> Pascal Lamy’s speeches
I am honoured to be awarded the Honorary Doctorate from the University of Edinburgh. The intellectual history of this city has shaped the way we understand the world. Mercantilism, the dominant theory of international trade for several centuries, was first proved wrong by the great minds of David Hume and Adam Smith. Coming from the World Trade Organization, I feel I have a special debt to this place.
As you all know well, Europe is going through troubled times. What are the causes of the euro crisis? What are the solutions? What does this crisis teach the rest of the world? I would like to share with you my reflections on these daunting questions.
The meaning of Greece
Let me start with what seems to be a puzzle. The Greek economy accounts for less than 2 per cent of the European Union’s Gross Domestic Product and has a share of 2.5 per cent of the euro area economy. Nonetheless, in the past two years the troubles in Greece have dominated economic news around the world and captured the attention of the international community to a degree that appears incompatible with the relative size of its economy. What explains this global interest? What are the deep symptoms behind the Greece factor?
Economists offer a simple explanation based on the notion of contagion. This is a play — or, maybe, a tragedy! — in three acts.
Act One opens with investors worried that the Greek government will be unable to pay back its debt. Years of weak competitiveness and lax policies have left their mark on external and fiscal imbalances. The deficient design and implementation of disciplines that bind together a monetary union is only too evident. As the crisis in Greece unfolds, markets begin to suspect that other European countries could find themselves in similar waters.
In Act Two, the real — or perceived — risk of insolvency leads investors to demand higher interest rates on bonds of highly indebted countries, such as Portugal, Spain and Italy. This, in turn, worsens public sector balance sheets and increases the risk of insolvency. Investors’ fear suddenly starts to look like a self-fulfilling prophecy.
Finally, in Act Three, instability spreads throughout the financial system. As the public debt of countries at the periphery of Europe is in the balance sheets of financial institutions, particularly in the euro area, the fiscal crisis turns into a banking crisis. At this point, contagion has made its course from a single economy to the EU and threatens the rest of the world.
The economists’ version of the Modern Greek tragedy offers a fascinating and convincing portrait, but the plot only shows the tip of the iceberg. The risk of contagion is a proximate explanation of the importance that the turmoil in Greece has for Europe. At its origin, there is a lack of confidence. This is the vector of contagion. Certainly, investors are showing little confidence in the ability of certain countries to service their debt and in the resilience of the banking sector.
But, at a deeper level, Greece is a symbol of the reversibility of the European integration process. It embodies the lack of confidence in the future of the European project. In mid-2010, citizens — and markets — suddenly discovered that Europe can move backwards; that integration can turn into disintegration; that the European edifice is not as strong as we thought.
A troubled Europe
Why is confidence in Europe lacking? The answer can be found in the history of its integration process. The spirit of the Schuman declaration, the founding stone of the European Union, was that the de facto solidarity formed through economic integration would gradually generate political unification.
Economic integration presupposes disciplines to regulate economic activity and to prevent the use of beggar-thy-neighbour policies, i.e. to create trust. The institutions of the internal market, such as competition policy and state-aid regulation, are primary examples. But economic integration generates competitive shocks that require solidarity to be managed or, else, it is not sustainable. Redistributive policies, such as the EU structural and cohesion funds, have precisely this goal. Finally, disciplines and solidarity can only be held together in a legitimacy space; that is, if citizens share a “feeling of belonging”. Political integration is about defining effective common institutions capable of entertaining this feeling of belonging.
The genius of the founding fathers of the EU consisted precisely in the simple realization that economic and political integration are complementary institutions. Progress in one domain would have led to advancement in the other. The history of European integration can be recast as a sequence of imbalances between economic and political integration. Accident or will have repeatedly moved the European edifice out of balance; each time requiring a new equilibrium between discipline, solidarity and legitimacy.
Both the introduction of the internal market disciplines with the Single European Act in 1985 and their extensions to ten new members from Central and Eastern Europe in 2004 were associated with an overhaul of the institutions of solidarity and legitimacy. New disciplines came about with an expansion of structural and cohesion funds, an increase in the power of the European Parliament, an extension of qualified majority voting in the Council of Ministers.
From this point of view, the current situation shares similarities with past episodes. The euro crisis shows that the institutions of political integration that exist in Europe today do not correspond to the economic integration that has been built. This imbalance is not sustainable, and new forms of disciplines, solidarity and legitimacy will need to emerge.
But this crisis is different in one important respect. European integration can either reverse or progress. Markets, but more importantly citizens, see that the European edifice is out of balance. And they understand the difficulty of the moment: the new equilibrium between disciplines and solidarity requires a high dose of “togetherness”, a feeling that appears to be a scarce commodity in today’s Europe. Worse, the crisis itself, through its instability and growing pain, is exacerbating resentment and mistrust of others. In these conditions, many seem to conclude, sliding backwards is more likely than moving forwards.
A troubled world
Europe is a microcosm of the world. The difficulties we are observing in the EU mirror the troubles of the multilateral system. Global governance, the legal and institutional framework to manage the ever-growing interdependence and interconnectedness at the world level, much like the European edifice, is built on a thin balance between disciplines, solidarity and legitimacy. And while the depth of integration is shallower at the global level — with disciplines that are often shallower, with solidarity often more dotted and with legitimacy certainly more distant — the mechanism and dynamics of this balance are not different.
Let me give you two examples. The first draws on my own experience with the Doha Round of trade negotiations; the second relates to the multilateral action to address climate change.
The GATT, the predecessor of the WTO, relied on the notion of “special and differential treatment” of developing countries. In broad terms, this implied that, while developed countries agreed to open their markets, developing countries were not expected to reciprocate in a substantial manner. This arrangement reflected the balance between disciplines, solidarity and legitimacy in the pre-WTO multilateral trading system.
In recent years, however, the impressive growth rate of certain developing countries has caused a big shift in the global economy and has moved the trading system out of its equilibrium. For some, emerging economies have attained a level of development that warrants greater reciprocity of obligations; while for others, the income gap with the advanced countries renders equality of disciplines unfair. The inability to find a new balance in the multilateral trading system has so far made it impossible to conclude the Doha Round, while many WTO members enter into bilateral trade initiatives.
In many ways, reaching a meaningful agreement on a global response to climate change faces similar challenges. The 1992 Earth Summit Declaration in Rio recognized that, even though all countries bear a responsibility to address climate change, countries have not all contributed equally to causing the problem, nor are they all equally equipped to address it.
The principle of “common but differential responsibility” was introduced in the 1997 Kyoto Protocol that established specific and binding emission reduction commitments for developed countries. Developing countries had no binding obligation.
The challenge now facing climate change negotiators is to agree on a multilateral response after the Kyoto Protocol’s first commitment period has expired in a world where developing-country growth has outstripped developed-country growth. Here again, the difficulty in finding a new balance between disciplines, solidarity and legitimacy in a muted context has certainly played an important role in holding back meaningful progress as we have just seen in the discussions during the Rio “plus” 20 Conference, which many observers have in fact dubbed the Rio “minus” 20.
A European legitimacy compact
Let me now turn back to Europe and to the debate on how to exit the euro crisis. So far, many have criticized the EU’s response, in part for good reasons. Economies around the world are slowing down as Europe is perceived as doing “too little too late” to restore confidence.
I would like to take a different approach, though. I will start from what has been achieved and what is still a work-in-progress. Then, I will focus on what lies ahead of us.
The euro crisis has three components: an economic, an institutional and a legitimacy crisis.
The economic component is the symptom. It is the dangerous combination of the competitiveness, fiscal and banking crises that I described earlier.
The institutional component is a reflection of the original sins in the design of the Monetary Union, which subsequent constitutional reforms embedded in the Lisbon Treaty have failed to address. First, the lack of a fiscal and a banking union. That is, the insufficient central powers in supervision, resolution and risk sharing. Second, the absence of an effective mechanism to incentivize structural reforms at the national level.
Lastly, the euro is also sucked into a legitimacy crisis. Support for the common currency and, more broadly, for the European project is on the wain. As a recent report by Notre Europe finds, the decline in “Euroenthusiasm” dates back to before the onset of the crisis, but the deterioration has been particularly severe in troubled countries, namely Greece, Portugal and Italy.
While still a work-in-progress, the EU has made some headway in the solution of the crisis. Only a few months ago, the debate seemed stuck in a fruitless discussion. Some campaigned for more disciplines, others responded asking for more solidarity. Both camps were right and wrong at the same time. Europe needs more disciplines and needs more solidarity. This simple truth is now broadly accepted.
The first pillar in improving disciplines has been the adoption of the Fiscal Compact. The treaty strengthens the monitoring of national fiscal policies and the enforcement of fiscal rules. The treaty also speaks to the issue of structural reforms. Even though it is less clear if this framework offers an adequate incentive mechanism to national governments. The second pillar under discussion is a euro area financial stability framework. Inter alia, this will imply central powers in banking supervision and resolution.
The debate on solidarity focuses on what Mario Draghi called a Growth Compact. In a speech at Bruegel last February, I outlined what I see as the four constituent elements of a growth plan for Europe: a fiscal union with its own resources (direct EU taxes, such as a carbon tax and a financial transaction tax, and joint financing instruments, such as project bonds); broader EU spending in areas of common interest, such as trans-national infrastructures, education, research and innovation; the completion of the internal market, namely in the services area; finally, a commitment to implementing reforms of national economies.
But solidarity requires more than a growth plan. First, stability in the euro area calls for more risk sharing: a common deposit insurance and instruments of fiscal risk sharing to complement the Fiscal Compact. Second, the EU should protect and promote the European social systems. This means assisting countries in improving and adapting their production structures, social safety nets and labour markets to the challenges created by globalization.
In brief, the growth versus austerity dilemma is both a wrong and a misleading simplification. It is really about the quality of growth and the type of austerity measures.
The EU Council that was concluded late last night proves that stronger disciplines and more solidarity go indeed together. The Council has given a clear mandate to the Commission to formulate a proposal for a single bank supervisory mechanism involving the European Central Bank. At the same time, the agreed Growth and Jobs Agenda contains novelties, including a pilot phase of project bonds to finance initiatives in energy, transport and broadband infrastructures. This goes in the right direction of transforming the EU’s budget into a tool for growth.
The last element of the debate has been forcefully brought to the table by Angela Merkel. This element is political union. Europe needs a “Legitimacy Compact” to complement its Fiscal and Growth Compacts. More stringent disciplines and stronger solidarity can only be held together in a more perfect political union.
What would a European Political Union look like? It would be based on four pillars: the Community method; the centrality of the European Commission; effective but limited central powers; democratic legitimacy. Some of these steps do not require amendments to the treaties, others do. If no broader agreement can be found, progress will have to move on through forms of enhanced cooperation.
A new European narrative
This is a defining moment for the European Union, because necessity creates momentum. As I have argued, Europeans are making progress in addressing the economic, institutional and legitimacy crises of the euro. But confidence has not been restored and the naysayers seem to have the upper hand. And frankly this should come as no surprise. So far, there has not been a common narrative over the crisis, over the answers to the crisis or over the manner in which citizens will be asked to contribute.
It is my strong belief that the survival of the euro hinges on the revival of the European integration process. Let me stress what I see as the three building blocks of this revival.
The first is a project. Europe needs a clear proposal, capable of linking short-run actions with long-term reforms, risk sharing with political integration. A plan that will deliver concrete results that meet the expectations of European citizens. In his memoires, Jean Monnet recalled the preparatory work that led to the establishment of the European Economic Community in 1957. Back then, what he saw as necessary was a project that would be perceived as a collective European enterprise; an objective that could be realistic and ambitious at the same time; a clear plan with a precise schedule to implement it. Nothing, besides the limits of our own ingenuity, prevents us today from walking the same walk. From talking a common talk.
This leads me to the second building block. Europe needs a new narrative. Policy makers often remind us that the break-up of the euro area, and as a consequence, the unavoidable fragmentation of the single market, would have incalculable costs. This is true. But what are the shared gains of integration? Paradoxically, non-Europeans, which are the vast majority of my interlocutors in my current position, often see more clearly than us the value of unity: the preservation of peace; the management of interdependencies; a space where civil liberties are protected; a serious concern about environmental protection; a broad market-based economy; a unique social welfare system. This is the European DNA and the raison d’être of the European common house. Without it, European citizens confined to their own national spaces would have much less opportunities.
Who shall frame a new narrative for Europe? Who shall propose the European project of the 21st century? I am convinced that this is the task of the EU common executive, of the European Commission. It is its mission and it is its duty. Individual national governments or various forms of directorates will simply lack the essential ingredient: a view of the common interest.
The third building block is an open political process. The current European stage is dark and dull. There can be no real sense of belonging unless Europe finds a way to have an open debate that transcends national borders, national issues, national parties. The EU needs to be ready to listen to its cities, to its regions, to its civil societies. In sum, the EU needs to be ready to listen to the European citizen. This is not a recommendation for a distant future, but for the European elections of May 2014.
Start today by linking the choice of the Commission president to the results of European elections, with each political grouping proposing a candidate during the campaign. With each candidate proposing a “programme”, a European-wide project. The European stage must be lit up for the European project to advance. Because as Abraham Lincoln used to say: “With public sentiment, nothing can fail; without it, nothing can succeed”.
Today, all eyes are on the Europeans. And they clearly will have to rise to the occasion.
But we would be too simplistic to believe that European action alone will be enough to dissipate the clouds over the world economy. Global growth is below potential, unemployment remains unacceptably high, so does poverty in many of our societies. WTO economists warn us that trade growth will further decelerate this year to around 3.5 per cent, down from 5 per cent in 2011.
Beyond Europe, another crisis is looming ahead. The IMF calls it the US “fiscal cliff”: the risk of excessive fiscal tightening in the United States under the current law. Uncertainty about contentious political decisions on automatic spending cuts and expiring tax provisions could provoke serious market turbulence and affect global demand via trade spillovers. A clear roadmap for fiscal consolidation will be needed from the US if we are to prevent a major shock to American and world growth at the end of the year.
Global imbalances still challenge the world economy. The growth engine in leading emerging economies will inevitably have to rely less on demand in advanced countries and more on domestic demand. Further progress will be needed from countries such as China, India or Brazil, both in terms of structural reforms as well as on the gradual opening of their economies to greater competition.
At this juncture, stronger collective action by G-20 countries would have a huge pay-off. The IMF estimates that coordinated actions would result in a growth of global GDP of 2.5 percentage points in five years. In the global economy, as in the microcosm of Europe, a collective inability to cooperate is imposing large costs on our societies.
The euro crisis is not only the biggest current threat to the world economy. Its implications go much deeper than the direct economic impact. Europe has been a laboratory for a post-Westphalian order, for a democracy that transcends national borders. The way the EU will manage or mismanage its crisis will have long-lasting consequences on how we think about the future of global and regional integration processes.
Multilateralism, much like the European project, is at a crossroads. It requires a new balance between disciplines, solidarity and legitimacy. Either multilateralism will advance, or our collective ability of coping with global economic, social and environmental problems will be greatly damaged. This, I believe, is the defining challenge of our time.