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Interview: Chief Economist of the European Policy Centre

Economic Observer: In the scheme of the whole crisis, where are we now?

Fabian Zuleeg: I think what we are seeing now, hopefully, is the end phase in the immediate crisis. What we are not seeing is a resolution for the medium and the long term issues which are as difficult, more difficult than dealing with the immediate crisis and that is something that Europe will have to work very hard at over the next month and years to put in place mechanisms which can ensure that we do not get into the same immediate crisis again.

EO: By immediate crisis, do you mean the solvency issue?

FZ: I think that in the medium term, the 2 issues we have to address is on the one hand economic governance. How can we make sure that countries such as Greece, but also other countries in the euro zone, follow the rules which are there and actually keep their public finances sustainable over time? And the 2nd one is the growth crisis we are facing in Europe. We are looking at a situation where growth is likely to be very sluggish and that means we will have aggravated problems with public finance. So unless we do something now to boost long term growth, my view will be that the current crisis will return.

EO: What will be the most likely scenario in the European economy in the next 3 to 5 years? As you said, it will be sluggish… can you predict a growth rate?

FZ:  I mean, at the current state, we are looking at predicted growth rates of maybe 1-1.5% in the more developed economies and a slightly higher rate in new member states which still have some more catching up to do. But this is something that is on and off. For countries such as Germany, France,  Italy... to only grow around 1-1.5% means that it not only aggravates the public finance situation, it also aggravates the labor market situation, and it aggravates generally the sustainability of the social model. So even if we do not see growth in the next year or couple of years, but in the medium term, we need the growth rate to return.

EO: Will Europe be in the same kind of situation as Japan was in the past 10 years? Is that a possibility?

FZ: it is a possibility. I think it depends on whether we make the right policy decisions now. I think what the Japanese example demonstrated is that you can't buy yourself out of a crisis like that. Japan tried to invest public funds to get out of the crisis and has, in essence, been in crisis for 2 decades now. Europe could go down the same road. What we actually need is much more thought about how we can invigorate the European economy. How we can create, for example, private sector growth so that we can increase competitiveness, increase productivity and drive forward the European economy that way. That I think is ultimately where our focus should be.

EO: But how can Europe drive the private sector growth? How could Europe find a way out of this economic dilemma?

FZ: In the short term, we are seeing that the weaker euro is helping the export industry in Europe and is helping to cushion to some extent the downward trend in countries such as Germany. But this isn't a long term solution. In the long term, there are still a lot of thing we can do. Overall in Europe, we need the think about how we can walk the walk. How we can invest in those areas which we have identified as areas of future competitiveness? For example, how can we invest more in education? How can we invest more in innovation? In those areas, where we think growth will come from. But there are also concrete things we can do at the European level. We still have a fragmented market, we still have a lot of areas, particularly in the knowledge economy; we have 27 different regimes in the knowledge economy. Particularly in the digital economy, we still have 27 different sets of rules which means that companies don’t invest.

EO: What do you think will be some leading factors of growth?

FZ: I think the leading sectors have to be the, to some extent, sectors where we are already strong, but can actually benefit much more from using productivity and advanced technologies.  In some areas of manufacturing, we are still very strong. High quality, high value added knowledge intensive manufacturing. There are certainly areas in the service sector which we have developed, but because we do not have a fully functioning market for services in Europe, we are not developing as fast as we should be.

EO: What changes will this crisis bring to the labor market?

FZ: It will make the situation even worse than it was before the crisis. We started to see some improvement in the labor market. We were going toward the 7% unemployment rate. Now we're at 10% and a lot of this unemployment is very persistent. Especially if we do not get higher growth rates, than we will have a lot of unemployment for a long time to come.

EO: What will happen to the euro zone? Do you think it will still keep 17 members in the euro zone or do you see them withdrawing from the euro zone?

FZ: I think it very unlikely that any country will choose to withdraw from the euro zone. There's been some speculation but neither on the political nor on the economic level have they given any indication. In fact, we now have Estonia joining the euro zone. So I think the trend is still in the other direction. But what we will see is a change in the rules of the euro zone and one of these changes might well involve at least the possibility that a country within the euro zone can be declared insolvent and we will have to take very strong corrective measures to deal with it.  But even then, I think it very unlikely that this will result in any country leaving the euro zone.

EO: You said one of the changes could be to declare a country insolvent?

FZ:  Yes, it is one of the changes which is on the table that at the moment there is no mechanism in the euro zone to do this. But it is one of the changes, which Germany has proposed, and is going in that direction.

EO: If you have the insolvency in the future so that you have to bail out Greece or something like that, they can save on their future without putting the whole euro into danger. Is that what Germany's planning to do?

FZ: Yeah I think that that certainly is the idea. You can also deal with things in an orderly and a controlled way. I think most people recognize that, in the end, it is unlikely that Greece will be able to pay everything back that they have borrowed. I wouldn't necessarily make it insolvency mechanisms. I would make it a mechanism which can deal with excessive debt.

EO: What kind of mechanism?

FZ: It's to some extent a play with words. I think it's important that we don't necessarily talk about insolvency, but that we talk about restructuring because that gives the country itself and the creditors a chance to do in the more long term in the more organized way. So in that sense insolvency implies a very sharp, immediate shock where as restructuring means we can actually spread the effect over a period.

EO: Do you still think hold optimism about Greece's future?

FZ: Yes. I think the situation for Greece itself is going to remain difficult whichever way the economy goes.  In some sense, the Greek economy is paying the price for years and years of mismanagement. What's unfortunate is that it's the Greek people that are paying the price. They didn't necessarily create this problem.

EO: Do you think that the other problem like Caja in Spain and the Landesbank in Germany will be a new banking liquidity crisis?

FZ: I doubt it because I believe that the knowledge is there that some of these institutions might fail the stress test*. So, I would expect that politicians in the countries involved, and we are talking about public institutions here, that those politicians will stand ready to come up with plans on how to increase capital in these institutions so that they get over the threshold in the stress test. These banks can even start to access the European emergency funds which have been set up, presumably for governments, but which could now even be used by the banks.

*this interview was conducted before the results of the European banking stress tests were announced on July 23

EO: Will liquidity still be a major concern for Europe?

FZ: I don't think liquidity is an immediate concern. I think if we survive the stress tests and the system calms down there will be enough liquidity to keep the banking system going. I think the problem is more in the long term on the financing needs of European companies. I think what is of longer term concern is the availability of funds in Europe for investment. We tend to have countries that rely more heavily on bank financing for example rather than on stock markets, etc, so I think we still have a problem to finance, to find venture capital, to find capital, to finance expansion..

EO: Which country in particular?

FZ: Well Germany, for example, is one of the countries that has always relied quite heavily on bank financing but other countries as well. I mean France, for example, has done the same. Stock markets tend not to be that important in the continental economies as they are in the Anglo-Saxon economies. So that I think is a longer term issue and we need to also look at how we can help from a public sector point of view, for example, how can we work  with a lot of the banks which are now in public ownership to actually make sure that investment capital is accessible.

EO: You predicted a very sluggish economic growth in the next 5 years, what does that mean for China and the world economy?

FZ: I think we have a world economy which is more interdependent than it has ever been in the past. And it is becoming even more interdependent despite the fact that there has been a dip in trade and in investment, but in the overall trend I think we will see increasing interdependence. In that sense, I don't think that Europe alone will be the major factor whether the Chinese economy is working well or not, but if some of the major economic blocs continue to have sluggish growth, continue to have problems, if for example we see that the US economy is not recovering, then I think we have a global problem.

EO:  How will this crisis impact China?

FZ: It depends how long the crisis lasts, I think that is the big question.  And it depends on how widespread the problem is and as US and Europe, the two biggest economic blocs will not grow in the next few years, I think that the economic boom which we've seen in China will start to die down. The big problem in China is its growth rate that has started to slowdown significantly; I think then you are starting to get problems in terms of peoples expected return on investment , asset bubbles, stock market bubbles, I think these are things which are quite worrying. I think for a healthy, global economy, we need, in essence a very broad base of economic growth and that includes Europe, the US and the developing countries.

EO: There are Chinese people that are trying to invest more here in Europe. Do you think it's a good time to do that?

I think so, and I mean I think that the problems which are there, there are still very significant areas of European industry, or European economy which are highly effective, which are highly competitive which in my view, and represent very good investment opportunities and given that we have a weaker euro…

EO: However, the downward trend for the euro depends on…

FZ: Yeah, I think, what we'll see to some extent is there is a lot of hype in the press. The reality is, I would say, that before the crisis, the euro was quite significantly overvalued. So in some senses what we’re seeing is a correction and while it is such a disastrous effect for Europe, it is actually not a bad thing to have a euro that is not weak but is slightly weaker than when the crisis began. And, I mean certainly, we do not seem to have any problems with inflation at the moment so, I think that, in essence, nothing fundamentally wrong with the euro rate where it stands within the current economic climate.

EO: Will the value of the euro change over the next 4 years?

FZ: It will change because it will depend on the economic climate as well. If the European economy picks up again, then I would expect that the euro will strengthen. If the economy remains weak against the US economy, against other global economies, then the euro will stay relatively weak. But overall, that is in a sense, how it should be, we should have a situation where the exchange rate reflects the relative competitiveness.

EO: How do you see the changes brought by the crisis to the euro zone? People are talking about the transfer from a monetary union to a fiscal union. Do you think that having one currency is one of the causes of the crisis?

FZ: I think we in some senses, we ignored the economic union aspect when we created the monetary union and that was a mistake. We should have paid more attention to harmonization or certain tax mechanisms for example greater coordination between the countries in fiscal policy. Now, in a lot of ways, we're catching up on what we should have done 10 years ago. I think it is the right direction, I think it is very difficult to imagine that the monetary union will continue to exist without more economic integration. So I think it's a positive move, but I see at the moment as we progress we're still too unwilling to go farther than just talking to each other. I think we need to have some mechanisms which can enforce certain things. That's where we need to go, but that is an open debate and that is a debate which we will see what happens at the European level.

For more information about the European Policy Centre, you can visit their website here.

Tang Xiangyang translated this interview into Chinese, The Chinese-language translation of the transcript can be found here.

The above interview was conducted by phone and is part of a series of interviews with various officials, scholars and journalists throughout Europe on the topic of the future of the European economy in the wake of the sovereign-debt crisis. You can find a collection of the interviews in English here and in Chinese here.




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