Interview with Jean Pisani-Ferry and Nicolas Veron

By Paul Pennay, Zhang Feifei
Published: 2010-08-25

Jean Pisani-Ferry is the director of Bruegel and professor of economics with Université Paris-Dauphine - Nicolas Véron is a senior fellow at Bruegel who specializes in capital markets, financial services, and foreign investment.

EO: How do you see the recovery/reform process in Europe? Will it be a long, drawn-out affair or is there a chance that things will pick up sooner?
Jean Pisani-Ferry: The lesson in general from crises of this sort is that you have a permanent imprint from the crisis. The question is whether it will also affect the growth rate after the GDP falls, whether after the recovery, your growth rate is permanently slower or whether you can return to nearly the same growth rate or, in exceptional cases, even regain all of the losses - that’s what happened to Sweden in the '90s.
It's really too early to say. The immediate/short-term growth prospects are not good, so they're consistent with either remaining at a lower level of even losing growth.
There are a number of countries undertaking a response, especially the hardest hit countries like Spain and Greece. That will have positive consequences in the mid-term.
And as for the rest, a lot will depend on the composition of the fiscal adjustment. The question is whether it’s going to be conducted on the basis of what is politically easy or in a way that maximizes the positive impact or minimizes negative impact on growth.

EO: Do you think the sovereign-debt crisis prompted the decision for stress tests?
NV: Yes, the trigger for the decision last month was the combined pressure of the European Central Bank ECB and Spain. It became very obvious by June, if not before, that the banking crisis and the sovereign crisis were two sides of the same phenomenon and that you couldn't address the sovereign situation without addressing the banking situation.
JPF: Previously there was the illusion that perhaps in time, providing banks with cheap liquidity would enable them to make easy profits – and that was the kind of scenario that was tried elsewhere and failed.
NV: The problem with a systemic banking crisis is that the losses are not equally distributed in the banking system and therefore the healthier banks make a lot of money when the policy rates are low but at the weaker banks, the fragility shares have such a gap to plug that even with low policy rates, they even are still falling behind.
And there is of course a political problem, a policy directed at enabling banks to make huge profits which is just unsustainable. And, this is what the Europeans have been doing for the past one and a half years.
By having low policy rates and lots of liquidity, it is basically giving the banks an opportunity to "carry-trade" and print money.

EO: On China and EU, with the formation of the European External Relations Action Service, is there a move toward a Europe wide policy and relationship with China?
NV: That is certainly what people have in mind. We would aim at more consistency and a more strategic policy. But its more than that, it's a question of how consistent your policies are in general. You have also the various aspects of your policy, fragmented internally, at different levels, among different nation states. That's really what is going to be determined

EO: Do you see any major problems with consistency, with respect to China in terms of major member states?
JPF: There is the degree to which member states have economic relations with China. Some see Xhina as a provider of imports, some as a major trade partner for exports and also have investment relationships and various other aspects, universities, research etc. It is very diverse.
NV: At the EU level, there's trade policy and trade agenda but there is no big issue with China right now. The Chinese so far have been standard takers, they have not been very assertive, and we can see that in the G20 and everywhere else. The EU has had friction with the US, but China has been low profile. It certainly will be an issue in five years' time or ten years' time. But it won't be an issue next year.
JPF: And it will be a strategic issue. But now our leaders are centered on domestic issuea. There will be a summit on relationships with developing countries in the autumn; this may be a step in this direction.

EO: Looking back over the past year, will Spain become the next Greece? Is that a possibility? How will this crisis evolve?
JPF: Spain and Greece are very different. Greece is a country that has mismanaged its finances entirely and has had long-lasting problems. Spain is a country that has managed its public finances well, and is going through a phase of development with an economy centered too much on non-tradables. It has lost competitiveness and experienced low productivity and an extensive growth base in increasing labor supply in low productivity sectors, especially in services. They have to reinvent their growth model. I wouldn't put them in the same category. Their fiscal track record is not the same, their debt levels are not the same.

But there is a temptation to look at the crises as a Eurozone fiscal problem and every country that experiences difficulties is put in the same category. That in part is because the EU mismanaged the Greek crisis. What they should have done is should have dealt with Greece quickly to avoid a contagion to other markets. They mismanaged the crisis in the first months, then gradually the spreads widened everywhere and people asked whether it was a self-fulfilling type of crisis.

NV: The current perception in the market place is that the Eurozone has an institutional/structural problem, that the policy framework is not sustainable because it does not address a lot of the things we have seen. The big question is whether this consensus will last or whether we will muddle through and get back to the previous order, where we know the Eurozone is incomplete and unsustainable but on a day-to-day basis, the market can live with it.

JPF: There is this expectation for a fiscal federation. But a big fiscal federation of the US type is not going to happen tomorrow. We had no crisis management regime but if we invent one on the spot, people will see that it is not ideal but we're building something with consistency.
NV: It won't be a full, centralized budget system, not a Eurotax or even a fiscal straight jacket to prevent the same kind of risks that we saw with Greece in the past few years. We will probably end up with a system that's a little more complete, a little more robust than the one we had. 

EO: So, where are we at now in regard to the crisis?
JPF: The next stage is where the discussion of governments will lead to, and an agreement on surveillance and then the crisis management. If this happens, the only question is whether there will be another new accident that raises questions about the sustainability of the system.
NV: Then the question becomes what happens to Greece's repayment, whether Greece is able to pay the debt or does it have to be restructured.
JPF: But the question for the market is not about restructuring but how its managed. If this MFU program is successful, then Greece will reach a level of debt at 140-150% of GDP. Is it sustainable? At present, all the officials say there is going to be no restructuring, the market place says it's not and there is going to be restructuring. But that's not the question, the question is if there is restructuring, are the banks in better shape to address the restructuring. It will be the first time an advanced country goes through this restructuring (how to deal with domestic and non-domestic creditors and etc). It comes down to the ability of the Europeans to deal with complex problems not foreseen in the treaty.

Why was the Greece crisis difficult? Because of disagreement. There was an agreement on paper, but not on what the paper meant. It was not the fact that there was a crisis in a country representing 2.5% of the EU GDP, the problem was the difficulty of dealing with the unexpected. Why? Because you start from a treaty and different views on what it means, leading to procrastination… 

EO: And the split between Germany and France?
JPF: Yes, but disagreement, that is normal. There are national traditions that approach problems differently. The French go in by saying "here is a problem, how do we deal with it?" The Germans say "here is a problem, what is the rule for dealing with it" If there is no rule, they ask "what rule should we have to deal with it?" They're totally different, and that is the EU. You have these traditions and none of them are dominant.

EO: Do you think France and Germany can act together in a future crisis, having learned from their past mistakes?
  Yes, but I'm not certain. The newspaper reactions to the 9th of May (the day the ECB agreed on several measures to address the severe tensions in the market) were positive in some parts of Europe but not others. The differences are there, and assessments of the differences are different.

EO: So what is the largest divide between the two countries?
In governance, France wants governance just of the Euro area. The perception in Germany is that the Euro 16 is too much of a coalition of southern Europe, because if France sides with Italy and Spain, then they are stronger than Germany. With all 27, there are northern countries, maybe the UK… they feel more comfortable there. 

EO: The treasury of Spain has said that with the maturation of the bonds in July, they will be fully paid, can we say that the crisis in Spain is over?
JPF: No it's not over. Spain does not have a solvency problem. Spain has an economic problem of competitiveness, a problem of productivity that takes time to solve. It will probably not be addressed until the general election, and a new government comes in and implements its vision of how to proceed. And then it will happen through reforms, but it is hard to outline how to deal with these problems. Regaining competitiveness means lower wages, lower prices, and people are not willing to accept that and you have no instruments of implementing them. You cannot do it by decree. Even if you do it for wages - decree lower wages, how can you do it for prices? And even then, how can you avoid major distribution consequences?

EO: Despite all the strikes against governments, I think the reform will carry on. Will it bring labor reform to Europe?
JPF: Yes, I think in these countries, reforms are taking place. They can have a more immediate effect on effectiveness and growth potential. The crisis is a major shock, but this may be an opportunity to introduce reforms that were badly needed in the first place. Take Greece for example, they can eliminate one level of government, if they have public sector costs linked to too many levels of governments. It's difficult but if you're able, then it's a long term plus. 

EO: Then across Europe reforms are ongoing?
No, I wouldn't say so. Germany is not undergoing major reforms. France has focused on pension reform and not much else, yet. Italy has not done much. Spain, Greece, and Portugal have, so it's mainly countries in crisis. Those countries are moving from focusing on the stimulus to focusing on the medium term. Until the beginning of the year, the focus was on the stimulus, you think first about stopping the depression.

EO: The Belgians, also, are raising their retirement age. Does that mean the high welfare, high labor cost era of Europe is ending?
JPF: No I don't think high welfare is ending. I think its realizing that the cost of welfare system is increasing. Or rather, the ability of the economy to sustain the welfare system is diminished. The focus is on readjusting, not on drastically cutting welfare. It's not a matter of changing the welfare system, its adjusting it to your ability to pay.

EO: But it's relative. People can't enjoy the same life they did before.
JPF: No, there was a generation that enjoyed a lengthened life expectancy without having to work longer. Compared to people who lived 25 years ago, this generation retired earlier and bought better houses with better pensions. That has to go. But basically the generation before the baby boomers, they had relatively low pensions, the baby boomers benefited with parameters set at a lower life expectancy rates. This next generation will go on retirement later, perhaps with a diminished pension, but will still enjoy a good pension system with respect to the rest of the world. But the baby boomers are the exception. And this has to go. It's not sustainable.

EO: The welfare system has been the basement of European society for some time.
JPF: Yes, look at the conservatives in the UK. They came and decided they were reducing pensions but not changing health care. So they're cutting aggressively other public programs to preserve health care. That indicates a strong consensus about the importance of health care.

EO: Considering the low level of exports and other problems, what can we expect from the European economy in the coming years?
JPF: There are some strengths Europe can build on. Strengthening integration can help by creating growth opportunities, and a number of reforms can help. We're going through a tough adjustment period, no doubt about that. But depending on how you conduct the adjustment, the medium term outcome will be very different. And I think that's what we have to focus on.

If you look at countries that have gone through crises of this sort, they could have a phase of low growth and then acceleration, then recovery. In the short term we will have deleveraging and the fiscal adjustment that goes on after the stimulus, so there are drags but also growth.

EO: But you still risk a slow recovery.
JPF: Yes - there is a risk.

EO: Even 0%?
JPF: We don't do forecasts. So I won't give you a number.

EO: What is the condition of the Eurozone right now?
JPF: I think that in terms of whether the union will hang together, I still think it will, the cost of leaving is very high. The pattern of reaction has been that you wait as late as you can since you don't have appetite for new integration and reform. But, in the end, if the choice is between failure and reform, you reform.

EO: Is it a transition then? A turning point?
JPF: The Eurozone is always something in the making. It's not a political union or federation but it's also not just letting things drift a part. You move toward the edges but then you rebound.

Bruegel is a Brussels-based European think tank working in the field of international economics. For more information about Bruegel you can visit their website here.

The above interview was conducted as 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. The interview was conducted at Bruegel’s Brussels office on July 12, 2010. It was transcribed by Ruoji Tang.

You can find a collection of the interviews in English here and in Chinese here.