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European Commission

Olli REHN

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

Current Account Surpluses in the EU and the 2012 Fiscal Sustainability Report: - Rebalancing for Sustainable Growth

Press Conference - Brussels

18 December 2012

Ladies and Gentlemen, I have the pleasure today of sharing with you some recommended Christmas reading on European Economic Policies, notably, the main findings of three important reports: first on current account surpluses, second on fiscal sustainability and the third on the quality of public expenditure.

These reports are a true goldmine of analytical findings with policy relevance and I am very proud that DG ECFIN has produced these reports. So many thanks to the teams who worked on them. In case you have very technical questions, I will turn to my staff. I can also inform you that I will be sending the reports to the EU Finance Ministers soon to provide them with policy-relevant material for the discussion in the Eurogroup and ECOFIN in January, concerning the evolution of economic and fiscal policy in Europe.

Concerning deficits and surpluses, which is obviously the background of the current account surplus study, they are usually a natural consequence of economic interaction between countries. They are not always imbalances, and they do not always reflect inefficiencies.

Thus, deficits and surpluses can often simply be the result of an appropriate allocation of savings, taking into account different investment opportunities across countries. Most often, they reflect, in fact, healthy competitiveness, but they may also be driven by market failures or policy settings that constrain domestic demand and investment opportunities. These market failures would imply a misallocation of resources which entail welfare losses, also in the surplus countries.

Welfare losses, especially in the deficit countries, usually reflect a misallocation of resources in the real economy. This can be seen in the excessive growth of some private sectors, such as construction and real estate in some countries like Spain or Ireland and of the public sector in others, like Greece.

The misallocation of real assets of the current account has its origins - and also its repercussions - in the financial accounts or the financial assets in the current account.

As regards the financial accounts, the first point is to note that the current account surpluses were channelled through chains of financial intermediation, not necessarily directly, but through the banking sector or financial system of Europe and often globally.

As the surplus countries accumulated foreign assets, they were also affected by losses in these assets, due to the financial crisis and due to the unwinding of imbalances triggered by the crisis.

This graph tells the story of Germany, in this regard, for every Euro of goods and services exported in net terms - which is the light blue line - Germany acquired foreign assets in return. Normally one would expect that the foreign net worth of Germany increase by the same amount, but here we can see that this was not the case (that is the black line) due the financial crisis, not least due to the variations losses related to the subprime crisis related in US through the banking system of Germany.

The German savings invested in foreign assets experienced valuation losses in this context (that is shown in the shaded area in the graph).

The build-up of large current account divergences since around 2000 was clearly not sustainable, this we have learnt the hard way. Since around 2008 or 2009, these accumulated imbalances have been gradually narrowing and the rebalancing is under way now in the European economy.

This is underway, both on the side of deficit countries and, to lesser extent, surplus countries. On the side of deficit countries, this is going on through deleveraging but also through improvements in their competitiveness.

The surplus countries are also adjusting, but they can contribute further to rebalancing by removing unnecessary regulatory and other constraints on domestic demand non-tradable activities and pro-active investments.

What is important to point out is that, at euro area level, several structural characteristics suggest that a moderate surplus is appropriate. These characteristics include the ageing of European population, the relative high levels of income per capita, the need for continued fiscal consolidation and the reduction in indebtedness in the private sector in many countries.

The trade and current account surplus of the surplus countries vis-à-vis the rest of the euro area has declined substantially. That is one of the essential findings of the report.

This graph shows again the case of Germany, and if you look at the bars towards the right side of the graph, towards, say, last year/this year, you can see that we can witness a decline in the current account balance of Germany vis-à-vis the rest of the euro area (that is the dark blue bar in the graph).

There is also a decline, albeit much smaller, in the current account balance vis-à-vis the non-euro countries of the EU (that is the yellow bar) the smaller one in between. In the meantime, there is a growing current account surplus in relation to the rest of the world.

What does this tell us? It tells us that reduction the current account surpluses within the EU, has been broadly compensated by higher surpluses with non-euro area EU countries and with the rest of the world, so surpluses within the Eurozone, in fact, especially broadly compensated by higher surpluses with the rest of the world.

This suggests that the euro area rebalancing has not been detrimental to the competitiveness of the surplus eurozone countries vis-à-vis the rest of the world.

Increase in domestic demand in surplus countries helps with the rebalancing. Obviously it increases the imports of these countries and, in reverse, the exports of their partners; but its impact should not be overestimated, that is another finding of the report. It is no panacea, no silver bullet for the countries suffering from large and other persistent current account deficits.

The reason is that, given the geographic composition of exports and imports and also the sectoral composition of exports and imports , an increase in demand of a country like Germany, will mainly increase the exports of the neighbouring countries, part of the same supply chain, in particular the Central and Eastern countries, rather than the Southern European economies.

So basically, this is a simulation of improvement in trade balance of selected countries. You can see that this simulates 1% increase in Germany's domestic demand, assuming either fiscal stimulus or rate increases, based on data of 2009, it shows that this 1% increase would have an impact on the trade balance of Spain for instance, of a very limited amount.

So next, if I just show one slide concerning the report on fiscal sustainability, while the current account imbalances are narrowing down and fiscal deficits are being reduced, the levels of public debt in the EU remain very high. Here, according to the report, in this picture, the solid blue line represents debt developments in the absence of any further policy measures. The debt in the EU would remain high and it would start to rise further as of mid- 2020, in the next decade, when the fiscal presence of population ageing takes hold more firmly.

The conclusion is that only an aimed policy action, to achieve the medium-term objectives (as indicated by the orange line) would bring the government debt on a downward path and bring the debt down to 60% of GDP by 2013.

The third report, the quality of expenditure, focuses on the drivers of growth and its relation to public finances and the conclusion is that, for the sake of growth, focusing on the public finances, especially public expenditure is more essential and more crucial than ever. A thorough review of public expenditure suggests that Members States should do more to prioritise growth-supportive spending elements in their budget, such as education and training, research and innovation, as well as stimulating public and private investment.

The EU fiscal framework offers a scope for enhancing the quality of public expenditure, and the stability and growth pact already takes this into account.

Furthermore, the Commission is exploring further ways to accommodate temporary and sustainability-enhancing investment programmes in the assessment of stability and convergence programmes. Especially under certain conditions, non-recurrent public investment programmes with a proven impact on the sustainability of public finances could qualify for a temporary deviation from the medium-term budgetary objective or the adjustment path towards this medium-term objective.

To conclude, the analysis included in these reports, is consistent with the EU strategy of prudent fiscal consolidation, both structural reforms and boosting private and public investment.

While we see that the fiscal deficits are coming down and that the rebalancing of the European economies is underway, consistent economic reforms are needed to restore confidence and generate sustainable growth and job creation in the European economy.


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