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Olli Rehn

Vice-President of the European Commission and Member responsible for Economic and Monetary Affairs and the Euro

Overcoming Europe's sovereign debt crisis – the road to stability and growth

Speech at St. Antony's College

Oxford, 17 May 2012

Ladies and Gentlemen,

I am very honoured to return to my alma mater. I spent many memorable moments here, at a time when the Cold War was coming to an end. As one chapter of history closed – another one opened with the optimistic beginning of the great European transformation, bringing with it both a deepening and a widening of the European Union.

I remember Lord Dahrendorf very well. When I studied here, Sir Ralf – as he was then known – was Warden of the College, following his remarkable career as a leading sociologist of his generation, Member of Parliament and European Commissioner. Ralf Dahrendorf was a strong believer in open and liberal societies. In his book "Reflections on the Revolution in Europe", he analysed the opening of societies in Eastern Europe and the conditions of lasting liberty. In that context, he said that "the European monetary union will and should happen". But he also recognised it would be a "grand and difficult project", with both technical and political challenges. He knew that countries would have to "have institutions and policies in place which sustain a stable common currency."

And this was written over 20 years ago! These words sound even wiser today as they did when he first wrote them!

Ladies and Gentlemen,

Today, European monetary union is no longer fiction, but a reality. Some of the Eastern European nations to which Ralf Dahrendorf was referring are members of the euro – Estonia joined last year and a number of others are preparing to join.

As we all are painfully aware, the eurozone is facing a new and most serious stage in the sovereign debt crisis. Again, Greece is the epicentre of this turbulence. And the effects are felt far beyond just Greece. Spain has recently been under pressure. At the same time, the country is taking decisive action to tackle its fiscal and banking problems.

Let me now say a few words about the current economic climate.

Our latest European Economic Forecast shows the EU economy to be in a mild and short-lived recession. A slow and subdued recovery is forecast to begin from the second half of the year on, and continue over 2012-13. But this will only happen on the condition that confidence gradually returns and decisive policy action is taken.

In the last quarter of 2011, Europe had fallen into recession. Yet, fresh data published this Tuesday shows that, for the first quarter 2012, growth was, in fact, not negative. Germany, in particular, showed better data than we had anticipated in our forecast. But I have been around long enough not to over-interpret one single data point.

Although the economic climate remains fragile, this does not mean there are no positive signs. At the beginning of this year, we saw global trade growth accelerate once again. This was particularly beneficial for those EU member states that are more open to trade, especially the countries in Northern and central Europe, but also programme countries - Ireland and Portugal, which have recently seen their exports grow well.

GDP growth will remain uneven across Member States. The same applies for unemployment, with some member states enjoying virtually full employment, with others suffering from rising unemployment. It is unbearably high for young people who need hope, confidence and opportunity for their future.

What we are seeing is a rebalancing of the macroeconomic imbalances that built up in Europe before and after the crisis began. Over the last decade, our integrated financial market channelled savings from countries with slow growth in domestic demand into countries with current account deficits, where domestic demand was thriving with credit booms and increasing wages and prices. This applies both within the EU as well as across the Atlantic.

To some extent, this was sign of our integrating EU economy, as some member states were catching up, and for whom the euro allowed better access to international capital markets. Macroeconomic imbalances were also the root cause of the crisis. While the Greek case has been largely (although not only) a fiscal crisis, Ireland and Spain suffered mostly from serious imbalances in the form of credit booms and real-estate bubbles. To provide the right medicine to heal these economic wounds, we first need to get the diagnosis right.

The US subprime crisis – especially the Lehman-moment in September 2008 – was the trigger of the financial and economic shock.

In the two years that followed, the response by the EU and its international partners was unprecedented, bringing together governments and central banks to effectively coordinate a global policy, using the resurrected Keynesian toolbox of massive fiscal and monetary stimulus to the full. This saved the world economy from a long and deep depression. But the downside is that public debt in the EU has risen from around 60% to almost 90% of GDP.

Ladies and Gentlemen,

Over the past two and a half years, the eurozone has taken unprecedented action to safeguard financial stability and economic recovery in Europe.

Vulnerable member states have stepped up fiscal consolidation and structural reforms. We have built financial firewalls with robust firepower. In addition, the European Central Bank has played an important role to ensure not only monetary but also financial stability.

The banking sector is being recapitalised, and in many countries, restructured. We have overhauled and strengthened European financial regulation and supervision. We have reformed economic governance in a way that anchors a stability culture in EMU and facilitates lasting growth.

The EU's comprehensive strategy has contained the crisis - but not yet tamed the crisis. There is much more to be done. We need to complete our crisis response; that is, stay the course on fiscal consolidation and reinforce growth through structural reforms and enhanced investment.

Thus, our strategy is based on three building blocks.

First, sound public finances are – and will remain – the cornerstone of our strategy. They are a prerequisite for sustainable growth. Relaxing consolidation could at best provide short-lived relief, but very soon endanger fiscal sustainability in many Member States – especially in the medium and long term. At the same time, an adequate rate of economic growth is central to successful and sustainable fiscal consolidation.

Some politicians and pundits are promoting the misperception that the EU fiscal framework forces all member states into a 'one-size-fits-all' consolidation straightjacket. But the Stability and Growth Pact is not stupid. Yes, the EU fiscal framework is rules-based, with clear reference values for public deficit and debt for triggering the excessive deficit procedure and, if needed, sanctions. But, at the same time, the Pact entails considerable scope for judgement, based on sound economic analysis, which is an integral part of the Pact's legal provisions. The Pact underlines the structural sustainability of public finances over the medium-term and implies differentiation among the member states according to their fiscal space and macroeconomic conditions.

This is clearly reflected in the "fiscal exit strategy" agreed by EU Economic and Finance Ministers three months ago. They agreed that those Member states with greater fiscal space should to let the automatic stabilisers function fully. Meanwhile, vulnerable Member States under close market scrutiny need to convince both market forces and policy-makers of their capacity to tackle their fiscal and other economic challenges and, once again, create confidence.

Second, we need growth-enhancing economic reforms to ensure lasting correction of fiscal imbalances and enhance the credibility of our strategy.

Indeed, macro-economic imbalances have reduced significantly. The largest corrections have been recorded in deficit countries, but surplus countries are also adjusting. For example, wage growth in Germany is forecast to be almost 2% in 2012 to 2013, compared to around 1% in the euro area and -1% in Spain. Recent wage negotiations in Germany point further to this direction.

However, more adjustment is still to come. The remaining accumulated stocks of internal and external imbalances continue to pose a formidable challenge. Some deficit countries still need to achieve surpluses to bring their external debt onto a declining trajectory. This requires inter alia further improvements in both price and non-price competitiveness. It also goes hand-in-hand with the need for private sector deleveraging and consolidation of public finances.

This is also the key rationale of EU-IMF programmes, which are much more about economic reform to return to growth than only fiscal adjustment. In other words, they are essentially about internal devaluation.

The programmes of Ireland and Portugal are on track. Ireland returned to growth last year, and for Portugal this is expected next year. Outside the eurozone, Latvia has gone through an internal devaluation with the help of an EU-IMF programme, while Estonia and Lithuania have done so without a programme. All three Baltic states are forecast to grow next year with rates of about 3½ - 4%.

As we all know, in Greece, adjustment has been slower and return to growth is delayed. Why? Mainly because of the obstacles to reform and growth created by vested interests, lack of national unity and weak administrative capacity. The reform programme is geared to overcome these obstacles and enable Greece to stay in the euro, which we want. The forthcoming elections are about the commitment to the reforms and the euro. It is a democratic choice of the Greek people.

All in all, we need to maintain the momentum of the wave of reforms that is currently moving in Europe, especially in the countries that need them most. Italy and Spain are taking decisive action in this regard.

We have many encouraging examples. They show that restoring confidence in public finances and undergoing ambitious structural reforms does work. Countries that have best weathered the storm are those that have gone through this kind of adjustment in the recent past. Just look at Denmark and the Netherlands in the 1980s, Finland and Sweden in the 1990s, and Germany in the first decade of this century.

Ladies and Gentlemen,

To support sustainable and dynamic growth in Europe, the single market remains our joint instrument. It still has untapped potential to deliver new sources of growth and jobs. Let me mention a few points for action:

The Commission will soon come forward with proposals to get more out of the Services Directive.

Going digital: Estimates show that EU GDP could grow by 4% by 2020, if we take the necessary steps to create a modern digital single market. As part of the Europe 2020 strategy the Commission has made proposals to build a digital single market.

Boosting innovation: the introduction of the long-awaited EU patent would reduce costs from € 36,000 to € 4,700 for patents on average; and meeting our 3% target for R&D spending would create 3.7 million new jobs and boost EU GDP by € 800 billion by 2020.

Drawing on external sources of growth: we need to accelerate trade and investment negotiations with dynamic partners outside the EU.

Finally, competition and efficiency in our utilities infrastructure: Long and uncertain procedures delay and inhibit much needed investment – the Commission has made proposals to reduce delays and to have a single authority to deliver permits for cross border investments.

The third part of the building block is the very strong case for more investment. The single market is our main engine for growth, but we need extra fuel to boost that engine.

The main problem we are facing at the current juncture is the fragile banking system that cannot provide the funds needed for the structural change. Investors' risk aversion has resulted in fewer and fewer new projects. And financing opportunities are limited because the private banking sector is still reeling from the harsh impact of the crisis.

This is why we have to be innovative. Last year, the Commission proposed the creation of project bonds for infrastructure investment, as a new tool to unlock private funding. Project bonds are not entirely unfamiliar to the UK. Before the financial crisis, monoline insurance companies took over risk from long-term projects.

Given the social returns to infrastructure, our key idea is that we can and must use public banks better. For the EU, this is the European Investment Bank, or EIB. The EIB and the EU budget can be used more effectively to achieve major leverage through limited risk-sharing with private investors. We are just about to put the legal provisions in place, so that we can launch the first project as early as this summer.

Moreover, the Commission has been urging the EU member states, who are actually the EIB shareholders, to agree to a capital increase. The EIB could then expand its lending volume, which is a quick and effective way of channelling badly needed financing to the real economy. In addition, the EU Budget would give capital relief to the EIB, so more risky projects could be funded with the participation of private capital.

Ladies and Gentlemen,

In my introduction I said that the recovery (albeit a slow recovery) projected for the second half of this year is conditional as it depends on a gradual return of confidence; confidence can only result from decisive implementation of the strategy I have set out.

These agreed policies point unequivocally to one direction – and that is to further and deeper integration of the Economic and Monetary Union.

Lessons of the past decade have taught us of the need to complement this process by more political integration.

In such an integrated union, the economists amongst you may be easily convinced: it would make economic sense to create a deep, liquid and stable market for government bonds with the joint issuance of common debt – Eurobonds. At least, once we have reinforced our economic governance further to ensure fiscal prudence and thus avoid moral hazard.

At the same time, the political scientists amongst you may have some doubts. This road namely would require a fundamental debate about the sovereignty in a union that pools its risks.

Conscious of the academic audience today, I would like to encourage you – economists and political scientists – to reflect on what shape you think the European Union should take to move towards deeper economic and political integration, in a way that would also allow joint issuance of debt to make sense for all Member States sharing the common currency.

You may object that there is a contradiction with individual freedom. Indeed, individual freedom is the pre-condition to bring about the structural change that Europe needs to overcome this crisis.

At the same time, such freedom can only reach its full potential if it has itself the right institutional foundation: a deeply – economically and politically integrated – European Union.

Thank you.

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