, the transition to the new agenda requires a closure of the ongoing Round. The easiest way to conclude the Doha Round would be to select another discrete set of deliverables that fulfills the development commitment of the Doha Development Agenda, thus paving the way for a new Round.

Can border carbon taxes fit into the global trade regime? Bruegel Policy Brief 2013/06, 9 December 2013

One complement to domestic climate policies could be the regulation of carbon dioxide emissions arising during the production of imported products. Such ‘border carbon adjustments’ (BCAs) are said to have several benefits, but are also severely criticised. This Policy Brief highlights some weaknesses in the standard argumentation for BCAs. But there is an alternative argument for border carbon measures, based on the fact that countries expose each other to climate externalities. The reformulated argument is economically more convincing, and provides a more convincing justification for the extraterritorial feature of border carbon measures. However, there are also several important factors mitigating against the implementation of such measures, including the risk that these measures will be used for protectionism. One complement to domestic climate policies could be the regulation of carbon dioxide emissions arising during the production of imported products. Such ‘border carbon adjustments’ (BCAs) are said to have several benefits, but are also severely criticised. This Policy Brief highlights some weaknesses in the standard argumentation for BCAs. But there is an alternative argument for border carbon measures, based on the fact that countries expose each other to climate externalities. The reformulated argument is economically more convincing, and provides a more convincing justification for the extraterritorial feature of border carbon measures. However, there are also several important factors mitigating against the implementation of such measures, including the risk that these measures will be used for protectionism.

When and how to support renewables? Letting the data speak. Bruegel Working Paper 2014/01, February 2014

Low-carbon energy technologies are pivotal for decarbonising our economies up to 2050 while ensuring secure and affordable energy. Consequently, innovation that reduces the cost of low-carbon energy would play an important role in reducing transition costs. We assess the two most prominent innovation policy instruments (i) public research, development and demonstration (RD&D) subsidies and (ii) public deployment policies. Our results indicate that both deployment and RD&D coincide with increasing knowledge generation and the improved competitiveness of renewable energy technologies. We find that both support schemes together have a greater effect that they would individually, that RD&D support is unsurprisingly more effective in driving patents and that timing matters. Current wind deployment based on past wind RD&D spending coincides best with wind patenting. If we look into competitiveness we find a similar picture, with the greatest effect coming from deployment. Finally, we find significant cross-border effects, especially for winddeployment. Increased deployment in one country coincides with increased patenting in nearby countries. Based on our findings we argue that both deployment and RD&D support are needed to create innovation in renewable energy technologies. However, we worry that current support is unbalanced. Public spending on deployment has been two orders of magnitude larger (in 2010 about €48 billion in the five largest EU countries in 2010) than spending on RD&D support (about €315 million). Consequently, basing the policy mix more on empirical evidence could increase the efficiency of innovation policy targeted towards renewable energy technologies.

In sickness and in health: protecting and supporting public investment in Europe. Bruegel Policy Contribution 2014/02, February 2014

The long-term decline in gross public investment in European Union countries mirrors the trend in other advanced economies, but recent developments have been different: public investment has increased elsewhere, but in the EU it has declined and even collapsed in the most vulnerable countries, exaggerating the output fall. The provisions in the EU fiscal framework to support public investment are very weak.The recently inserted ‘investment clause’ is almost no help. In the short term, exclusion of national co-funding of EU-supported investments from the fiscal indicators considered in the Stability and Growth Pact would be sensible. In the medium term, the EU fiscal framework should be extended with an asymmetric ‘golden rule’ to further protect public investment in bad times, while limiting adverse incentives in good times. During a downturn, a European investment programme is needed and the European Semester should encourage greater investment by member states with healthy public finances and low public investment rates. Reform and harmonisation of budgeting, accounting, transparency and project assessment is also needed to improve the quality of public investment.

Cross-country insurance mechanisms in currency unions. Bruegel Working Paper 2014/04, 27 March 2014

Countries in a monetary union can adjust to shocks either through internal or external mechanisms. We quantitatively assess for the European Union a number of relevant mechanisms suggested by Mundell’s optimal currency area theory, and compare them to the United States. For this purpose, we update a number of empirical analyses in the economic literature that identify (1) the size of asymmetries across countries and (2) the magnitude of insurance mechanisms relative to similar mechanisms and compare results for the European Monetary Union (EMU) with those obtained for the US. To study the level of synchronization between EMU countries we follow Alesina et al. (2002) and Barro and Tenreyro (2007). To measure the effect of an employment shock on employment levels, unemployment rates and participation rates we perform an analysis based on Blanchard and Katz (1992) and Decressin and Fatas (1995). We measure consumption smoothing through capital markets, fiscal transfers and savings, using the approach by Asdrubali et al. (1996) and Afonso and Furceri (2007). To analyze risk sharing through a common safety net for banks we perform a rudimentary simulation analysis. |